Carbon switch won't stop price rise

Prime Minister Kevin Rudd's proposed early move to a carbon trading system linked to European prices does nothing to change the long-term trajectory of energy prices if lawmakers remain determined to force carbon dioxide emissions down.

Australia would begin trading permits in July next year, one year earlier than originally planned, and tie in to a European system that prices carbon much more cheaply than Australia's carbon tax does. The tax would price carbon dioxide at $24.15 a tonne in 2014-15. Carbon dioxide prices peaked in Europe at more than €30 in 2008, slumped as Europe's sovereign debt crisis undermined economic growth and energy demand, went as low as €2.75 in April this year after an initial attempt to rig the market failed, and are now around €4, or $5.70, a tonne.

Europe's system is broken in policy terms, because it isn't forcing the price of carbon dioxide emission higher. European lawmakers aim to fix that by rigging the market, and they are likely to succeed: the European Parliament earlier this month voted in favour of tightening the supply of trading permits by postponing until 2018-20 the planned resale of 900 million surplus permits.

European prices are unlikely to be much higher in July next year, however. Europe's economy is only slowly mending, and it will take a couple of years to negotiate bureaucratic hurdles and get the carbon price fix in place. The Australian price may also start below the European price as big energy-hungry projects including LNG processing plants in Queensland and Western Australia are delayed, reducing total demand for energy.

If Australia links to Europe's system while it is broken and dysfunctional, permit prices will therefore probably be about a quarter of the carbon tax price. Energy prices will fall, and some of the political damage that Labor incurred when it introduced the carbon tax will be repaired.

Unless climate adaption policies gain traction globally in a world where both the political will for climate mitigation strategies and the sense of certainty around climate change predictions has eroded, it will be a short-term effect.

Coal-fired power stations that have their capital cost fully depreciated can produce power here for less than $10 per megawatt hour, and a new coal-fired station could produce power at a cost of about $50 a megawatt hour.

To do what it is supposed to do, carbon pricing must push that cost base up, to a point where alternative generation methods are competitive on cost.

Average wholesale prices in Australia in 2011-12 ranged from $28 a megawatt hour in Victoria to $33 a megawatt hour in Tasmania. Geothermal energy, which is meant to eventually be the source of up to a quarter of Australia's baseload capacity, is expected to cost north of $120 a megawatt hour, and Treasury has estimated that in a regime where the supply of tradeable emission permits is restricted, that hurdle will be cleared around 2030.

Bottom line: if carbon dioxide emissions reduction is the end game, significantly higher energy prices are inevitable, with the steepness of the curve dependent on emissions targets, and how heavily the supply of permits is restricted, here, but also in Europe, where emissions targets so far only stretch to 2020. Any short-term relief that flows from an early link to Europe's system will be a political fig leaf.

Rate cut unlikely

The Australian dollar ticked higher after the release of the minutes of the Reserve Bank's July 2 rate-setting meeting on Tuesday because they suggested that the central bank will not be eager to cut its cash rate when it next meets, on August 6.

The picture the minutes paint is a familiar one for Reserve Bank watchers. Economic growth overall is a bit below the long term trend, and the outlook for a baton-pass from resources investment to non-resources investment, jobs growth and demand growth remains uncertain.

When it met and left the cash rate unchanged on July 2, the board still believed that earlier cuts in the cash rate including ones of a quarter of a percentage point in December last year and May this year had "further to run".

It did not believe the Australian dollar's decline was threatening an inflationary breakout, felt the $A could fall further as the resources boom cooled, and believed that would assist the economy as it increased price-competitiveness here and overseas.

The benign inflation outlook gave "some scope" for more cash rate cuts, but with earlier cuts and the lower $A still feeding in, the status quo was appropriate, the board decided - as it also did when it met in June.

Reserve board minutes are written soon after the board meets, and there's been weak retail sales and jobs numbers since. The July minutes display enough "wait and see" inertia to suggest that an August cut is less likely.

mmaiden@fairfaxmedia.com.au