Pricing Carbon - Policy Perspectives 2013

Pricing Carbon POLICY PERSPECTIVES

2013

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There has been a huge amount of taxing and regulating around carbon, but the outcome has been far from optimal. Countries are pricing carbon in a multitude of ways – sometimes too high, but often too low. This is a chaotic landscape that sends no clear signal, and must be addressed.

Angel Gurría, OECD Secretary-General

PRICING CARBON KEY MESSAGES •

There is a strong need for more ambitious policies to address climate change. Given the size of the problem, we cannot afford inefficient policies: least-cost solutions are needed to keep carbon prices as low as possible.

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However, current explicit prices that are put on carbon by means of taxes or emissions trading systems are generally much lower than those needed to limit the global average temperature increase to 2°C above pre-industrial levels.

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Nevertheless, economic instruments like taxes and emission trading systems have been shown to be the most cost-effective instruments to limit greenhouse gas emissions by a significant margin. They could be even more cost-effective if their design was improved. Frequent exemptions for various energy products (e.g. coal) and different uses (e.g. aviation, agriculture and energy-intensive sectors) should be scaled back; the taxes on diesel should be set at least as high as the taxes for petrol; and total ‘caps’ in emission trading systems should be made stricter, and permits auctioned.

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Many other policy instruments in current use, such as subsidies for biofuels and feed-in tariffs for renewables, implicitly entail very high costs for abating carbon emissions. Some are intended to achieve other policy goals, such as energy security or developing cleaner technologies. Their cost-effectiveness in achieving these goals should be carefully assessed, taking into account their interactions with other policy instruments. If they are not cost-effective in these respects, consideration should be given to phasing out the use of these instruments and expanding the use of economic instruments.

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Governments also need to reform the estimated USD 55-90 billion of support provided each year to fossil fuel exploration, production and consumption in OECD countries and the USD 523 billion in energy subsidies in developing countries. While the stated objective of subsidies for consumers are often for social reasons, they are usually poorly targeted, expensive, often highly regressive and ultimately undermine climate policy action.

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To achieve the 2°C goal, ambitious mitigation actions and nonnegligible carbon prices need to start now. Delaying actions until after 2020 would mean steeper emissions cuts thereafter to “catch up” and higher carbon prices. Carbon prices fall rapidly once carbon markets in different jurisdictions are linked or more sectors and gases are included. Carbon prices needed to meet the same goal would need to be higher if energy technology options become constrained.

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Introduction Limiting emissions of CO2 and other greenhouse

This Policy Perspectives brochure gives an overview of

gases (GHGs) is vital in order to reduce the risks of

recent OECD findings on each of these forms of carbon

major future changes to the climate. In this context,

pricing. It documents the current use of different types

“carbon pricing” is a central issue. However, this term

of carbon pricing and fossil fuel support, and finally

can have several different meanings:

considers carbon prices for different policy approaches

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Placing an explicit price on GHG emissions, either by establishing taxes on the carbon content of various fuels or on the emissions of other GHGs, or by setting up an emission

that will be needed to reach internationally agreed goals to limit climate change. The overall conclusion is that explicit and implicit carbon prices vary considerably, both within and across countries.

trading system where the price of GHG emission allowances represent the “carbon price”.

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Placing an implicit price on carbon following the application of any other type of policy instrument that has an intended or unintended impact on GHG emissions.

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Placing a negative price on carbon, i.e. subsidising actions that lead to emissions of carbon dioxides in the form of subsidies or support to fossil-fuel production or use.

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The climate change challenge we face is so enormous that we cannot afford inefficient policies: countries need the most costeffective policy instruments.

2

Explicit carbon pricing An increasing number of countries use “carbon taxes” or emission trading systems to put a price on carbon and thereby reduce their emissions. Carbon taxes put an explicit price on a unit of carbon and the revenues generated can be used for example, to lower distortive taxes or to reduce public budget deficits. The amount of carbon that will be abated under carbon taxes is generally uncertain. In emission trading systems, the amount of carbon to be abated is fixed, but the price of carbon can fluctuate in order to meet that objective.

Emissions trading systems can also generate public revenues, but only if emission permits are auctioned and not distributed for free. Both of these approaches, in principle, can promote a cost-effective achievement of given abatement objectives – but the practical design of the taxes and trading systems in current use often leaves significant scope for improvement.1 The OECD’s Environmental Outlook to 2050 contains an overview of carbon pricing systems in place in different countries.2

Emissions trading The largest carbon emission trading system in operation is the European Union’s Emission Trading System (EU ETS). It has established an upper limit on the total emissions from installations in selected sectors (e.g. electricity generation; oil refineries; the iron & steel, pulp & paper, cement and aluminium sectors, intra-Union aviation). In part due to the current economic crisis, the prices of emission allowances are currently low (around EUR 5 per tonne of CO2 in early September 2013). In the most recent phase of the scheme, an increasing share of allowances is being auctioned.

Another large trading system has been established in California, United States. It was recently agreed to link the Californian trading system with its counterpart in Quebec, Canada from 1 January 2014. In an auction that took place in May 2013, the clearing price for allowances for 2013 emissions was USD 14 per tonne of CO2.

New Zealand has a nation-wide GHG emission trading system, Korea is preparing to implement one, and Chile is considering whether to establish one. Tokyo, Japan operates a local GHG emission trading system. China has recently introduced 7 local or regional pilot emission trading schemes.

