Why does emissions trading under the EU Emissions Trading System (ETS) not affect firms’ competitiveness? Empirical findings from the literature

Environmental policies may have important consequences for firms’ competitiveness or profitability. For the European Union Emissions Trading System (EU ETS) the empirical literature documents that significant emissions reductions have resulted from it. Surprisingly, however, the literature shows that there have been hardly any concurrent negative effects on firms’ competitiveness during the first two phases of the scheme (2005–2012). We show that the main explanations for the absence of negative impacts on competitiveness are a large over-allocation of emissions allowances leading to a price drop and the ability of firms to pass costs onto consumers in some sectors. Cost pass-through combined with free allocation, in turn, partly generated windfall profits. In addition, the relatively low importance of energy costs indicated by their average share in the budgets of most manufacturing industries may have limited the impact of the EU ETS. Finally, small but significant stimulating effects on innovation have been found so far. Several factors suggest that over-allocation is likely to remain substantial in the upcoming periods of the scheme. Therefore, we expect to see no negative competitiveness effects from the EU ETS in Phases III and IV (2013–2030).

Key policy insights

• Empirical literature on the EU ETS shows that there have been hardly any effects on firms’ competitiveness or profitability.

• One main explanation is a large over-allocation of emissions allowances leading to a price drop. This reduced incentives for innovation.

• Moreover, firms were able to pass costs on to consumers in some sectors which partly generated windfall profits.

• Innovation effects have so far been small but positive.

• We expect to see no negative competitiveness effects on regulated firms in the near future suggesting that no further reliefs for regulated firms are required.

     

Aligning emissions trading and feed-in tariffs in China

In 2013, China launched its domestic pilot emissions trading scheme (ETS) as a cost-effective strategy to reduce CO₂ emissions. Theoretically, the ETS can interact with the feed-in tariffs (FITs) applied to renewable energies (REN). This article presents a simple method to demonstrate how FITs can be adjusted based on the evolution of ETS carbon prices in order to provide a cost-effective climate policy package in China. First, by using provincial data and wind and solar power as examples, it calculates the implicit carbon prices that FITs generate in different Chinese provinces and finds that they are much higher than current carbon prices in the pilot ETS. This shows the necessity of using both instruments to guarantee current level incentives to develop REN for climate change purposes, at least in the short and medium terms. Second, by keeping the annual total carbon price level stable (the sum of the implicit FIT carbon price and the ETS carbon price), and taking into account the cost evolution of REN development, this article demonstrates, for the 2018–2020 period, that FIT should decrease at an annual rate of 3.04–4.63% (for wind) and 7.84–8.87% (for solar) based on different growth rates for progressive national ETS carbon prices.

Policy relevance

There are a number of studies and debates on the interactions between climate policies in Europe in particular, ETS and subsidies for REN. The key issue is that a climate policy package should be cost-efficient and the implementation of one policy should not jeopardise the performance of another. For a country like China, a considerable scale effect on climate target achievement and total cost savings could be produced by the careful design of the climate policy package. FIT and ETS, which are cost-efficient policies if implemented separately, will very probably constitute a major climate policy package in the future in China, which is aiming to limit the use of command-and-control policies. So far, there is some debate on how to reduce FIT for wind power in China due to development cost changes. But discussions are lacking on the linkage between FIT and ETS. This paper fills this gap.     

Developing Africa’s energy mix

Africa is growing rapidly both in terms of population size and economically. It is also becoming increasingly clear that fossil fuels impose a high price on society through local environmental pollution and Africa’s particular vulnerability to climate change. At the same time, Africa has an excellent renewable energy potential and prices for renewable energy are reaching the price range of fossil fuels. Comparing results from state-of-the-art Integrated Assessment Models we find different options for achieving a sustainable energy supply in Africa. They have in common, however, that strong economic development is considered compatible with the 2°C climate target. Taking both challenges and appropriate solutions into account, some models find that a complete switch to renewable energy in electricity production is possible in the medium term. The continental analysis identifies important synergy effects, in particular the exchange of electricity between neighbouring countries. The optimal energy mix varies considerably between African countries, but there is sufficient renewable energy for each country. The intermittency and higher capital intensity of renewable energy are important challenges, but proven solutions are available for them. In addition, we analyse the political economy of a sustainable energy transition in Africa.

