NEW YORK WHOLESALE

WHEN we wake up tomorrow, Australia will have carbon pricing. How will its effects compare with those expected a year ago, when I produced my Climate Change Review for the Federal Parliament's multiparty committee?

Let me focus on changes in the electricity sector, and on the international context of Australian climate change policies.

Electricity prices have four components: wholesale power generation; long-distance transmission; distribution to households and businesses; and retail services to the customer. Carbon pricing affects wholesale prices. It was expected to raise wholesale prices enough to push up total electricity prices to households by about 10 per cent. It now looks as if wholesale prices tomorrow may be no higher in real terms than five and six years ago, even when the effects of carbon pricing are included.

The upward effect of carbon pricing on wholesale prices from tomorrow will be offset to an unexpected extent by the downward pressures from an electricity surplus. Energy savings induced by six years of rising prices, better house insulation and greater consumer and business awareness have reduced electricity demand. Restructuring of the economy in response to the resources boom and the high exchange rate has also reduced demand. At the same time, generation capacity has increased with the expansion of wind and rooftop solar facilities. The overall effect has been a surplus of electricity generation capacity and strong downward pressure on wholesale prices.

Regrettably, the non-carbon sources of increased prices - distribution, transmission and retail costs - will be much as expected. Even after tomorrow, these will have contributed more or less the whole of the huge increase in household electricity prices since 2006 and 2007.

There will be small additional increases in household electricity costs from the carbon price in the next two years - a bit more than 1 per cent in each year. After that, it depends on what happens to international carbon prices. If international carbon prices in 2015 were similar to now, there would be a big fall in the component of electricity prices attributable to carbon pricing. But there is no guarantee that international carbon prices will stay this low.

The pressure for higher future electricity prices will come from transmission, distribution and retail charges, as it has in each of the past six years. Only changes to the regulatory arrangements will end the relentless upward march of household electricity prices. The good news is that over the past year, the necessary changes have been placed on the reform agenda. With weak demand growth, some established generators will reduce production. Carbon pricing will place generators with the largest emissions per unit of electricity under pressure to reduce output.

The 2011 Climate Change Review anticipated different behaviour in gas prices in two countries with huge recent increases in gas reserves. Expectations of higher gas prices in Australia reflect the emergence of a gas export industry on the east coast. The lower prices in the United States flow from a similarly large increase in local gas supplies in the absence of an export industry.

Expectations of higher gas prices mean that emissions reductions in the Australian electricity sector now are likely to come much more from reduction in demand, increases in renewable energy supplies, and contraction of coal generation than from the replacement of coal by gas.

When the carbon pricing arrangements were announced last year, there were anxieties about the disruption of electricity supplies. The anxieties have eased with experience.

International action has been stronger over the past year than was anticipated in the 2011 Climate Change Review. The review was unfashionable in suggesting that the United States government should be taken at its word. The US had advised the international community of its intention to reduce emissions by 17 per cent between 2005 and 2020.

After the House of Representatives' rejection of the President's legislation on carbon pricing had denied the low-cost path to reducing emissions, high officials advised me that the US government would achieve its emissions reductions by other means.

Since then, the Federal Environment Protection Agency has moved to tighten regulatory controls on emissions in motor vehicles. The recently proposed power regulations effectively ban new coal-based and open-cycle gas generation in the absence of carbon capture and storage. The US government has continued its strong support for research, development and commercialisation of new technologies. State-based regulation has had large effects, and California has passed legislation to start an emissions trading scheme at the beginning of 2013. These developments, alongside private harassment of investment in high-emissions activities, progress in energy saving and what the 2011 review called the ''gas revolution'', increase the chances that the US will meet its emissions reduction targets.

Across the border, Canada has moved in the other direction, with repudiation of its binding commitments under the Kyoto Protocol. At the same time, Canada has made commitments under the Cancun agreements that it will match US emissions reductions. There are contradictions to be resolved.

China has moved further and faster than I anticipated a year ago. Trials for emissions trading schemes have begun in two provinces and five cities, and there are suggestions these could lead to nationwide carbon pricing. Energy saving and the rapid, downward movement of renewable energy costs are being reinforced by huge new public financial commitments to investment in new technologies. China's large nuclear energy program, suspended for review after the Japanese tsunami, has been renewed with enhanced focus on safety.

Elsewhere in Asia, Korea has legislated to introduce an emissions trading scheme.

In the low-emissions developed countries in Europe and Japan, emissions reductions are proceeding more or less as anticipated despite the setback to use of nuclear power. Slow economic growth in Europe has meant that emissions targets are being met with much lower carbon prices over the past year.

Finally, the international agreement based on concerted unilateral action that emerged from the Cancun meeting of the United Nations Framework Convention has demonstrated its worth over the past year. The Durban meeting last December strengthened commitments from all substantial developing countries to contribute to the global mitigation effort.

Professor Ross Garnaut is an economist at Melbourne University.