1. OECD’s database on instruments used for environmental policy provides a lot of information on relevant taxes and trading systems; see www.oecd.org/env/policies/database.

2. OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction, OECD Publishing.doi: 10.1787/9789264122246-en.

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Carbon taxes There is a direct link between the carbon content of a

A key point is that it is the sum of all the tax elements

given fuel and the CO2 emissions that will result from combustion of that fuel. This suggests that from a climate perspective, the tax rates applied to different fossil fuels should be set at a rate based on their carbon content.

However, available information shows that instead of applying the same rate, countries apply different tax rates per unit of carbon to different fuels, and/or to different uses of a given fuel.

that will affect people’s use of the fuels and the related CO2 emissions; the names applied to the different “taxes” are not important in this regard. Figure 1 illustrates how it can be misleading to only consider the “carbon” element of the taxes: Whereas Sweden has much higher CO2 taxes than the other 5 countries shown in the graph, the total taxes on at least petrol and diesel do not stand out as being particularly high.

Figure 1 illustrates all taxes on fossil fuels, including carbon taxes as well as various excise taxes for six Northern European countries. Each of these countries apply taxes that are explicitly labelled as “carbon taxes” and they are shown as the bottom parts of each vertical bar for each fuel in question, with significant variations within and among most of the six countries.3

Figure 1. Comparison of carbon taxes and other taxes on selected fuels, EUR per tonne of CO2 350

Diesel Petrol Natural gas Coal Heating oil

300

In most cases, countries also apply other taxes on the same fuels, and the distinction between the “carbon” element and the “other” elements in the total taxes that are levied on a given fuel is somewhat arbitrary. In Figure 1, these other taxes are shown by the upper parts of (most of) the vertical bars.

In addition to the countries shown in Figure 1, several other jurisdictions apply explicit carbon taxes, including Slovenia, Japan and the provinces of British Columbia and Quebec in Canada.

EUR per tonne of CO2

250 200 150 100 50 0 Denmark

Finland

Iceland

Ireland

Norway

Source: The OECD database on instruments used for environmental policy.

Australia introduced a carbon tax in 1 July 2012, with the intention of transforming it to an emission trading system after three years. In July 2013, the Australian Government proposed to convert the tax into a trading system after two years instead. After a general election in September 2013 where the outgoing government lost its majority in the Parliament, the tax is likely to be abolished.

Notes: “Other taxes” include taxes levied on a per-volume or per-weight basis but does not include ad valorem taxes, such as VAT.

3. Figure 1 shows the main tax rates applied to the different fuels, but in several countries there are (normally) lower rates for products used in certain sectors, etc. The rates shown for heating oils are those that apply to the household sector.

4. OECD (2013), Taxing Energy Use: A Graphical Analysis, OECD Publishing.doi: 10.1787/9789264183933-en.

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Sweden

3

Implicit carbon pricing Any type of policy that affects GHG emissions will implicitly define a carbon price. This section summarises some of the findings of recent OECD studies that have analysed implicit carbon pricing.

Taxes on energy use Figure 1 aggregates the various taxes applied to selected fuels in the 6 countries included. The totals are an estimate of the implicit carbon prices applied to those fuels.

The OECD report, Taxing Energy Use: A Graphical Analysis,4 provides detailed “maps” of the energy taxes applied in all OECD countries, with the tax rates expressed as implicit rates per tonne CO2 and alternately, per unit of energy content. Figure 2 presents CO2 emissions on the horizontal axis and the related tax rates on the vertical axes, distinguishing between three broad categories of energy use: transport; heating and process use; and electricity.

As in most countries, energy products used in transport (mainly gasoline and diesel) are taxed significantly more

than energy products used for heating or process use, or to generate electricity (with an exception regarding residential electricity use in Denmark). This is linked to the broader range of policy goals that governments may aim to address in the transport sector compared to other areas of energy use. While the combustion of fossil fuel emits CO2 and certain air pollutants regardless of use, fuels used in road transport also contribute to other externalities, such as congestion, traffic accidents and noise, which may have an even higher social cost than these emissions.

In the absence of road pricing, which may be the best approach, road fuel consumption may be a rough proxy for these other external costs, since fuel use is correlated with distance driven. In addition, a number of countries formally or informally earmark road fuel taxes to fund road construction and maintenance, or use motor fuel taxes as a source of revenue more generally.

Figure 2. Taxation of energy in the OECD area on a carbon content basis

Source: OECD (2013), “Climate and Carbon: Aligning Prices and Policies”, OECD Environment Policy Papers, No. 1, OECD Publishing. doi: 10.1787/5k3z11hjg6r7-en.

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Within the heating and process use category, many countries tax energy products used for industrial or energy transformation purposes at lower rates than the same energy products used for residential or commercial purposes. This is often motivated by the interest of not undermining industrial competitiveness. In a number of other countries, however, the reverse holds, and energy used in industry and power generation is taxed at a higher rate than in the residential and commercial sectors. This is often linked to concerns about the social impacts of high energy prices and the desire to protect poorer households. However, policies that reduce energy prices for particular sectors can distort energy use in an environmentally damaging manner, and there are usually better mechanisms for addressing the concerns motivating these policies. For example, it is usually more effective from an environmental point of view to preserve the price signal sent by fuel taxes and address the impacts on industry or low-income families by more direct means, such as cash transfers that do not directly subsidise energy use.