Key policy insights

• An almost complete shift towards renewable energy (RE) is considered feasible and affordable in Africa.

• By 2050, electricity generation could be sourced largely from solar, wind and hydro power.

• Prices for RE in Africa are now within the price range of fossil fuels, partly due to the excellent RE potential.

• The optimal energy mix varies strongly between countries, but RE is sufficiently available everywhere.

• Addressing intermittency is possible, but requires investments and cooperation on the grid.

     

Challenges for hydropower-based nationally determined contributions: a case study for Ecuador

Hydropower is the dominant renewable energy source to date, providing over two-thirds of all renewable electricity globally. For countries with significant hydropower potential, the technology is expected to play a major role in the energy transition needed to meet nationally determined contributions (NDCs) for greenhouse gas (GHG) emission reductions as laid out in the Paris Agreement. For the Republic of Ecuador, large hydropower is currently considered as the main means for attaining energy security, reducing electricity prices and mitigating GHG emissions in the long-term. However, uncertainty around the impacts of climate change, investment cost overruns and restrictions to untapped resources may challenge the future deployment of hydropower and consequently impact decarbonization efforts for Ecuador’s power sector. To address these questions, a partial equilibrium energy system optimization model for Ecuador (TIMES-EC) is used to simulate alternative electricity capacity expansion scenarios up to 2050. Results show that the share of total electricity supplied by hydropower in Ecuador might vary significantly between 53% to 81% by 2050. Restricting large hydropower due to social-environmental constraints can cause a fourfold increase in cumulative emissions compared to NDC implied levels, while a 25% reduction of hydropower availability due to climate change would cause cumulative emissions to double. In comparison, a more diversified power system (although more expensive) which limits the share of large hydropower and natural gas in favour of other renewables could achieve the expected NDC emission levels. These insights underscore the critical importance of undertaking detailed whole energy system analyses to assess the long-term challenges for hydropower deployment and the trade-offs among power system configuration, system costs and expected GHG emissions in hydropower-dependent countries, states and territories.

Key policy insights

• Ecuador’s hydropower-based NDC is highly vulnerable to the occurrence of a dry climate scenario and restrictions to deployment of large hydropower in the Amazon region.

• Given Ecuador’s seasonal runoff pattern, fossil-fuel or renewable thermoelectric backup will always be required, whatever the amount of hydropower installed.

• Ecuador’s NDC target for the power sector is achievable without the deployment of large hydropower infrastructure, through a more diversified portfolio with non-hydro renewables.

     

Power,coalitions and institutional change in South African climate policy

This paper examines power relations, coalitions and conflicts that drive and hinder institutional change in South African climate policy. The analysis finds that the most contested climate policies are those that create distributional conflicts where powerful, non-poor actors will potentially experience real losses to their fossil fuel-based operations. This finding opposes the assumption of competing objectives between emissions and poverty reduction. Yet, actors use discourse that relates to potentially competing objectives between emissions reductions, jobs, poverty reduction and economic welfare.

The analysis relates to the broader questions on how to address public policy problems that affect the two objectives of mitigating climate change and simultaneously boosting socio-economic development. South Africa is a middle-income country that represents the challenge of accommodating simultaneous efforts for emissions and poverty reduction.

Institutional change has been constrained especially in the process towards establishing climate budgets and a carbon tax. The opposing coalitions have succeeded in delaying the implementation of these processes, as a result of unequal power relations. Institutional change in South African climate policy can be predominantly characterized as layering with elements of policy innovation. New policies build on existing regulations in all three cases of climate policy examined: the climate change response white paper, the carbon tax and the renewable energy programme. Unbalanced power relations between coalitions of support in government and civil society and opposition mainly from the affected industry result in very fragile institutional change.

Key policy insights

• The South African government has managed to drive institutional change in climate policy significantly over the past 7 years.

• Powerful coalitions of coal-related industries and their lobbies have constrained institutional change and managed to delay the implementation of carbon pricing measures.

