As the pace of international climate negotiations has slowed, the interest and attention of international organisations and climate policy watchers has been diverted to national climate change responses.

National programs are seen as a major driver of the next international climate change deal. In this setting, Australia is searching for partners to shape the future of a global market response to climate change.

Perversely, given that it was ostracised in climate negotiations for so long, Australia – with its climate price in place and a connection with the European Union’s emissions trading system assured – is now being portrayed as a climate leader and broker.

We recently attended a gathering in the United States of policy-makers, lawyers and scholars from Australia and California, and got the impression the carbon price has given Australia negotiating clout. While presentations were being made inside the conference venue, outside Australian government officials, led by Parliamentary Secretary for Climate Change and Energy Efficiency Mark Dreyfus, were discussing linking Australia’s carbon price scheme with California’s cap-and-trade system.

California has recently linked its now operational cap-and-trade system with Quebec. There is a real possibility of Australia linking its carbon price with California’s and further extending and entrenching cross-border carbon markets. In the next five years we might see Australian emissions reductions or emissions offsets being transferred between companies in Perth, Rome, Los Angeles or Montreal.

The contextual differences

There are contextual differences that Californian and Australian negotiators have begun to explore as a precursor to striking any deal to link carbon schemes.

As Australian legal scholars, including Godden and Prest have noted, Australia’s carbon policy has been framed by economics and market theory. Bureaucrats have acknowledged that Australia’s carbon laws are not environmental laws. They are laws that create a carbon market.

Australia’s carbon price and the market it creates is the centrepiece of Australia’s carbon laws. It is supplemented by incentives to promote renewable technologies (such as the Clean Energy Finance Corporation) and create offsets (like the Carbon Farming Initiative).

The Californian cap-and-trade system reflects a broader stakeholder concern than in Australia, and is described as a “back-stop” by the agency that designed and will implement it. It is only needed to address those carbon emissions that are not mitigated through the range of other environmental regulatory measures. These include:

• ratcheting emissions and fuel standards;
• bans on the expansion of coal and fossil fuel generation;
• prohibitions on the purchase of carbon intensive fuels; and
• statutory obligations on utilities to find energy efficiency savings.

Cap-and-trade is only expected to meet 20% of California’s emissions reduction target, whereas in Australia the carbon price is expected to deliver most of, if not all, Australia’s emissions reduction target.

Just as it did when negotiating its EU deal, Australia might need to modify its carbon legislation should California seek greater complementarity between systems.

Ultimately, we do not see the broader contextual differences as a barrier to linking. Once Australia’s scheme converts from a fixed price to a trading scheme, the structure and operation of the carbon pricing regimes will be fundamentally the same across both jurisdictions. There will be general compatibility between emissions reductions and emissions offsets, even if California’s scheme is only intended to achieve a minor proportion of its mitigation objectives.

The barriers

There are barriers that could delay or frustrate linking. There are reports California is concerned about the lack of an auction reserve price in Australia. While this has price implications, it is not a barrier to linking. Removing a price floor (and associated reserve price) was a feature of the European system that Australia adopted. California may also drop the feature if it wants to connect with Europe.

A more substantial barrier, in our view, is that despite California being a larger economy with a bigger population than Australia, it lacks international personality. Australia cannot negotiate a treaty with California to formalise any system connections. Both jurisdictions will likely be limited to non-binding memoranda of understanding and regulatory endorsement of each other’s schemes. Australia will face the risk of Californian regime change should the Unites States federal government limit or implement a carbon market.

A related issue is that Australia will need reassurance from the United States government that it will recognise Californian emissions reductions at the national level and in a global climate change agreement. It will also presumably be necessary to get the EU on side with such a link. This is because ultimately, once linked, Californian offsets allowed into Australia, at least indirectly, will also flow into the EU emissions trading system.

The prospects and opportunities

There is one positive to not being able to formalise the linking of schemes with a treaty. It means linking can be achieved relatively quickly, as was the case with the arrangement for one-way linking with the EU. We therefore do expect some form of linkage soon, possibly ahead of the Australian federal election.

The simplest way would be to link through offsets. California has a similar offsets mechanism to Australia’s Carbon Farming Initiative, covering the land and agricultural sectors. An initial link could be agreed through a one-way or mutual recognition of these domestic offset credits. For instance, emissions reductions generated by the capture of methane at landfills or the planting of vegetation could be traded between the two schemes.

This option was raised in the public discussions last week. California is currently seeking comments on using offsets from linked schemes. Significantly, the recognition of Californian offsets in Australia’s scheme could be achieved without further amendments to Australia’s carbon legislation.

There are significant political and structural opportunities for linkage for both Australia and California. California will continue to lead the United States, as it desires, on climate change – reaping the rewards of innovation and the plaudits of progressive law-makers. And it will continue to exert political pressure on the Obama administration to act.

For Australia, the more credentials it receives and the more connected its carbon price becomes, the more difficult and humiliating it will be for any future Coalition government to extricate itself from the system. This is a win-win scenario for the current government both politically and for its approach to taking action against climate change.

This article was co-authored by Katherine Lake, Senior Associate in the Climate Change and Energy Practice at international law firm, Ashurst.