The third category shown in each country profile is electricity generation. Electricity is a secondary energy product generated from some primary energy source, like natural gas, coal or wind. To take account of this, the maps show the fuels used to generate electricity.

This enables both the primary energy production and the significant amount of energy lost in converting fossil energy into electricity to be captured. Countries tax electricity in two ways: by taxing the fuels used to generate electricity, and/or by taxing the consumption of electricity. The country profiles take into account both types of tax. Where the consumption of electricity is taxed, the effective tax rates are calculated as if the electricity tax were an implicit tax on the underlying fuels used to make electricity, according to their relative proportions in the mix of primary energy used for electricity generation in the particular country.

Taxing Energy Use: A Graphical Analysis also allows comparisons of the implicit tax rates applied to different percentiles of total CO2 emissions. In Figure 3, effective tax rates for a few selected countries are presented from the lowest to the highest tax rate. The horizontal axis presents the proportion of the tax base (in tonnes of CO2), while the vertical axis presents the corresponding effective tax rate on carbon. The graph shows the rates at which different fractions are taxed.

Figure 3. Effective tax rates on a carbon-emission basis in selected countries EUR per tonne CO2 450 SWE

400 350 300

DEU ISR

250

JPN

200

The graph highlights the wide variance in effective tax rates on carbon both within and across OECD economies.

In general, the highest levels on the right side of these profiles represent the tax rates applied on transportation fuels.

150

AUS

100 50 0

USA

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Source: OECD (2013), Taxing Energy Use: A Graphical Analysis, OECD Publishing. doi: 10.1787/9789264183933-en.

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0.9

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Comparing implicit carbon pricing via different types of policy instruments Not just taxes, but any sort of policy instrument that intentionally or unintentionally has an impact on CO2 emissions, will implicitly establish a “carbon price”; that is, the cost to society of abating a tonne of CO2 using this instrument.5 Another 2013 OECD publication, Effective Carbon Prices, estimated the costs to society of a broad range of policy instruments applied in electricity generation, road transport, pulp & paper and cement, as well as households’ domestic energy use in selected countries; the amount of CO2eq emission reduction each of the instruments contributed to; and, hence, the cost per tonne of CO2eq per instrument.6 The report provides a snapshot of the post-policy situation compared to a counterfactual snapshot of no policy. It gives an indication of the relative incentives to abate carbon in 2010 within and across the countries examined. In spite of methodological and data limitations, the differences in magnitude of the abatement incentives are sufficiently large to provide a good level of confidence about the lessons to be drawn about the cost-effectiveness of different policy instruments in abating GHG emissions.

The 2013 OECD publication, Effective Carbon Prices found large differences in effective carbon prices: 1.

Within a given sector, across the countries covered.

2. Across the different sectors, within each of the countries.

3. Across the different instrument types, across all the countries covered.

In many respects, the last two findings are the most interesting and robust. There are a number of caveats that should be kept in mind when analysing the estimates. However, while there may be some uncertainty regarding the “ranking” of carbon prices within a given sector across countries, it is very unlikely that any caveat could “explain away” the latter two main findings – and they do not seem very sensitive to the exact year of study.

5. Some policy instruments, such as subsidies to fossil fuels, can contribute to increasing GHG emissions. The implicit carbon prices are in such cases negative. These are discussed further in the section below.

While carbon pricing via carbon taxes and emission trading systems is more visible, the costs to society of reducing greenhouse gas emissions via other types of policy instruments can be many times higher.

6. The book uses a methodology developed in a 2011 report by the Australian Productivity Commission, Carbon Emission Policies in Key Economies, cf. www.pc.gov.au/projects/study/ carbon-prices/report.

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Figure 4. Estimated average effective carbon prices in the electricity sector, by instrument type 2010 EUR per tonne of CO2 abated Feed-in tariffs Other subsidies

Trading systems Other regulations

Taxes Tax preferences

GBR – Feed-in tariff, PV KOR – One Million Green Homes programme GBR – Feed-in tariff, wind KOR – Regional Deployment Subsidy programme KOR – General Deployment Subsidy programme CHN – Jiangsu PV feed-in tariffs KOR – Feed-in tariffs ESP – Premiums for renewable energy generation JPN – National PV capital subsidies JPN – Tokyo PV capital subsidies JPN – Solar PV feed-in tariffs GBR – Feed-in tariff, hydroelectricity GBR – Feed-in tariff, anaerobic digestion JPN – Renewable Portfolio Standards JPN – Promoting the local introduction of new energy JPN – Supporting new energy operators (debt guarantee) GBR – Feed-in tariff, micro CHP GBR – Renewable energy certificate scheme CHN – Golden Sun demonstration scheme GBR – Feed-in tariff, existing micro-generators GER – Renewable Energy Sources Act (feed-in tariffs) GBR – Climate Change Levy exemption, renewables CHN – Subsidy for solar PV in buildings FRA – Feed-in tariffs EST – Renewable Energy and Cogeneration Support AUS – Renewable energy certificates (RECs) CHN – Biomass feed-in tariffs DNK – EU ETS – Indirect subsidy to renewable energy DNK – Subsidies for renewable energy generation GER – Feed-in tariff for combined heat and power CHN – Wind feed-in tariffs CHN – Value added tax exemption for wind power GBR – EU ETS, coal-to-gas substitution BRA – Feed-in tariff: biomass BRA – Feed-in tariff: wind GBR – Climate Change Levy exemption, CHP FRA – EU ETS – Supply-side effect GER – EU ETS, fuel switching DNK – EU ETS – coal-to-gas switching AUS – Queensland Gas Scheme (certificate trading) BRA – Feed-in tariff: small hydro EST – Increased electricity prices from several policies NZL – ETS KOR – Korea Certified Emission Reduction Scheme AUS – Greenhouse Gas Reduction Scheme CHN – Large Substitute for Small Programme -100

775 800

Figure 4 shows the average effective carbon prices in the electricity sector, by instrument type. It clearly demonstrates that feed-in tariffs and various (other) subsidy schemes entail the highest costs to society per tonne of CO2eq abated, in some cases by a considerable margin. Trading systems dominate the low-cost part of the graph.