• A successfully managed renewable energy programme has started to transform a coal- and nuclear-powered electricity sector towards integrating sustainable energy technologies. The programme is vulnerable to intergovernmental opposition and requires management at the highest political levels.

• Potential conflict with poverty reduction measures is not a major concern that actively hinders institutional change towards climate objectives. Predominantly non-poor actors frequently use poverty-related discourse to elevate their interests to issues of public concern.

     

Which policy instruments attract foreign direct investments in renewable energy?

Reducing GHG emissions and mitigating climate change would require significant investments in renewable energy technologies. Foreign direct investments (FDI) in renewable energy (RE) have increased over the last years, contributing to the diffusion of RE globally. In the field of climate policy, there are multiple policy instruments aimed at attracting investments in renewable energy. This article aims to map the FDI flows globally including source and destination countries. Furthermore, the article investigates which policy instruments attract more FDI in RE sectors such as solar, wind and biomass, based on an econometric analysis of 137 Organisation for Economic Co-operation and Development (OECD) and non-OECD countries. The results show that Feed in Tariffs (FIT) followed by Fiscal Measures (FM), such as tax incentives and Renewable Portfolio Standards (RPS), are the most significant policy instrument that attract FDI in the RE sector globally. Regarding carbon pricing instruments, based on our analysis, carbon tax proved to be correlated with high attraction of FDI in OECD countries, whereas Emissions Trading Schemes (ETS) proved to be correlated with high attraction of FDI mainly in non-OECD countries.

Key policy insights

• Feed in Tariffs is the most significant policy instrument that attracts FDI in the Renewable Energy sector globally.

• Fiscal Measures (FM), such as tax incentives, show a significant and positive impact on renewable energy projects by foreign investors, and particularly on solar energy.

• Carbon pricing instruments, such as carbon taxation and emissions trading, proved to attract FDI in OECD and non-OECD countries respectively.

• Public investments, such as government funds for renewable energy projects, proved not as attractive to foreign private investors, perhaps because public funds are not perceived as stable in the long run.

     

Reducing global GHG emissions by replicating successful sector examples: the ‘good practice policies’ scenario

This article shows the potential impact on global GHG emissions in 2030, if all countries were to implement sectoral climate policies similar to successful examples already implemented elsewhere. This assessment was represented in the IMAGE and GLOBIOM/G4M models by replicating the impact of successful national policies at the sector level in all world regions. The first step was to select successful policies in nine policy areas. In the second step, the impact on the energy and land-use systems or GHG emissions was identified and translated into model parameters, assuming that it would be possible to translate the impacts of the policies to other countries. As a result, projected annual GHG emission levels would be about 50 GtCO₂e by 2030 (2% above 2010 levels), compared to the 60 GtCO₂e in the ‘current policies’ scenario. Most reductions are achieved in the electricity sector through expanding renewable energy, followed by the reduction of fluorinated gases, reducing venting and flaring in oil and gas production, and improving industry efficiency. Materializing the calculated mitigation potential might not be as straightforward given different country priorities, policy preferences and circumstances.

Key policy insights

• Considerable emissions reductions globally would be possible, if a selection of successful policies were replicated and implemented in all countries worldwide.

• This would significantly reduce, but not close, the emissions gap with a 2°C pathway.

• From the selection of successful policies evaluated in this study, those implemented in the sector ‘electricity supply’ have the highest impact on global emissions compared to the ‘current policies’ scenario.

• Replicating the impact of these policies worldwide could lead to emission and energy trends in the renewable electricity, passenger transport, industry (including fluorinated gases) and buildings sector, that are close to those in a 2°C scenario.

• Using successful policies and translating these to policy impact per sector is a more reality-based alternative to most mitigation pathways, which need to make theoretical assumptions on policy cost-effectiveness.

     

South East Europe electricity roadmap – modelling energy transition in the electricity sectors

One of the most important challenges for the South East Europe region will be replacing more than 30% of its presently installed fossil fuel generation capacity by the end of 2030, and more than 95% by 2050 if its age structure is considered. This requires a strong policy framework to incentivise new investments in a region currently lacking investors, but also presents an opportunity to shape the electricity sector over the long term according to the broader energy transition strategy of the EU and the Energy Community. The aim of this paper is to assess what type of long-term pathways exist for electricity sector development in the region if they follow the energy transition process of the EU. In this model-based scenario assessment, long term electricity sector futures are explored using a set of interlinked electricity models evaluating the level of renewable energy investment required in the region to reach a deep decarbonization target, assuming emission reduction above 94% by 2050 compared to 1990 in line with the long term market integration and climate policy goals of the EU. It also explores what are the most important system wide impacts of the high deployment of renewable energy concerning generation adequacy and security of supply.

