CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE © 2021 International Bank for Reconstruction and Development/The World Bank 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of the World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Cover design: Fathom Creative i ACKNOWLEDGMENTS This report was prepared by Vivid Economics and the European Roundtable on Climate Change and Sustainable Transition (ERCST). The Vivid Economics team was led by Stuart Evans with direction from Thomas Kansy, and supported by Karishma Gulrajani, Christian Mortlock, Ladislav Tvaruzek, and Anca Pop. The ERCST team was led by Andrei Marcu, supported by Dana Agrotti and Matteo Caspani. Expert input was provided by Justin Johnson, Luca Taschini, and Dave Sawyer. The World Bank oversaw the development of the guide, including providing substantive inputs and managing the project. The World Bank team consisted of Joseph Pryor, Marissa Santikarn, Daniel Besley, Harikumar Gadde and Marcos Castro Rodriguez. Janet Peace provided a technical review. We sincerely thank jurisdiction and external organization representatives who shared their practical insights and knowledge. These include Jurisdiction Organization Name/s Australia Department of Industry, Science, Energy and Resources Staff from the Department of Industry, Science, Energy and Resources Brazil PMR-Brazil Programme at Ministry of Economy Guido Couto Penido Guimaraes California California Air Resources Board California Air Resources Board Staff Canada Environment and Climate Change Canada Adam Priban Chile Ministry of Energy Juan Pedro Searle Francisco Dall’Orso Colombia PMR-Colombia Programme at Ministry of Environment and Marco Antonio Murcia Sustainable Development France Ministry for Economy, Finance and Recovery Philippe Wen Germany Federal Ministry for Environment, Nature Conservation and Malin Ahlberg Nuclear Safety Massachusetts Department of Environmental Protection William Space Mexico PMR-Mexico Programme at Secretariat of Environment and Ximena Aristizábal Natural Resources New Zealand Ministry for the Environment Elizabeth Rine Scott Gulliver Philippines Department of Finance Paola Sherina A. Alvarez Québec The Ministére de l’Environnement et de la Lutte contre les Jean-Yves Benoit Jonathan Beaulieu changements climatiques Thomas Duchaine Jérôme Gagnon-April Stéphane Legros Singapore Prime Minister’s Office Benedict Chia South Africa Treasury Memory Machingambi Sri Lanka Ministry of Environment Staff from the Ministry of Environment Sweden Swedish Energy Agency Moa Forstrop Ministry of Finance Daniel Waluszewski Switzerland Federal Office for the Environment Simon Fellermeyer Thailand Thailand Greenhouse Gas Management Organization Staff from Thailand Greenhouse Gas Management Organization Tokyo Tokyo Metropolitan Government Satoshi Chida United Department for Business, Energy and Industrial Strategy Henry Dieudonne-Demaria Michael Evans Kingdom Hannah Lewis Jay Shah Emily Worthing Ukraine Ministry of Energy and the Environment Olga Yukhymchuk We wish to acknowledge the additional and valuable contributions provided by Cyril Cassisa and Luca Lo Re (International Energy Agency); Dirk Heine, Keisuke Iyadomi, and Rachel Mok (the World Bank Group); and Nicolas Muller. ii CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE CONTENTS Introduction to the guide___________________________________________________________________ 1 1 Introduction to carbon pricing______________________________________________________________ 4 2 The jurisdictional context__________________________________________________________________ 16 3 Impact assessment________________________________________________________________________ 29 4 Reaching a recommendation______________________________________________________________ 46 References________________________________________________________________________________ 54 A1 Attachment 1: Identifying policy interactions_______________________________________________ 58 A2 Attachment 2: Questionnaire on jurisdictional context_____________________________________ 62 A3 Attachment 3: Data tip sheet______________________________________________________________ 65 A4 Attachment 4: Capacity assessment tool__________________________________________________ 67 A5 Attachment 5: Modeling technical summary_______________________________________________ 74 A6 Attachment 6: Example TOR_______________________________________________________________ 83 A7 Attachment 7: Recommendation paper best practice______________________________________ 96 LIST OF TABLES Table 1 Simplified comparison of ETSs and carbon taxes________________________________________________ 7 Table 2 Trade metrics and their use in assessing competitiveness impacts_______________________________ 32 Table 3 Types of models commonly used in climate policy analysis______________________________________ 38 Table 4 Mapping of modeling and other approaches to assess potential carbon pricing impacts____________ 42 Table 5 Mapping between policy paper topics and content of this guide_________________________________ 51 Table 6 Indicative examples of policies that interact with the CPI________________________________________ 58 Table 7 Policy interactions template to fill in___________________________________________________________ 59 Table 8 Worked example of policy interactions for a hypothetical jurisdiction_____________________________ 60 Table 9 Questionnaire_______________________________________________________________________________ 63 Table 10 Data tip sheet_______________________________________________________________________________ 66 Table 11 Governance assessment: Template___________________________________________________________ 68 Table 12 Capacity to manage trade assessment: Template_______________________________________________ 68 Table 13 Enabling environment assessment: Template___________________________________________________ 69 Table 14 Sector capacity assessments: Template_______________________________________________________ 69 Table 15 Governance assessment: Worked examples___________________________________________________ 70 CONTENTS iii Table 16 Capacity to manage trade assessment: Worked examples_______________________________________ 71 Table 17 Enabling environment assessment: Worked example____________________________________________ 72 Table 18 Sector capacity assessments: Worked example________________________________________________ 73 Table 19 Linking policy questions to modeling output and functionality requirements_______________________ 74 Table 20 Example of a good practice in defining modeling policy scenarios________________________________ 77 Table 21 Example of the effective communication of scenarios___________________________________________ 97 LIST OF FIGURES Figure 1 This guide complements the PMR’s other knowledge products___________________________________ 2 Figure 2 An overview of the topics and support tools included in this guide________________________________ 3 Figure 3 Key benefits of carbon pricing_________________________________________________________________ 5 Figure 4 Emissions can be regulated at the point source of emissions, upstream or downstream____________ 12 Figure 5 The impact of policy interactions on carbon price_______________________________________________ 13 Figure 6 Considering objectives and potential preference for ETS or carbon tax___________________________ 17 Figure 7 Aspects of jurisdictional context______________________________________________________________ 18 Figure 8 Capacity requirements may differ for different CPIs_____________________________________________ 26 Figure 9 An illustration of Cost pass-through for different sectors________________________________________ 31 Figure 10 Example trade intensity calculation___________________________________________________________ 32 Figure 11 An illustration of impacts on households_______________________________________________________ 33 Figure 12 Key aspects required when designing a modeling study_________________________________________ 40 Figure 13 Selecting a suitable model___________________________________________________________________ 42 Figure 14 Jurisdictions must balance short-term and long-term considerations_____________________________ 50 Figure 15 Visualizations can help clarify key findings_____________________________________________________ 97 LIST OF BOXES Box 1 Attachments to the guide_____________________________________________________________________ 3 Box 2 Case study: Mexico’s dual CPI system_________________________________________________________ 9 Box 3 Case study: The role of carbon pricing in different jurisdictions__________________________________ 10 Box 4 Policy interactions attachment________________________________________________________________ 13 Box 5 Questionnaire on jurisdictional context________________________________________________________ 18 Box 6 Data tip sheet_______________________________________________________________________________ 18 Box 7 Post COVID-19 recovery and opportunities for carbon pricing___________________________________ 22 Box 8 Capacity assessment tool____________________________________________________________________ 27 Box 9 Sector-specific risks from a low-carbon transition______________________________________________ 34 Box 10 Approaches to environmental justice__________________________________________________________ 35 Box 11 Modeling technical summary_________________________________________________________________ 39 Box 12 Developing a modeling TOR attachment_______________________________________________________ 41 Box 13 Case studies: Development of policy scenarios_________________________________________________ 43 Box 14 Case study: Singapore’s process for selecting a carbon tax_____________________________________ 47 Box 15 Key issues in carbon pricing policy development in the UK______________________________________ 48 Box 16 Recommendation paper best practice_________________________________________________________ 52 iv CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ACRONYMS BAU Business as usual BB Building blocks CDM Clean Development Mechanism CER Certified emissions reduction CGE Computable General Equilibrium CPI Carbon pricing instrument CPLC Carbon Pricing Leadership Coalition DNP National Planning Department (Colombia) EITE Emissions-intensive, trade-exposed ETS Emissions trading system EU European Union FTE Full-time equivalent GHG Greenhouse gas GIZ Deutsche Gesellschaft für Internationale Zusammenarbeit (Germany) GVA Gross value added IAM Integrated assessment model ICAP International Carbon Action Partnership IEA International Energy Agency IPCC Intergovernmental Panel on Climate Change MADS Ministry of Environment and Sustainable Development (Colombia) MEG4C Modelo de Equilibrio General Computable de Cambrio Climático para Colombia (Colombia) MINEA Ministry of Environment and Energy (Costa Rica) MRV Monitoring, reporting, and verification NCCS National Climate Change Secretariat NDC Nationally Determined Contribution OECD Organisation for Economic Co-operation and Development PMR Partnership for Market Readiness PSAM Price or supply adjustment measure RGGI Regional Greenhouse Gas Initiative tCO2e Metric tons of carbon dioxide equivalent TOR Terms of reference UNFCCC United Nations Framework Convention on Climate Change VCS Verified Carbon Standard INTRODUCTION TO THE GUIDE 1 INTRODUCTION TO THE GUIDE INTRODUCTION TO THE GUIDE Many countries and subnational jurisdictions are policy landscape to determine what role a carbon price considering putting a price on carbon to help reduce can play, identifying the most appropriate carbon pricing greenhouse gas (GHG) emissions and achieve their options, and understanding their environmental, social, and climate commitments. A carbon price applies a direct economic impacts. Typically, this case is then presented and explicit cost to GHG emissions, thereby incentivizing to legislators or senior policymakers in a recommendation behavior change and investment in abatement solutions to paper. reduce emissions. The objective of this guide is to help policymakers There are currently 64 carbon pricing instruments build the case for carbon pricing and choose an (CPIs) in place or in the process of implementation, appropriate CPI. It begins with a brief introduction to with 10 launched in 2019 alone. These initiatives are carbon pricing and discusses how a CPI could fit into the spread globally: South Africa became the first African broader climate policy mix. It then provides guidance on country to price carbon, Singapore was the latest assessing jurisdictional circumstances and selecting a CPI jurisdiction to introduce a carbon tax in Asia, and Mexico’s most suited to meeting jurisdiction-specific objectives. cap and trade pilot system paves the way for emissions Potential impacts and ways of measuring these impacts trading in Latin America. Carbon pricing is also not are also discussed. Finally, the guide describes how to limited to national systems. The European Union (EU) has reach a recommendation on carbon pricing in light of the established an emissions trading system (ETS), which is a evidence collected and translate this into a compelling multinational CPI. Canada’s provinces and territories are recommendation paper. Developing a communication establishing systems to price carbon pollution, California plan is another key element in the initial preparation stage. has been operating an economy-wide cap and trade However, this component is discussed in more detail in program since 2012, and New York City is considering the Partnership for Market Readiness’ (PMR) Guide to emissions trading for the building sector.1 Communicating Carbon Pricing. Before a jurisdiction implements a CPI, it will often This guide does not advise on the detailed technical examine the role a CPI would play and the rationale design of specific CPIs. Instead, it refers readers to for adopting it. Only then can policymakers convince other World Bank technical guidance as set out in decision-makers and, to the extent possible, obtain the Figure 1. 2 buy-in of stakeholders. Putting forward a convincing case for carbon pricing involves analyzing the existing 1 World Bank 2020a. 2 The technical guidance published by the PMR includes the Carbon Tax Guide: A Handbook for Policy Makers, Emissions Trading in Practice: A Handbook on Design and Implementation, and the forthcoming A Guide to Carbon Crediting: Designing and Implementing Domestic Carbon Crediting Mechanisms and Designing Accreditation and Verification Systems: A Guide to Ensuring Credibility for Carbon Pricing Instruments. 2 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Figure 1 This guide complements the PMR’s other knowledge products INTRODUCTION TO THE GUIDE Preparing for carbon pricing Design and implementation phase Making the case for carbon pricing Carbon pricing design Managing costs and benefits Supporting systems and processes * * As part of the World Bank’s Mitigation Action Assessment Protocol (MAAP), the Carbon Pricing Assessment Module (MAAP-CPI) supports the assessment of a government’s capacity to implement a CPI by providing a structured checklist of key building blocks based on international best practices. MAAP-CPI provides a framework for scoring each building block, which allows jurisdictions to track progress and adjust areas of focus over time. More information available at https://maap.worldbank.org/#/homepage. This guide outlines key elements for preparing for X Impact assessment. Chapter 3 outlines how to REFERENCES carbon pricing, including assess the potential impacts of carbon pricing on key X Introduction to carbon pricing. Chapter 1 sets out stakeholders. It first discusses how to identify the the rationale for putting an explicit price on carbon and questions to be answered through impact analysis. It examines the two main options for implementation: then outlines the potential impacts of carbon pricing ETSs and carbon taxes. It then lays out the various on businesses, households, and other stakeholders. roles carbon pricing can play within a policy mix, and Economic models can help policymakers understand how it can help meet a jurisdiction’s broader objectives. the nature and scale of these impacts, though modeling also has many limitations. X The jurisdictional context. Chapter 2 outlines the X Reaching a recommendation. Chapter 4 describes local conditions that policymakers need to consider. This includes a jurisdiction’s economic and emission how the work done in the previous sections can be profiles, legal and institutional governance, and the used to make an informed recommendation for carbon political landscape. The capacity of both regulators and pricing implementation, and how this recommendation businesses will also need to be factored in, particularly can then be communicated effectively. in the early years of carbon pricing. INTRODUCTION TO THE GUIDE 3 This guide also provides tools to assist policymakers in performing the analyses presented (see Box 1). INTRODUCTION TO THE GUIDE Box 1 Attachments to the guide 1. Identifying policy interactions. Carbon prices interact with the broader policy landscape and are best deployed in a coherent policy package. This attachment provides a rubric for mapping existing or planned policies and their interactions with a carbon price. 2. Questionnaire on jurisdiction context. This provides a list of key questions policymakers should answer to map out the country context. It includes questions on economic and emissions attributes, policy coherence, public acceptance, and implementing institutions. 3. Data tip sheet. The tip sheet identifies the key data required to answer the questionnaire on jurisdiction context and suggests potential sources for collecting these data. This document is to be used alongside the questionnaire on jurisdiction context. 4. Capacity assessment tool. This tool maps broad carbon pricing requirements against key attributes of capacity for both regulators and businesses to assist in identifying an appropriate CPI. 5. Modeling technical summary. This document is an introduction to the modeling process and major types of economic models used in climate policy analysis, covering their main areas of focus, strengths, and limitations. 6. Example terms of reference. This outlines recommended content (along with examples) for a terms of reference for economic modeling services. This should assist jurisdictions in formulating a modeling request that covers the key aspects required to assess the impact of carbon pricing options. 7. Recommendation paper best practice. This attachment provides a structure for developing a brief policy paper summarizing the process of evaluation, the CPI recommended, and how it matches jurisdiction objectives and priorities. It also includes best practices on drafting policy papers. The links between the sections in the guide and the annex attachments are summarized in Figure 2. Figure 2 An overview of the topics and support tools included in this guide 1. Introduction to carbon pricing Carbon 3. Impact assessment The case for Carbon pricing pricing in the Carbon pricing carbon pricing options policy mix interactions Modeling the Stakeholder impacts impacts of carbon pricing 1 Identifying 6 policy Modeling interactions technical 5 2. The jurisdictional context summary Example terms of Capacity for The local Jurisdictions’ reference implementation context objectives 4. Reaching a recommendation 4 3 2 Capacity Questionnaire Data tip sheet Communicating Synthesizing assessment on country tool context the evidence recommendation 7 Recommendation paper best practices Adopt a carbon pricing instrument 4 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 1. INTRODUCTION TO CARBON PRICING Key takeaways: 9 There are a number of advantages of carbon pricing, from the revenue generation to development benefits and reduced greenhouse gas (GHG) emissions. Carefully considering and communicating these benefits can help policymakers appeal to a wider array of stakeholders. TO CARBON PRICING INTRODUCTION 9 Both carbon taxes and emissions trading systems (ETSs) have their advantages and disadvantages; the best instrument is one that meets a jurisdiction’s objectives and circumstances. 9 Coverage and the scale of emissions reduced by the carbon pricing instrument (CPI) should be considered at an early stage. 9 Carbon pricing will interact with other climate and energy policies, particularly where there are overlapping or countervailing policies in place. Understanding the role of carbon pricing in the policy gain market share. Over time, these costs are likely to mean mix, and the specific ways in which carbon taxes and that lower-emissions producers gain market share over their ETSs function, is the first step in providing a suitable higher-emissions competitors. At the same time, consumers recommendation on carbon pricing. To this end, this are likely to shift toward lower-emissions products due to chapter is structured as follows: their relative cost advantage, while consumption of higher- X Section 1.1 outlines the case for carbon pricing; emissions products is likely to be reduced or avoided. X Section 1.2 sets out the key instruments used to Putting a price on GHG emissions provides emitters implement carbon pricing; with flexibility in choosing whether to pay for X Section 1.3 examines the roles carbon pricing can play; emissions or reduce them, which allows them to X Section 1.4 introduces the types of policy interactions minimize their compliance costs. This contrasts that can occur when introducing a CPI; and with traditional “command and control” environmental regulation, which stipulates how environmental outcomes X Section 1.5 discusses how to apply lessons from other are achieved. This means that carbon pricing can jurisdictions in your analysis. incentivize the changes in investment, business planning, production, and consumption patterns needed to transition 1.1 THE CASE FOR CARBON PRICING to a low-carbon economy in a more cost-effective way than command and control regulation. Carbon pricing Underlying the case for carbon pricing is the need also brings a range of other potential benefits that may be to reduce GHG emissions to mitigate the risks of important to jurisdictions deciding whether to introduce dangerous climate change. Climate change is one of carbon pricing (summarized in Figure 3)—for example, the greatest global challenges of our time. It threatens raising revenue or facilitating regional cooperation. to roll back decades of development progress and puts A compelling case for carbon pricing emphasizes the lives, livelihoods, and economic growth at risk. To stay multiple environmental, economic, social, and political well below 2°C of global atmospheric warming, the benefits that carbon pricing can provide, including Intergovernmental Panel on Climate Change (IPCC) says X Delivers cost-effective mitigation: Carbon pricing the world will need to get to net zero emissions by 2050.3 provides an efficient way for jurisdictions to reach their Carbon pricing can be an important part of the solution. emissions reduction targets. Economic theory shows Carbon pricing is any policy that places an explicit that carbon pricing, regardless of instrument choice, price on GHG emissions, such as those emitted from allows businesses and consumers to reduce their the use of fossil fuels. When GHG emissions are more emissions in the most cost-effective way possible. expensive, economic actors are incentivized to account X Incentivizes low carbon growth: By internalizing for the costs of their emissions when making commercial the cost of GHG emissions, carbon pricing increases decisions. Businesses will treat these costs like other costs the cost of carbon-intensive technologies, thus and aim to reduce them to increase profit margins and/or providing a financial incentive to invest in climate- friendly technologies. It also provides an incentive for 3 https://www.ipcc.ch/2018/10/08/summary-for-policymakers-of-ipcc-special-report-on-global-warming-of-1-5c-approved-by-governments/. INTRODUCTION TO CARBON PRICING 5 continuous improvement, helping to drive low-carbon Figure 3 Key benefits of carbon pricing innovation and avoiding stranded assets. X Raises revenue: Carbon pricing can raise revenues that can be used by governments for a variety of Delivers cost-effective purposes. For example, revenues can be used for mitigation environmental projects or low-carbon research and development, directed toward protecting low-income households from