Even if motor fuel taxes were not introduced with the aim of reducing greenhouse gas emissions, they in practice do so at a much lower cost per tonne abated than any other policy instrument.

0

100 200 300 400 500 600 700 2010 EUR per tonne of CO 2 abated

Source: OECD (2013), Effective Carbon Prices, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264196964-en.

Note: Ranges shown for some countries reflect different choices about assumptions used in the estimates. All the “Other regulations” covered in the electricity generation sector are renewable portfolio standards.

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Figure 5. Estimated effective carbon prices in the road transport sector, by instrument Figure 5 shows the estimated effective carbon prices in the road transport sector by instrument type.

With a few exceptions, fuel taxes dominate the low-cost, bottom side of the graph. “Tax preferences”, “Capital subsidies” and “Other regulations” all entail higher costs to society per tonne of CO2 abated – and in many cases, very substantially so.

The lower effective price of abating carbon achieved by taxes and emission trading systems compared with other instrument categories can be explained by their higher cost effectiveness.

With the exception of a support scheme for electrical vehicles in Estonia, policies promoting biofuels were the most costly policies for abating CO2 in the transport sector. The calculations probably underestimate the cost involved, inter alia because indirect land-use changes related to the production of biofuels were not taken into account.

Taxes

Tax preferences

Other subsidies

Other regulations

EST – Support for electric vehicles DNK – Biofuel mandate – Impact on diesel prices DNK – Biofuel mandate – Impact on petrol prices USA – Biofuel policies JPN – Biofuel tax preferences – Ethanol KOR – Biofuel tax rebate CHN – Tax preferences – Biodiesel AUS – Ethanol production grants NZL – Fuel tax exemption – Ethanol GER – Tax exemption and fuel mandate – Ethanol GBR – Renewable Transport Fuels Obligation – Ethanol GBR – Renewable Transport Fuels Obligation – Biodiesel BRA – Fuel mandate – Biodiesel BRA – Fuel mandate – Anhydrous ethanol GER – Tax exemption and fuel mandate – Biodiesel BRA – Fuel mandate – Hydrous ethanol FRA – Biofuel tax preferences – Ethanol RUS – Petrol taxes GER – Tax exemption and fuel mandate – Vegetable oil RUS – Diesel taxes AUS – Cleaner Fuels Grants Scheme NZL – Grants scheme – Biodiesel DNK – Petrol taxes GBR – Petrol taxes GER – Petrol taxes ESP – Petrol taxes – Leaded ESP – Petrol taxes – Unleaded, 97 octane or more FRA – Petrol taxes ESP – Petrol taxes – Unleaded, other GBR – Diesel taxes FRA – Biofuel tax preferences – Biodiesel KOR – Petrol taxes JPN – Petrol taxes RUS – Fuel levy exemption – Bioethanol DNK – Diesel taxes FRA – Diesel taxes EST – Petrol taxes GER – Diesel taxes ESP – Diesel taxes EST – Diesel taxes GBR – LPG taxes NZL – Petrol taxes KOR – Diesel taxes CHL – Petrol taxes JPN – Diesel taxes AUS – Petrol taxes KOR – LPG taxes AUS – Diesel taxes BRA – Petrol taxes RUS – Fuel levy exemption – Biodiesel GER – LPG taxes JPN – LPG taxes CHN – Fuel taxes NZL – LPG taxes USA – Petrol taxes FRA – LPG taxes USA – LPG taxes USA – Diesel taxes CHL – Diesel taxes BRA – Diesel taxes ESP – Boethanol taxes NZL – Diesel taxes

1 205 1 613 1 532

0

200

400

600

800

1 000 1 200

2010 EUR per tonne CO 2 abated Source: OECD (2013), Effective Carbon Prices, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264196964-en Note: Ranges shown for some countries reflect different choices about assumptions used in the estimates.

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Figure 6 illustrates another important finding of the study; namely that very large differences in the effective carbon prices were found across different sectors of the economy.7 In all the countries, the effective carbon prices in the two industrial sectors studied (pulp and paper, and cement) are a small fraction of those in the other sectors.

This may be linked to concerns about loss of international competitiveness.

From an economic point of view, reducing carbon emissions would be more efficient if different sectors faced similar abatement incentives. In addition, costs would be reduced if the most cost-effective types of policy instruments to limit CO2 emissions were applied. The recent empirical analysis conducted by OECD suggests that many of the policy instruments applied to reduce carbon emissions are cost-ineffective.

It may be objected that some policy instruments, for example subsidies for house insulation were not intended primarily to abate carbon emissions, and, that as a result, “judging” their “performance” in terms of costs per tonne of CO2 abated is “unfair”. Clearly the objective of the policy instrument is an important consideration in judging its effectiveness. However, all policies which have an impact on CO2 emissions were included in the analysis. For some of the instruments with very high effective carbon prices (e.g. measures put in place to promote biofuels and other renewable energy sources), carbon abatement has indeed been one of the main arguments applied in public debates in favour of their introduction.