Key policy insights

• Energy policies in the South East Europe (SEE) region, both at the national and regional level, should focus on enabling renewable energy integration, as this will be a key component of the future energy mix.

• EU and Energy Community policies should be incorporated into national energy planning to ensure that SEE countries embark on the energy transition process at an early stage.

• Stranded costs should be carefully considered in decision-making on new fossil-fuel generation and gas network investment in order to avoid lock-in to carbon intensive technologies.

• If consistent decarbonization policy prevails, with a significant and persistent CO2 price signal, the role of natural gas remains transitory in the region.

• The SEE region offers relatively cheap decarbonization options: the power sector can reduce GHG emissions above 94% by 2050 in the modelled scenarios.

     

Electricity regulation in the Chinese national emissions trading scheme (ETS): lessons for carbon leakage and linkage with the EU ETS

Carbon leakage is central to the discussion on how to mitigate climate change. The current carbon leakage literature focuses largely on industrial production, and less attention has been given to carbon leakage from the electricity sector (the largest source of carbon emissions in China). Moreover, very few studies have examined in detail electricity regulation in the Chinese national emissions trading system (which leads, for example, to double counting) or addressed its implications for potential linkage between the EU and Chinese emissions trading systems (ETSs). This article seeks to fill this gap by analysing the problem of ‘carbon leakage’ from the electricity sector under the China ETS. Specifically, a Law & Economics approach is applied to scrutinize legal documents on electricity/carbon regulation and examine the economic incentive structures of stakeholders in the inter-/intra-regional electricity markets. Two forms of ‘electricity carbon leakage’ are identified and further supported by legal evidence and practical cases. Moreover, the article assesses the environmental and economic implications for the EU of potential linkage between the world’s two largest ETSs. In response, policy suggestions are proposed to address electricity carbon leakage, differentiating leakage according to its sources.

Key policy insights

• Electricity carbon leakage in China remains a serious issue that has yet to receive sufficient attention.

• Such leakage arises from the current electricity/carbon regulatory framework in China and jeopardizes mitigation efforts.

• With the US retreat on climate efforts, evidence suggests that EU officials are looking to China and expect an expanded carbon market to reinforce EU global climate leadership.

• Given that the Chinese ETS will be twice the size of the EU ETS, a small amount of carbon leakage in China could have significant repercussions. Electricity carbon leakage should thus be considered in any future EU–China linking negotiations.

     

Energy-intensive manufacturing sectors in China: policy priorities for achieving climate mitigation and energy conservation targets

In this study, a long-range energy alternative planning (LEAP) model was built to evaluate the relative priority of three kinds of policies expected to be implemented for the energy-intensive manufacturing sectors (EIMS) in China to achieve CO₂ mitigation and energy conservation targets. These policies encourage (1) the use of more electricity instead of coal; (2) the continuous improvement of energy efficiency; and (3) a shift to other less energy-demanding sectors. The results indicate that the policy of shifting economic activity from the EIMS to other sectors is most helpful for China to achieve its targets of mitigating CO₂ emissions and conserving energy. Encouraging the EIMS to use more electricity can help China to achieve a higher proportion of non-fossil-fuel based energy in its overall primary energy consumption. No single policy will allow China to achieve all the targets, emphasizing the need for an integrated policy design that combines all types of policies.

Key policy insights

• The policy of encouraging a shift to less energy intensive industries should receive the highest priority in aiming to peak China's energy-related CO₂ emissions as early as possible, and lower overall CO₂ emissions, coal consumption and primary energy consumption in the long run.

• Encouraging a shift to electricity should go hand-in-hand with greater energy efficiency, otherwise such a policy cannot help China significantly reduce energy-related CO₂ emissions.