increasing energy costs, or shielding energy-intensive and trade-exposed industries from TO CARBON PRICING unfair competition from jurisdictions with less ambitious INTRODUCTION carbon prices. Revenues may also be used to substitute Benefits of carbon pricing for the reduction of other taxes that reduce economic Regional or Incentivizes activity, such as taxes on labor or production. They international low carbon cooperation growth can also be recycled through the general budget. Policymakers can use carbon pricing revenues to ensure that the low-carbon transition is just and that no one is left behind.4 Communicating and visibly demonstrating to the public and other stakeholders how the revenue is used can increase the political Generates Raises development revenue acceptability of a carbon price. benefits X Generates development benefits: GHG emissions reduction policies can provide development benefits, such as improved air quality, an increase in employment in low-carbon industries, and technological innovation, as (called “companion policies”) are required to overcome well as improved energy security.5 These broader carbon nonprice barriers, including lack of information and high pricing benefits can help developing countries meet other initial technology costs, or to reduce emissions in sectors policy priorities while addressing climate change. not covered by the carbon price (for more see Section 1.3). X Regional or international cooperation: Jurisdictions may use carbon pricing as a means of enhancing 1.2 CARBON PRICING OPTIONS political and economic cooperation with regional or international partners. For example, Article 6 of the CPIs generally take the form of a carbon tax or an Paris Agreement establishes a framework for countries ETS. In some cases, a carbon tax or ETS also allows (Parties) to voluntarily cooperate to support meeting regulated entities to use “carbon credits” to meet a their Nationally Determined Contribution (NDC) goals. share of (or “offset”) their compliance requirements, for Such cooperation can increase the efficiency of carbon instance, instead of surrendering allowances under an pricing policies by allowing for international trading of ETS. The three main instruments (carbon tax, ETS, and mitigation outcomes.6 crediting mechanism) are defined and summarized in the following subsections. However, it is noted that in practice A carbon price should be one element in a jurisdictions sometimes adopt design aspects (e.g., price comprehensive policy package to address climate floors or ceilings in an ETS) that reduce the differences change. Carbon pricing may not be appropriate in between these instruments. Further, in some cases a all sectors. In addition, other economic, financial, or jurisdiction may have more than one CPI operating at the behavioral barriers may hinder emissions reductions same time, although this is not common (Section 1.2.4). and low-carbon technology development. For example, consumers may need additional information about the 1.2.1 Carbon taxes energy cost savings associated with efficiency measures like insulation and lighting changes. While a carbon price Carbon taxes are those that explicitly put a price on can unlock emissions reduction options by providing GHG emissions—they establish a direct link between financial incentives, it needs to operate as part of a broader the GHG emissions of a product or process and the tax policy mix that addresses the barriers and hurdles to a that must be paid on it (that is, a uniform price per metric low-carbon transition. In particular, other policies in the ton of carbon dioxide equivalent [tCO2e] or per unit of fuel climate change portfolio and in other relevant sectors based on its carbon content).7 This provides a financial 4 See the Partnership for Market Readiness’ (PMR) Using Carbon Revenues Report for a more detailed discussion. 5 See the PMR’s forthcoming Development Benefits of Carbon Pricing Guide. 6 Article 6 of the Paris Agreement relates to international cooperation on achieving emissions reductions, which might include trading of mitigation outcomes across countries through market-based approaches. At the time of writing, the rules around functioning of this mechanism are yet to be finalized. 7 World Bank, Ecofys, and Vivid Economics 2016. 6 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE incentive for taxpayers to lower their emissions in order to Further details on the design of carbon taxes can be found reduce their tax obligations, whether through switching to in the PMR’s Carbon Tax Guide.9 more efficient practices, choosing cleaner fuels, or, in the case of consumers, changing their lifestyle habits. 1.2.2 Emissions trading systems Carbon taxes provide certainty over the price of ETSs (also called cap and trade systems) work by emissions, but not on the level of emissions and placing a quantitative limit (a cap) on the amount emission reduction delivered. The government sets the of GHG emissions in one or more sectors of the tax rate charged per metric ton of emissions or per unit economy.10 Regulated entities are required to surrender of carbon in fossil fuel. But the regulator does not have one allowance for each unit of emissions for which they are TO CARBON PRICING responsible.11 Regulated entities either acquire allowances INTRODUCTION full knowledge about how an emitter will respond to the tax (e.g., the extent an emitter will reduce its emissions to from auctions, are allocated allowances (e.g., for free from lower its tax liability) and thus it is challenging to know the the regulator), or purchase allowances from other regulated resulting level of emissions reductions. entities in a secondary market. The carbon price will vary with changes in allowance supply and demand. Nevertheless, the price predictability of a tax has advantages and can help with forward planning for An ETS provides certainty over the quantity of both compliance and long-term investment. It is emissions reduced, but not over the carbon price. relatively straightforward for regulated entities to assess Policymakers set the cap on emissions, and the carbon their carbon tax costs (and for policymakers to estimate price will fluctuate depending on market forces aligning revenue raised by the tax) based on the tax rate and allowance supply and demand. However, there are design their expected emissions profile. This price certainty is features that allow policymakers to exercise some degree important to regulated entities as it allows them to assess of control over carbon prices and allowance supply. their long-term cost exposure and the value of long-term These include auction reserve prices, price floors, or the low-carbon investments. Because policymakers set the tax levying of additional fees and charges that can help avoid rate, they also have more control over the strength of the overly low prices or too many allowances in the market. price signal transmitted to regulated entities. Options used to respond to overly high prices or a scarcity of allowances including cost containment reserves or However, it can be difficult to align the carbon tax level hard price ceilings. Price or supply adjustment measures needed to an emissions target as the total emissions (PSAMs) are now in operation in some form in all major reductions driven by a certain carbon price are highly operating ETSs. For instance, both California and Québec uncertain. 8 This can pose a challenge for jurisdictions use price floors and a price ceiling via a price containment if the primary role of the carbon price is to reduce reserve, which allocates allowances at successive price emissions to a level specified by the jurisdiction’s climate thresholds.12 In 2021, California will shift to using two price commitments (discussed further in Section 1.1). containment points, as well as a hard price ceiling. The European Union (EU) ETS uses a Market Stability Reserve The relative simplicity of a carbon tax makes it to adjust the number of allowances that are auctioned an attractive option for jurisdictions with limited based on the total number of allowances in circulation. administrative capacity or resources available for implementation or that want to introduce carbon An ETS provides greater flexibility regarding where pricing quickly. Carbon taxes are easier to implement than and when emissions reductions occur, which can an ETS as they do not require a secondary market and can lower mitigation costs. Secondary market trading build on existing tax infrastructure (for example, through enables businesses in high abatement cost sectors to buy an existing fuel excise or tariff system). Additionally, a tax allowances from businesses in low abatement cost sectors. may be simpler for jurisdictions that lack emissions data on The gains from trade are particularly advantageous where which to base an ETS emissions cap. Taxes also have an covered entities have significantly different abatement advantage in countries where there are not enough market costs. An ETS will help ensure emissions reductions occur participants, which could lead to insufficient liquidity in the in the most economically efficient way. If the jurisdiction’s secondary market. The capacity requirements for each ETS is linked with another system, trading can also take instrument are discussed in Section 2.3. place across borders, offering regulated entities access 8 Metcalf 2019 suggests a dynamic and self-adjusting tax rate which could, in theory, be designed to meet emissions reduction targets. However, this has not been implemented in practice. 9 PMR 2017. 10 The remainder of this report uses the term ETS to specifically mean a cap and trade system. However, it should be noted that, in theory, any mechanisms by which participants can trade emissions commitments is an ETS. The most notable is a baseline and crediting system, where firms have either credits or liabilities depending on their performance relative to a baseline function like an ETS — credits are traded between firms to meet any liabilities. However, it is distinct from a cap and trade system because it does not have a set limit or cap on emissions. 11 One allowance typically equates to one metric tonne (1000 kg) of carbon dioxide equivalent, or one short ton (907 kg) of carbon dioxide equivalent in some systems in the US. , 12 CARB 2019. INTRODUCTION TO CARBON PRICING 7 to a broader array of mitigation options. Furthermore, the allowances). Linking has a range of benefits, including ETS price automatically adjusts with economic activity, bolstering international cooperation on climate goals, reducing in recessions and increasing in booms.13 This improving the cost-effectiveness of the linked system, countercyclical behavior leads to lower costs overall. reducing price volatility, and increasing market liquidity.14 Depending on the design of the ETS, entities may also be allowed to bank surplus allowances for later use, and in However, ETSs are more complex to create and some cases, to borrow allowances from future compliance administer than carbon taxes. An ETS involves additional periods. This affords businesses flexibility on when infrastructure and administrative setup when compared to emissions reductions occur, letting them choose the timing a tax, especially given the need to create and manage a secondary market for emissions allowances. TO CARBON PRICING of investment according to their needs. Banking can also INTRODUCTION incentivize earlier emissions reductions because of the Further detail on ETS design can be found in the PMR’s ETS expectation of higher carbon prices in the future. However, Handbook.15 careful design is needed to ensure these flexibility options do not undermine the environmental integrity of the cap. A simplified comparison of key features of carbon For example, if significant borrowing allowance from future taxes and ETSs is provided in Table 1. As the table years is allowed, economic conditions could arise where highlights, while there are some differences between repayment becomes difficult to enforce. As such borrowing carbon taxes and ETSs, both instruments have relatively is limited heavily in most systems. flexible design features. As this guide outlines, the extent to which one instrument is preferable to the other will likely ETSs can make international cooperation on climate depend on the jurisdictional context and policy priorities. easier. It helps governments meet international emissions Equally, it is unlikely to be the choice of instrument that reduction targets with more confidence and opens the determines effectiveness, but rather the design choices possibility of linking carbon pricing systems across and trade-offs that are made. jurisdictions (which is facilitated by trading emission Table 1 Simplified comparison of ETSs and carbon taxes Element Carbon Tax ETS It is difficult to estimate emissions reductions An ETS cap provides certainty on an upper limit of emissions, Certainty of achieved through a tax in advance, making it enabling its alignment to a certain policy target (for example, a emissions levels hard to align to an emissions target.16 carbon budget).17 A tax does not provide the economic efficiency An ETS allows for economic efficiency between and within Cost- gains of trading among entities and across sectors (as a result of trading) and over time. However, market effectiveness sectors and offers less temporal price flexibility power, lack of liquidity, and excessive volatility in allowance for regulated entities. prices can reduce cost-effectiveness. Carbon taxes can be implemented fairly quickly Developing an ETS requires the creation of a secondary market Timeline of as they can build on existing tax infrastructure. in which allowances can be traded, therefore making its creation implementation a longer process. While a tax requires a robust monitoring, An ETS is more complex to implement because, in addition to reporting and verification (MRV) system, the infrastructure required for a tax, it also involves a secondary Ease of it does not require any infrastructure for market for trading allowances. The regulator and regulated administration trading allowances, and the ability to rely on a entities therefore need to have additional capabilities. This might and scope jurisdiction’s existing tax infrastructure makes it make it more difficult to include certain sectors in the scope. easier to implement in a broad range of sectors. The carbon price is set by predefined tax rates. The carbon price is determined by the market. This automatically Price This provides a stable price signal to inform adjusts for economic conditions but might lead to price predictability investment decisions. volatility.18,19 13 A dynamic price set by market forces will vary with the supply and demand of ETS allowances. Assuming the emissions level corresponds to economic activity, an economic contraction would lead to reduced demand for allowances from regulated entities, and therefore lower prices. Conversely, allowance prices would rise with a growing economy and growing emissions. However, rapid change in demand or supply can cause price volatility. For further information see Vivid Economics 2009. 14 Linking is discussed more fully in the PMR’s and International Carbon Action Partnership’s (ICAP) Emissions Trading in Practice: A Handbook on Design and Implementation and A Guide to Linking Emissions Trading Systems 2021. 15 See the PMR’s and ICAP’s Emissions Trading in Practice: A Handbook on Design and Implementation 2021. 16 It can also be difficult to set an economically “optimal” tax rate that suitably prices carbon but does not introduce market distortions. See the World Bank’s Carbon Tax Guide: A Handbook for Policy Makers for further details. 17 However, PSAMs that permanently remove or add allowances to the cap may alter the emissions reductions achieved. 18 A dynamic price set by market forces will vary with the supply and demand of ETS allowances. Assuming the emissions level corresponds to economic activity, an economic contraction would lead to reduced demand for allowances from regulated entities, and therefore lower prices. Conversely, allowance prices would rise with a growing economy and growing emissions. However, rapid change in demand or supply can cause price volatility. 19 PSAMs can be used to increase price predictability in an ETS. 8 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 1.2.3 Crediting mechanisms because individual emitters (such as farms) are often too small and too numerous to be effectively regulated and A crediting mechanism creates a supply of tradable emissions monitoring technologies for farm activities are credits for each unit of verified emissions reduction expensive or highly uncertain. In this way crediting can or removal. Carbon crediting is an instrument that can be support low-carbon investment, learning, and engagement used with a tax or an ETS within the framework of a carbon while effectively sending a carbon pricing signal. market. Crediting offers positive incentives for entities to Additionally, crediting offers compliance flexibility to entities reduce emissions. Under a crediting mechanism, tradable covered by a traditional CPI by allowing them to exploit credits are issued for actors who voluntarily implement mitigation opportunities in uncovered sectors. Finally, the approved emission reduction or removal activities. These TO CARBON PRICING use of crediting in uncovered sectors can help policymakers credits can be issued through domestically established INTRODUCTION understand whether it would be feasible to eventually bring crediting mechanisms, through international mechanisms uncovered sectors under a carbon tax or an ETS. like the Clean Development Mechanism (CDM) developed under the Kyoto Protocol, or through independent Crediting mechanisms must also be designed and mechanisms like the Gold Standard or Verified Carbon implemented in a manner that promotes environmental Standard (VCS). integrity. Promoting environmental integrity in a crediting system means ensuring that aggregate emissions do not Crediting mechanisms are complementary and need increase as a result of the crediting transactions.22 This a source of demand for credits to have value. Unlike requires consideration of multiple elements, including carbon taxes or ETSs, crediting mechanisms do not in ensuring that the activity is additional, the emissions themselves create a carbon price directly or indirectly. abatement is independently verified, there is no double Instead, they complement initiatives that create demand counting of emissions reductions, and the emissions for emissions reducing activities, at either the domestic reductions are permanent.23 In some crediting projects, or the international level. For carbon credits to have value, there is a need to manage the risk of reversal, where crediting mechanisms require an external source of carbon dioxide sequestered by a certain activity is later demand for the credits. For instance, the EU ETS initially released into the atmosphere (e.g., a forest fire causes the allowed credits from mechanisms like the CDM and Joint release of sequestered carbon dioxide that had previously Implementation to be used for compliance.20 In Colombia, been credited). Without additional measures, like buffer domestically sourced credits from a variety of recognized reserves, a reversal event may undermine the integrity carbon crediting mechanisms, including the CDM, VCS, of the issued credits. The use of crediting can also alter and Gold Standard, can be used by regulated entities distributional outcomes, as financial flows for low-carbon to fully or partially reduce liabilities under Colombia’s investment and the broader benefits associated with carbon tax.21 Ultimately the type of crediting mechanism emissions reductions will also shift to the regions where to allow (or whether to use one at all) is a choice for each the credit is issued. Further, the use of crediting in a jurisdiction. At present, most ETSs and several carbon CPI can reduce emissions reductions from compliance taxes currently allow credits to be used for compliance; sectors that seek lower-cost reductions elsewhere, such however, those credits need to meet certain qualitative as energy and transport, which may in turn mean that criteria and there are quantitative limits imposed on the important development benefits are not achieved. The number of credits a regulated entity may use. drawbacks of crediting can be allayed by quantitative and Crediting can be used to incentivize mitigation in qualitative restrictions on the credits that can be used for sectors, activities, or regions where there are barriers compliance.24 to direct coverage under a CPI. By providing a positive See the PMR’s forthcoming A Guide to Developing incentive for entities in uncovered sectors to abate Domestic Carbon Crediting Mechanisms for further details emissions, entities with the required capacity and access on crediting mechanisms. to cost-effective abatement in uncovered sectors can “opt in.” For example, some abatement opportunities in the agricultural sector have traditionally been difficult to cover 20 European Commission 2020. 21 Organisation for Economic Co-operation and Development (OECD) 2019. 22 Schneider and La Hoz Theuer 2019. 23 Schneider and La Hoz Theuer 2019; Broekhoff et al. 2019. 24 See the PMR’s and ICAP’s Emissions Trading in Practice: A Handbook on Design and Implementation 2021, Chapter 8 on offsets. INTRODUCTION TO CARBON PRICING 9 1.2.4 Multiple CPIs carbon content of fossil fuels, including kerosene and gasoline. The carbon tax was introduced as part of a Jurisdictions will usually select one type of CPI to broader tax reform. In 2018, the country adopted a climate apply across a range of emissions sources, but law25 that established a legal mandate to develop an ETS. some jurisdictions have adopted more than one CPI The carbon tax has provided an easy way for domestic operating at the same time. In general, this has occurred actors to familiarize themselves with carbon pricing while when one type of CPI (for instance, a carbon tax) has the ETS is under development, for instance by enabling been implemented, and then the jurisdiction has chosen improved accounting of emissions for use in setting an to introduce another type of CPI (for instance, an ETS) to ETS cap. Box 2 describes the case of Mexico, where both address specific circumstances. Jurisdictions that have TO CARBON PRICING a carbon tax and an ETS have been used to fit its specific followed this approach include Colombia, the UK, and INTRODUCTION local circumstances. Mexico. In 2016, Colombia imposed a tax based on the Box 2 Case study: Mexico’s dual CPI system Mexico has had a carbon tax since 2013, and in 2020 began implementing its ETS. The adoption of two CPIs reflects the use of different approaches to achieve different outcomes and contrasting methods for different sectors and sources of emissions. The General Climate Change Law of April 2012 paved the way for the introduction of carbon pricing, including provisions enabling the introduction of an ETS. However, policymakers saw a political window of opportunity and implemented a carbon tax as part of a broader fiscal reform in 2013. Since its implementation, the tax rate has increased annually with inflation, but it remains at a relatively low price, approximately USD 3/tCO2. In December 2017, regulations allowing the use of credits from the CDM, called certified emissions reductions (CERs), were published. These regulations allow regulated entities to use CERs from Mexican projects approved by the United Nations Framework Convention on Climate Change to satisfy up to 20 percent of their tax obligation. A National Emissions Registry was also developed and came into operation in 2015. This required companies or facilities with annual emissions over 25,000 tCO2e to report their emissions, providing the basis of Mexico’s ETS MRV systems. In 2018, the Mexican government mandated the introduction of an ETS through a reform of the General Climate Change Law. Mexico’s pilot ETS started operating in January 2020 and aims to be fully operational by 2022. The pilot covers direct carbon dioxide emissions from the energy and industry sectors, for facilities that generate at least 100,000 tCO2 per year. Around 300 entities are covered by the pilot, corresponding to just under 40 percent of national emissions.26 These two instruments may have different roles to play within the policy landscape and address emissions from different regulation points. Sequencing them may also be considered. The carbon tax on fuels was an early and easy way to implement an instrument, introduced at a low rate, that allowed regulators, businesses, and households to engage with a carbon price while the capacity for a more complex instrument was built. The ETS let Mexico focus its efforts on the largest emitters in the country. It will also ideally be able to ramp up ambition. An ETS may also facilitate international cooperation with regional partners, including the Western Climate Initiative carbon market (which includes California and Québec) and the Pacific Alliance countries (Mexico alongside Chile, Colombia, and Peru), which have agreed to cooperate on carbon pricing. If multiple CPIs are used, it is important to minimize price signal in a way that enables the identification of the and carefully manage potential overlaps. Using multiple most cost-effective mitigation options in an economy. CPIs together may make it more difficult for regulated When sources of emissions face different carbon price entities to achieve emissions reductions in an efficient incentives, this can reduce the cost-effectiveness of the and cost-effective way. The cost-effectiveness of carbon policy mix. pricing relies on different entities responding to the same 25 Colombia, 2018. Law 1931. 