KEY POINTS:
With the Government close to outlining its planned emissions-trading regime, businesses exposed to this new cost need to start keeping an eye on international carbon prices and where they may be heading.
And policymakers need to be wary of taking too sanguine a view of the price outlook
because, for all our clean, green image, Kiwis' carbon footprints are Ian Thorpe-sized.
It's not that we are particularly heavy users of fossil fuels, at least not by developed country standards.
Our rate of carbon dioxide emissions per dollar of GDP is comparable to that of the United States and similar or somewhat higher than those of most European countries.
Unfortunately, CO2 makes up only about half the country's emission. The other half is methane and nitrous oxide from the bodily functions of cattle and sheep.
That leaves us with a highly emissions-intensive economy by international standards.
And that is not a comfortable position to be in as the world moves to pricing "carbon" - rights to emit greenhouse gases.
Policymakers and environmentalists often talk about exposing emitters to "the world price of carbon". That is like talking about "the world interest rate". There is no such thing. Some interest rates, however, like US Treasury yields, influence others.
Similarly, the European emissions trading scheme, as the most liquid of the carbon markets to have emerged so far, tends to drive prices in other markets.
One is the market in certified emissions reductions (CERs) created under the Kyoto Protocol's clean development mechanism (CDM).
CERs arise from climate-friendly projects in developing countries which have been certified by a United Nations agency set up under Kyoto.
The Government, faced with the inevitability of New Zealand failing to meet its Kyoto target, is likely to have to buy CERs to cover much of the overshoot.
It may give local emitters the option of buying them too, to meet at least some of their obligations under the forthcoming New Zealand emissions trading scheme.
Mark Lewis, a London analyst with Deutsche Bank, has raised eyebrows by forecasting a price of €35 ($63.31) a tonne for allowances traded on the internal European emissions market over the 2008 to 2020 period.
That compares with a market price of around €20 for 2008.
It is also about five times higher than the $13 a tonne carbonprice the Government uses in estimating the value of this country's Kyoto liability in the Crown accounts.
Climate Change Minister David Parker told a Wellington business audience on Tuesday night that a carbon price of $51 a tonne, which he considered a "rather inflated" fugure, would over five years shave about a quarter of a per cent off gross domestic product compared with business as usual - about $400 million.
Lewis argues that the medium-term target the European Union has unilaterally adopted - to reduce its emissions to 20 per cent below 1990 levels by 2020 - is ambitious.
It would require emissions to be reduced at about twice the rate achieved since 1990 and without the benefit of the one-off changes that have reduced European emissions so far: the fact that a lot of Soviet-era chimneys in eastern Europe have gone cold and the "dash for gas" switch from coal to gas-fired electricity generation in Britain.
Lewis is less sanguine than policymakers are about Europe's ability to meet its two subsidiary targets, a 20 per cent improvement in energy efficiency and deriving 20 per cent of primary energy from renewable sources.
He concludes that the cap or total limit on allowed emissions that Brussels will have to set for Phase III of the ETS (2013 to 2020) will have to be a lot tougher than that for Phase II (2008 to 2012).
And because allowances can be banked from Phase II to Phase III, the prospect of higher prices after 2013 will pull up prices before then as well.
There are a couple of ways in which internal European prices might affect carbon prices in New Zealand.
One is if there were to be formal direct linkage of the two markets, with each recognising the other's traded instruments.
That would certainly add liquidity to the New Zealand market.
"However," said Lewis, "if we are right and the price on the European corporate scheme is going to be €35 a tonne, I don't see how you can have a lot of other schemes linked into it.
" It's just politically impossible to imagine Australia, Canada, the United States or even New Zealand are going to be willing to startwith those sorts of prices."
The other is the broader CDM market.
So far European buyers, mainly corporates, have bought about two-thirds of the CERs made available; the Japanese have bought most of the rest.
So CERs tend to be priced off European ETS prices, though they trade at a discount of about 25 per cent because of the greater risks they involve.
Lewis agrees that a higher internal European price will bid up the price for CERs as well.
But two factors would limit that effect, he said.
He expects Brussels and the member state Governments to scale back in future the extent to which corporate emitters can use CERs to cover their obligations instead of reducing emissions within Europe.
And he believes the supply side of the CDM market will need to be greatly expanded if additional countries, especially the United States, are to be brought into the system. That is likely to mean forestry-based projects are included.
So Lewis envisages a two-tier global carbon market emerging.
One would include New Zealand, Australia and the United States, looking to offsets from the CDM market to provide the cheapest possible emissions reductions.
The other would be dominated by the European market where the marginal price of carbon would be set by emissions reductions within Europe rather than offsets.
Lewis said European policymakers' willingness to tolerate a carbon price other countries would consider too rich for their blood reflected both a higher level of energy efficiency to start with, and a strategic desire to develop and commercialise the technologies, like clean coal, that a carbon-constrained world would need.
Lewis believes a €35 carbon price would be high enough to make carbon capture and storage (CCS) technology economically viable.
The concept is attractive - a lot of CO2 is produced in one place, such as a coal-fired or gas-fired power station; instead of going up a chimney it is separated, compressed and piped away to be injected into suitable undergound structures where it will stay put.
The carbon price at which CCS is commercially viable is a number which everyone needs to know but no one yet does because such plants have yet to be built on commercial scale.
The German generator RWE has announced plans to build a 450MW coal-fired power station using the technology.
The European Commission wants all generation built after 2020 to incorporate the technology. The Americans and the Australians are also spending serious money on developing the technology.
It is hard to see what else can deliver global emissions reductions on the scale required in the time frame required.
So it is ultimately what is likely to set the carbon price New Zealand emitters face.