• Encouraging the EIMS to use more electricity should receive the highest priority in helping China achieve a higher proportion of non-fossil-fuel based energy in its overall primary energy consumption.

     

Sustainable energy transition in developing countries: the role of energy aid donors

Dialogues on global climate policy are increasingly discussing the sustainable energy transition, with Goal 7 of the UN’s Sustainable Development Goals highlighting the importance of affordable and clean energy. This study looks at foreign aid as a carrier of global climate policy and examines donor behaviour in the energy sector. By examining donor behaviour when giving energy aid, one can grasp how the donor community helps recipients achieve a sustainable energy transition. A panel of donor–recipient pairs, covering 29 donors and 99 recipients, was constructed for the period between 1996 and 2013, using data from Organisation for Economic Co-operation and Development Creditor Reporting System (OECD CRS), International Energy Agency (IEA) and World Development Indicators (WDI). The pair-year panel data were empirically analysed using a two-part model to test whether energy aid donors respond to recipients’ needs with regard to renewable energy and residential electricity. The findings demonstrate that donors respond to recipients’ sustainable energy needs, both renewable and residential, when selecting recipients. Moreover, donors tend to increase the amount of aid based on renewable energy needs. The findings also highlight the significant role of international climate policy, as donors have changed their energy aid-giving patterns since the start of the Kyoto Protocol. Contrary to the common belief in the aid-giving literature, this study shows that, with regard to energy aid, donor interests are more weakly related to recipient selection than are recipient needs.

Key policy insights

• Donors are influenced by the residential energy needs of recipients when giving energy aid, which aligns with the Sustainable Development Goals.

• Donors’ energy aid-giving patterns changed between the periods before and after entry into force of the Kyoto Protocol, highlighting the significant role of international climate change policy.

• Policy makers and aid practitioners can steer donors to continue to allocate resources to the development of recipients’ energy policy and to help recipients prepare institutional structures to attract private investment in sustainable energy.

     

Perceived fairness and public acceptability of carbon pricing: a review of the literature

While carbon pricing is widely seen as a crucial element of climate policy and has been implemented in many countries, it also has met with strong resistance. We provide a comprehensive overview of public perceptions of the fairness of carbon pricing and how these affect policy acceptability. To this end, we review evidence from empirical studies on how individuals judge personal, distributional and procedural aspects of carbon taxes and cap-and-trade. In addition, we examine preferences for particular redistributive and other uses of revenues generated by carbon pricing and their role in instrument acceptability. Our results indicate a high concern over distributional effects, particularly in relation to policy impacts on poor people, in turn reducing policy acceptability. In addition, people show little trust in the capacities of governments to put the revenues of carbon pricing to good use. Somewhat surprisingly, most studies do not indicate clear public preferences for using revenues to ensure fairer policy outcomes, notably by reducing its regressive effects. Instead, many people prefer using revenues for ‘environmental projects’ of various kinds. We end by providing recommendations for improving public acceptability of carbon pricing. One suggestion to increase policy acceptability is combining the redistribution of revenue to vulnerable groups with the funding for environmental projects, such as on renewable energy.

Key policy insights

• If people perceive carbon pricing instruments as fair, this increases policy acceptability and support.

• People’s satisfaction with information provided by the government about the policy instrument increases acceptability.

• While people express high concern over uneven distribution of the policy burden, they often prefer using carbon pricing revenues for environmental projects instead of compensation for inequitable outcomes.

• Recent studies find that people’s preferences shift to using revenues for making policy fairer if they better understand the functioning of carbon pricing, notably that relatively high prices of CO₂-intensive goods and services reduce their consumption.

• Combining the redistribution of revenue to support both vulnerable groups and environmental projects, such as on renewable energy, seems to most increase policy acceptability.