26 More details on Mexico’s pilot ETS can be found at ICAP 2020b and Secretariat of Environmental and Natural Resources and Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) 2019. 10 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 1.3 THE ROLE OF CARBON PRICING reductions. A carbon price can also provide a source of government revenue, raising funds that could be used The role of carbon pricing and its importance as part to compensate for a removal of other taxes that reduce of the broader climate policy mix will vary across economic activity, like taxes on labor or production. The jurisdictions. Some jurisdictions, like New Zealand and revenue can also be used to protect vulnerable consumers British Columbia, use it as a central driver of emissions or industry from cost impacts or pay for additional reductions. Other jurisdictions, like Singapore and emissions reductions in sectors covered by the CPI to drive California, use carbon pricing more as a safety net to additional emissions reductions. All these approaches can provide further incentives to ensure that emissions be appropriate; what is important is that policymakers are reduction targets are met. If other measures, such as TO CARBON PRICING clear on the role of carbon pricing before attempting to INTRODUCTION emissions standards or direct investment, prove less select and design a CPI. Box 3 provides examples of the effective than hoped, the carbon price can be increased varying roles of carbon pricing in different jurisdictions (in an ETS this occurs automatically if emissions covered based on their specific policy objectives. by the cap increase) to incentivize additional emissions Box 3 Case study: The role of carbon pricing in different jurisdictions The role of an ETS: X In New Zealand, carbon pricing is a key driver of mitigation. The country set up an ETS that provides broad sectoral coverage and is now being used as a key tool to meet the country’s net zero targets by 2050. X The EU ETS is the cornerstone of the EU’s emissions reduction policy. To ensure that all sectors of the economy share the burden of emissions reductions, the Effort Sharing Decision establishes binding emissions reduction targets for sectors that are not covered by the EU ETS. In this way, the legislation captures emissions from uncovered sectors, ensuring that overall emissions are constrained across both covered and uncovered sectors. X California’s ETS operates alongside a range of other policies that seek to drive economy-wide decarbonization. For example, in California the Renewable Portfolio Standard requires that electricity providers source a minimum amount of energy from renewable sources, and the Low-Carbon Fuel Standard provides regulation to ensure that the fuel mix sold for transportation in California aligns with its GHG targets. The ETS largely acts as a backstop to ensure climate targets are met and is a source of revenue to fund other low-carbon and climate resilience activities. The role of a carbon tax: X The carbon tax in British Columbia was introduced as part of broader fiscal reforms, reducing corporate and personal income taxes in favor of an environmental carbon tax. A tax provides greater certainty of revenues, which is important given the province has legal obligations to balance fiscal revenue and expenditure. Revenues are directed to promoting green initiatives, maintaining industrial competitiveness, and improving energy affordability for households and businesses (for instance through the Climate Action Tax Credit). X Colombia introduced a carbon tax to discourage the use of fossil fuels and incentivize technological improvements so they can be used more efficiently. The carbon tax also raises revenue for conservation measures and ecosystem protection. A crediting mechanism was then added to stimulate mitigation initiatives for emissions reductions or removals. It also builds capacity in the carbon crediting markets and reduces costs to firms. Building these capabilities has also positioned Colombia well for potential future access to international carbon markets. Certain design elements can influence the role of the However, two key design features to consider at an CPI (or whether carbon pricing is implemented at all) early stage are and should be considered early in policy deliberations. X The scope of the CPI, including the sectors and The detailed design of a CPI is a complex process that entities to be covered, the gases to be covered, and the generally occurs after the initial decision is made to pursue point in the supply chain at which these emissions are carbon pricing. regulated; and X The ambition of the CPI, which refers to the scale of emissions reductions sought, either through the ETS cap and cap trajectory or the carbon tax rate and trajectory. INTRODUCTION TO CARBON PRICING 11 These features determine which stakeholders benefit sources of emissions. For instance, carbon taxes often and which will bear the costs imposed by the policy cover transport fuels by covering the small number of and the extent of those costs, including broader firms that usually distribute fuel and drawing on taxation economic impacts. This information is essential to reporting infrastructure that is used for fuel excise taxation understanding the political feasibility of a CPI, including in many jurisdictions. the likely supporters and sources of opposition. It also determines the appropriate role for carbon pricing in the The decision on GHG coverage is closely related to climate policy mix. For example, if it is clear early on that sectoral coverage, and in most cases, jurisdictions some sectors that have high emissions cannot be covered opt to cover the largest sources of emissions initially, and most tend to increase this coverage over time. In TO CARBON PRICING by the carbon price, it is unlikely that the CPI will be the key INTRODUCTION driver of emissions reductions for that jurisdiction. some cases, it may not be practical to cover all gases, for instance, due to limited MRV capabilities, high uncertainty in quantification, and/or high costs of measurement. All 1.3.1 Scope CPIs currently cover carbon dioxide, which is the most The scope of a CPI refers to the emissions sources prevalent type of GHG in most jurisdictions. However, that will be regulated. Policymakers need to consider in some jurisdictions other gases such as methane and the sectors, types of GHGs or fuels covered, as well as nitrous oxide (for example from industrial processes, fossil thresholds for the size of facilities that may be liable. fuel extraction, landfills, and agriculture) may form a large Because it determines which sectors and firms would be part of a jurisdiction’s emissions profile, especially in subject to the carbon price, the scope is a fundamental developing countries and economies with large agricultural consideration when determining whether and how to adopt sectors. a carbon price. This also means that policymakers need to ensure those firms have the skills and expertise to comply Emissions can be regulated at different points in with the CPI. the supply chain. This determines which firms have compliance liabilities, and the number of entities covered Generally, for an ETS to function well it must have by the CPI. Liabilities are incurred either at the point sufficiently broad coverage to include a wide pool of source, where emissions are physically released into the entities that can efficiently participate in trading in the atmosphere; before the point source (upstream); or after secondary market. This is important both to ensure a the point source (downstream), as illustrated in Figure 4. sufficient level of trading for the market to function and to For example, in the California Cap-and-Trade Program, reduce the risk that market players with large amounts of the point of regulation for transport fuels is upstream, at market power will corner the market. Additionally, a broad the point they enter commerce. In practice, the point of ETS coverage will likely result in higher gains from trade if regulation is at terminal racks and large refineries, where the entities covered have significantly different abatement transportation fuels are physically transferred. The owners costs. The coverage required to meet this need will differ of these facilities pass the costs reflecting the embedded in jurisdictions with different levels and compositions of carbon dioxide through to the consumer in the form of emissions. In most cases, an ETS should consider covering higher fuel product prices. The Tokyo-Saitama ETS covers emissions from the electricity and industrial sectors. emissions from electricity used in buildings, which is This is due to the large contribution of these sectors to downstream of the source of emissions. Both ETSs and jurisdictions’ emission levels, the amount known about carbon taxes can be applied at various points in a supply abatement costs and options, the ease of identifying chain, and different sectors under the same CPI may also sources of emissions, and the fact that most firms in these have differing points of regulation. However, these choices sectors have sufficient capacity to analyze carbon liabilities will influence the administrative costs and MRV needed and participate in carbon markets. for implementation. As discussed above, the number of entities and variety of sectors covered will also affect A carbon tax can operate effectively even with more liquidity of the secondary market for an ETS. limited coverage and a smaller pool of covered firms. As a carbon tax does not require trading, it does not need the infrastructure to oversee a secondary market. Because of this, taxes are often used to cover more concentrated 12 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Figure 4 Emissions can be regulated at the point source of emissions, upstream or downstream Electricity Transport Agriculture (power generation) (mobile fuel combustion) (livestock emissions) Extractors Refiners Farmers Point & importers & importers (Thousands) source (Tens) (Tens) Upstream TO CARBON PRICING INTRODUCTION Emissions Generators (Hundreds) Downstream Emissions Point Retailers Processors Upstream source (Hundreds) (Tens) Retailers (Tens) Downstream Consumers Consumers Consumers (Millions) (Millions) (Millions) Emissions Point source Source: Emissions Trading in Practice: A Handbook on Design and Implementation 2021. 1.3.2 Ambition 1.4 CARBON PRICING INTERACTIONS The ambition of the cap or tax is important for Carbon pricing operates within a broader policy determining the role the CPI will play in achieving landscape; its role and interactions with other policies a jurisdiction’s emissions reduction target and the has implications for choosing a CPI. Developing a clear impact it will have on stakeholders. The ambition of the understanding of these dimensions is a key step in moving CPI will determine the strength of the abatement incentive. through the design process. Changes in the broader A tighter ETS cap, and one that increases in stringency policy context also mean that the CPI design should be over time, will result in higher prices and increased regularly reviewed and improved to account for changing investment in low-carbon technology, and therefore interactions. incentivize more abatement. The same applies for a higher, increasing tax rate under a carbon tax.27 Carbon pricing is just one tool within a wider policy toolbox and should form part of a broader suite of Importantly, more ambitious climate policies are policies. Carbon pricing creates financial incentives to likely to have greater impacts on stakeholders, as reduce GHG emissions. However, it may not be able to discussed further in Chapter 3. Through its impact on address nonprice barriers to mitigation, or to overcome stakeholders, therefore, the level of ambition — how much barriers such as the initial high cost of new mitigation of the emission reduction target it would achieve, for technologies. For instance, some clean technologies, like example — is an important consideration in the decision to battery storage for renewable electricity, may initially be adopt a CPI. It will also influence design choices that aim to expensive because they have not been deployed at a scale ameliorate any adverse impacts. that would reduce their cost. Therefore, synergies should be explored with other instruments, such as dedicated technology funds, low-carbon technology mandates, or R&D support, to reduce technology costs. A variety of 27 PSAMs reduce or increase supply in the ETS when market outcomes fall outside preferred parameters, for instance if prices are too high or too low. An auction reserve price is an example of a PSAM. INTRODUCTION TO CARBON PRICING 13 enabling policies are required to establish Figure 5 The impact of policy interactions on carbon price standards, mitigate risks, and create the right market conditions for wide-scale low-carbon Likely impact on allowance demand technology deployment, regardless of CPI and carbon price choice. Examples in an ETS Complementary CPIs operate within a complex policy improve • energy market reform landscape, and interactions with other functioning of (e.g. facilitating cost pass-through) policies may affect how the tax or ETS carbon markets • infrastructure upgrades will function. Other policies can affect the TO CARBON PRICING • energy efficiency labeling INTRODUCTION operation of the CPI, including the level of • pollution/emissions measurement emissions reductions; the carbon price; and the distributional impacts on businesses, households, and other stakeholders. The Overlapping types of interactions fall into three categories. duplicate • feed in tariffs incentives in • green certificate programs, such Complementary policies can help improve carbon markets as renewable energy targets the effectiveness of the CPI, as overlapping policies duplicate incentives provided by the CPI and countervailing policies contradict Countervailing the incentives provided by the CPI.28 It is oppose • fossil fuel subsidies therefore important for policymakers to incentives in • industry tax breaks and special identify the various policies that may interact carbon markets treatment with the CPI and assess what effects they Source: Emissions Trading in Practice: A Handbook on Design and Implementation 2021. might have. Similarly, after a CPI is in place, policymakers should carefully consider the introduction of new policies — assessing the objectives of new policies and how they The impact of companion policies should be may impact on the effectiveness of the CPI. A carbon considered when selecting and designing a CPI, to price should operate alongside complementary policies enable these policies to provide mutual support and that support decarbonization, while overlapping and improved outcomes. Successful carbon pricing policies countervailing policies should be consolidated, revised, exist alongside measures that support deeper emissions or (where possible and appropriate) removed, noting reductions over time. Complementary policies are typically that these policies may be focused on achieving a range associated with energy and electricity reform to ensure of other policy objectives. Figure 5 summarizes these energy markets are competitive, providing physical and interactions and provides examples of companion policies institutional infrastructure for consumers to respond to in each category. prices, innovation policies, and behavioral incentives. For instance, electricity market reforms to ensure customers are The policy interactions attachment (See Attachment 1) free to choose their electricity supplier; there is unbundling identifies key policy interactions and helps guide of supply, generation, and networks ensuring competition in policymakers through the types of policy interactions wholesale and retail markets; power plants are dispatched and their effect on the CPI. based on their economic merit; and independent regulators are assigned to monitor the market. Similarly, land tenure reforms that provide formal property rights can complement Box 4 Policy interactions attachment pricing land sector sequestration because it helps landholders access finance more easily. Providing electric Attachment 1 is designed to help policymakers vehicle charging infrastructure can accelerate demand-side assess the interactions between carbon pricing responses to carbon pricing in the transport sector. Rolling and related climate and energy policies. It presents out smart meters can raise awareness of energy use and a table of policies categorized by how these prompt consumers to change their usage behavior. Other policies may interact with the CPI (complementary, reforms may have a less direct but still important effect; overlapping, or countervailing). This table provides for instance, reforms to support an appropriately regulated a template for identifying relevant policies and a financial sector can improve the operation of secondary worked example to guide these considerations markets for emissions allowances or credits. regarding policy interactions. 28 World Bank, Ecofys, and Vivid Economics 2016. 14 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Overlapping policies should be considered when 1.5 LEARNING FROM OTHER designing a CPI and consolidated where possible. JURISDICTIONS Overlapping policies like green certificate programs, subsidies to low-carbon projects, or fuel taxes can Existing international experience can provide duplicate the effect of a CPI in the short term but might important information on the options available and be in place to address other barriers to emissions common challenges in the selection, design, and reductions or to achieve other objectives. For example, implementation of CPIs. The experience of existing CPIs policymakers might want to encourage specific mitigation can also strengthen the case for pursuing carbon pricing options to lower their long-term costs or achieve other or adopting a given CPI. For example, it can provide jurisdictions’ experiences on the mitigation and cost TO CARBON PRICING strategic objectives such as improved air quality or INTRODUCTION security of energy supply. Overlapping policies should be impacts of CPIs, government finance and distributional consolidated, revised, or removed where appropriate, and impacts, competitiveness effects, and wider benefits. the design of the CPI should consider those that remain Real-world examples of the effects of a CPI and the results in place (for example, through targeting coverage to those it has delivered can be complemented by locally focused sectors not covered by other policies). This approach can quantitative and qualitative research. improve the effectiveness of the overall policy mix while A cautious approach must be taken when assessing still attaining other objectives of interest. Further, attempts international experience, given the different contexts in should be made to adjust existing policies (where possible which CPIs are operating. Jurisdictional context can have and appropriate) to better reflect or be more compatible a large impact on the likely operation of a CPI (discussed with carbon pricing.29 in more detail in Chapter 2). These local factors need In general, jurisdictions should try to avoid to be considered when comparing against international countervailing policies (such as fossil fuel subsidies) experience. For instance, the way markets operate in very that undermine carbon market incentives. However, large jurisdictions like the EU or China may be very different this too requires careful analyses, as these policies to how they operate in smaller jurisdictions like New may achieve other objectives that may be of value to a Zealand or South Korea. Similarly, the distributional impacts jurisdiction. For example, they might support strategic of a carbon tax in a developing country like Colombia may economic sectors, lower-income groups, or disadvantaged be different to the impacts in a developed country like geographic regions. Importantly, jurisdictions should Sweden. This means that the relevance of the examples for consider the existing policy landscape when introducing a a given jurisdiction could differ substantially given its size, CPI. Indeed, it will be easier to coordinate and harmonize level of development, and an array of other factors. a CPI with policies under consideration. At the same time, By identifying case studies, a practical set of evidence it can be more challenging to introduce a CPI in a policy regarding CPI design and operation can be assembled. environment that consists of several mature policies, some Key aspects to look for to ensure comparability and direct of which may run contrary to the objective of the CPI, as applicability of case studies include these policies are entrenched and vested interests may resist them. They will also affect the performance of the X CPI type, design, and role: Does the CPI cover similar carbon price. For example, the investment incentives or different sectors? What is its level of ambition and provided by a carbon price could be undermined if it what role does it play in the policy mix? Is it an ETS or a is operating alongside fossil fuel subsidies. Moreover, carbon tax, and does it have a crediting mechanism? policymakers might consider formulating CPI design X Jurisdictional context: Are the jurisdictions elements (such as providing income support through comparable in terms of emission, economic, revenue raised) to benefit these same groups without the institutional, or other factors? Are these neighboring negative consequences of the countervailing policy. For jurisdictions or close trading partners? example, revenue from a carbon tax could be targeted X Policy context: How does the jurisdiction compare in to support disadvantaged groups that may be negatively terms of climate, energy, and other policies that may be affected by the removal or phaseout of fossil fuel subsidies. relevant for how a CPI works? Detailed case studies can also be found in World Bank resources and guidebooks. This includes the State and Trends of Carbon Pricing series,30 Emissions Trading in Practice: A Handbook on Design and Implementation, Carbon Tax Guide, A Guide to Developing Domestic Carbon Crediting Mechanisms, and specific guides on a range of 29 OECD 2019b. 30 World Bank 2020a. INTRODUCTION TO CARBON PRICING 15 topics including carbon pricing benefits, competitiveness, raising and wider economic impacts.36 Similarly, they and carbon leakage.31 Insights into jurisdictions’ can consider if other domestic or international policies experiences can also often be drawn from reports or outcomes bring insights on the likely impacts of a CPI, published by regulators and ministries on the performance such as trade policies and exchange rate movements of CPIs already implemented. Briefs and events put on by that can affect the international competitiveness of trade- the World Bank Carbon Pricing Leadership Coalition (CPLC) exposed industries and provide a benchmark against which can also be rich sources of information. to assess carbon pricing impacts. Existing carbon prices will provide frameworks, tools, and access to third-party In addition to public sources of evidence, capacity- vendors and experts that can reduce the time to set up building programs and direct engagement with these TO CARBON PRICING these functionalities. Building on the structures established INTRODUCTION jurisdictions can provide valuable information. Bodies in existing markets in other areas, like commodities, can like the PMR, CPLC, Finance Ministers’ Coalition for also reduce start-up costs. Climate Action, and ICAP provide unique fora to bring together policymakers from the early to more advanced stages of carbon pricing. There have also been expansive 1.6 FURTHER GUIDANCE bilateral cooperative engagements across jurisdictions The following resources may provide useful introductions that policymakers can build on, including the EU-China to key carbon pricing concepts: ETS cooperation,32 the German GIZ’s Global Carbon X PMR (Partnership for Market Readiness). 