Figure 6. Estimated effective carbon prices in the different sectors, by country, 2010 EUR per tonne of CO2 abated 250

2010 EUR per tonne CO2 abated

200

Electricity generation Road transport Pulp & paper Cement Households

150

100

50

0

Source: OECD (2013), Effective Carbon Prices, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264196964-en

7. The bars in Figure 6 represent weighted averages of the effective carbon prices found for different instruments applied in a given sector in the different countries. The amounts of abatement that each instrument is estimated to have contributed are used as weights in the calculation of the averages. The bars on the far right end of the graph show weighted averages of these averages, calculated across the countries for which effective carbon prices have een calculated, using emissions in the various sectors in the given countries as weights.

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Support to fossil-fuel production or use Explicit and implicit carbon pricing policy measures do not operate in a vacuum. OECD work shows a wide range of budgetary transfers and tax expenditures in place that encourage the production and use of fossil fuels.

As a result, governments often have a policy package that explicitly and implicitly puts a positive price on carbon on the one hand, while pursuing mechanisms that subsidise fossil fuel production and use on the other.

Such policy arrangements are not mutually supportive and can significantly undermine the effectiveness of overall climate policies. This argues strongly in favour of removing fossil fuel subsidies, which would also have the benefit of reducing public spending and increasing tax revenues. Over time, such reforms contribute to a shift away from fossil-fuelintensive activities and towards low-carbon technologies.

IEA estimates that fossil fuel consumption subsidies in developing and emerging economies amounted to USD 523 billion in 2011. The OECD (2013b) has identified over 550 individual support mechanisms that directly or indirectly encourage the production or consumption of fossil fuels across OECD countries. Producer support mechanisms include: i) government intervention in market mechanisms to alter costs or prices; ii) transfers of funds to producers; iii) reduction, rebate or removal of certain taxes; and iv) the government assuming part of the production risk. Examples of consumption support include direct transfers, tax relief, and rebates on energy products. A few country examples of consumption and production support mechanisms are summarised in Box 1.

Box 1. Examples of consumption and production support to fossil fuels Mexico Consumption support in Mexico is provided through a floating excise tax on transport fuels. The tax rate is designed to respond to changes in international benchmark prices, so that when international prices increase, the tax rates for diesel and gasoline decrease, and even become negative (i.e. a subsidy) when oil prices are particularly high. For example, when the cost of crude oil in 2008 averaged USD 100 per barrel, the total value of consumer support amounted to MXN 223 billion (USD 20 billion) or around 1.8% of GDP. In response to the government’s strategy to cut greenhouse gases by 50% by 2050 compared to the 2000 baseline, efforts are underway to better target energy subsidies and bring prices in line with costs. A new cash-transfer scheme was introduced to help poor households cover their energy needs, which is considered less distortionary than the floating excise tax. The 2013 Fiscal Reform proposed by the Mexican President includes the phase-out of gasoline subsidies, and electricity subsidies are being examined closely through the Energy Reform proposals.

Poland In Poland the coal industry receives the majority of the government support available to the energy sector. Over the period 1999 to 2011, that support exceeded PLN 25 billion (USD 7 billion). During the communist era, the coal industry benefitted from various social benefits for coal miners and the regulation of coal prices. During the economic transition in the 1990s, the coal sector was gradually restructured through a series of capacity-adjustment programmes that brought about the closure of unprofitable mines and reduced the level of employment in the coal sector. These programmes, however, failed to bring about an effective restructuring of the sector. Since 2011, in line with EU Council regulations, government support has been limited to the closure of mines, the treatment of health damages sustained by miners, and environmental liabilities related to past mining.

Sweden Producer support measures in Sweden are negligible since it only produces a small amount (about 1.2 million tonnes of coal equivalent) of peat for energy use; oil, natural-gas and coal are imported. Sweden, however, does provide consumer support through exemptions and reductions from energy- and CO2-taxes for particular users and uses of fossil fuels. In 2011, this amounted to about SEK 19.1 billion (USD 2.9 billion). It is estimated that 69% of the tax exemptions were linked to the consumption of diesel that is taxed at a lower rate than gasoline for transport purposes. Plans are underway to review the support mechanisms in order to reduce government tax expenditures.

Source: OECD (2013), An OECD-Wide Inventory of Support to Fossil-Fuel Production or Use, OECD Publishing, Paris, available at: www.oecd.org/iea-oecd-ffss.

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The overall value of the support mechanisms identified in the OECD inventory is estimated between USD 55 and USD 90 billion a year for the period 2005-11. Petroleum products (i.e. crude oil and its derivative products) have generally been the primary beneficiaries of these measures, accounting for about two-thirds of the total. This reflects the importance of oil in the OECD’s total primary energy supply and the relatively higher taxes that are generally levied on refined oil products.

The 2008 peak in Figure 7 can in part be explained by transfers provided through Mexico’s floating tax, as the international oil price reached a high of USD 140 per barrel.

While the evidence clearly shows that subsidies to fossil fuel consumption are generally poorly targeted, and thus the majority of the subsidy tends to accrue to high or middle income households, potential impacts of reforms on poor households still need to be addressed.

