A framework to decarbonise the economy

Progress towards decarbonisation is lagging Rapid acceleration in global mitigation is needed IEA’s global emissions scenarios Temperature Rise by 2100

Gt CO2 40 35

15 10 5

60

Required emissions reduction until 2030

25 20

% 70

+2.6°C

30

Historical Stated Policies Scenario (STEPS)

+1.8°C

Announced Pledges Scenario (APS) - updated with COP26 pledges Net-Zero Emissions Scenario (NZE)

0 2000 Source: IEA, 2021

2010

2020

2030

2040

+1.4°C 2050

Distance from 2030 target differs across countries, depending on policies and level of ambition

Emissions increasing

% 70

Emissions decreasing

60

50

50

40

40

30

30

20

20

10

10

0

0

Max -10 possible emissions -20 increase

NZL NOR CAN USA JPN ARG EU GBR AUS BRA Source: Calculations based on UNFCCC National Inventory Submissions, 2021

-10 -20 KOR

RUS

CHE

Note – left figure: Orange arrows (upwards) identify countries whose emissions are increasing and green arrows (downwards) identify countries whose emissions are decreasing in the last 10 years. The figures represented by the blue bars are calculated as the percentage point differences between the level of emissions in 2019 or latest available year (ARG: 2012; BRA, CHL, KOR: 2016, MEX: 2013) and targeted level of emissions in 2030 (expressed with respect to the 1990 level). A positive blue bar shows the minimum required emission reduction for the country to meet its stated 2030 target. A negative blue bar shows the maximum possible increase in emissions for the country to meet its stated 2030 targets. For example, for the EU there is a 25 percentage point difference between the 2019 emission level and the 2030 estimated targets (height of blue bar). This results from the difference between the stated target of reducing emissions by 55% by 2030 relative to the 1990 level and the 30% reduction in emissions already achieved between 1990 and 2019. Left panel: Emissions and targets include land use, land-use change and forestry (LULUCF). Right panel: Emissions and targets exclude LULUCF.

CHL

A multi-step approach to cost-effective, inclusive and comprehensive decarbonisation strategies

Cross-country differences in economic structure call for country-tailored policy packages GHG emissions share (excluding land use, land-use change and forestry) for selected OECD countries

A mapping of OECD indicators: • GHG emissions and emissions intensities; • CO2 emissions from fuel combustion and CO2 emission intensities; • CO2 demand-based emissions (carbon footprint); • CO2 emissions from transports.

A comprehensive policy mix consists of three building blocks: Incentivise to reduce emissions

Emission pricing (explicit carbon price)

Standards and regulation (implicit carbon price)

Combination of policies depends on country characteristics, preferences, political constraints

Complementary policies Provide enabling conditions

(R&D subsidies, infrastructure)

• Lower the cost of achieving a certain reduction in emissions • Strengthen public acceptability

Pricing and non-pricing policies complement each other •

They can combine • emission pricing, • standards & regulations • enabling complementary economic, social and fiscal policies

•

Combination of emission pricing and standards and regulation depends on country-specific characteristics (e.g. social preferences, political constraints, abatement costs…)

•

Complementary policies (e.g. innovation support mechanisms and infrastructure investments) lower the costs of achieving a certain reduction in emission and strengthen public acceptability

Market failures contribute to excessive emissions • Negative externalities (pollution); • Private markets under-provision of research and technological innovation; • Unpriced co-benefits of reducing emissions, such as improved health and biodiversity; • Financial frictions; • Network effects and coordination failures in relevant industries (e.g. electricity, transport, recycling); • Lack of information about energy efficiency and products’ carbon content; • Demand-side ‘behavioural’ effects (e.g. hyperbolic discounting, status quo bias, dynamic inconsistencies)

Policy assessment criteria The effectiveness of policy options can be assessed through criteria as:  Lowering abatement costs in the short term (i.e. static minimisation of abatement costs;  Lowering abatement costs in the medium-long term (i.e. dynamic minimisation of abatement costs);  Administrative costs;  Capacity to deal with uncertainty;  Reallocation and distributional effects;  Public acceptability;  Impact on public budget

Trade-offs and synergies across policies call for a comprehensive policy mix Assessment criteria Short-term minimisation of abatement costs

Long-term minimisation of abatement costs

High

High

Moderate

Subsidies to abatement Technology standards

Administrative costs

Ability to deal with uncertainty

Reallocation and distributional concerns

Political economy and acceptability

Fiscal revenues and expenditures

Moderate to High

High

Moderate

Low

Rev. raising

Moderate

Low

Low

Low

High

Neutral

High

Moderate

High

High

Moderate to High

High

Expenditure

Low

Low

Low

Low

High

High

Neutral

…

…

…

…

…

…

…

Policy instrument GHG tax Non-tradable performance standards

…

Enabling policies are key to accelerating the climate transition and lowering its costs • Favouring innovation and business dynamism – Technology-push: targeted support, basic long-term research – Framework policies: e.g. legal liability, IP protection and diffusion – Reallocation friendly policies

• Mobilising private capital – Improve the regulatory environment (securitisation of green infrastructure projects, fiduciary duties for green mandates, etc.)