2017. Carbon Market 2018–2021 project,33 or the support of state and provincial governments of California and Québec in the Tax Guide: A Handbook for Policy Makers. ETS pilot program implementation.34 This not only can X World Bank. 2019. Using Carbon Revenues (Technical provide a source of evidence regarding experience in note No. 16). different jurisdictions but also enables policymakers with X World Bank. 2020. State and Trends of Carbon Pricing direct experience in dealing with these issues to share 2020. best practices and ideas for addressing novel or emergent X PMR (Partnership for Market Readiness), and ICAP challenges. (International Carbon Action Partnership). 2021. Further, jurisdictions can build on other relevant Emissions Trading in Practice: A Handbook on Design domestic and international policy experience when and Implementation. Washington, DC. considering CPIs’ impacts. For instance, policies that X PMR (Partnership for Market Readiness). 2021. A Guide have looked at reforming and/or raising energy taxes, as to Developing Domestic Carbon Crediting Mechanisms. well as those reforming fossil fuel subsidies, are likely X PMR (Partnership for Market Readiness). Forthcoming. to have analogous impacts to introducing a CPI. Thus, The Development Benefits of Carbon Pricing. jurisdictions can build on a large amount of existing evidence that has looked at the impacts of energy taxes, ranging from their distributional impacts35 to revenue 31 See the PMR’s Carbon Leakage: Theory, Evidence and Policy Design 2015. 32 EU-China Emissions Trading System 2020. 33 GIZ 2019. 34 Climate Scorecard 2020. 35 Pizer and Sexton 2019. 36 OECD 2019a. 16 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 2. THE JURISDICTIONAL CONTEXT Key takeaways: 9 A carbon pricing policy is most effective when it takes into account the local context. 9 Assessing the local context includes developing an understanding of the environmental, economic, governance, and political contexts, as well as the capacity of institutions to implement and regulate the carbon pricing instrument (CPI). 9 A jurisdiction’s objectives should guide the selection process, but different objectives may compete against each other. Policymakers should choose an evolutionary approach to CPI design that accommodates both short- and long-term objectives. Grounding a carbon pricing recommendation in the and policymakers will have to consider and think through THE JURISDICTION local context leads to targeted and more compelling these trade-offs. Throughout, policymakers should advice. Considering the local context shifts carbon pricing CONTEXT consider the environmental integrity of CPIs. A relatively from a theoretical option to a policy recommendation ambitious tax could deliver more emissions reductions calibrated to address jurisdictional challenges and than an ETS with a loose cap, even if a jurisdiction’s priorities. objectives point toward an ETS. The environmental integrity will be contingent on local factors like enforceability (see Mapping CPI options against the jurisdiction’s Section 2.3) and the political context (see Section 2.2). objectives, context, and capacity of key actors helps policymakers identify the parameters for a practical Achieving emissions targets cost-effectively is a and desirable CPI choice. The jurisdiction’s objectives will primary focus of jurisdictions when implementing a influence what role the CPI plays in the policy mix, as well carbon price. Carbon pricing allows for the least-cost as which instrument is most effective in achieving those mitigation options to be found and implemented across objectives. But the extent to which this plays out in reality sectors and so both taxes and ETSs are considered cost- depends on the jurisdiction’s environmental, economic, effective policy instruments. An ETS has the additional political, and governance landscapes. Finally, considering benefit of minimizing costs across time through its the capacity of specific actors in the government and countercyclical price response, which means it has greater private sector is necessary to understand the practicality of temporal flexibility when compared to a tax. However, an different options and identify capacity-building needs. ETS may have additional administrative costs relative to a carbon tax. If carbon pricing is the primary means for This chapter is structured as follows: a jurisdiction to achieve its emissions reduction targets, X Section 2.1 discusses how to align a recommendation policymakers may prefer the use of an ETS (which has an on carbon pricing with a jurisdiction’s objectives; emissions cap) instead of a carbon tax. This can guarantee X Section 2.2 outlines how to map the jurisdictional that the jurisdiction limits emissions to a predefined level. context, including the emissions profile, economic Carbon pricing can benefit low-carbon investment, profile, governance landscape, and political context; and raise revenue, and deliver broader environmental X Section 2.3 sets out an approach to assess a and development benefits. Low-carbon investment is jurisdiction’s capacity for implementing a carbon price mobilized through transparent, predictable, and increasing and how that influences instrument choice. prices. Carbon taxes can give policymakers direct control over the carbon price, thus allowing them to choose the strength of the price signal. Policymakers also control 2.1 JURISDICTIONS’ OBJECTIVES the strength of the price signal in an ETS, but this is done There are several types of benefits that may be of indirectly by adjusting the quantity of allowances in the greater or lesser importance to jurisdictions and the market or using measures to constrain low or high prices.37 relative priority of these objectives can determine Both carbon taxes and ETSs can raise revenue, but taxes whether a carbon tax or emissions trading system may offer a more predictable source of revenue. Further, (ETS) might be preferred. There may also be competing broader fiscal reform or tax shifting may open a political or contradictory demands in achieving multiple objectives space for a carbon tax to be enacted. Both ETSs and 37 These options are discussed further in the Partnership for Market Readiness’ (PMR) and International Carbon Action Partnership’s (ICAP) Emissions Trading in Practice: A Handbook on Design and Implementation 2021. THE JURISDICTION CONTEXT 17 taxes can deliver local benefits Figure 6 Considering objectives and potential preference for ETS or carbon tax like improvements in air and water quality. However, policymakers concerned with maximizing these ETS advantages Carbon tax advantages benefits might want to limit the Emission outcome certainty use of international offset credits or allowances from linked ETSs, Regional/international cooperation which may result in some of these benefits shifting abroad. Cost-effective mitigation Jurisdictions may look Local benefits to galvanize regional or international cooperation through their carbon price. Thus Promotes business investment certainty far, jurisdictions have achieved Raises predictable revenue this international cooperation via linking ETSs and through crediting mechanisms. It is easier THE JURISDICTION for policymakers from different CONTEXT jurisdictions to agree on a cap to emissions rather than a price level, These objectives may also point to different making an ETS preferable for regional and international instruments in the short and long runs. Short-run cooperation. Further tradable allowances and credits objectives like the ease of planning and implementing the enable businesses to trade, providing a bottom-up channel instrument often skew toward a tax. Conversely, long-run for cooperation. objectives like achieving emissions targets or cooperating with other jurisdictions are better achieved through an Overall, both a carbon tax and an ETS can be effective ETS. Section 2.1 provides more detail on balancing these tools for achieving a wide range of objectives, yet each objectives and the potential evolution of the instrument has specific areas in which they may outperform the over time. other. Figure 6 shows objectives that jurisdictions may look to pursue and an indication of what CPI may best meet that To determine the role that a CPI can play, it is objective. important to consider the perspectives of stakeholders from an early stage. Stakeholders affected by CPIs In some cases, the objectives of a jurisdiction will lead represent a wide array of interests and include businesses, to a clear CPI preference. For instance, the Regional households, government, and civil society groups. Greenhouse Gas Initiative (RGGI) in the northeastern Typical concerns are the environmental effects of the United States enabled linking across states. Additionally, CPI; its impact on the competitiveness of industry; and an ETS was a known and tested option for these states, the flow-on effects on low-income households, affected going back to their participation in the allowance trading workers, or other disadvantaged groups. These channels program under the federal Acid Rain Program that had are discussed further in Chapter 3. However, stakeholders been established in 1990. This also means that individual will often have views and may seek to provide input on the RGGI jurisdictions do not have to agree on a price, as the form of a CPI, its level of ambition, and its scope. As such, market sets the price in an ETS. Conversely, Mexico’s engaging stakeholders early in the process is essential to carbon tax was introduced in the context of a broader making an informed decision and building support. fiscal and taxation reform, with the more predictable nature of revenue from a carbon tax making it the obvious choice for introduction. 2.2 THE LOCAL CONTEXT Jurisdictions do not always have clear-cut objectives The effectiveness of a CPI varies with jurisdictional that align with a CPI choice. For instance, many context — there is no “one-size-fits-all” approach. jurisdictions look for certainty in their emissions level, There are a wide range of variables that can be relevant which is best achieved through an ETS. However, many for the choice and operation of a CPI. Some factors may also wish to generate a reliable source of revenue, which be more important or influential in the overall direction of is best done through a carbon tax. Policymakers must design of a jurisdiction’s carbon pricing approach. Some decide what is more important on balance and design the factors, like administrative capacity, may be overcome with instrument to accommodate conflicting objectives as much targeted capacity-building programs and tools. as possible, which is discussed in Section 4.1.3. 18 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Policymakers can assess jurisdictional context Figure 7 Aspects of jurisdictional context through a range of sources, including a review of data sets and extensive stakeholder engagement. Economic impacts differ National statistics agencies and international institutions by sector and across society often produce data on relevant economic and emissions Economy indicators (see Box 6) and are often the first place to look. Market characteristics determine market operation Where the data needed does not exist, policymakers should consider how it may be collected or proxied. Emissions profile helps Quantitative data must be overlaid and augmented with identify emissions to cover qualitative information on stakeholder perceptions and Environment concerns about carbon pricing (see Section 3.1.4). Emissions targets define the mitigation required Box 6 Data tip sheet Institutions influence oversight and MRV processes Included with this guide is an attachment (see Governance Attachment 3) that introduces potential sources of Legal considerations can limit data that policymakers may need throughout the THE JURISDICTION implementation options selection process. These are categorized by topics CONTEXT of interest and are meant to provide a starting Political considerations point for the data collection process. This list is not determine feasible options set exhaustive and should be supplemented with local Politics knowledge and expertise. Stakeholder interests and public opinion need to be considered 2.2.1 Environmental context The following subsections lay out the key aspects The key objective of a carbon price is environmental; it of jurisdictional context that should be assessed. aims to mitigate the adverse effects of climate change Specifically, they discuss the environmental context, by incentivizing emissions reductions. It is therefore economic profile, governance landscape, and political essential to understand a jurisdiction’s environmental considerations that should be considered. These are context. Most important for a carbon price are the emissions summarized in Figure 7. profile and a jurisdiction’s specific emissions reduction targets. Nonetheless, broader environmental objectives can To better focus their work, the questionnaire be influential in determining the design and operation of a attachment (see Box 5) sets out the key questions CPI. These topics are discussed in turn below. policymakers should answer about the local context. (1) Emissions profile Assessing the emissions profile of the jurisdiction Box 5 Questionnaire on jurisdictional context allows policymakers to understand the level and This questionnaire (see Attachment 2) helps sources of emissions and develop targeted policy policymakers build a structured understanding of solutions. The emissions profile plays a crucial role in their jurisdictional context and how it feeds into determining the role of carbon pricing within the broader decision-making. It outlines potential areas of focus policy mix, the scope, and selecting an appropriate CPI. alongside a brief description of why they matter for Once policymakers know where emissions are coming the decision to adopt a CPI and which instrument from — and how they are expected to grow over the next to select. Policymakers should consider each of years — they can figure out where a carbon price can fit these questions before selecting an instrument. in to help reduce emissions. For example, other sector- This questionnaire only provides a general guide, specific regulations may be preferable to a CPI if nonprice however, so there may be other questions that barriers to mitigation are most important for that sector, a policymaker will need to consider to better as these are not directly addressed by a carbon price. understand their local context. Alternatively, if emissions are from sectors where long-run investment in mitigation technologies is required, then a carbon tax can provide price certainty, which can underpin investment decisions (see Section 1.3.1). Developing an understanding of the jurisdiction’s emissions profile can also help policymakers situate their circumstances within THE JURISDICTION CONTEXT 19 the broader global context. Understanding which other (biogenic methane from livestock and landfill waste). jurisdictions have similar emission sources may help in This approach aims to reach net zero long-lived applying international best practices to local circumstances GHG emissions by 2050, and to stabilize short-lived and understanding potential impacts more easily. GHGs at 24 to 47 percent below 2017 levels by 2050. This approach was developed to reflect the In particular, the following facets of the jurisdiction’s Intergovernmental Panel on Climate Change’s special emissions profile might be informative: report, which found that in scenarios limiting warming X Current level of emissions and their trend over to 1.5 degrees with limited or no overshoot, the central time: The levels of past, current, and future emissions range of reductions in global agricultural methane determine how ambitious a jurisdiction’s mitigation emissions is 24 to 47 percent below 2010 levels. policy needs to be to meet its climate commitments. X Emissions intensity: This is a metric that captures Carbon pricing seeks to drive long-term reductions in the emissions released per unit of output or revenue emissions, so the direction of emissions over time is for firms, consumption, or relative to GDP at a country a key consideration. Certain sectors may become of level. The emissions intensity (along with abatement greater or lesser importance over time. Analyzing sector costs) provides information on the relative impact activity and emission trends over extended periods the carbon price is likely to have. Typically, the same is thus important. For example, rising emissions in amount of emissions reduction, say 10 million metric THE JURISDICTION domestic aviation may indicate that this is an important tons of carbon dioxide equivalent (tCO2e), will be sector to include under a future carbon price. Emissions CONTEXT significantly easier for a jurisdiction with a GDP of USD projections can be used to prioritize mitigation 1,000 billion to abate than a jurisdiction with a GDP opportunities across sectors. The scale and associated of USD 100 billion. This is because economies with a costs of these mitigation opportunities, in turn, can help high GDP generally have better access to the capital, determine the emissions reduction response to the CPI. research, technologies, and other resources required X Share of emissions by sector and source: Generally, for cost-effective abatement. A larger pool of resources CPIs will cover a subset of emissions from certain means the lowest-cost option is more likely to be sectors or sources. As such, looking at the share of available or be developed. Additionally, the relative emissions across these sectors and sources can help to economic impact of reducing emissions is likely to be identify which sectors and sources are most important lower given the larger GDP involved. Economies with to national emissions and are therefore most important a low emissions intensity (Switzerland or Singapore, to decarbonize. The sectoral composition of emissions for example) are likely be relatively less affected by will also influence CPI choice or design (particularly the carbon prices, all else being equal, but may have a point of regulation), because an ETS is more suited to harder time achieving low-cost GHG reductions. Finally, certain sectors. For example, coverage of the power it is important to identify emissions-intensive sectors sector often underpins an ETS. This sector is typically because they have a large emission share relative to a significant source of emissions, and emitters are their economic size. Abatement investments in these sophisticated enough to engage in relatively complex sectors can lead to large reductions in emissions. secondary market interactions, which helps to ensure However, as they may be more sensitive to competitive market efficiency. The European Union (EU) ETS’s first pressures that could result from a carbon price, sectors phase covered only carbon dioxide emissions from that are highly emissions intensive may need assistance power generators and energy-intensive industries. A in the initial stages of the CPI. carbon tax can be used in any sector that responds to prices. However, it is easier to implement in sectors with (2) Environmental objectives existing tax infrastructure. For example, carbon taxes The environmental objectives of a jurisdiction will are often employed in the transport sector because also influence the recommendation on carbon pricing. they can piggyback off existing tax arrangements on Well-designed CPIs can deliver ambitious environmental transport fuels, such as excise taxes. outcomes. Nonetheless, the specific nature of a jurisdiction’s X Share of emissions by type of gas: This can affect mitigation ambition and the jurisdiction’s other environmental coverage decisions for the CPI. Carbon dioxide is objectives should be considered in CPI design. almost always covered because it is often the largest source of GHG emissions. Jurisdictions will usually Two factors to consider here are cover a broad range of greenhouse gases (GHGs) to X Mitigation ambition: The fundamental purpose of improve policy effectiveness and efficiency. Some carbon pricing is to incentivize GHG mitigation. The jurisdictions may need to pay particular attention target adopted, and its ambition, can therefore be an to certain gases. For instance, New Zealand has important consideration for CPI selection and design. adopted separate targets for long-lived GHGs (carbon For ETSs and carbon taxes, ambition is a function of the dioxide and nitrous oxide) and for short-lived GHGs level of the cap and the tax rate, respectively. The rate 20 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE at which the cap declines, or the tax rate increases, will (1) Economic impacts determine the progress of ambition over time. However, The economic profile of a jurisdiction is a key policymakers may find that one instrument can deliver determinant of the cost of abatement and how the cost more ambitious outcomes than the other given their is distributed across sectors and geographies. The jurisdictional circumstances. For example, it may be economic profile refers to the structure of the economy, difficult to adjust the level of the tax if it is not delivering including its size and split among different sectors (like the emissions goal, due to barriers to frequently manufacturing, services, power, and government). It is updated fiscal codes and political barriers to explicit therefore a vital part of the background against which price increases (the requirement of a supermajority vote carbon pricing policy is set. Policymakers may wish to to raise a tax, for instance). In this situation, an ETS identify sectors, regions, or communities likely to face with a cap might be preferable because there is less of significant impacts and possible measures to mitigate these a direct connection between the government decision impacts within the final recommendation. For example, on ambition and eventual price, which is determined if higher electricity prices as a result of a carbon price by market forces. Policymakers may consider the ease raises concerns about energy affordability for low-income with which ambition might be ratcheted up or political households, the policy recommendation may also identify risks (such as repeal) when deciding what type of CPI additional measures, like direct financial compensation to implement. Having a clear trajectory of high ambition or energy efficiency projects, to reduce this impact. If the THE JURISDICTION and mechanisms for review and adjustment will help analysis reveals that carbon pricing may have a negative ameliorate political risk for both taxes and ETSs while CONTEXT impact on domestic competitiveness, policymakers could also meeting mitigation targets. consider options to address these risks, for instance X The potential for broader benefits, like air quality through free allocation in an ETS or benchmarked rebates improvements: In addition to emissions mitigation, in a tax. The economic profile and type of impacts carbon pricing may lead to other beneficial outcomes, identified can also influence how policymakers engage which may be a priority for jurisdictions. Reducing air with stakeholders, as well as the modeling and evidence- pollution is, for example, important to many jurisdictions. gathering process (see Chapter 3). If a carbon price could be designed to complement air quality improvement efforts by the government, this Key factors to include: may increase the level of support for the policy. This X Abatement opportunities: Different sectors will have prioritization may affect other design choices in the different opportunities and obstacles to reduce their CPI, though. For instance, it could reduce the appeal of emissions. Industries that produce a large amount using international crediting mechanisms, where local of process emissions may find emissions abatement air quality benefits — and the scale of those benefits challenging. For example, cement production creates — may shift to a different jurisdiction. Certain sectors significant process emissions through the chemical may also be associated with specific environmental reactions during the production process, for which benefits, and therefore might be priorities for coverage mitigation options are limited. Firms in these “hard- or crediting. For instance, emissions reductions from to-abate” sectors may require specific policies and avoided deforestation can bring a number of benefits to additional support measures to develop low-emissions the environment and local communities. technologies and processes. X Preexisting trends: Carbon pricing does not occur 2.2.2 Economic profile in isolation and may interact with other trends or The economic context of a jurisdiction determines the disruptions in particular sectors. For example, heavy impacts of a carbon price and who will be impacted, industry has faced a steady decline in developed and also can affect the way specific CPIs function. The economies for many years. The introduction of a carbon economic impacts of carbon pricing are often a key area of price may compound this shift and therefore generate contestation for carbon policy. Further, CPIs can function strong opposition. Sometime these changes can have very differently depending on the characteristics of the disruptive impacts; for instance, the unconventional market, leading to very different costs and benefits. These gas boom in the United States led to an unanticipated factors are discussed in turn below. Revenue use and and rapid fall in demand for allowances in RGGI, which its distribution will influence the final economic cost and depressed carbon prices for several years. These benefit distribution, which is discussed in more detail in the trends will be specific to each jurisdiction, but it is PMR’s Using Carbon Revenues Guide.38 typically useful to conduct an analysis of macro-level indicators (for example, employment, output, and trade statistics) over time and by sector to spot trends or irregularities. 