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Increase the availability and transparency of support data to facilitate an informed debate between parties in favour of and against such policies. Good data can also support peer review processes and encourage compliance with future subsidy reforms.

Consumer measures accounted for two thirds of total support over the 2005-11 period, though there remain considerable differences at the country level reflecting countries’ resource endowments, tax rates and other factors. For example, producer support remains significant in many countries that possess abundant fossil resources while several other OECD countries are large consumers of fossil fuels and do not produce any significant amounts of coal or hydrocarbons (e.g. France, Italy, Japan and Sweden). Overall, almost half of the measures listed in the OECD inventory directly target the end-use of fossil fuels while around a third benefit fossilfuel extraction, with only a few supporting intermediate stages of the supply chain (i.e. transportation, refining and processing).

•

Provide carefully targeted, temporary and transparent financial support to vulnerable groups during the transition period.

•

Where possible, integrate taxation and fossil fuel reforms in broader structural reforms.

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Demonstrate the government’s commitment to compensate vulnerable groups and to use freedup public funds in a beneficial way. This can be achieved through broad communication strategies, appropriate timing of subsidy removal, and implementation of compensatory social policies.

Despite the arguments in favour of reforming or eliminating special tax exemptions or outright fossil-fuel subsidies, it is in practice politically challenging to do so. This is in part due to the strong lobbying capacity of large companies benefitting from such exceptions, but also because of the potentially negative impacts reform can have on vulnerable households.

Experience from countries that have successfully reduced fossil fuel and electricity subsidies show four common strategies for success (IEA/OPEC/OECD/World Bank, 2011):

Figure 7. Support to fossil fuels in OECD countries by year and type of fuel Millions of current USD 100 000 80 000 60 000 40 000 20 000 0 2005

2006 Coal

2007

2008

Petroleum

2009

2010

2011

Natural Gas

Source: OECD (2013), Taxing Energy Use: A Graphical Analysis, OECD Publishing. doi: 10.1787/9789264183933-en.

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What carbon pricing to achieve international climate policy objectives?

Above sections focused on the empirical evidence on carbon pricing in OECD and other countries. Looking forward, what carbon pricing will be needed in the future to tackle climate change? The international agreements on climate change under the United Nations Framework Convention on Climate Change (UNFCCC) recognised the need for deep cuts in global GHG emissions in order to limit the global average temperature increase to 2 degrees Celsius (2°C) above pre-industrial levels.

Research suggests that if the world could stabilise GHG concentrations at 450 ppm CO2eq, the chance of keeping the global temperature increase under 2°C would be between 40% and 60%.

Using model-based simulations to estimate carbon prices to achieve certain climate mitigation goals can provide relative costs and benefits of different policy actions.

The OECD Environmental Outlook to 20508 analysed three hypothetical scenarios that could keep GHG concentrations at the end of the 21st century below 450 ppm. The 450 Core scenario assumes full flexibility in the timing of emission reductions up to the year 2100, and the use of mitigation options including biomass energy with carbon capture and storage (CCS) known as “BECCS”.

It further assumes that global co-operation is achieved for tackling climate change, and thus emission reduction is implemented through a fully harmonised carbon market that encompasses all regions, sectors and gases.

As all least-cost mitigation options are included, this scenario acts as the cost-effective reference point against which to compare the other scenarios. The 450 Accelerated Action scenario assumes greater mitigation efforts in the first half of the century, and less reliance on unproven emissions reduction technologies (like BECCS) in later decades. The 450 Delayed Action scenario reflects the current situation in that the level of mitigation is limited to the high end of the pledges that countries made in the Copenhagen Accord and Cancún Agreements (with strict land-use accounting rules and no use of surplus emission credits from the Kyoto Protocol commitment period).

This leads to less mitigation in the first half of this century compared to the 450 Core scenario, and significant additional mitigation efforts will have to be made after 2020 to “catch up”. It also assumes that the various domestic carbon markets are not linked until 2020.

8. OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction, OECD Publishing. doi: 10.1787/9789264122246-en.

9. Clarke et al. (2009), “International climate policy architectures: overview of the EMF 22 international scenarios”, Energy Economics 31 (2), S64-S81.

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The OECD’s model-based analysis projects rapidly increasing carbon prices in these scenarios to keep GHG concentrations at the end of the 21st century below 450 ppm. In the least-cost 450 Core scenario, curbing global emissions beyond 2020 would require a carbon price increasing to USD 325 per tonne of CO2eq in 2050 (in constant 2010 USD PPP exchange rates). The larger mitigation efforts in the 450 Accelerated Action scenario imply lower environmental risks but higher carbon prices than the 450 Core scenario, at least in the first decades.

By 2030, carbon prices would be about 50% higher in the 450 Accelerated Action scenario than in the 450 Core. In the 450 Delayed Action scenario, carbon prices vary between regions until 2020, ranging from zero for regions that do not have a binding pledge to more than USD 50 per tonne of CO2eq for the combined Japan and Korea region. These numbers depend on a number of crucial but uncertain assumptions about the interpretation of the pledges countries have made.

Without the possibility to trade permits, many low-cost mitigation options would remain unexploited, driving up the economic costs in the 450 Delayed Action scenario relative to the 450 Core scenario. In the longer run (to 2050), the 450 Delayed Action scenario requires more ambitious mitigation efforts to bring concentration levels back down to the 450 ppm target before the end of the century. For countries with an initially low carbon price, this implies a very rapid increase from 2020 onwards, whereas for other regions, the transition is a bit smoother. Nonetheless, by 2050, the global carbon price is higher in this scenario compared to the other two scenarios.