     

The impact of the Tokyo Metropolitan Emissions Trading Scheme on reducing greenhouse gas emissions: findings from a facility-based study

This paper provides a detailed analysis of the Tokyo Metropolitan Emissions Trading Scheme (Tokyo ETS), Japan’s first emissions trading scheme with mandatory cap initiated by the government of Tokyo. Unlike trading schemes in other countries, the Tokyo ETS covers indirect emissions from the commercial sector. It is well known that a variety of market barriers impede full realization of energy efficiency opportunities, especially in the commercial sector. Experiences with the Tokyo ETS should therefore provide important lessons for the design of climate change mitigation policies, especially when targeting the commercial sector. The emissions from covered entities have been drastically reduced from those at the scheme’s outset, with an average 14% reduction as of the end of the first commitment period of five years (2010–2014) compared with 2009 levels. This paper shows that the Tokyo ETS alone did not cause these reductions; there were other drivers. Among them, the energy savings triggered by the Great East Japan Earthquake in 2011 were crucial. The contribution of credit trading, in contrast, was limited since most of the covered entities reduced emissions by themselves. Through an investigation of official reports, an assessment of the emissions data from the covered entities compared to those of uncovered entities and in-depth interviews with firms covered by the scheme, this paper confirms that the main drivers of emissions reductions by covered entities were separate from the ETS. In fact, the advisory aspect of the scheme seems to be much more important in encouraging energy-saving actions.

Key policy insights

• Most of the observed emission reductions were not caused by the Tokyo ETS alone.

• An advisory instrument was crucial to the effectiveness of the Tokyo ETS.

• The experience of the Tokyo ETS suggests that making full use of the advantages of emissions trading is difficult in the case of the commercial sector.

• Price signals have not provided a stimulus to climate change mitigation actions, which implies that establishing a cap to yield effective carbon prices poses a challenge.

     

The differentiated impact of emissions trading system based on company size

Most countries implementing an emissions trading system (ETS), such as EU member states, California in the US, or South Korea, are generally targeting large sized companies, which consume energy above a specific threshold. However, previous studies using computable general equilibrium (CGE) models have analyzed climate policies without considering company size. This may have led to inaccurate results because the impacts of climate policy would differ depending on the coverage of regulated companies. Accordingly, this study examines the environmental and economic impacts of greenhouse gas emission reduction policies, assuming policy results vary by firm size, as covered by the Korean emission trading system. To this end, a CGE model with a separate social accounting matrix based on company size is used to compare three scenarios that reflect different types of carbon pricing methods. The results show that greenhouse gases will be reduced to a lower extent and utility will decrease more if mitigation policies are only imposed to large companies.

Key policy insights

• Carbon pricing policies should consider the different impacts on companies of different sizes and industry sectors.

• Without considering the different sizes of companies covered by an ETS, the expected carbon price and its economic impact will be underestimated.

• Small and medium-sized companies will face more negative impacts than large companies in some industry sectors under an ETS, even if the mitigation burden is only faced by large companies.

     

Implications of Japan’s long term climate mitigation target and the relevance of uncertain nuclear policy

Achieving long-term climate mitigation goals in Japan faces several challenges, starting with the uncertain nuclear power policy after the 2011 earthquake, the uncertain availability and progress of energy technologies, as well as energy security concerns in light of a high dependency on fuel imports. The combined weight of these challenges needs to be clarified in terms of the energy system and macroeconomic impacts. We applied a general equilibrium energy economic model to assess these impacts on an 80% emission reduction target by 2050 considering several alternative scenarios for nuclear power deployment, technology availability, end use energy efficiency, and the price of fossil fuels. We found that achieving the mitigation target was feasible for all scenarios, with considerable reductions in total energy consumption (39%–50%), higher shares of low-carbon sources (43%–72% compared to 15%), and larger shares of electricity in the final energy supply (51%–58% compared to 42%). The economic impacts of limiting nuclear power by 2050 (3.5% GDP loss) were small compared to the lack of carbon capture and storage (CCS) (6.4% GDP loss). Mitigation scenarios led to an improvement in energy security indicators (trade dependency and diversity of primary energy sources) even in the absence of nuclear power. Moreover, preliminary analysis indicates that expanding the range of renewable energy resources can lower the macroeconomic impacts of the long term target considerably, and thus further in depth analysis is needed on this aspect.

Key policy insights

• For Japan, an emissions reduction target of 80% by 2050 is feasible without nuclear power or CCS.

• The macroeconomic impact of such a 2050 target was largest without CCS, and smallest without nuclear power.

• Energy security indicators improved in mitigation scenarios compared to the baseline.

