Carbon Pricing: Exploring Scope for Ambitious Climate Action

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1 Carbon Pricing: Exploring Scope for Ambitious Climate Action The ambition of the international community is to move the world onto a path towards decarbonisation. The 2 C objective can still be reached if immediate action is taken. Hence, there is a need to scale up greenhouse gas emission reductions and to develop cost-effective policies which allow countries to commit to targets within the given temperature limit. Countries can choose between a variety of policy measures to reduce greenhouse gases. Market-based policies that put a price on carbon address emissions on a large scale and enable countries to reach their climate targets at the lowest cost to the economy. By making abatement financially profitable, pricing carbon triggers private sector resources and investment in emissions reduction strategies and technologies, thus facilitating a lowcarbon development. Developing and developed countries are called upon to contribute to mitigation in the new climate agreement. To fulfill these contributions and the envisaged targets, countries need suitable policy instruments. Carbon pricing instruments can be adapted to national circumstances and their flexibility and cost-effectiveness can be further enhanced by linking them to other systems. In addition, the revenues generated by the pricing instrument enable countries to facilitate climate action by reinvesting in further reduction of greenhouse gas emissions in other sectors without burdening the budget. Benefits of Carbon Pricing: Cost effective mitigation Flexibility Private sector engagement Generates revenues for state budget and climate action Handout Carbon Pricing: Exploring Scope for Ambitious Climate Action Page 1/5

2 1. Carbon pricing instruments In recent years the worldwide spread of carbon pricing has gained considerable momentum. Countries interested in carbon pricing may benefit from the experience of about 40 national and 20 subnational pricing initiatives that now cover 22% of global greenhouse gas emissions. Basically, there are three different types of carbon pricing instruments - emissions trading systems, carbon taxes, and crediting mechanisms. An emissions trading system (ETS) sets a limit or so-called cap on overall emissions in targeted sectors. The governing jurisdiction issues a limited amount of allowances and distributes them by auctioning or free allocation among liable entities. Every entity must surrender one allowance for every tonne of CO 2 emitted, with the flexibility to buy additional allowances or to sell those that were not used. The price of allowances develops from trading on the market and is influenced by the stringency of the cap and costs of mitigation measures. The price shapes decisions in both the short-term management of existing assets and the longer-term direction of investment. The amount of revenues generated depends on the mode of allocation (free of charge or auctioning). Figure 1: Carbon Pricing initiatives wordwide. Source: Worldbank, Handout Carbon Pricing: Exploring Scope for Ambitious Climate Action Page 2/5

3 Emissions Trading Worldwide There are several countries or subnational jurisdictions that have implemented or plan to develop an ETS. The EU ETS was the first ETS, launched in It covers about 45% of the overall GHG emissions in 31 countries. During the 1st and 2nd trading period of the EU ETS, almost all emission allowances were issued free of charge. At the beginning of the 3rd trading period in 2013 the EU decided to auction about half of the overall quantity of emission allowances, with the share of auctioning continuing to increase over time. It was stipulated that at least 50% of auction revenues must be used to promote projects which reduce greenhouse gas emissions or support adaptation to the impacts of climate change. A carbon tax levies a fee per unit of emitted GHG. The tax rate sends a price signal that creates an incentive for emitters to shift to less GHG intensive production, resulting in reduced emissions. In contrast to an ETS, carbon taxes provide certainty regarding the price of emitting CO 2 and the government revenues generated. However, a tax does not define the total amount of allowed emissions and thus does not guarantee that a quantified target will be reached in the sectors covered. Crediting mechanisms are established outside the boundaries of an ETS or a carbon tax. They allow more flexibility to fulfill the mitigation objective. A crediting mechanism can be project-based or designed for a sector or a broad segment of the economy. Under crediting mechanisms, tradable credits are issued ex post for emission reductions below the level of a baseline or a sectoral crediting threshold. The participation in a crediting mechanism is voluntary and hence demand has to be generated e. g. by means of a mandatory system (ETS or tax) or through climate finance. Carbon Taxes About 11 countries have introduced a carbon tax. The design of carbon taxes has evolved to allow more flexibility to reduce emissions. For example, entities could be exempt from the carbon tax through voluntary agreements to improve energy efficiency (Denmark) or by adopting an emission reduction target (Switzerland). In the emerging carbon tax schemes (e. g. South Africa and Mexico), entities will be allowed to use domestic offset credits to meet their liability under the tax. Handout Carbon Pricing: Exploring Scope for Ambitious Climate Action Page 3/5