Clarke et al. (2009)9 compare carbon prices across a range of different models for harmonised scenarios, including 450 ppm stabilisation scenarios. The report shows a range of global carbon prices in 2020 of USD 15–263 (2005 USD). Also noteworthy is that many models were not able to simulate a 450 ppm stabilisation scenario without temporary overshooting of the target, or with incomplete participation. Clarke et al. noted that the exclusion of models that were not successful in producing the more challenging climate-action cases inherently biases the reported carbon prices and economic costs downward”.

However, more recent model comparison exercises (Kriegler et al., 2013) suggest that most model simulations by different modelling groups are able to project 450 ppm stabilisation scenarios.10 One way to keep mitigation costs as low as possible is through the linking of carbon markets. The OECD report “Addressing the competitiveness and carbon leakage impacts arising from multiple carbon markets: a modelling assessment” illustrates how direct linking of carbon markets can ensure that all low-cost options are exploited.11 By harmonising carbon prices, relatively expensive reduction options in certain regions are replaced by relatively low-cost options in other regions.

This result can also be reached through indirect linking, where several emission trading schemes allow credits from a common pool of offsets. A second way to keep carbon prices as low as possible is to include more sectors and gases in the mitigation policy. Table 1 illustrates how carbon prices fall rapidly once carbon markets are linked or more sectors and gases are included.

Table 1. Carbon prices in acting countries in multiple carbon markets scenarios 2020, USD 2007 per tonne of CO2eq Region Australia & New Zealand Canada EU & EFTA Japan & Korea Other European Annex I countries Russia USA Average, all acting

Partial

Offsets

Link

Offsets & Link

Incl. Agri.

Incl. Fin. Dem.

Incl. NonCO2 gases

All sources

75

44

40

24

74

60

35

18

117

76

40

24

112

79

57

36

86

55

40

24

83

52

28

17

259

159

40

24

257

187

178

124

21

14

40

24

21

11

3

2

0

0

40

24

0

0

0

0

64

41

40

24

59

47

26

19

114

72

40

24

111

81

60

41

Source: Lanzi, E., et al. (2013), "Addressing Competitiveness and Carbon Leakage Impacts Arising from Multiple Carbon Markets: A Modelling Assessment", OECD Environment Working Papers, No. 58, OECD Publishing. doi: 10.1787/5k40ggjj7z8v-en.

Note: World carbon prices for each of the scenarios are calculated as an average over acting countries, and weighted by emission reductions. As these carbon prices are based on different base years for exchange rates, they cannot directly be compared to the carbon prices reported in the Environmental Outlook to 2050.

10. Kriegler, Weyant, Blanford et al. (2013), “The role of technology for achieving climate policy objectives: overview of the EMF 27 study on technology and climate policy strategies”, Climatic Change, forthcoming.

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Figure 8. Economic impacts of technology choices for the 450 Accelerated Action scenario OECD AI

Russia and rest of AI

Rest of BRIICS

Rest of the world

World

Carbon price (right axis)

% impact on real income in 2050 0

Panel A. Economic impacts of the technology choices in 2050

Carbon price in 2050 (USD/tCO 2e) 600

-5

500

-10

400

-15

300

-20

200

-25

100

-30

0 450 scenario (all technologies)

Low efficiency and renewables

Nuclear phase-out

No CCS

Source: OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction, OECD Publishing. doi: 10.1787/9789264122246-en.

Notes: OECD-A1 = the group of OECD countries that are also part of Annex I of the Kyoto Protocol Foss w/o CCS Foss w/CCS Nuclear RestA1 = rest of Annex I countries not included in the OECD group BIICS = Brazil, India, Indonesia, China and South Africa Renewables Electricity generation (right axis) ROW= rest of the world

Panel B. Changes in the energy system in 2050

The reference point for the analysis behind OECD AI Table 1 is a stylised hypothetical Partial policy scenario % share in the power mix Electricity generation (TWh) where only a smaller group of countries act, and with 10 800 100 some types of emissions excluded. This scenario is 10the 600 based on the pledges made by Annex I countries in 80 Copenhagen Accord; international permit trading 10 is not 400 allowed.

All the scenarios in Table 1 are based on the 60 10 200 Partial policy scenario, but either add linking options or 10 000 include certain sectors or gases. The Offsets scenario 40 includes indirect linking of carbon markets through the 9 800 use of a common offset scheme. By assumption, only 20 600 sectors in non-acting countries that are covered by9 ETS in acting countries are considered as eligible sources 9 400 0 for offsets, with a cap on equal of the Nuclearto 20% No CCSemissions Low 450 scenario phase-outThe second response (all reduction inefficiency the Partial scenario. andis a direct linking (Link scenario) among technologies) policy considered renewables the domestic ETSs of acting countries, where regulated entities can trade emission allowances with another. The Rest of BRIICS of allowances acrossElectricity participating countries % share in allocation the power mix generation (TWh) 500 100 corresponds to the domestic targets defined in the17 Partial scenario. These policy responses are implemented in the 17 000 80 model in a stylised way, since the model cannot consider all frictions that are present in the markets, etc. 16 500

60

16 000 The Incl. Agri. scenario includes emissions from the agricultural sectors; similarly, final demand emissions 15 500 (emission related to households and government) are 20 included in the scenario Incl. Fin. Dem. Finally, the most 15 000 inclusive scenario (All sources) includes all emission 0 sources and sectors in the climate policy. A crucial14 500 Nuclear No CCS Low 450 scenario assumption in all these scenarios is that the same phase-out efficiency (all economy-wideand emission reduction needs to be achieved, technologies)

40

renewables

i.e. any low-cost mitigation efforts by sectors or gases Russia and rest of AI that are excluded in the Partial scenario need to be % share in the power mix Electricity generation (TWh) compensated by increased efforts in reducing the 1 600 100 emission sources that are covered by the scheme.

