In a corner of the noisy financial trading room at ICAP in Sydney on Friday, where I was visiting Business Spectator’s Matthew Johnson, I spied a small desk that, unusually for that place, wasn’t doing much shouting.

It was the energy desk, and one of the contracts being traded was for September 2011 Australian carbon emission units. So, there is now a market in Kevin Rudd’s carbon policy. When I was there on Friday, the market was bid $19.75, offer $22.50, last sale $21.50 — per tonne of carbon dioxide. It is traded in 10,000 tonne lots, so each contract is a $215,000 transaction.

The first forward trade was done in May this year when AGL Hydro Partnership sold 10,000 tonnes to Westpac, for settlement on February 1, 2012 at $19 a tonne. The contracts were drawn up by Minter Ellison’s Mitzi Gilligan. The price for Australian carbon emissions has risen 13 per cent in three months but is still at a big discount to the European Climate Exchange. There the 2011 price is €25.83 or $44.50 — more than twice the current Australian price.

In a way, this arbitrage is a real-life expression of the current climate policy problem in Australia: basically the market is saying that the Rudd Government’s policy will be half as tough on Australian companies as the European policy is. Of course the traders here are dealing in the dark because the policy has not been decided yet.

But they have read the Garnaut Report and the Government’s Green Paper, listened at length to the Minister Penny Wong, watched the Opposition thrashing about, put that into the context of the international groping towards a successor to the Kyoto Protocols, and then put real money on the table at $21.50 a tonne for 2011. It’s always better to listen to money rather than blather.

There are two ways for a government to soften the cost of carbon emissions for the firms in its own country, and give them an advantage over others: to have an unambitious target for emissions reduction and to issue lots of free permits.

The Europeans did the latter when they launched emissions trading in April 2005. The price started at €16.88 a tonne and got up to €29 a tonne (nearly $50), before the power generators started selling their free credits.

Under the weight of their selling the price got down to two euro cents a tonne last year, which is effectively zero — the cost of processing the trade. But now the market has cleared and is a reasonable reflection of the European emissions reduction targets.

In the Australian Government’s Green Paper, there was a chapter on “Linking the Scheme to International Markets” which discussed a process for importing and exporting carbon emission units to and from other schemes, such as Europe.

“With unrestricted linking, the price of an Australian permit will be set by international carbon markets. Currently, international carbon markets are immature but evolving rapidly. Australia, being a relatively small emitter, is likely to be a price taker; that is, Australia will have little impact on world prices for carbon.

“A key consideration for Australia is how quickly it wants international demand and supply conditions to determine the domestic price, as an alternative to it being determined primarily by domestic demand and supply conditions.”

Of course the real problem is not the prospect of the Australian price rising to, say, the European price with open trading of emission units between countries, but for the lowest common denominator to prevail — that is, companies would naturally buy their emissions where they are cheapest, which is unlikely to be Europe. (China? The United States?)

According to the Green Paper, the Government’s preferred position is for a scheme designed to link with international markets, with a preference for open trade. Looking at the difference between the European and Australian 2011 prices per tonne of emissions, it is easy to see the essential problem with this whole subject.

How will any politician justify having a policy that imposes a higher carbon price on its citizens than other countries (or a lower one for that matter)? 

And if carbon prices are different between countries, and international trading is allowed, those differences will be arbitraged away unless there are restrictions or taxes. But extra restrictions and taxes that keep the carbon price higher here than anywhere else will arbitrage the politicians themselves away.