     

Low carbon scenarios and policies for the power sector in Botswana

The Government of Botswana has pledged a nationally determined contribution (NDC) as a commitment to the Paris Agreement. For the power sector, the NDC states that the government expects renewable energy (RE) to meet 25% of peak electricity demand by 2030. However, due to high initial cost of RE technologies, the government plans to maintain a coal-based power system in the future. Therefore, the purpose of this paper is to examine Botswana’s national plan from an economic perspective, using scenario and cost analysis, to explore the possibility of the power sector’s low carbon transition in the light of Botswana’s NDC. Five scenarios are designed to reflect a range of investment cost changes of RE technologies. While most scenarios only achieve 19% (P3, P4 and P5) and 54% (P6) of the NDC’s power sector target, the P7 scenario far exceeds the goal by achieving 188% of the NDC target. Furthermore, as the difference of levelized cost of electricity among the scenarios is minimal, the P7 scenario is the most attractive pathway for the government. Even for other scenarios, the government should still deploy the suggested capacity of solar photovoltaic (PV) as it is both economically and socially beneficial in the long term. However, in these cases, the government’s political will to meet the NDC’s power sector target and to promote the solar PV industry will be critical in designing future power sector policies.

Key policy insights

• Model results show coal as the cheapest resource for electricity generation in Botswana up to 2030, but the cost competitiveness of solar photovoltaic (PV) against coal will continue to increase over time.

• It is economically and socially beneficial to adjust the current national plan and substitute some share of coal with solar PV in the future energy mix.

• Government support is critical in achieving the power sector’s NDC target, as cost reduction of solar PV alone does not guarantee success.

• Encouraging independent power producers (IPP) with financial support mechanisms would be a suitable business model for developing the renewable energy industry.

     

The accountability imperative for quantifying the uncertainty of emission forecasts: evidence from Mexico

Governmental climate change mitigation targets are typically developed with the aid of forecasts of greenhouse-gas (GHG) emissions. The robustness and credibility of such forecasts depends, among other issues, on the extent to which forecasting approaches can reflect prevailing uncertainties. We apply a transparent and replicable method to quantify the uncertainty associated with projections of gross domestic product growth rates for Mexico, a key driver of GHG emissions in the country. We use those projections to produce probabilistic forecasts of GHG emissions for Mexico. We contrast our probabilistic forecasts with Mexico’s governmental deterministic forecasts. We show that, because they fail to reflect such key uncertainty, deterministic forecasts are ill-suited for use in target-setting processes. We argue that (i) guidelines should be agreed upon, to ensure that governmental forecasts meet certain minimum transparency and quality standards, and (ii) governments should be held accountable for the appropriateness of the forecasting approach applied to prepare governmental forecasts, especially when those forecasts are used to derive climate change mitigation targets.

POLICY INSIGHTS

• No minimum transparency and quality standards exist to guide the development of GHG emission scenario forecasts, not even when these forecasts are used to set national climate change mitigation targets.

• No accountability mechanisms appear to be in place at the national level to ensure that national governments rely on scientifically sound processes to develop GHG emission scenarios.

• Using probabilistic forecasts to underpin emission reduction targets represents a scientifically sound option for reflecting in the target the uncertainty to which those forecasts are subject, thus increasing the validity of the target.

• Setting up minimum transparency and quality standards, and holding governments accountable for their choice of forecasting methods could lead to more robust emission reduction targets nationally and, by extension, internationally.

     

Escaping the climate policy uncertainty trap: options contracts for REDD+

Climate policy uncertainty significantly hinders investments in low-carbon technologies, and the global community is behind schedule to curb carbon emissions. Strong actions will be necessary to limit the increase in global temperatures, and continued delays create risks of escalating climate change damages and future policy costs. These risks are system-wide, long-term and large-scale and thus hard to diversify across firms. Because of its unique scale, cost structure and near-term availability, Reducing Emissions from Deforestation and forest Degradation in developing countries (REDD+) has significant potential to help manage climate policy risks and facilitate the transition to lower greenhouse gas emissions. ‘Call’ options contracts in the form of the right but not the obligation to buy high-quality emissions reduction credits from jurisdictional REDD+ programmes at a predetermined price per ton of CO₂ could help unlock this potential despite the current lack of carbon markets that accept REDD+ for compliance. This approach could provide a globally important cost-containment mechanism and insurance for firms against higher future carbon prices, while channelling finance to avoid deforestation until policy uncertainties decline and carbon markets scale up.

