The water shortage across eastern Australia is now so acute it has begun to affect power supplies, and the country is at risk of electricity shortages next year.
"I think we are in denial, and are going to have brownouts in NSW if we don't get snow this winter," a source within the electricity market said.
Coal and hydro power generation require very large amounts of water, and the Snowy scheme depends on it for 86 per cent of its generation capacity.
"Last year we had the lowest snowfall ever recorded. If this happens again we are in trouble," the source said. He declined to be named because electricity pricing and supply is a politically charged subject.
Prices are already tipped to double in South Australia.
The news comes amid calls for the Government to adopt a carbon emissions trading scheme. This would have the effect of making alternative forms of energy generation - such as solar, wind and geothermal - more competitive with coal-fired power stations. It would also offer greater certainty to those looking to develop power assets.
Reports that the Government is close to adopting a scheme with nations in the Asia-Pacific region have come under fire, with Labor's environment spokesman Peter Garrett arguing it has come too close to an election to be credibile.
It's understood carbon trading will be on the agenda at the APEC summit in September, when the leaders of 21 countries meet over three days.
"Obviously we're open minded about it, but it comes on the back of 11 years of inaction, of denial and of doing nothing on the part of the Howard Government in relation to climate change and global warming,'' Mr Garrett told reporters in Sydney today.
"Frankly it comes a little late ... to have a great deal of credibility.''
Mr Garrett said the possibility of brownouts indicated how unprepared Australia was for the impact of climate change.
"We will see an intensification of droughts and an intensity in terms of increasing periods of hot weather, increasing periods of weather where there is not much rain as a consequence of failing to address climate change,'' he said.
The head of the CSIRO's Australian climate change science program, Paul Holper, said: "Lack of water could become a problem for power generation.
"You've got to find a supply of water to set aside for power generation, but there is already a shortage of water for agriculture. So this is going to become more of a problem."
The stock market has already sent an alarm signal. The price of electricity futures has almost doubled so far this year.
In January the price of a megawatt hour for delivery to NSW in 2008 was $38. This week the price rose to just over $72, a 90 per cent rise in less than five months. The electricity price in Queensland has more than doubled. The volume of trading in electricity futures has roughly quadrupled this year.
According to a market assessment from the Sydney Futures Exchange, it ranks as one of the biggest commodity price increases ever seen, and is not driven by market speculation but is caused by the convergence of several negative trends, dominated by the water shortage.
If this week's widespread rains continue, and the drought breaks, a power problem will be averted and the market will stabilise. But Australia is now an advanced economy at the mercy of the weather. Certainty over water supply has gone.
Power stations have a voracious appetite for water, and the shortage is affecting production in NSW, Victoria and Queensland, despite an abundance of coal and gas supplies.
"Australia has never factored in the cost of water, which is why it has some of the cheapest power in the world," the market expert said.
"Eventually, where there is not enough water for power in the Snowy, they will not be able to meet their contractual obligations."
Snowy Hydro is the most vulnerable supplier because 86 per cent of its generating potential comes from hydro power. Water storage in the Snowy scheme system is at its lowest May level since the Snowy scheme was completed in 1974. The main water storage, Lake Eucumbene, is the lowest it has been since construction. Water levels are down to just 8 per cent of active capacity in the Snowy system.
Although Snowy Hydro is responsible for only about 7 per cent of NSW power generation, it is crucial for relieving demand upon the main power stations during periods of peak demand.
If the water supply is cut and hydro power halted, there will not be enough coal power to meet demand in peak periods.
"If the current drought conditions continue, it is likely that Eucumbene Lake levels will continue to drop, possibly to below original minimum operating levels," Snowy Hydro conceded in a statement eight days ago.
"Water inflows during the past 12 months are significantly below the previous lowest ever minimums since records were kept over the past 101 years. Snowy Hydro believes it can meet its water and electricity commitments this coming winter and into next summer."
This assurance extend only for the next eight months. Beyond that depends on rain and snowfall.
In Victoria three giant coal-fired power stations, Loy Yang A, Loy Yang B and Yallourn W, receive an annual water entitlement from the Government equal to about 20 per cent of Melbourne's annual water use. But water shortages have forced them to buy water elsewhere to maintain capacity.
The surge in electricity futures prices places state regulators in a dilemma because they must balance the protection of consumers from excessive price rises and fluctuations with the realities of the market.
Coal is both abundant and the cheapest fuel, but investment in coal-fired production capacity has stopped because of uncertainty over future carbon taxes.
- SMH, with AAP