38 PMR 2019. THE JURISDICTION CONTEXT 21 X Export and import composition: This can help understand these impacts (see Section 3.2) and inform policymakers understand what products and sectors the design of policies to mitigate or offset their effects. face international competition and who may bear the Policymakers will need to make sure they have or can brunt of increases in costs from carbon pricing. The access data related to those dimensions (for instance, impact of a carbon price on the energy sector will also census information or household surveys indicating have flow-on effects for international trade in fossil race, income level, or gender). Revenue recycling fuels, energy independence, and terms of trade. These or funding social programs can help policymakers factors, combined with the level of international trade compensate for potential social impacts from a carbon exposure an economy faces, will also be relevant tax or ETS from the outset. to issues around domestic competitiveness. These X Geographic characteristics: Understanding competitiveness impacts and potential risks of carbon geographic characteristics, particularly the regional leakage are discussed more in Section 3.1.1. distribution of sectors that are impacted by the CPI, is X Employment: While existing CPIs have thus far had important to understanding where impacts will be felt. limited impacts on employment (see Section 3.2.1), High-carbon industries are often regionally clustered, over the long term, CPIs aim to shift the composition which means that the impact of carbon pricing may of the economy to a lower-emissions pathway. Some also be geographically concentrated. For instance, in sectors will face significant challenges in reducing South Africa a large proportion of coal mining activity THE JURISDICTION emissions and may contract in size while others will is concentrated in the Witbank Coalfield.41 Those CONTEXT benefit from increased innovation and growth, with industries, and the communities and jobs that indirectly consequences for employment.39 Understanding rely on them, will likely be more acutely affected than current sectoral employment levels and employment others (see Section 3.2.2). trends will build an understanding of how current and future employment may be affected.40 Unemployment External factors can influence the economic can have significant economic and social impacts, environment and can create opportunities for carbon particularly when concentrated in certain localities. pricing. Box 7 outlines how carbon pricing can play a role Understanding impacts on employment can therefore as part of a coordinated policy response to the COVID-19 help policymakers develop an appropriate policy pandemic. As well as changing the economic environment, response (for example, through job creation and major shocks like COVID-19 can influence the politics of retraining programs). Employment impacts can be introducing carbon pricing (see Section 2.2.4). For example, politically contentious, and a thorough investigation of public perception of the environmental and human health the nature of employment in the jurisdiction is required benefits from climate action and decarbonization may be to factor opportunities and risks associated with the heightened following the COVID-19 pandemic. Economic CPI’s employment impacts into decision-making. shocks may also influence the choice of CPI. By design, an ETS has a variable carbon price that adjusts quickly X Demographic characteristics: Carbon pricing in times of economic downturn. Legislative initiatives in may interact with demographic characteristics and response to economic shocks may create opportunities existing inequality across dimensions such as race, for carbon pricing implementation. For example, a stimulus income level, or gender. This could cause concerns package or broader tax reform may create an opportunity around, for example, energy affordability for vulnerable for legislating an ETS or carbon tax rather than starting communities. Modeling and surveys can help from scratch. 39 Organisation for Economic Co-operation and Development 2020. 40 Employment intensity, or employment elasticity, is a measure of how much employment is expected to grow for a given increase in economic growth. This is important to consider for the rate and level of support needed for growing or contracting sectors. 41 Minerals Council South Africa 2020. 22 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Box 7 Post COVID-19 recovery and opportunities for carbon pricing As well as seriously impacting the health of populations, COVID-19 presents major economic challenges, including reduced growth, increased unemployment and poverty, and declining government revenue. The initial focus of the response to COVID-19 has been on the public health emergency, maintaining liquidity for households and businesses, and humanitarian support for the worst affected. Following this, attention turns to economic stimulus and recovery. The quality, content, and strength of the stimulus packages will determine both economic and environmental outcomes for decades to come. Carbon pricing presents opportunities to support a resilient and sustained economic recovery from the COVID-19 crisis: X Green jobs: Carbon pricing supports sustainable industries and promotes the competitiveness of low-emission products and processes, such as renewable energy and energy efficiency. Global estimates show the high job creation potential of renewable energy and energy efficiency: while USD 1 million spending in fossil fuels would create 2.7 full-time equivalent (FTE) jobs, that same spending would create 7.5 FTE jobs in renewable energy and 7.7 FTE jobs in energy efficiency.42 X Green investment and economic resilience: Carbon pricing can help direct investments toward low-emissions technologies and mobilize much-needed revenue. For example, by ensuring fuel prices capture both supply and environmental costs, carbon pricing reduces the risks of locking in carbon-intensive capital. Such lock-in can be THE JURISDICTION very costly to reverse later. CONTEXT X Increased revenue: Carbon pricing presents an opportunity to regain lost revenue and strengthen frameworks to support debt and spending growth. This is particularly relevant in the context of falling fossil fuel prices. Futures prices indicate that oil prices may remain low for several years. This would allow the government to capture some of the benefits of low prices as revenue, while reducing the impact of reform on households and businesses. (2) Sectoral attributes influence the abatement incentives of firms. Emitters In some cases, the economic makeup of a jurisdiction in concentrated markets may be able to pass on their can directly affect the viability or design of a CPI. increase in costs rather than abate (see Section 3.1.1). Market attributes to consider include X Abatement options and incentives: Firms in different X Market structure and concentration: The market sectors will have different incentives and abilities to concentration (that is, the number of firms operating abate. In cases where there are limited options for in each sector and their market share) will impact mitigation, a carbon price may be complemented by recommendations for a CPI. If a handful of emitters policies to help develop and deploy new technologies. are responsible for most of the pollution, an ETS might However, a carbon price often plays an important role struggle with secondary market liquidity. Conversely, in incentivizing mitigation from unexpected sources if the sector is made up of numerous small emitters, from across the supply chain. Market structure will also the administrative burden of engaging in a secondary influence the ability and incentives for firms to abate. market might be too high. In developing countries like X Access to supporting services: While jurisdictions Brazil, a significant share of emissions comes from the often consider high-emitting sectors of the economy agricultural sector, which is often made up of many when selecting a CPI, other sectors can also play an small emitters. This may lead policymakers to choose important role in determining a CPI’s operation. For other regulatory instruments in these sectors because example, the UK’s large and sophisticated financial putting a price on carbon can be challenging in these services sector supports trade in a wide range of conditions. If using a CPI, it makes the inclusion of commodities with similar attributes, including electricity, crediting a potentially attractive design feature (for a tax energy, and physical commodities trading. This means or an ETS) to capture those more challenging sectors the UK has more actors engaged with trading and because it provides a positive incentive for entities businesses with a high degree of capacity, suggesting to reduce emissions (without penalizing those that it may support relatively liquid markets even for cannot).43 CPI design may accommodate for varying relatively small market sizes. Similarly, countries with market structures by placing the point of regulation sophisticated support ecosystems (like legal services at the most concentrated part of the supply chain or a network of auditors and verifiers) might find (see Section 1.3.1). The market structure may also implementing an ETS easier. 42 Garrett-Peltier 2017. 43 While it is rare to cover the agriculture and forestry sector directly within an ETS or tax (not via crediting mechanisms) it is certainly possible. New Zealand, for example, covers these sectors within its ETS. Also see the forthcoming World Bank publication Designing Fiscal Instruments for Sustainable Forests for details on carbon pricing in relation to deforestation and land use changes. THE JURISDICTION CONTEXT 23 X Interactions between sectors: These interactions provide systems that can be leveraged or adapted for determine how the carbon price spreads throughout carbon pricing, and will likely determine which government the economy, particularly to noncovered entities. bodies will control future policy design. Key issues to Knowledge of these interactions can then inform CPI consider include considerations around the point of regulation and X Constraints on feasibility and design: The existing sector coverage. For instance, some sectors, such as legal and institutional structure may make some power generation, have the potential to pass on higher policies more feasible than others, which will influence carbon costs to sectors that use their electricity, such the role of the CPI as well as the instrument selected. as industrial manufacturers. This means that even a Rules on taxation and spending, in particular, will sector with low direct emissions may still be highly likely determine the design of the CPI, or even which impacted by a carbon price if it is heavily reliant on CPI options are feasible. For instance, in the EU, tax fossil fuel inputs. For instance, aluminum smelting often measures require unanimous agreement to introduce, produces relatively low levels of direct GHG emissions while the requirements on environmental measures are relative to indirect emissions because its production less onerous (requiring a “qualified majority”).46 This requires significant electricity consumption, which may means tax measures are more difficult to implement be reliant on fossil fuel generation. than environmental measures, such as an ETS. The X Market regulation: Market regulation might influence initial proposal for a carbon tax in France in 2009 THE JURISDICTION the effectiveness of a carbon price, especially in was deemed unconstitutional because of a number CONTEXT electricity markets.44 In a fully liberalized electricity of exemptions and the design of the compensation market, a carbon price would push up the prices for for low-income households.47 Legal factors may electricity generated from fossil fuels, a mechanism also influence specific design features of interest to known as cost pass-through. This encourages decision-makers. For example, some jurisdictions might electricity generators to switch to cleaner and place restrictions on the earmarking or the specific more efficient ways of producing electricity and uses of tax revenues. There are also often constitutional motivates firms and households to reduce electricity or legal limitations on the type of taxes that can be consumption. Conversely, where prices are strongly enacted at a subnational level in federal systems, as regulated carbon cost pass-through may be inhibited. is the case in the US. In some cases, existing market Policymakers may wish to target such regulated sectors rules may make it more challenging to implement a with companion policies — for example, renewable carbon price. For instance, the regulation of prices in portfolio standards, which have been used in California. the electricity sector can often restrict a firm’s ability to X Experience with carbon pricing: Certain sectors pass through cost increases to end consumers and can or firms may have voluntarily participated in existing make covering the electricity sector challenging. carbon markets like the Clean Development Mechanism X Ease of implementation: Existing institutions and or the Verified Carbon Standard. This experience may frameworks can be useful to either facilitate or create increase the capacity of the government and firms to barriers to the implementation of CPIs. The introduction implement carbon pricing requirements such as robust of CPIs often draws on rules and legislation developed monitoring, reporting, and verifying (MRV) systems. for other policies. For example, it is common for CPIs to Further, large firms may also have experimented with build on existing fuel taxes, particularly in the transport internal carbon pricing or may already face carbon sector, by using the existing fuel tax infrastructure for prices in other jurisdictions in which they operate.45 measuring and reporting emissions and levying the This might make them better able to engage with a carbon tax. In many jurisdictions, the implementation jurisdictional carbon price. of a carbon tax is often quite straightforward if these systems are already in place. ETSs usually require 2.2.3 Governance landscape the establishment of new institutional frameworks to operate. In some cases existing institutions can be used; The governance of a jurisdiction spans both the for instance, registries for trading renewable energy legal context of the jurisdictions and the institutions certificates have similar functionalities and processes that operate within this context. Existing legal and as those needed for an ETS. Nonetheless, establishing institutional factors can differ substantially across an ETS generally requires at least coordination across a jurisdictions and have a large impact on CPI choice and range of entities and institutions, and the establishment design. These factors may constrain CPI options and 44 Acworth et al. 2018 discuss the use of ETSs in regulated electricity markets in detail. Carbon pricing instruments can operate in regulated electricity markets but there may be ramifications on how the instrument is designed; some insights are provided in Acworth et al. 2018. 45 Internal carbon pricing creates effective, or shadow, carbon prices for operations within the company. For example, the internal carbon price may be used in a cost-benefit analysis of a project. 46 The qualified majority is a procedure that requires more than a majority support but less than unanimous support. 47 PMR 2017. 24 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE of the infrastructure required to support secondary Considerations around political context that should be markets when this is not already in existence. assessed include X Control of policy design and implementation: X Political positioning: Political actors will differ in the Internal structures within government might have way they position themselves on climate ambition and different objectives, administrative capacity, expertise, policy approaches. Some governments will view the and responsibilities. This may influence the choice implementation of an ambitious carbon pricing policy of CPI, and who controls it. For example, Ministries as an opportunity to demonstrate their environmental of Finance might prefer a carbon tax due to their credibility to domestic constituents and/or on the experience with and knowledge of fiscal instruments. international stage. For example, the EU is widely seen Often, Ministries of Finance will be responsible for the as a leader on carbon pricing, and a decision to follow implementation of carbon taxes, while Ministries of in its footsteps and implement a similar system could be Environment will be responsible for the implementation desirable for some emerging economies. On the other of ETSs. For instance, in the UK, the ETS policy was hand, some governments and political parties would within the remit of the Department of Energy and like to be perceived as prioritizing domestic economic Climate Change,48 while carbon taxes, including Carbon issues. Such jurisdictions may therefore choose Price Support, were controlled by the Treasury. the instrument that most effectively raises revenue. The beliefs of the political parties that comprise the THE JURISDICTION These legal and institutional issues should be carefully government (or are active in the opposition) could reviewed to assess their impact on the functioning of a CONTEXT also influence the ambition and design of the CPI. For proposed CPI. example, New Zealand’s recent reforms to adopt a 2050 target and strengthen carbon pricing were implemented 2.2.4 Political considerations under a Labour-led coalition government, with a Green A jurisdiction’s political context can play a significant Party representative as Minister for Climate Change. role in the selection and longevity of a CPI. For instance, X Public opinion: Understanding the importance changes of government in Australia, Ontario, and New the wider population places on climate action will Jersey precipitated the repeal of carbon pricing (and, in help gauge support for ambitious policies. Without New Jersey, its recent reintroduction).49 Introducing a strong public support, carbon pricing will remain carbon price is therefore not just a technical decision, but at risk of backsliding from governments, thereby also a political one. Political acceptability can evolve over undermining its long-term effectiveness. The political time and CPIs may become more durable over time as the opportunity for carbon pricing is often short, which public sees the benefits of carbon pricing and support for means policymakers should utilize periods of public climate action grows. support when it arises. The proliferation of net zero commitments globally has created the opportunity to Policymakers should engage in early discussions strengthen climate policies, including a carbon price. with a wide range of stakeholders to assess political Clear communication and stakeholder engagement support and develop an effective communications can also help avoid or navigate public concern. An strategy. This can build acceptance internally across approach that has been used to limit the initial cost the government and externally with key stakeholders shock is to start with a low price or low stringency and from the private sector and civil society. Opinion surveys, clearly communicating that the price will gradually focus groups, and other forms of market research can increase over time. Future prices and stringency are be important tools for understanding public opinion particularly important to long-lived capital investment (see Section 3.1.4). The PMR’s Guide to Communicating decisions and a gradual approach can reduce price Carbon Pricing has a more detailed discussion of shocks while still sending the signal that low-carbon communications research and communications strategy. innovation is valuable. The use of revenues to support Furthermore, engaging with stakeholders that are policies or programs can also help improve public skeptical or unsupportive of carbon pricing is particularly acceptance when paired with effective communication important since understanding their concerns early gives of the environmental, social, and economic benefits of policymakers time to acknowledge and address those carbon pricing.50 concerns. In deciding to adopt a CPI, decision-makers X Policy preferences: Businesses, interest groups, and will want to know that the views of interest groups are the general public may prefer a tax or an ETS, with understood and have been considered. opinion polls in various countries consistently showing 48 Department of Energy and Climate Change is now part of the Department for Business, Energy & Industrial Strategy. 49 Santikarn et al. 2018. 