Emissions trading in Australia is firmly on the new Federal government's policy agenda, alongside ratification of the Kyoto Protocol.

However, a UNSW academic and leading Australian expert on emissions trading warns that a poorly designed scheme might fail to achieve significant emissions reductions, while providing large polluters with windfall profits.

Dr Regina Betz of UNSW's Centre for Energy and Environmental Markets (CEEM) studied the experience of the European Union (EU) Emissions Trading Scheme, the world's first and largest scheme, and said it provides a cautionary tale.

Greenhouse gas emission permits were given for free to large polluters, who subsequently built the "cost of carbon" into their prices to account for the cost that would be created by buying permits at market price in the future.

"Effectively EU energy consumers have paid large emitters tens of billions of euros for emissions permits these polluters were given for free," Dr Betz said.

"Even worse, more permits were given away by governments than were actually required so the scheme was ineffective in reducing emissions significantly."

Global emissions trading experts met at UNSW on November 30 to discuss key design criteria for achieving effective, efficient and equitable emissions trading at the Third Annual CEEM Conference.

The experts, from the US, Germany, New Zealand and Australia, drew on their experience in global emissions trading policies to debate key design elements of future emissions trading for Australia. These elements include genuine emissions reduction targets, careful management of offsets and penalty arrangements, and equitable and efficient permit allocation.

Prime Minister Kevin Rudd's ratification of the Kyoto Protocol also opens Australia to the possibility of linking its emissions trading scheme with other schemes internationally, which could deliver lower prices for carbon via a larger marketplace.

One major issue of discussion at the conference was the implications of auctioning permits rather than distributing them to major emitters for free.

"Auctioning in emissions trading schemes solves many problems," Dr Betz said.

"The US is set to introduce more auctioning into the various multi-state schemes now being developed. Australian proposals to date, however, still seem to suggest a preference for free allocation that is likely to have adverse efficiency and equity outcomes."

The key role of mechanism design has been acknowledged most recently with the award of the Nobel Prize for Economics to Leonid Hurwicz, Eric Maskin, and Roger Myerson.

"Emissions trading schemes are designer markets because governments create and can change rules. Such flexibility poses both opportunities and risks for policy-makers," said Dr Betz.

"The policy process is vulnerable to stakeholder pressure and it's possible to create extremely complex and abstracted schemes that don't achieve their environmental objectives.

"Given the climate crisis we have to ensure that such policy failures are avoided. There is simply no time to repeat any mistakes in the design."