Supporting Energy Pricing Reform and Carbon Pricing Policies Through Crediting IISD REPORT © 2014 The International Institute for Sustainable Development © 2016 International Institute for Sustainable Development | IISD.org February 2016 Supporting Energy Pricing Reform and Carbon Pricing Policies Through Crediting © 2016 The International Institute for Sustainable Development Published by the International Institute for Sustainable Development. International Institute for Sustainable Development The International Institute for Sustainable Development (IISD) is one of Head Office the world’s leading centres of research and innovation. The Institute provides 111 Lombard Avenue, Suite 325 practical solutions to the growing challenges and opportunities of integrating Winnipeg, Manitoba environmental and social priorities with economic development. We report on Canada R3B 0T4 international negotiations and share knowledge gained through collaborative projects, resulting in more rigorous research, stronger global networks, and Tel: +1 (204) 958-7700 better engagement among researchers, citizens, businesses and policy-makers. Fax: +1 (204) 958-7710 Website: www.iisd.org IISD is registered as a charitable organization in Canada and has 501(c)(3) status Twitter: @IISD_news in the United States. IISD receives core operating support from the Government of Canada, provided through the International Development Research Centre (IDRC) and from the Province of Manitoba. The Institute receives project funding from numerous governments inside and outside Canada, United Nations agencies, foundations, the private sector, and individuals. Supporting Energy Pricing Reform and Carbon Pricing Policies Through Crediting February 2016 IISD Authors: Peter Wooders, Philip Gass, Richard Bridle and Christopher Beaton Perspectives Authors Axel Michaelowa, Stephan Hoch, Matthias Honegger, Tyeler Matsuo and Vanessa Villa Ricardo Authors Mark Johnson and James Harries Acknowledgements This report was prepared under a contract from the World Bank’s Climate and Carbon Finance Unit funded by the Carbon Asset Development Fund of the Carbon Partnership Facility, led by Klaus Oppermann, Senior Policy Advisor and Suphachol Suphachalasai, Economist. The authors acknowledge the excellent guidance and many improvements which resulted from their input. However, the work, and any errors or omissions within it, remain the full responsibility of the authors. © 2014 The International Institute for Sustainable Development IISD.org ii Supporting Energy Pricing Reform and Carbon Pricing Policies Through Crediting Executive Summary With the successful conclusion of the Paris Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC), international carbon market mechanisms became a key element of the future, post-2020, international climate policy architecture. Paris delivered a new UNFCCC-governed baseline and crediting mechanism, applicable both in developing and developed countries. Paris also recognized voluntary cooperative approaches that enable international transfer of mitigation outcomes to be accountable against countries’ mitigation pledges (in the form of nationally determined contributions). In both cases, the scope of mitigation activities is likely to go beyond the project-by-project level as in Clean Development Mechanism (CDM) and Joint Implementation (JI). Earlier discussions suggested that sectoral crediting approaches (or approaches using other aggregates, such as the level of a city), might emerge. Crediting of policies is clearly a further option, and the Paris agreement encourages results-based payments for policy approaches in the context of REDD+. Policy crediting—i.e., the crediting of the emission reductions resulting from the implementation of a policy action or components of it—is a new concept. So far there exist no real case examples. Some work was done on regulatory policies (such as energy-efficiency standards, including under the CDM and with an aim to reforming the CDM beyond a project-level scope) both from a methodological side and through blueprinting of operational models. Similar approaches were developed for policies such as feed-in tariffs for renewable energy. The potential crediting of implicit or explicit carbon pricing policies is uncharted territory. Anecdotally, the CDM played a major role in building capacity, awareness and interest in many countries to implement domestic carbon pricing schemes to provide their economies with a price signal. Crediting of carbon pricing policies might be a way to support countries further and on a higher scale in these efforts. It might also be possible to achieve much larger emission reductions and international carbon flows in crediting such policies than what CDM and JI have achieved. This study examines the role that policy crediting might play in increasing the mitigation impact of energy pricing reform and carbon pricing policies (pricing reform1) This can either be through: • a policy being implemented that would not have been without crediting; or • an existing policy or one that has been decided upon is made more stringent (i.e., that its mitigation impact is increased). The literature on this topic is not very broad. However, extensive experience with the CDM and other project- based mechanisms provides useful references for baseline setting and associated monitoring, reporting and verification (MRV) of emission reductions. The literature review conducted in this study also looked at relevant experiences from results-based financing. Finally, the direct experience from pricing reform schemes shows a variety of mechanisms used to overcome barriers to implementation—which are often political as much as economic. While this experience looks at the reallocation of revenue from internal sources, the findings should be applicable to other (external) sources of finance. The study developed four detailed case studies analyzing pricing reform undertaken in developing countries:2 1. Morocco – energy subsidy reform 2. Indonesia – energy subsidy reform 3. Mexico – carbon tax 4. Beijing (China) – pilot emission trading scheme (ETS) 1 Here we use the general term “pricing reform” to cover carbon pricing approaches such as emissions trading systems (ETS) and carbon taxes, and removal of negative carbon prices (i.e., reductions of fossil fuel or energy subsidies). For description and examples of these pricing reform/policies, see e.g., International Monetary Fund (IMF) (2013) and World Bank (2015). 2 These case studies were conducted on the© basis2014 of publicly The Internationalavailable material. Elaborations Institute on forpotential Sustainable crediting approaches Development are purely hypothetical and for illustrative purpose. IISD.org iii Supporting Energy Pricing Reform and Carbon Pricing Policies Through Crediting While none of these cases featured external crediting, the detailed analysis of how they were designed, the expected savings/revenues, and their utilization provide valuable lessons to the (hypothetical) question of this study—could policy crediting increase the mitigation impact of pricing reforms? Main conclusions from the case studies have been drawn: 1. The need to increase fiscal resources and/or to improve economic efficiency was the principal reason for energy subsidy reform and an important driver for carbon taxation. For ETS, the fiscal consideration is also important once allowances are auctioned. Encouraging the transition to a cleaner and greener economy was also part of the policy rationale in all cases. 2. There were significant political economy concerns with the impacts of higher costs on both the population and parts of industry in all cases. The Mexico case saw a major reduction in stringency from the initial proposals, and subsidy reform in Indonesia and Morocco is proceeding on a gradual basis across fuels and electricity. 3. Other than the Beijing ETS (which is a pilot scheme), the potential fiscal gain – the reduced cost of subsidies (in Indonesia and Morocco) and the revenue raised from the carbon tax (in Mexico) – from the “base” policy is large: USD 15.5 billion, USD 3 billion and about USD 1 billion respectively. 4. It may seem an obvious point, but the greenhouse gas (GHG) emission reductions realized are strongly dependent on what the fiscal resources are redirected to. First order analysis undertaken for Morocco’s energy subsidy reform by IISD using its Global Subsidies Initiative-Integrated Fiscal (GSI–IF) model shows that if 20 per cent of savings were redirected into energy efficiency and a further 10 per cent into renewable energy, the GHG reductions could nearly double. Analysis using other techniques that included feedbacks within the domestic economy and to the world economy may yield further insights into such things as impact on inflation and other short-term shocks and concerns around strategic or vulnerable sectors of the economy. 5. The “carbon economics” ratios indicate that potential incremental revenue from policy crediting is low compared to fiscal gain from implementing the “base” policy without any external crediting support—implying that the inclusion of policy crediting would unlikely be a critical factor of policy decision/implementation in the three cases studied. One question this study posed was whether or not revenue from credits could be used to compensate key stakeholders adversely impacted by the policy. The analysis shows that such compensation could be sourced from the “base policy”