KEY POINTS:
They say that if you ask an economist a question about what is going to happen you get one of two answers: "It depends" or "It's too soon to tell".
The same is true if you ask people in the carbon market where prices are heading.
New Zealand is now committed, whichever of the major parties is in power, to a regime in which "carbon" - the right to emit the greenhouse gases blamed for global warming - will be rationed and will cost money.
While pundits and politicians speak airily of exposing New Zealand emitters to "the world price of carbon" there is no such thing, any more than there is such a thing as "the world interest rate".
Instead we have an emerging archipelago of carbon markets with complex inter-relationships between them.
The key one for our purposes is the market in certified emission reduction (CER) units created under Kyoto's clean development mechanism (CDM).
CDM was set up for two purposes: to facilitate technology transfer by providing a means for money to flow from emitters in developed countries to climate-friendly projects in developing countries, and to allow emitters in developed countries to access cheaper means of reducing emissions than might be available at home. It is, of course, immaterial to the global climate where emissions reductions occur or who pays for them.
It is dominated by Europe on the demand side and Asia, especially China, on the supply side.
CER prices are likely drive the price of carbon in the New Zealand market. That is because the projected demand from New Zealand emitters over the next five years will be much greater than the domestic supply of units from Kyoto forest sink credits.
Demand is estimated to be about 120 million tonnes - two-thirds of it from oil companies covering emissions from the fuels they sell - while the potential supply of forest credits would be about half that.
But it is far from clear how many Kyoto foresters will opt into the scheme - since with the credits comes the corresponding liability for the carbon in their trees when they are harvested - or how many of those who do opt in will just put their credits in the bottom drawer.
So imported CERs are likely to determine the marginal cost of carbon in the local market. But this is where it gets complicated.
CERs are not a physical commodity of course. They have to be created by a United Nations body which, to project the environmental integrity of the scheme, has to be satisfied that they represent emissions genuinely avoided. It has to be persuaded that a project is such that a tonne of carbon dioxide, or its equivalent in another greenhouse gas, is not emitted that would have been without the income from the scheme.
It is a tortuous process. At the front end of the pipeline more than 3000 projects representing a potential 3 billion tonnes of emissions reductions by 2012 have reached what is called project design document stage. But so far only 92 million tonnes of CERs from 844 projects have been issued.
They have a value before that, but it is discounted by the market's view of the risks involved, like the project failing to deliver the emissions reduction projected by the time expected or falling at a later regulatory hurdle.
Craig McBurnie of ABN Amro in Sydney says the supply of projects entering process is rising every month - which suggest some degree of confidence that the market will still be there after 2102 when Kyoto's first commitment period ends.
But over the past six months or so there has been a significant rise, he says, in the number of projects subject to review. "When they get to the final hurdle two-thirds of these projects have been questioned as to their eligibility.
"A year ago a 50:50 proposition would have got the benefit of the doubt and been passed. The 50:50s are going the other way now."
One of the largest aggregators of CERs, EcoSecurities Group, this month saw its share price plunge 46 per cent after it wrote down its project pipeline by a fifth, blaming UN bureaucratic delays.
And the big Swiss-based bank UBS has cut by 20 per cent its estimate of how much carbon will be available to the CDM market.
Stuart Frazer of carbon brokers NZCX says another source of uncertainty on the supply side is whether there will be a successor agreement to Kyoto. Until that's clear some projects may be delayed.
There is also an issue of market power. The supply side of the market is dominated by Asia, especially China with a market share of about 60 per cent.
National governments also have to approve CDM projects as well as the UN and the Chinese Government has been able to use that power to enforce a price floor by not approving anything worth less than €9 a tonne.
On the demand side the uncertainties are just as great.
Although European corporates represent the lion's share of demand in the market, there are limits on the extent to which European emitters can use CERs to cover their obligations.
Some observers, like Geoff Sinclair of Standard Bank, believe that when they have filled their boots the CER price will fall.
But then he adds that Japanese corporate buyers may become a larger force in the market if their current voluntary scheme morphs into a mandatory one.
Towards the end of the 2008-12 period the Australian emission trading scheme will be up and running. Australian emitters will be able to access the CER market, but McBurnie believes price-capping measures could limit the extent to which they need to.
That's another uncertainty, but one dwarfed by the question marks about when parts, or all, of the United States will enter the market.
And will Canada, which is on track to be seriously short, stick to its current policy of reneging on its Kyoto obligations? If not it would rival Europe as a source of demand.
In the meantime Point Carbon, an authoritative monitor of the market, says prices range from €7 for the cheapest, highest risk CERs to around €17 for high-quality "secondary" CERs, where large banks or other intermediaries strip out and carry the delivery risk.
McBurnie and Frazer expect New Zealand emitters with a carbon book to manage will opt, like their European counterparts, for a core holding of the least risky but most expensive units and a more speculative position of cheaper but riskier ones. They could mitigate the risk of non-delivery, and therefore penalties from the Government, by holding more than they should need or participating in syndicated deals. It would depend, of course, on their appetite for risk.
Companies may now be wishing they had supported the more straightforward option of a carbon tax when it was on the table.