Key policy insights

• Climate policy uncertainty discourages abatement investments, exposing firms to an escalating systemic risk of future rapid increases in emission control expenditures.

• This situation poses a risk of an abatement ‘short squeeze,’ paralleling the case in financial markets when prices jump sharply as investors rush to square accounts on an investment they have sold ‘short’, one they have bet against and promised to repay later in anticipation of falling prices.

• There is likely to be a willingness to pay for mechanisms that hedge the risks of abruptly rising carbon prices, in particular for ‘call’ options, the right but not the obligation to buy high-quality emissions reduction credits at a predetermined price, due to the significantly lower upfront capital expenditure compared to other hedging alternatives.

• Establishing rules as soon as possible for compliance market acceptance of high-quality emissions reductions credits from REDD+ would facilitate REDD+ transactions, including via options-based contracts, which could help fill the gap of uncertain climate policies in the short and medium term.

     

Nationally Determined Contributions under the Paris Agreement and the costs of delayed action

Current country-level commitments under the Paris Agreement fall short of putting the world on a required trajectory to stay below a 2°C temperature increase compared to pre-industrial levels by the end of the century. Therefore, the timing of increased ambition is hugely important and as such this paper analyses the impact of both the short and long-term goals of the Paris Agreement on global emissions and economic growth. Using the hybrid TIAM-UCL-MSA model we consider the achievement of a 2°C target against a baseline of the Nationally Determined Contributions (NDCs) while also considering the timing of increased ambition of the NDCs by 2030 and the impacts of cost reductions of key low-carbon technologies. We find that the rate of emissions reduction ambition required between 2030 and 2050 is almost double when the NDCs are achieved but not ratcheted up until 2030, and leads to lower levels of economic growth throughout the rest of the century. However, if action is taken immediately and is accompanied by increasingly rapid low-carbon technology cost reductions, then there is almost no difference in GDP compared to the path suggested by the current NDC commitments.

Key policy insights

• Delaying the additional action needed to achieve the 2°C target until 2030 is shown to require twice the rate of emissions reductions between 2030 and 2050.

• Total cumulative GDP over the century is lower when additional action is delayed to 2030 and therefore has an overall negative impact on the economy, even without including climate change damages.

• Increased ratcheting of the NDC commitments should therefore be undertaken sooner rather than later, starting in conjunction with the 2023 Global Stocktake.

• Early action combined with cost reductions in key renewable energy technologies can reduce GDP losses to minimal levels (<1%).

• A 2°C future with technological advancements is clearly possible for a similar cost as a 3.3°C world without these advances, but with lower damages and losses from climate change.

     

The political roots of divergence in carbon market design: implications for linking

There is a substantial literature on optimal emissions trading system (ETS) designs, but relatively little on how organized political interests affect the design and operation of these economic instruments. This article looks systematically at the political economy of the diffusion of ETS designs and explores the implications for carbon-market linking. Contrary to expectations of convergence – as has been observed in many areas where economic policy diffuses across markets – we found substantial divergence in the design and implementation of ETS across the nine systems examined. The architects of these different systems are aware of other designs, but they have purposely adjusted designs to reflect local political and administrative goals. Divergence has sobering implications for visions of ubiquitous linkages and the emergence of a global carbon market that, to date, have been predicated on the assumption that designs would converge. More such ‘real world’ political economy analysis is needed to understand how political forces, mainly within countries, act as strong intervening variables that affect instrument design, implementation and effectiveness.

Key policy insights

• Our finding of design divergence indicates that policy efforts aimed at achieving integrated international markets are unlikely to be successful.

• Visions of carbon market linkage will need to confront the reality that there are well-organized political coalitions, anchored in the status quo, that prefer divergence.

• In linking ETS, policy-makers should devote more attention to preventing excessive capital flows that can undermine political support for linkage, while also creating incentives for convergence in trading rules over time.