– Encourage transparent climate-related disclosure

• Green infrastructures – Electricity: investments in new (green) capacity – Transport: prepare for a long-term paradigm shift

Complementary policies: an example of infrastructure investment Norway: Investments in infrastructure network (fast and ultrafast EV chargers) significantly increased the share of EVs Vehicle-related tax revenue, billions NOK Billions NOK 80

Registration taxes

Annual taxes

CO2 tax

Electricity tax

Road usage taxes

70

Policies that encourage innovation and the upgrade of network infrastructures enable the emergence and adoption of promising low-carbon technologies, including those that are still far from the commercialisation stage, especially in the electricity and transportation sectors.

60

50

The experience of Norway suggests that the provision of fast charging infrastructure is a strong driver for EV uptake as users prefer fast and ultra-fast chargers for both inter- and intra-urban travel. However, there are challenges: • Lower revenues from vehicle-related excise duties • Generous incentives translate into high abatement costs • At current trends it will still take decades for EVs to fully replace combustion-engine cars

40

30

20

10

0

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Note: Adjusted for inflation, estimated 2022 NOK values.

Source: OECD (2022) and Royal Norwegian Ministry of Finance.

2020

2021

2022

Climate policies can have unequal distributional impacts Policy type

Distributional impact

Carbon pricing: Transport / road fuel Carbon pricing: Electricity Carbon pricing: Heating Carbon pricing: Air transport Carbon pricing: Maritime transport

Mixed evidence Regressive Regressive Progressive Regressive

Subsidies on low-carbon technology (e.g. US tax credits for renewables)

Regressive

Public investment in low-carbon technology or infrastructure

Mixed evidence

Higher tariffs on high-carbon imports Energy and vehicle efficiency standards (e.g. the US CAFE)

Mixed evidence

Agriculture related policies (e.g., taxes or standards)

Regressive

Regressive

Three channels: •

‘Source-side’ income effects • Uneven remuneration of labour and capital; • Policy options: ALMPs, reskill and upskill, place-based policies, …

•

‘Use-side’ income effects • Change in relative prices of goods whose consumption vary across the income distribution; • Policy options: use revenues, transfers, investments, …

•

Non-pecuniary effects • Asymmetric effects on health, productivity, property values, etc.; • Policy options: target adaptation

Addressing distributional effects requires specific policies 1) Utilising revenues to balance distributional ‘use-side’ income effects: • Earmarking of excise fuel taxes revenues; • Fixed (i.e. lump-sum) transfers; • Targeted transfers; • Tax cuts; • Investments and social funds (e.g. ‘green’ social housing)

2) Addressing ‘source-side’ income effects through supporting workers in transition: • Active labour market programs (ALMPs) (e.g. job brokerage services, support to start-ups); • Targeted training and skill development programs; • Unemployment support and welfare benefits

Distributional effects of a carbon tax under different uses of revenue Percentage change in income across income quintiles, United States 2015

Applying the framework to formulate policy recommendations OECD Denmark Economic Survey (2021) recommends:

Implement a wellbalanced policy mix of: pricing, regulatory measures, investment and structural reforms

Use tax revenue from emissions pricing to offset distributional consequences

Strengthen supports to green innovation through technologicalneutral subsidies

Consult further with dealers and investors on the best model for green bonds

The rise in energy prices underscores the importance of a comprehensive transition strategy, including energy security • Over the past year (mid 2020 and forth), gas prices increased more than 170% in Europe for several reasons including:  Constrained gas supply, low storage levels, rebound of energy demand…

The rise in energy prices is largely driven by fossil fuel costs – not carbon pricing

• Carbon pricing accounts for only a small share of gas price increases • Decarbonisation should strive to strengthen the resilience of energy systems to shocks

Note: The figure shows the impact of fossil gas price and EU ETS allowances price on the cost of electricity generation from combined cycle gas turbines power plants (EMBER 2021). Data is from Powernext for TTF fossil gas prices (day ahead), EEX for EU-ETS carbon prices (December contract). Costs are calculated using emissions intensity of 0.37tCO2eq/MWh and plant efficiency rate of 55%.

Source: EMBER, 2021: https://ember-climate.org/commentary/2021/09/21/fossil-gas-uk-electricity-prices/ Climate Action Network, 2021: https://caneurope.org/high-electricity-prices-links-fossil-gas-need-shift-to-renewables/