1 550

80

Sensitivity analysis on the availability of different 1 500 technology options for the Environmental Outlook’s 60 450 Accelerated Action scenario shows that, to keep the 1 450 cost 40 of mitigation as well as carbon prices low, multiple 1 400 technology options are needed in transformation pathways towards a carbon-free energy system (using 20 1 350 nuclear energy and carbon capture and storage (CCS), and speeding-up technology developments for energy 1 300 0 efficiency450 and renewables).

Limiting any of these No CCS Nuclear Low scenario phase-out efficiency (all technology options would lead to higher carbon prices, as andthe ENV-Linkages model. The technologies) illustrated in Figure 8 using renewables 450 scenario (all technologies) refers to the 450 Accelerated Action scenario, where all Rest technologies are available of the world for mitigation costs as low as possible (within % keeping share in the power mix Electricity generation (TWh) 9 200 100 boundaries set by capacity constraints). Compared to the default assumptions in the 450 Accelerated Action scenario, 9 100 80 efficiency and renewables scenario assumes the Low less energy-efficiency improvement in energy use in 9 000 60 production, and slower increases in renewable energy 8 900 production. The Nuclear phase-out scenario assumes that 40 after 2020, no new nuclear unit will be built, so that the 8 800 world total nuclear capacity by 2050 will be reduced 20 of the natural retirement of existing plants. because 8 700 Finally, the No CCS scenario assumes no greater use 8 600 0 technologies beyond the levels projected in the of CCS Nuclear No CCS Low 450 scenario Baseline. Kriegler et al. (2013) present similar scenario phase-out efficiency (all analysis technologies) for a much widerand group of models.

renewables

11. Lanzi, E., et al. (2013), “Addressing Competitiveness and Carbon Leakage Impacts Arising from Multiple Carbon Markets: A Modelling Assessment”, OECD Environment Working Papers, No. 58, OECD Publishing. doi: 10.1787/5k40ggjj7z8v-en.

OECD POLICY PERSPECTIVES PRICING CARBON - 15

It should be stressed, however, that in such modelling exercises, the projected carbon prices are relatively sensitive to model assumptions regarding baseline emission developments; developments in the energy system, including on improvements in energy efficiency; and the speed with which households and firms can alter their behaviour in light of the higher carbon pricing. This sensitivity is not least due to the fact that carbon prices reflect the situation “at the margin” (i.e. the marginal cost of emission reductions), whereas other indicators of climate costs, such as real income losses, reflect an aggregated cost of emission reductions. Figure 8 illustrates this: cost of mitigation in terms of reduction in global real income is particularly detrimental; for slow developments of energy efficiency and renewable power technologies, whereas a lack of availability of CCS increases carbon prices most. In sum, model-based simulations of different mitigation pathways in the coming decades indicate that:

•

Ambitious mitigation actions and non-negligible carbon prices are need starting now to limit the global average temperature increase to 2 degrees Celsius (2°C) above pre-industrial levels at least cost.

•

Given the size of the problem, we cannot afford inefficient policies: least-cost solutions and marketbased instruments are needed to keep carbon prices as low as possible.

•

Delaying actions until after 2020 would mean steeper emissions cuts thereafter to “catch up” and higher carbon prices.

•

Carbon prices fall rapidly once carbon markets in different jurisdictions are linked or more sectors and gases are included.

•

Carbon prices needed to meet the same goal would need to be higher if energy technology options become constrained.

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Relevant OECD References Lanzi, E., et al. (2013), “Addressing Competitiveness and Carbon Leakage Impacts Arising from Multiple Carbon Markets: A Modelling Assessment”, OECD Environment Working Papers, No. 58, OECD Publishing. doi: 10.1787/5k40ggjj7z8v-en.

OECD (2013), “Climate and Carbon: Aligning Prices and Policies”, OECD Environment Policy Papers, No. 1, OECD Publishing. doi: 10.1787/5k3z11hjg6r7-en.

OECD (2013), Effective Carbon Prices, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264196964-en.

OECD (2013), Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil Fuels 2013, OECD Publishing. doi: 10.1787/9789264187610-en.

OECD (2013), An OECD-Wide Inventory of Support to Fossil-Fuel Production or Use, OECD Publishing, Paris, available at: www.oecd.org/iea-oecd-ffss.

OECD (2013), Taxing Energy Use: A Graphical Analysis, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264183933-en.

OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction, OECD Publishing. doi: 10.1787/9789264122246-en.

OECD Contact BRAATHEN Nils Axel, ENV/EPI, Nils-Axel.BRAATHEN@oecd.org

For more information: www.oecd.org/env/tools-evaluation/carbon-prices.htm

OECD POLICY PERSPECTIVES PRICING CARBON - 17

For more information: www.oecd.org/env/tools-evaluation/carbon-prices.htm