WELCOME to Garnautland, a fantastic and magical place where dreams of an abrupt yet manageable shift to a low-carbon future can come true.

Its creator is Professor Ross Garnaut, who has taken a handful of courageous assumptions, a little guesswork and a big bucket of optimism to create an epic vision of a little country that made a big difference.

Garnautland is a marvel of positive thinking and selective policy engineering.

It has been built entirely inside that other magical kingdom, Labor Party policy.

In Garnautland nuclear energy isn't needed unless all other low-emissions sources have been tried. The efficacy of the Rudd Government's large and arbitrary mandatory renewable energy target is just accepted, along with non-existent reform of retail electricity markets and the unchallenged logic of starting a national emissions trading scheme in 2010.

In Garnautland the industries and companies that produce most of the nation's greenhouse gases enjoy generous profits that will only be slightly rifled by a national emissions trading scheme. They need the discipline of an emissions trading scheme to bring them into line with their OECD peers.

The pain of transition will not be so bad because Australia's relatively unique industrial profile dominated by export-focused primary industries and energy-intense primary processing like steel and aluminium isn't unique at all. All you have to do is aggregate them with the rest of the manufacturing sector.

It helps if you also ignore the fact that emissions profiles of a number of other OECD economies were forced to switch to lower-emissions fuels such as gas and enjoy the benefit of zero-emissions nuclear power.

The foundations of Garnautland are built on the assumption that the cost of permits in an emissions trading scheme will fall, not increase, as fossil fuel prices increase.

Higher prices will reduce demand, helping to stabilise energy prices. In the European trading scheme now being trialled they're finding the exact opposite. There the permit price is being driven by what is needed to make gas power stations competitive with coal.

Gas is a good substitute for oil and is tracking the world price; coal is a weak substitute and rises at a much slower rate.

Deutsche Bank thinks the current $45 a tonne carbon price is undervalued, and will increase to more than $100 a tonne by 2020. As a result of this heroic assumption, the initial price increases for electricity are driven mainly by rising gas and coal prices and only augmented by the introduction of a price on carbon, rather than the other way around.

This means increased price volatility, which can't be a good thing for electricity retailers trying to sell into price-regulated retail markets.

But Victoria's four big privately owned brown coal generators -- AGL, TRUenergy, International Power and Babcock & Brown Power -- will apparently not need any transitional assistance because while sales volumes will fall, they will be able to recover by selling into higher electricity prices.

Their margins will be cut, but then they are likened to the tobacco and asbestos industries, and could do with a bit of greenhouse discipline.

Actual sectoral modelling assuming the carbon price is a significant driver of price shows that most of these power stations are completely unprofitable north of a carbon price of $15 a tonne, no matter who runs them and would shut down.

But don't worry, because that can't happen in Garnautland.

In Garnautland no one is afraid of speculators shorting the new Australian carbon market -- in fact, they look forward to paying these European prices.

Trading for these permits could begin next year, locking Australia into a fully open and fixed start from 2013, ahead of crucial global negotiations in Copenhagen at the end of 2010 and full information on the true nature of the world carbon market.

International negotiations are assumed to make remarkable progress. Global sectoral agreements on targets for the world's biggest emitting industries like aluminium, chemicals, cement and steel could be kicked off and completed all before 2013.

These remarkable breakthroughs in global negotiations will help solve the otherwise intractable problem of providing ongoing compensation to Australia's large trade-exposed, energy-intense industries.

Growing carbon constraints in Australia will otherwise just drive these fast-growing industries to relocate and invest in other unregulated economies.

In the interim, who gets this temporary compensation will be determined by the King Solomon of climate change justice: mathematical formulas. Big industries with big emissions will be compensated; little industries with big emissions will not.

Now that's fair. Up to 30 per cent of the receipts from the auctioning of carbon permits will be paid out in compensation. It's an arbitrary number, given without reasoning, but in Garnautland that's OK.

Professor Garnaut has been at pains to emphasise the scale of the global policy challenge his is working with. He has assumed the freedom to create an optimistic model to try and solve it.