50 Burke et al. 2019. THE JURISDICTION CONTEXT 25 taxes to be less popular than other regulations.51 particularly focused on how these policies will affect Entrenched views on taxation may therefore limit jobs and on achieving a “just transition,” the latter instrument choice. This may be remedied with design of which looks at making the low-carbon transition attributes such as recycling revenues and the use of equitable and inclusive (see Section 3.1). Active crediting mechanisms. The British Columbian carbon engagement with labor and social organizations to tax, for example, has widespread support partly explain the rationale and benefits of a CPI can help because revenues are partially recycled. On the other build a broad-based coalition supporting the policy. The hand, some stakeholders may oppose a market-based impact on employment is a key concern for government instrument like an ETS because it is perceived to regardless of the policy, designing a CPI and supporting be in the interest of industry by “privatizing” and policies to generate low-carbon jobs and ensure the commodifying the climate.52 However, if the CPI is transition from high-carbon jobs is manageable can help presented as a package or part of broader reform, dispel the false narrative that climate action comes at instrument options may be more flexible since potential the expense of the economy. opposition to carbon pricing can be mitigated through X Alignment with other jurisdictions: The extent to support for the broader policy package that seeks to which the jurisdiction aims to align its policy with achieve a range of policy objectives rather than focusing another jurisdiction (such as a major trade partner) on how the policy instrument works. will affect CPI selection and design. The potential for THE JURISDICTION X Interest groups: Groups representing business, linking is often a key consideration in both the design CONTEXT environmental, and social organizations often play and the evolution of ETS design over time. For instance, an important role in shaping the public discourse on jurisdictions in the Western Climate Initiative have carbon pricing. Business opposition to carbon pricing agreed on key design parameters for their linked ETS. is often one of the major barriers to its implementation. Similarly, Switzerland made changes to its ETS design Businesses often organize themselves in powerful to coordinate its regulation with the EU prior to linking lobbies, which can influence government decision- the two systems.53 Other international agreements may makers and inhibit their ability to implement a carbon also play a role; for instance, the Association Agreement price or increase its ambition. Building coalitions among between the EU and Ukraine required the Ukraine move supportive businesses and sectors can help increase toward implementing an ETS.54 the likelihood of implementing a carbon price and having it last. Business support can provide confidence in the system, showing that the regulated entities acknowledge 2.3 CAPACITY FOR IMPLEMENTATION the need for carbon pricing and environmental policy, An important step in ensuring that a CPI is appropriate and that they can participate effectively. Environmental for a given jurisdiction is mapping the complexity of organizations can often be among the most vocal CPIs against the capacity of government to implement supporters of climate action, though they may not and enforce policies, and businesses to respond always be supportive of a carbon price as the means of to them. Both instruments can still achieve ambitious tackling climate change, preferring other policies and outcomes with simple designs, but there are some raising environmental justice and/or equity concerns. inherent differences in the level of capacity required for They will often lobby for policymakers to adopt stronger implementation. This section outlines how CPIs differ in emissions reduction targets, to adopt policies with complexity both inherently and by design, and how the local environmental benefits, and to limit levels of capacity of governments and businesses can vary both assistance to businesses. Early outreach to climate and within and between jurisdictions. The ability of government environmental advocates to understand their concerns and businesses to handle the complexity of different and discuss the distributional impacts of the CPI can CPIs will influence what policy can be implemented and inform policy makers’ program design. For instance, its design features. Limited existing capacity should to assess whether complementary policies or design not discourage CPI implementation. Capacity can be adjustments are needed to ensure local environmental built up over time through trainings and investments benefits are generated and equally distributed. in infrastructure (such as registries and exchanges for Having their support, particularly for more ambitious secondary market trading), while some CPI designs require policies, can help balance corporate interests against limited new capacity. However, simple design does not increased climate action. Finally, social organizations, guarantee easy implementation, especially if key actors including labor unions and civil society groups, may be have little experience with carbon pricing. 51 This finding is consistent across a wide range of countries, including Australia, Austria, Bangladesh, Canada, Finland, Germany, Norway, Sweden, Switzerland, Taiwan, and the United Kingdom. See numerous sources summarized in Lachapelle 2017. 52 Paterson 2010.  53 This is discussed further in the linking section of the PMR’s and ICAP’s Emissions Trading in Practice: A Handbook on Design and Implementation 2021. 54 EU 2014. 26 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 2.3.1 Capacities needed for CPI 2.3.2 Identifying instrument complexity implementation CPIs differ in their inherent complexity relating both Jurisdictions have differing capacity in both the to the governance of the CPI and its interaction public and the private sectors, which impacts the with markets. As Figure 8 outlines, establishing a effectiveness of CPIs. Historically carbon pricing has comprehensive MRV structure that generates accurate and been pursued by largely developed nations that are able reliable data will be the foundation for any CPI. Beyond to utilize existing institutions and policy frameworks this requirement, a carbon tax will need an enforcement built up over many years. Even then, carbon pricing mechanism but otherwise does not require a secondary implementation, particularly of ETSs, has required market and is generally easier than an ETS to implement. additional institutions to be set up, as well as trainings This means they can be quite rapid to implement and workshops to build the required capacity among because many jurisdictions may have tax systems in government regulators and regulated businesses. In recent place, particularly for fuel taxes, that can be utilized and years, however, the uptake of carbon pricing in developing adapted. Crediting mechanisms, which can be used in both economies has accelerated as jurisdictions experiment taxes and ETSs, also require some market infrastructure with CPI designs that are suitable for their specific context. to function. However, only an ETS requires additional There has also been increased participation in crediting systems for allocating allowances, either through auctions mechanisms, which has built private sector capacity to or for free. Critical to all CPIs will be sufficiently robust THE JURISDICTION engage in carbon markets. In the early stages of carbon and effective MRV systems, as well as the capacity for CONTEXT pricing consideration, jurisdictions need to assess the governments to enforce, and businesses to comply with, capacity — and identify any gaps — of businesses and the MRV requirements. regulators. The need for additional market capacity should Capacity can be considered in terms of governance not discourage the implementation of an ETS. The and market requirements. Governance capacity nature of an ETS means that it has the broadest capacity focuses on what is needed for CPI compliance, while requirements, with allocation and compliance systems market capacity looks at what is needed to trade on a needing to be implemented in addition to the structures carbon market (that is, in an ETS or a carbon crediting needed for trading. While markets add additional mechanism). Figure 8 outlines the capacity needs for complexity, they are only one part of the considerations regulators and businesses based on these two metrics. for CPI selection. Market capacity can be developed while planning and rolling out the ETS. Policy makers can look to other ETSs to provide resources like learning opportunities, frameworks, existing tools, and access to third-party Figure 8 Capacity requirements may differ for different CPIs Capacity required Regulatory capacity Business capacity Compliance ► Credible enforcement mechanisms and ► Clear lines of responsibility punishments for emissions liabilities ► Access to emissions verification or Governance auditing service providers Carbon tax MRV ► Monitoring and reporting institutions for ► Established data collection processes other policies (such as taxes) or standalone ► Access to verification services Emissions trading system data gathering and reporting system Crediting Market ► Financial market regulation that provides ► Businesses’ ability and willingness to oversight stability and punishes misconduct comply with regulation Trade Registry for holding/trading units Liquid market, operating through exchange Markets ► ► infrastructure based trading ► Internal carbon risk management processes Allocations ► Production and emissions data for ► Understanding of allocation design and determining free allocations competitiveness implications THE JURISDICTION CONTEXT 27 vendors and experts that can reduce the time to set up Box 8 Capacity assessment tool these functionalities. Building on the structures established The capacity assessment tool (see Attachment 4) in existing markets in other areas, like commodities, can helps policymakers map the capacity of business and also reduce start-up costs. As ETSs become established government to the requirements of different CPIs. policy tools, a greater variety of external vendors can assist Policymakers fill in the color code based on current in establishing a well-functioning secondary market. capacity for each component, which is then mapped Design choices will also impact instrument complexity. onto the requirements of differing CPIs. This will aid Covering emissions from transport upstream at the point policymakers in understanding what capacities they of fuel distribution, for example, means fewer firms are have, and which CPI those strengths are compatible directly covered by the regulation, which substantially with. The tool will also point to where capacity needs reduces complexity and administrative cost. Alternatively, to be developed. Included with the tool is a worked complexity can also be reduced by building on existing example, as well as a list of questions to aid in policies — for instance, environmental regulations that thinking about the existing capacity. require air pollution monitoring may establish much of the reporting requirements needed for MRV systems.55 Finally, the complexity of the CPI will also depend on the sectors The complexity of CPIs and the capacity of covered. Whereas coverage of electricity generation can governments and businesses that must implement and THE JURISDICTION often enable a CPI to cover a large share of emissions from respond to them will change over time. This means that CONTEXT a small number of entities, sectors with diffuse emissions the most appropriate CPI design may also evolve over time sources like waste and agriculture may be far more with these circumstances. challenging to cover. Specific design elements are covered Carbon pricing should be designed to accommodate in detail in the ETS Handbook56 and Carbon Tax Guide.57 scaling up of ambition and the use of more efficient ICAP’s report on options to keep ETS design simple58 may and complex designs as capacity grows over time. also provide useful guidance on minimizing complexity. For instance, the introduction of elements such as offsets may improve the overall efficiency of a policy but may 2.3.3 Mapping capacity to instrument require the development of both regulatory and business complexity capacity to implement effectively. However, simple designs To identify an appropriate instrument, it is crucial to do not equate to a lack of ambition; a simple carbon tax map the level of complexity of the CPI with the capacity can still set a strong carbon price to drive emissions of both government and businesses. This can help reductions. Sweden’s carbon tax utilizes existing revenue identify what CPI designs are likely to have a high chance collection systems and is levied on all fossil fuels. While of success, determine which sectors are most ready for administratively straightforward, it is set at EUR 110/tCO2e, coverage, and provide a compelling rationale for the design the highest in the world. The ambition of the tax has been choice in the policy recommendation. It can also help increased over time. When first introduced in 1991, the tax policymakers target training programs and the creation of level was EUR 23.59 Political challenges sometimes mean tools and other support options to address any capacity that simple design does not mean simple implementation. gaps needed to implement a CPI. To aid in mapping, this South Africa experienced a 10-year policy development guide includes a capacity assessment tool (see Box 8). process despite enacting a relatively “simple” carbon tax. Some jurisdictions have found implementing a simpler CPI or starting with a voluntary pilot program has paved the way for a more complex CPI design over time. New Zealand phased sectors into the ETS by initially having one year of voluntary reporting and, for most sectors, one year of mandatory reporting prior to the introduction of surrender obligations under the ETS. The Republic of Korea smoothed introduction to its ETS by introducing a Target Management System, which involved both mandatory reporting and firm-specific emission reduction targets, applied to the same parties that were expected to be regulated by the ETS. To prepare for 55 For more see the PMR’s Developing Emissions Quantification Protocols for Carbon Pricing: A Guide to Options and Policy Makers 2020. 56 PMR and ICAP 2020. 57 PMR 2017. 58 Eden et al. 2019. 59 Government Offices of Sweden 2020. 28 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE the Mexico ETS, policymakers had a period of learning, 2.4 FURTHER GUIDANCE engaging with policymakers from jurisdictions with existing ETSs. In addition, they had extensive stakeholder The following resources may be useful for understanding consultation before introducing a pilot ETS in 2020. They the jurisdictional context and capabilities: also simulated market trading to train potential ETS X PMR (Partnership for Market Readiness). 2015. participants. The benefits from adding to or changing Checklist on Establishing Post-2020 Emission Pathways. a new CPI should be weighed against the potential X PMR (Partnership for Market Readiness). 2017. Carbon uncertainty that unanticipated changes can create. Clear Tax Guide: A Handbook for Policy Makers. communication of the objectives of the CPI, and the fact X PMR (Partnership for Market Readiness), and CPLC that its design may change over time to better achieve (Carbon Pricing Leadership Coalition). 2018. Guide to these objectives, can help avoid surprises and reduce Communicating Carbon Pricing. opposition when these changes occur. X PMR (Partnership for Market Readiness), and ICAP (International Carbon Action Partnership). 2021. Emissions Trading in Practice: A Handbook on Design and Implementation. IMPACT ASSESSMENT 29 3. IMPACT ASSESSMENT Key takeaways: 9 A carbon price has implications across the economy. Early engagement with stakeholders is critical to understanding the impacts of, and building support for, a carbon price. 9 A carbon price will increase the relative cost of carbon-intensive goods and services. An impact assessment will help identify how these changes may affect business operations and policy options to help businesses transition, noting the carbon pricing impacts will vary across and within sectors. 9 Households will experience a change in the price of goods from passed-on carbon costs, and vulnerable groups may need additional support. 9 Modeling provides a powerful quantitative evidence base for carbon pricing but is only one part of the evidence base. If modeling is used, the approach, assumptions, and results should be presented clearly and transparently. Impact assessments show how a carbon price could on a combination of assumptions, theory, and data, all of affect the economy and key stakeholders. These which bring inherent uncertainty. Models can provide an assessments provide important inputs for carbon pricing indication of potential outcomes and impacts but cannot instrument (CPI) selection and design by identifying and be solely relied on to provide definitive answers. quantifying the potential costs and benefits of carbon pricing. Impact assessments give an indication of the This chapter is structured as follows: distributional impact of carbon pricing and can show X Section 3.1 outlines how carbon pricing can impact ASSESSMENT the magnitude of the costs and benefits. It is up to different sets of stakeholders, particularly businesses IMPACT policymakers to then assess which potentially negative and households potentially affected by increased costs; impacts need to be addressed. For example, a cost and increase for high-income households can be reasonably X Section 3.2 discusses the approaches to modeling borne, whereas low-income households may need the impacts of carbon pricing on these stakeholders, support. Outlining the economic, social, and environmental including the role and potential limitations of economic impacts of a CPI in the policy recommendation and modeling. ways in which negative impacts can be ameliorated can increase support for the proposed policy. The impact assessment can alleviate concerns from stakeholders 3.1 STAKEHOLDER IMPACTS in cases where concerns are shown by the impact The impact of carbon pricing on key stakeholders assessment as unfounded. The data and insights from is of crucial importance to governments, as it can assessing the jurisdictional context (see Chapter 2) can influence both the effectiveness of the policy and its help identify priorities for the impact assessment. Impact political success. Carbon pricing will create winners and assessments can also be informative when deciding on losers across society, even if the overall impacts of carbon the role of the CPI, designing complementary policies, pricing are small. Understanding stakeholder impacts, for selecting the appropriate instrument, and engaging in the instance, through stakeholder engagement and impact design process. A central part of the impact assessment is assessments, must therefore inform the design of carbon stakeholder engagement, which can help identify priorities, pricing policies. Understanding these impacts can also assumptions, and concerns about a carbon price. help policymakers identify constituencies that may support Modeling is an important source of insight for an or oppose a carbon price. impact assessment. There are a wide range of models The key stakeholder groups that are impacted by a carbon that are used for developing a carbon pricing impact price include assessment. Generally, relevant models are economic X Businesses: Firms may be impacted by a change in in focus, but these may also seek to represent complex energy or natural systems where climate change and demand for their products and a change in supply for carbon pricing have a large impact. The scope of modeling intermediate products after the introduction of a CPI. can vary from specific sectors or technologies to economy- This may impact output and employment, as well as wide impacts. Economic modeling can simulate changes shifting relative costs of inputs. in policy design and their impacts on the jurisdiction. X Households: Individuals purchase goods and services However, modeling must be used with care as it relies and provide labor to businesses. The price of goods 30 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE (including environmental services) may change with a are referred to as emissions-intensive, trade-exposed carbon price. Employment may also be affected through (EITE) industries. Firms outside of the direct scope of the changes in business demand. CPI may also be indirectly affected, facing changes in X Other stakeholders: This includes stakeholders within production costs if, for example, they receive production government, given the carbon price’s interactions with inputs from firms facing a carbon price. These costs should existing policies, and civil society stakeholders who be considered within the context of the broader policy represent impacted interest groups. mix, as existing policies may interact with carbon pricing (see Section 2.1.3), which will affect the overall competitive Policymakers seek to quantify these impacts to assess position of firms. the direction, scale, and importance of these different types of impact. Understanding impacts early on gives Carbon leakage is a risk for industries that experience policymakers a chance to adjust the design of their CPI a loss in international competitiveness. If international to limit any potentially negative effects. Some impacts competitors do not need to comply with equally stringent may represent reasonable or desirable costs that should carbon regulation, the carbon price creates a differential be borne; for example, price rises on carbon-intensive in production costs. As a result, domestic firms are goods to drive demand for lower-carbon products. These competing in markets (through imports or exports) where assessments should consider how behavior change foreign producers may not face an equivalent carbon price. can contribute to reducing these costs. A carbon price This potential loss of competitiveness can cause firms to could encourage product substitution; for instance, reduce their production or investments into productive consumers could avoid additional energy costs by riding capacity. Carbon leakage occurs when a reduction in to work instead of driving. Such behavioral responses domestic production is replaced by more emissions- should be considered in the impact assessment. A fall intensive production in other jurisdictions. This is important in demand for carbon-intensive goods does not require to consider since it may appear that the carbon price has policymakers to compromise on the price signal or to reduced emissions. However, if production has simply sacrifice environmental ambition. Policymakers should moved to a jurisdiction with less stringent environmental look to ensure low-carbon alternatives are available and regulation, emissions could increase overall. ASSESSMENT affordable. Other impacts may require amendments to IMPACT Empirically, there is little evidence of carbon leakage, CPI design or additional policies, for example, to reduce and any risk of leakage will fall with greater global excessive cost impacts on households. In some cases, action on climate change. There has been limited revenues generated from the carbon price can offset these empirical evidence of employment losses arising from negative effects. Some impacts will be small, or of a lower CPIs, even in EITE sectors.61 Many other factors, like the priority; for example, changes due to the carbon tax on cost of production capital, market access, or the availability income tax revenue by the carbon price will likely be small. of labor are more important for production decisions. In most cases, carbon pricing is likely only a small component 3.1.1 Businesses of the production and investment decision, meaning the The primary impact of a CPI on businesses is risk of leakage is low. However, most existing CPIs include increased costs, which can sometimes affect the provisions to protect against carbon leakage risk. This may international competitiveness of firms, and stimulate also help to explain why there has been no evidence of demand for low-carbon alternatives. Firms that are leakage to date. Additionally, it may be due to the modest covered by the CPI will experience a change in their carbon prices thus far; hence carbon costs have only production costs to varying extents. In many cases, played a small part in the production decision. This could firms will be able to pass on some or all these costs to change as national targets become more ambitious and consumers, which will spur product substitution and CPIs are strengthened as a result. Policymakers will need behavior changes, such as switching to lower-carbon to continuously assess carbon costs, particularly those of fuels and/or improving energy efficiency. However, in their trading partners, to determine the risk of leakage and some cases these increased costs cannot be passed on to competitiveness. Despite the lack of carbon leakage to to consumers.60 This presents a risk to firms’ international date, leakage risk remains an important issue for industry. competitiveness, which will be most pronounced for firms Figure 9 summarizes the potential for carbon pricing cost that have a large increase in costs because of the carbon pass-through in firms. Carbon leakage, and approaches to price and are unable to pass on this increase (typically address leakage, are discussed in detail in the Partnership because of international competition). These industries for Market Readiness’ (PMR) Carbon Leakage Report and Carbon Tax Guide and the PMR’s and International Carbon 60 See the Carbon Pricing Leadership Coalition’s (CPLC) Report of the High-Level Commission on Carbon Pricing and Competitiveness 2019 for a detailed discussion on carbon pricing and competitiveness. 