4 US$175/ 168 Swedish carbon tax 2. Effective implementation The effectiveness of carbon pricing instruments in terms of stimulating mitigation activities depends on design details and how these influence economic decision US$100/ making. One strength of carbon pricing instruments is the multitude of design options which makes it possible to take into account sector-specific conditions. For example, the financial burden of a tax or ETS could be reduced by 95 Tokyo Cap-and-Trade allowing the use of credits from a crediting mechanism. At the same time, by linking a mandatory system with a crediting mechanism countries can channel funding to other sectors where financial support is needed to stimulate low-carbon development. US$75/ All three types of carbon pricing may be implemented Norwegian carbon tax (upper) Swiss carbon tax alongside each other, addressing different scope and sectors. The effectiveness of a carbon pricing instrument increases if carbon policy is aligned with the phase-out of fossil fuel subsidies. Generally, the choice of carbon pricing instruments should be guided by each country s US$50/ 48 Finnish carbon tax unique circumstances, the specific characteristics of targeted sectors and the overall objective of the national climate policy. US$/ US$25/ Danish carbon tax British Columbia carbon tax, Irish carbon tax Australia CPM French carbon tax, Icelandic carbon tax, Guangdong Pilot ETS, Québec CaT 10 California CaT, 11 Shenzhen Pilot ETS 9 Beijing Pilot ETS / EU ETS US$0/ UK carbon price floor Mexican carbon tax (upper), Tianjin Pilot ETS, Norwegian carbon tax (lower) Japanese carbon tax 4 2 South African carbon tax, 5 Shanghai Pilot ET S 3 RGGI 1 Mexican carbon tax (lower), New Zealand ETS Figure 2: Prices in existing carbon pricing schemes. Source: World Bank Handout Carbon Pricing: Exploring Scope for Ambitious Climate Action Page 4/5

5 Crediting Schemes The largest crediting mechanism in terms of project numbers and emissions reductions is the Clean Development Mechanism (CDM). The CDM has been building extensive capacity, knowledge, and experience in host countries. As a result, a number of countries are now considering scaling up and using crediting instruments in their own domestic context. An innovative example is the Low Carbon City Program (LCC) in Thailand. The aim of the LCC program is to support municipalities and communities in achieving the national goal to shift towards a low carbon society by implementing GHG reduction activities. Once a domestic ETS or tax is established, the LCC credits should be eligible for compliance in the scheme. To support the development of projects under the LCC program, a carbon fund (LCC fund) is being set up which will be fed by voluntary market players and international donors. This approach enables the national market in Thailand to be linked up with international cooperation measures. 3. Looking ahead: Building readiness for carbon pricing instruments When countries consider their mid- and longterm mitigation pathways, an important task is to analyze the development of the economy and its related emissions over the coming decades. The design feature of the chosen carbon pricing policy has to be brought into line with the overall national climate change policy. There is a growing number of policy options for carbon pricing that allow countries the transition to a lowcarbon development. To tailor the knowledge of these instruments gained so far to a country s circumstances is challenging. Market readiness has to be built up in order to enable interested countries to prepare and implement the most appropriate policy for their country. The World Bank s Partnership for Market Readiness (PMR) is an important initiative to support countries in technical and institutional readiness for implementing carbon pricing instruments by focusing on capacity building in the core components such as monitoring, reporting and verification (MRV), data collection, or baseline setting. The International Carbon Action Partnership (ICAP) supports capacity building on emissions trading and their linkage. Edited by: Malin Ahlberg, division KI I 6, European Climate and Energy Policy, New Market Mechanisms malin.ahlberg@bmub.bund.de August 2015 Handout Carbon Pricing: Exploring Scope for Ambitious Climate Action Page 5/5