Carbon market flaws evident

The collapse of the European carbon price exposes the structural flaws of the government's plan to cut greenhouse gases.

A European Commission plan to cut emissions permits for up to seven years and thus push up their price was rejected on Tuesday by the European parliament because it would pass on higher costs to struggling industries and consumers.

Emissions trading is supposedly a market system based on supply and demand.  But behind the jargon, trading schemes are just government-mandated markets influenced by political interests.  When too few companies are required to buy emissions permits, or too many permits are allocated, or both, the price collapses.

This reality is unfolding in Europe.  A tonne of emissions is now $3.20, and is expected to fall to $1.20 compared with $7 earlier this year, a 2008 starting price of nearly $50 and Australia's $23 carbon tax, which will increase to $24.15 on July 1.  The European carbon price crash is not unprecedented.  The voluntary Chicago climate exchange traded permits for about $7.50 in 2008, but bottomed out at 5c when the scheme closed in 2010.

Political manipulation of carbon pricing for private interests was always likely.  Even Ross Garnaut argued in his 2008 review, ''If there is a chance that political pressure will reap rewards in the form of special treatment, then the system will promote a large diversion of management resources towards rent seeking from governments''.

European politicians have recognised how little public appetite there is to increase their hip pocket costs to cut emissions and reward rent seekers.

All this bodes poorly for Australia.  Under the government's plan the Climate Change Authority will recommend our emissions target with the assumption our elected officials would blindly adopt it.  That assumption is now exposed for the hokum it always was.  Politicians can always make political capital opposing tax increases.  The only difference with Europe is Julia Gillard included an automatic target cut if the parliament can't agree on an alternative.

The capacity for political manipulation ensures carbon markets never deliver the certainty their supporters claim.  That might not matter if they cut emissions, but they fail there too.

A report by the UN's climate change secretariat concluded Europe would largely meet its Kyoto targets because of economic decline.  By comparison the US Energy Information Administration reported a rapid drop in US emissions last year, to their lowest level since 1992.

This was achieved ''during a year of positive growth in gross domestic product'' from expansion in the use of cheap, fracked gas.  Meanwhile the Treasury's Strong Growth, Low Pollution modelling shows that despite having the world's most broadly applied, highest cost carbon tax Australia's emissions will continue to rise.

It's probably the only assumption Treasury got right.  Comprehensive modelling would have assumed realistic scenarios about whether countries would impose their own equivalent schemes and sign up to a global carbon cutting agreement.

Instead Treasury assumed an utterly unrealistic global carbon price of $29 in 2015, and that each country would have carbon taxes, or their equivalent.  The scheme, linked to the lower European price, exposes a fiscal gap between the fixed ''over-compensation'' and the billions in expected government revenue.  It is a mess.

Technocrats advocate for trading schemes in theory because it is the most efficient way to price emissions, in practice they can be manipulated like any other regulation.

The European parliament's action this week to avoid increasing taxes on households has exposed the problems of emissions trading.  Europe should abandon its structurally flawed scheme, and Australia should learn from their mistakes and follow.