61 Joltreau and Sommerfeld 2018. IMPACT ASSESSMENT 31 Action Partnership’s (ICAP) Emissions Figure 9 An illustration of Cost pass-through for different sectors Trading in Practice Handbook.62 Carbon pricing can increase the demand for low-carbon products, $ expanding or opening new consumer markets. Firms that benefit from the Carbon CPI can partially counteract the losses price experienced in the negatively impacted sectors.63 The imposition of a carbon price incentivizes firms to move away Increased costs from polluting inputs and methods, and rewards those that do. For example, Non-EITE EITE energy producers would be incentivized to increase the share of renewable energy in their mix. This will therefore increase demand for producers of renewable energy Cost pass-through Low cost pass-through equipment, such as wind turbines and (higher prices) (lower business income) photovoltaic panel producers. Another channel is increased demand for producers of greener production inputs. For example, steelmakers may increase their purchases of recycled steel as a production input Substitution Risk of carbon leakage and reduce iron ore, as the processing of (lower production and emissions) (emissions move overseas) recycled steel is less emissions intensive. $ ASSESSMENT Carbon pricing can also motivate firms IMPACT to change their conduct in a way that benefits their overall competitiveness. Note: EITE is defined as emissions intensive and trade exposed, referring to sectors that both have It can encourage firms to innovate, either emissions-intensive production and face high international competition, so are not able to pass through in their production methods to reduce costs. carbon and energy costs, or by offering low-carbon products and services to attract new sources of demand. Modeling and data on trade flows can help assess Expenditure on research and development may increase a potential CPI’s impact on business. There are a in response to the increased incentives for carbon range of well-established methods and models to assess abatement.64 Firms can also invest in capital, upgrading to competitiveness impacts, price changes, and demand more efficient technology and processes to reduce overall shifts from carbon pricing (see Section 3.2). Where costs. Carbon pricing may stimulate demand in other modeling tools are unavailable, metrics can be created sectors outside of industry; for example, new sources of using trade data to approximate the risk of a loss in demand for marketing may arise to market green aspects competitiveness. Metrics like trade intensity and revealed of products. The number of sectors and extent to which comparative advantage can indicate which sectors are high they benefit from a carbon price will influence the weighing risk. Table 2 presents examples of trade metrics that can up of the costs and benefits for the CPI and can often be used to help assess competitiveness impacts.  provide a powerful political case for a CPI. 62 PMR 2015a, 2017, 2021. 63 Hafstead and Williams 2020. 64 For example, van Leeuwen and Mohnen 2017 find evidence of increased innovation in response to environmental regulation in the Netherlands. 32 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Table 2 Trade metrics and their use in assessing competitiveness impacts Indicator Definition Use Absolute Quantity/value of the trade in a sector/product. This can be used to assess the magnitude of trade trade from a jurisdiction. Import/export Share of a country’s total exports/imports relative to the This can be used to assess changing world market share world’s total exports/imports. share of a jurisdiction over time. Uses relative export shares to indicate whether a country It can inform whether the share of a jurisdiction’s Revealed has an advantage or a disadvantage in a particular product exports in a specific product is higher or lower than comparative market. Divides a product’s share of total country exports by the global average export share in that product. advantage the same product’s share of total global exports. A modified revealed comparative advantage index, where the It provides an indication of whether the share of a denominator is measured by specific markets or partners. jurisdiction’s exports in a specific product is smaller Export This means it indicates whether a country has an advantage or larger than the import share of that same product specialization or a disadvantage in a product relative to a market of interest. for a specific jurisdiction. In other words, it shows the Divides a product’s share of total country exports by the same relative dependence of a product for a jurisdiction’s product’s share of total imports into a particular market. exports relative to a target market’s imports. A measure of a jurisdiction’s trade intensity in a particular It informs whether a jurisdiction’s export share of a Trade product to a particular market, relative to the global average specific product to a specific market is smaller or intensity trade intensity in that product and market. larger than the average world export share of that index product to that specific market. Figure 10 presents an example of one of these metrics, using a common trade Figure 10 Example trade intensity calculation intensity calculation to assess the risk of Firm A Firm B competitiveness impacts for two firms. Firm ASSESSMENT Measure Firm value Measure Firm value A’s trade with external markets makes up a IMPACT Imports 100 Imports 100 larger share of imports and production than Exports 200 Exports 20 Firm B’s. To estimate cost pass-through Production 700 Production 1,400 and price changes without modeling, simple formulas and relationships can be used. Trade intensity % calculation: These can be combined with estimates of Imports + Exports 100 + 200 100 + 20 elasticity (that is, the responsiveness of = 37.5% = 8% Imports + Production 100 + 700 100 + 1,400 demand to changes in price) to approximate demand changes. Using a collection of Higher risk of Lower risk of competitiveness impact competitiveness impact trade metrics can provide a rounded picture on the sectors that are trade exposed and the relative importance of international trade to the sector and wider economy. competitiveness concerns can help to reduce political Consulting with businesses, including understanding pushback. The role of carbon pricing and supporting channels of risks and trade partners, can help provide policies in the policy mix is discussed in detail in the PMR’s a more holistic picture of potential competitiveness and ICAP’s Emissions Trading in Practice Handbook and impacts. Engaging with sectors identified as high risk the PMR’s Carbon Tax Guide. through quantitative analysis can provide qualitative insight into the channels through which they will be impacted. In understanding the change in competitiveness, it is also 3.1.2 Households important to consider the climate policies of a jurisdiction’s How a carbon price affects households can vary trade partners. The increase in costs from a carbon substantially across economic, employment, and price are less likely to be detrimental to competitiveness regional groups both within and across jurisdictions. if the trade partner also has a carbon price. The more The primary channels are through increases in the price of ambitious the partner’s carbon price, the lower the risk of emissions-intensive goods and services, as well as impacts competitiveness losses and carbon leakage. on employment (see Figure 11). Metrics policymakers typically focus on when assessing these channels include Strategies to address business impacts need energy access, consumption and affordability, poverty to be considered as part of the broader policy rates, employment, and income levels. Household impacts recommendation. Listening to concerns, modeling, can be moderated by the specific design of the CPI and its and developing initial policies to protect against interactions with other policies. IMPACT ASSESSMENT 33 Figure 11 An illustration of impacts on households $ Change in prices Carbon Change in employment price High-carbon New low-carbon Declining Energy goods markets markets Firms producing energy or high-carbon goods may carbon-intensive spending as a share of income is often pass their increased costs on to consumers through higher for poorer households despite wealthier households higher prices. Lower-income households may not be able producing more carbon emissions in absolute terms due to manage these higher costs as easily as higher-income to greater overall consumption. For instance, in the US households. For example, they may be unable to easily low-income households tend to spend a larger proportion substitute for poorly insulated homes or purchase energy- of their income on energy for cooking and heating, which efficient products to counteract increased energy costs. have fewer (affordable) options for substitution.66 To help Reduced purchasing power combined with low income and address this issue, the 11 US states participating in the high bills may reduce energy access in these households. Regional Greenhouse Gas Initiative (RGGI), which covers ASSESSMENT Differences in purchasing power may play out regionally. electricity in those regions, require at least a quarter of IMPACT For instance, in some regions people will spend more the revenue from the auction of allowances be used for on energy because of climate conditions (either extreme low-income efficiency investments, which reduces the heat or extreme cold). Rural populations that are more cost of electricity to those users (even as the price may dependent on personal vehicles for transport may also face increase). After more than a decade, this has resulted in a a larger increase in costs than urban populations. reduction in electricity demand and lower average prices than when the program first started. Detailed evaluation CPIs can have a progressive or regressive impact of potential CPI impacts, along with data on household on household income and energy consumption energy usage and household income levels, can help draw depending on the underlying economic conditions a more nuanced picture for policymakers. in a jurisdiction. For instance, research suggests CPIs tend to be more progressive in jurisdictions with relatively Like other climate policies, the impacts of a CPI are lower incomes. More progressive policies means that generally concentrated in certain sectors, which can the lower-income groups benefit more (or are negatively result in equally concentrated impacts on certain impacted less) from the policy than higher-income groups, regions’ and households’ employment. For example, which results in a reduction in the gap between higher- and emissions-intensive industries typically experience lower-income groups. CPIs are more progressive where greater economic impacts than service-based industries. lower-income groups have limited access to fossil fuels Industries such as coal mining and oil refining may become relative to higher-income groups. As a result, they are likely obsolete as a result of the global low-carbon transition to be less directly affected by a carbon price.65 However, and workers may require reskilling or retraining. These a carbon price can prevent them from moving toward industries are often highly regionalized. Regions with lower-carbon fuel sources or expanding their energy high concentrations of emissions-intensive industries mix. For instance, lower-income groups may be unable or that rely on extraction of fossil fuels may experience to move away from coal to alternatives due to increases disproportionate economic impacts. In Canada, the in the price of other fuel sources like natural gas or grid province of Alberta accounts for 65 percent of Canada’s electricity. Equally, low-income groups may face a negative coal-fired electricity generation, where the coal phaseout impact in absolute terms, and additional support to will lead to approximately 2,000 to 3,000 jobs being phased these groups may be necessary. In developed countries, out by 2030.67 Alberta has implemented a CAD 40 million 65 Dorband et al. 2019 and CPLC 2020. The corollary of this is that in countries where lower-income groups use fossil fuel-based energies there is a greater risk of negative impacts where there are high levels of poverty and measures are not taken to address these impacts. 66 Sager 2017. 67 Natural Resources Canada 2020. 34 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE transition fund that began operating in 2018 to finance Box 9 provides examples from the European Union (EU) on support programs for affected coal workers.68 the sector-specific risks from decarbonization. Box 9 Sector-specific risks from a low-carbon transition Coal production is highly regionalized in many jurisdictions, which means that the costs of decarbonization from reduced consumption of coal could be disproportionately concentrated. In the EU, the coal sector faces significant transformation with the EU’s ambition of climate neutrality by 2050 and with a broad package of policies from member states such as Germany targeting the phaseout of coal use. In the EU in 2020, 200,000 people were employed in the coal sector. Without support, it was estimated that around 160,000 of those jobs could be lost,69 including up to 41,000 coal-related jobs in one coal region of Poland alone. However, through the Just Transition Mechanism, investments in sustainable technologies and infrastructure, as well as the reskilling of workers, are expected to transform the EU’s coal regions. These are expected to create up to 460,000 jobs by 2050, providing employment opportunities that should to some extent offset losses incurred in the coal sector.70 Fairness is an important issue in assessing household Well-designed and carefully implemented CPIs can impacts. In the context of environmental policy, fairness is help mitigate potentially negative effects, provide strongly linked to the concept of environmental justice (see support, and allow for fairer environmental outcomes. Box 10). Environmental justice looks to deliver improved Where energy costs make up a larger share of income in environmental outcomes while avoiding excessive costs low-income households, a portion of the carbon revenues on vulnerable groups, distributing environmental benefits can be used to compensate these households via direct and costs in a fair manner. Carbon pricing may reduce transfers. Governments can employ revenues to assist ASSESSMENT emissions cost-effectively, but this does not guarantee workers in sectors or regions that are highly affected by a IMPACT emissions are reduced everywhere or that they are reduced carbon price. For example, in France, revenues from the equally across a jurisdiction. However, carbon pricing will EU ETS were targeted at improving the energy efficiency likely have beneficial distributional impacts, especially in homes occupied by low-income households. British in the longer run. A shift toward renewable energy and Columbia’s carbon tax recycles much of its revenue to electric vehicles will reduce domestic air pollution. This households to largely offset price increases and has could have a proportionally greater beneficial impact on reduced emissions by 5 to 15 percent.72 The example of lower-income or minority households, which are less able the EU in Box 9 demonstrates that with suitable provisions, to avoid pollution exposure.71 This may reduce existing decarbonization presents an opportunity for sustainable health inequalities, especially in heavily polluted cities and inclusive growth. Further details on how to mitigate where lower-income households are more likely to live in potentially negative impacts are set out in the World Bank’s locations affected by poor air quality. Understanding these Using Carbon Revenues.73 impacts and the communities affected is the first step in developing an appropriate response. 68 For more on the program see Government of Alberta 2021. 69 Alves Dias et al. 2018. 70 Zoi et al. 2020. 71 Sun et al. 2017. 72 Murray and Rivers 2015. 73 World Bank 2019. IMPACT ASSESSMENT 35 Box 10 Approaches to environmental justice Environmental justice is concerned with delivering ambitious emissions reductions to mitigate the effect of climate change, while avoiding excessive costs on vulnerable groups both domestically and internationally. Climate change is the greatest risk for the countries that are least able to deal with the consequences. Of the 50 most vulnerable countries to climate change, only two are classed as high- or upper-middle income.74 Domestically, there is a risk that climate action may have a disproportionate and negative impact on vulnerable groups, for example, through rising energy prices. An important part of environmental justice relates to the costs of climate action, and which domestic groups bear these costs. Carbon revenues can be targeted to disadvantaged communities to address domestic environmental justice and fairness concerns. For example, California requires at least 35 percent of ETS auction revenue to be spent on projects that benefit disadvantaged communities. In 2019, almost USD $2 billion in projects was implemented, with more than half going to disadvantaged and low-income communities. The projects include training and job replacement programs in low-emission truck driving and welding, as well as improving drinking water systems to ensure adequate and safe drinking water supply. Revenue generated from RGGI is predominantly spent on energy efficiency and renewable energy. This aids poorer households (as they spend a higher percentage of their income on electricity) and reduces their pollution exposure.75 Another facet of environmental justice is ensuring the broader benefits of climate action (such as lower levels of air pollution) are reaped fairly. Requiring offsets to be based domestically is one aspect of carbon pricing design that can encourage investment in projects that aid domestic environmental justice. For instance, from 2021 in California, no more than one-half of the quantitative usage limit for offsets can come from projects that do not provide direct environmental benefits in the state.76 Understanding the impacts on households requires Alternative methods of impact assessment can be ASSESSMENT assessing how prices and employment are distributed valuable; market research and household surveys can IMPACT among different communities. This could include be tailored to the primary concerns of the policymaker considering income levels, geography, and other and can provide both quantitative and qualitative data. characteristics. Stakeholder engagement is important in understanding why households are unable to offset higher costs, which can A range of methods can be used to understand the help policymakers decide what kind of additional support household impacts. Formal modeling of consumer is required (see Section 3.1.4). Policymakers may be able to price changes is well established, often through methods adapt existing survey data to the needs of their household involving social accounting matrices. These matrices impact assessment. For example, national statistical detail how expenditures flow among the different groups bodies may have existing research on living costs and of society; for instance, showing how energy costs may energy expenditure by households. The policymaker can impact different households or income groups. Social complement this with the simple cost pass-through models accounting matrices are often available from finance or described in Section 3.1.1 to make an initial estimate of the employment ministries, or alternatively through academic impact of the carbon price on energy expenditure. research. The impact on different income groups is a common concern so they are often modeled. Other groups Strategies to address household impacts need impacted by, for example, age, gender, geography, or to be considered as part of the broader policy minority community can also be modeled. In identifying the recommendation. The role of carbon pricing and impacts of a potential UK carbon tax on households, five supporting policies in the policy mix is discussed in detail characteristics were considered: income, occupancy, fuel in the PMR’s and ICAP’s Emissions Trading in Practice type used, fuel poverty status of the household, and tenure Handbook and in the PMR’s Carbon Tax Guide. and construction features. The impact of the carbon price on different income levels was also modeled. The results 3.1.3 Other stakeholders were presented by region.77 Further guidance on developing Carbon pricing has wide-ranging impacts and requires a modeling approach is discussed in Section 3.2 and coordination across government and engagement Attachment 5. with broader civil society. Certain service sectors, like auditing and advisory services, will also be impacted by 74 ND-GAIN 2020. 75 RGGI 2020. 76 Center for Climate and Energy Solutions 2020. 77 Burke et al. 2020. 36 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE the CPI. Further, the impacts of a CPI on businesses and (CGE) modeling could be done alongside models that households also implies engagement of specific interest estimate local benefits like health outcomes from air quality groups such as business associations, environmental improvements. For instance, environmental organizations groups, and labor unions. will be interested in the impact on emissions and related environmental outcomes such as biodiversity, air, and water Introducing a CPI will have implications across pollution. Social organizations representing underprivileged government. The choice of CPI often determines groups may be interested in the distributional outcomes which ministry has policy responsibility. Carbon taxes from CPI implementation, while labor unions may be are usually the responsibility of Finance Ministries that interested in the impact on employment outcomes for their administer tax systems, while ETSs are often administered members (see the discussion on assessing household by Environment Ministries as part of their broader impacts in Section 3.1.2). Understanding these groups, environmental portfolio. The ministry that controls a given and listening to their interests and concerns, is important policy should nonetheless consider impacts on other parts for managing the social impacts of carbon pricing and its of government. For instance, the emissions reductions ultimate acceptance. outcomes from a carbon tax have clear implications for an Environment Ministry’s work to achieve a jurisdiction’s climate target. Similarly, revenue from an ETS will impact 3.1.4 Stakeholder consultations a Finance Ministry that is interested in the government’s Stakeholder priorities and views will vary among overall fiscal balance. Given the high interest in fiscal groups. As described in previous sections, the CPI impacts, these are often included in modeling (see will elicit different opinions and views from a range of Section 3.2). Ministries that represent business and stakeholders. It is important to understand these views, industry covered by the carbon price are a good candidate communicate policy measures that will counteract negative to engage with these sectors but will likely experience impacts, and, where misconceptions arise, provide a forum lobbying from industry to scale back the carbon price, to correct them. Stakeholder consultation can also draw or to provide additional support. A carbon price can also out impacts that may otherwise be missed to improve result in new requirements on monitoring and enforcing the accuracy of the impact assessment. Research may ASSESSMENT bodies, as well as having funding implications on regional be needed to get a better understanding of stakeholder IMPACT and city-level bodies. Covering sectors, for example waste profiles and their values. For example, there may be or power, that may be run by regional governments could strong public interest in specific mitigation options (such result in higher costs faced in providing these services, and as forestry projects with broader environmental benefits) a worsened fiscal balance. and views regarding particular CPIs (such as opposition to carbon taxes from business groups or skepticism regarding The lead ministry should engage with and consult ETSs from civil society groups). Details on how to map other government departments to build understanding stakeholder interests and views are discussed in the PMR’s and communicate potential impacts. Mapping the and ICAP’s Emissions Trading in Practice: A Handbook on responsibilities of key ministries and agencies will help Design and Implementation.78 The World Bank’s Guide to identify those that should be prioritized in engagement. The Communicating Carbon Pricing provides further details on identifying policy interactions attachment (Attachment 1) best practices for stakeholder engagement.79 can help policymakers decide which areas of government should be engaged with both from the outset and Consultations are important in understanding these throughout the development of the CPI. It is important views. Consultations should be open and transparent to to consult between government levels. Depending on provide individuals and groups with sufficient opportunities the jurisdiction, strong coordination between national to engage. This engagement can be used to inform and government and regional government may be required. gather views on the findings of an impact assessment and Extensive and early engagement is vital in cases of strong provide inputs for the development of a communications opposition or disagreement between national and regional strategy. Consultation should include internal stakeholders governments. Building understanding of each parties’ like government ministries with responsibilities that would responsibilities and of key aspects like revenue uses and be affected by climate policy, and external stakeholders like impacts on local industry are likely to be important topics. businesses and households. The impacts of carbon pricing on particular groups Different avenues of communication should be used or outcomes may be the focus of civil society for different stakeholders. Workshops and panel organizations. Impact assessments and modeling can discussions are good ways to consult with business and identify and/or respond to concerns of these groups. For government. Public consultations provide an opportunity instance, traditional Computable General Equilibrium for engagement with representative bodies and civil society 78 PMR and ICAP 2021. 79 PMR and CPLC 2018. IMPACT ASSESSMENT 37 that represent the concerns of household groups. This of a CPI and advise on specific design considerations, such multi-avenue approach was used by Singapore, which held as the stringency of a carbon tax rate or ETS cap. Models in-depth consultations with stakeholders using a range of have the benefit of allowing policymakers to simulate a formats.80 These included bilateral consultations, sector variety of policy designs. Comparing modeling results from group sessions, and engagement with industry associations these different designs can help improve CPI design and to discuss key issues including CPI design; monitoring, identify key potential risks. With opposition to carbon pricing reporting, and verification; and carbon leakage. Public often framed as concern over cost increases, modeling can consultation was used to receive input from civil society. be used to counteract negative or inaccurate narratives with Generally, they received feedback from environmental compelling evidence to support the introduction of carbon groups, academics, businesses, and individuals.81 The most pricing. appropriate option for jurisdictions will likely be shaped by the local context, existing requirements and practices Modeling can provide useful insights but cannot that outline the process for stakeholder engagement more precisely predict the outcomes of implementing a CPI. broadly, and the availability of resources. In the sections below the guide introduces the modeling approaches available and sets out the role and limitations Ensuring that groups of different income levels, of economic modeling, how to undertake modeling, and ethnicities, and sectors are consulted and can provide how to interpret and present results. While a powerful their input will be important, especially in balancing tool, modeling should be used with care and its findings out the inputs from larger and better-organized considered alongside other quantitative and qualitative stakeholders. As discussed above, utilizing different assessments. avenues of communication can facilitate inputs from a range of participants. However, other methods such as 3.2.1 Introduction to modeling approaches targeted consultations through focus groups or other Economic models come in various types and may use consultative fora may also play a role, as certain groups vastly different analytical approaches to reach an may not have the same flexibility and resources to be answer. To introduce the range of options, the models aware of, attend, and meaningfully engage with these ASSESSMENT are grouped based on the systems that they seek to traditional avenues. This may also mean assessing the IMPACT understand. The model groups are summarized in Table 3 way in which information is presented. Policymakers (Attachment 5 provides further details). The key model should ensure this is clear and employ simple language. focus areas discussed in this guide are: Citizens’ assemblies are one approach to consulting with X Integrated assessment models (IAMs): IAMs develop a broader range of groups. These are a deliberative body composed of randomly selected citizens who broadly long-run scenarios for climate impacts, technological represent the wider population. Through assessing the developments, and biophysical systems, and are population’s view on carbon pricing, citizen assemblies sometimes used for calculating the social cost of aim to build consensus and enhance legitimacy of the carbon.83 recommendation. The UK started a citizens’ assembly X Macroeconomic models: These are top-down in June 2019 to understand public preferences on how multisector models with many inputs. They focus on to tackle climate change, with the group delivering its assessing the impacts of CPIs on variables like GDP, recommendations in September 2020.82 Demonstrating an gross value added (GVA), and economy-wide emissions. understanding of the views expressed in consultation is X Energy system models: Bottom-up single-sector important to gain support. A policy paper should seek to models with an emphasis on how CPIs impact the identify the key concerns and how these will be addressed. specific operation and composition of the energy system. This shows decision-makers that potential impacts and X Land use models: These models take account stakeholder concerns have been considered. of biophysical (for example, water availability or carbon content of different vegetation) and economic 3.2 MODELING THE IMPACTS OF characteristics to assess the impact of CPIs on land use CARBON PRICING and associated emissions, and usually provide spatial results. Carbon pricing works through complex systems, and X Market models: Models designed to provide insight modeling is a useful tool to help understand the way in into specific sector impacts of CPIs, the ways that which a carbon price operates and how it can affect a carbon markets could develop over time and provide wide range of stakeholders. This can be fundamental to opportunity for capacity building. building an evidence base regarding the economic impacts 80 National Climate Change Secretariat (NCCS) 2017. 81 NCCS 2020. 82 Climate Assembly 2020. 83 The social cost of carbon is the costs associated with emitting one ton of CO2e. 38 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Table 3 Types of models commonly used in climate policy analysis Model focus Model subtypes Examples Brief description Simple economic and physical climate models to evaluate Cost-benefit DICE, PAGE scenarios for climate impacts and mitigation pathways by Integrated comparing costs of climate impacts and benefits of mitigation. assessment models Complex technological, biophysical, and economic models that Global system REMIND-MAgPIE, develop detailed scenarios for mitigation options, often combining models MESSAGE-GLOBIOM energy system and land use models. Computable General Detailed economic representations of relationships between ViEW Equilibrium industry sectors, consumers, and international markets. Models that assess interactions between the financial sector Dynamic Stochastic Macroeconomic G-cubed and other sectors of the economy (businesses, government, and General Equilibrium consumers). Models that use historical data to estimate relationships between Macro-econometric E3ME key macroeconomic parameters for forecasting purposes. Models that represent the energy system in detail, often at a Whole energy system MESSAGE, REMIND, global level, to identify key interactions and assess costs of optimization TIMES different energy technologies. Long-term electricity models that assess options for electricity Electricity system WeSIM generation and distribution to assist in network planning and optimization investment. Models that seek to model the electricity sector in very short Energy system Electricity dispatch PLEXOS time steps to shed light on operational decisions and short-term system balancing. ASSESSMENT Bottom-up behavioral models that represent the behavior of IMPACT Simulation MUSE heterogenous agents to assess likely responses to changed incentives. Technology Models of various forms developed to assess specific Technology specific (such as solar, wind, technologies, their pathways, costs, and mitigation potential. battery, EVs) Allocation Models that match specific parcels of land to optimal use given MAgPIE GLOBIOM optimization land characteristics and economic, climate, and policy scenarios. Land use Econometric Models that use historical data to try to identify likely behavioral LURNZ allocation responses of land use to changed incentives. Models that seek to assess likely production decisions given Various proprietary Competition models policy and cost scenarios for products/sectors when firms have models market power. Market Proprietary models Allowance market Models that predict behavior and prices in secondary markets such as from models given policy and economic settings. Refinitiv, BNEF, ICIS Carbon pricing modeling can use a mixture of A more detailed discussion of the role of modeling in modeling subtypes and focuses. For instance, a land this context can be found in the PMR’s Checklist on use allocation model can be linked with an economy-wide Establishing Post-2020 Emission Pathways. model to assess wider impacts of a CPI’s role in the agriculture and land sectors. As well as directly testing Box 11 describes the modeling technical summary CPI design, modeling can also shed light on the trajectory attachment, which discusses the steps needed for of emissions and inform decisions on emissions targets. successful modeling. IMPACT ASSESSMENT 39 Box 11 Modeling technical summary employment may indicate that employment in the energy sector could increase from the introduction of a carbon Attachment 5 provides more detail on how price, but some heavy industry may suffer. Additional policymakers can develop and undertake a carbon policy support for the heavy industry sector, like retraining pricing modeling study. This sets out the key inputs programs, may be needed. to a modeling analysis. It then provides a summary of the different economic model types. Economic models can broadly project — but not The modeling technical summary outlines the forecast — the potential economic and social impacts different types of models, categorized by their of a CPI. Many models provide outputs regarding differing focuses. The table provides a description of important indicators such as carbon emissions, GDP what the model type does and how it works before impacts, energy costs, air quality, and distributional outlining the strengths and limitations of the model impacts, based on assumptions. The outputs from type and what the model type presents as outputs. the model have a degree of uncertainty around them, The table is designed to help jurisdictions form initial particularly if they are making economic and emission ideas on the models they would be interested in projections. This uncertainty is often inherent in the using. complex systems being modeled where data is often imperfect, and simplified assumptions must be made about underlying economic activity. Model results provide a range of potential values insight into key drivers and guidance on 3.2.2 Role and limitations of economic models the magnitude and direction of economic outcomes. Modeling often plays an important role in impact assessments, but it provides just one among several Models can test a variety of CPI designs, which can relevant inputs. Models provide unique, quantitative insights inform policy choice. For example, modeling different but they must be considered alongside a wider set of options for covering emissions sectors and sources can evidence. Understanding the role and limitations of economic provide evidence on whether wider coverage substantively modeling is important in giving the modeling results the reduces costs or alters the energy mix. Assumptions ASSESSMENT appropriate weighting in the recommendation paper. made in modeling regarding business-as-usual scenarios IMPACT may become invalid as circumstances change. Changes Economic models provide a quantitative framework in technology and underlying economic conditions often that combines economic theory with data to create have large impacts on business-as-usual projections. a simplified version of the world that can be used to Policymakers need to account for any changes in external examine policy questions and understand possible circumstances when interpreting modeling results. outcomes. The “world” used in the model contains the essential components needed to answer the questions the Modeling highlights the benefits from carbon pricing, model aims to solve. These components will themselves including the benefits from increasing ambition be simplified, and models are designed to only answer over time. Carbon pricing has a range of benefits (see a specific set of questions. For example, a model to Section 1.1) that modeling can quantitatively assess. understand how climate policy may impact land use will Scalability is an important benefit of carbon pricing focus on sectors like agriculture and forestry. Such a over alternative policies. Comparing the outcomes from model can help policymakers understand how biophysical reaching a jurisdiction’s climate targets with and without characteristics and economic and policy drivers relate to carbon pricing will likely highlight the benefits (including key outputs such as land use choice and productivity. The cost reductions) from a carbon price (see Section 3.2.5). covered sectors in the model are expressed as simplified The ability to ratchet up carbon pricing ambition over sets of equations that establish how the sector responds time means carbon pricing is a significant driver for to a carbon price. However, these simplifications can mean future investment. Modeling can display the benefits from that important interactions can be missed and important increased abatement investment made today by forward- changes in the economy not included. For example, looking actors who account for the increased ambition models of resource use in the 1970s and 1980s often failed in their decisions. Earlier abatement is a key driver in to account for the innovation that pricing could stimulate minimizing the costs of climate action. and many erroneously predicted that energy resources like One of the strengths of economic models is that they oil and gas would be exhausted within several decades. can identify unexpected benefits and costs arising from Models can identify which parts of the economy will carbon pricing. The nature of a model may mean that it likely experience the greatest impacts, and when picks up wider impacts than can be identified by other forms additional policy action might be required to address of quantitative analysis, such as interactions in complex, adverse outcomes and unintended consequences. For economic, energy, or biophysical systems. For instance, example, an economic model looking into the impacts on modeling can help quantify the potential implication of carbon pricing on household consumption, employment in 40 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE uncovered sectors, or land use response to carbon pricing Economic models usually do not model barriers to signals. The extent to which models can identify unexpected implementation. One of the simplifying assumptions impacts will depend on their specification and the number of models usually make is that a policy is “perfectly” variables modeled. Where important variables are omitted implemented, and that noncompliance and government from the model these impacts will be missed. For example, failure are minimal. A policy option that may be preferred economic models often do not account for innovation by a model may not be better in practice due to difficulties spillovers from technological change,84 as well as the health in implementation. and wider environmental benefits of climate mitigation that can be modeled through noneconomic models like Models often cannot account for large economic dispersion models. shocks and complex interactions between sectors. The nature of many models allows for some shocks, like Importantly, however, models are not suited to compare recessions, to be included in the modeling. However, a carbon tax and an ETS. 85 In theory, both instruments shocks by their nature are unexpected in their arrival and achieve the same objective of delivering a quantity of unpredictable in their size. Shocks in the future are unlikely emission reduction at a given cost. Most economic models to have been perfectly modeled by those in the past. struggle to differentiate between different CPIs, which limits This includes negative shocks, like the timing and size their use in assessing the impacts of different types of CPI. of recessions, and positive shocks, like the introduction As such, modeling should only ever complement and support of new technologies. A similar argument extends to policy analysis and rationale for instrument choice as part of interactions between sectors. The interrelationships a more holistic consideration of the evidence base. between sectors are often based on empirical data, meaning that future changes in relationships are unknown Multiple models may be used to assess policy impacts and cannot be captured with full certainty. It may be the and draw on different models’ respective strengths. case that the CPI itself changes the relationships between In these cases, comparisons of outputs across models sectors, which may not be captured by the model. should be assessed carefully, as they may reflect different model setups, assumptions, or approaches. For example, 3.2.3 Developing a modeling study ASSESSMENT estimates of cost impacts may differ substantially between IMPACT a macroeconomic model, which considers interactions A well-designed modeling study will incorporate between sectors, and an energy systems model, which will several steps to ensure that it is fit for its purpose and only consider systems costs in the energy sector. The more identifies the information needed by a jurisdiction. that the same insight is found in multiple models or studies, Figure 12 summarizes the key steps in designing and the more robust that insight. undertaking a modeling study. Figure 12 Key aspects required when designing a modeling study Steps Detail 1. Modeing objectives ► Establish key modeling objectives based on key policy questions and stakeholder concerns; this will ! determine all the following steps of the analysis Identifying the ► Set out key data to prevent poor input data issues leading to inadequate depth and misleading 2. Inputs, outputs, right modeling conclusions of the modeling analysis; agree on key outputs and indicators and indicators approach 3. Reference scenario ► Establish a reference scenario (no carbon price) against which the carbon pricing options will be assessed 4. Policy scenarios ► Develop policy scenarios that are reflective of country context, policy landscape, and emissions profile Running the and vary in key carbon pricing design aspects (e.g., sector coverage, role of offsets) model ► Identify and test key modeling sensitivities and uncertainties in order to check the robustness of policy 5. Sensitivity analysis scenario results Interpreting ► Present modeling results using the key outputs and indicators helping to analyze the established policy 6. Results and presenting questions results 84 International Monetary Fund 2019. 85 Direct comparison between different CPI options requires considering a variety of factors, including some that are qualitative in nature. IMPACT ASSESSMENT 41 Policymakers may need to outsource modeling work, engagement (see Section 3.1.4) can help identify issues depending on the availability of in-house expertise of concern. Initial estimations through the more informal and resources. This guide contains an example terms of methods described in Section 3 may help identify where reference (TOR) document for a carbon pricing modeling formal modeling may be required. Understanding the project (see Box 12 for details). This document should be context and key policy questions helps design a modeling used in conjunction with Attachment 5, which provides approach that is tailored to address any evidence gaps. detail on modeling. The specific model to address the project scope will likely be left open for the bidder to Policymakers must then decide on the modeling decide. If policymakers are deciding on a modeling specifications that meet these objectives. This requires approach, the objectives and modeling of requirements X Identifying the required indicators and outputs: should inform the model chosen. Models have different outputs, where there is a need for the model to provide insights on certain indicators or potential outputs (e.g., impact on GDP or price levels). Box 12 Developing a modeling TOR attachment This can inform model choice. It is critical to make sure Attachment 6 helps policymakers draft a TOR for a that the required indicators and output are well aligned project on modeling the impacts of carbon pricing. with answering the policy question. X Identifying the required model functionality: Models The attachment provides recommended content, have specializations and specific capabilities that may be along with examples, of a TOR that covers the key needed to answer a policy question. Some, for example, aspects discussed in this section. The attachment are global in nature and attempt to account for the covers background, project scope, tasks, main integration of biological systems and regional economies. deliverables, input and coordination arrangements, Others specialize in domestic electricity systems, while level of effort, qualifications, budget and contract others have broader detail about the global energy duration, and contacts. mix and account for trade flows. Understanding these This attachment should be used in conjunction with functionalities require a certain degree of technical ASSESSMENT the modeling technical summary attachment, which understanding but can help ensure that the selected IMPACT provides detail on developing a modeling approach model is appropriate for its intended use. and main modeling types. The objectives and areas of focus for modeling will influence the most appropriate model. Figure 13 presents a process policymakers can follow to help select 3.2.4 Identifying the right modeling approach the appropriate model for their policy questions. Before starting a modeling study, policymakers should first decide if modeling is even appropriate Table 4 provides an example of potential impacts that and feasible given the jurisdictional circumstances. policymakers may wish to assess and the types of models For instance, insufficient time or difficulties in sourcing that are most appropriate for assessing these impacts. data may create barriers to modeling. These challenges Attachment 5 provides examples of how policy questions can sometimes be addressed; for instance, jurisdictions can be linked to modeling output and functionality may be able to fill some data gaps through methods requirements. such as the transparent use of assumptions, clearly Because of these different functionalities, jurisdictions indicating what assumptions are used and the data gaps may need to draw on a range of modeling approaches. these assumptions fill. In cases where modeling is not For instance, modeling developed for Sri Lanka sought appropriate or data gaps cannot be overcome, impacts to provide policymakers with policy-relevant information can be assessed by drawing on alternative methods as on both the broad economic impacts and impacts on described in Section 3. transport and electricity as key sources of emissions If modeling is pursued, policymakers should first through the use of a CGE model linked with a transport decide on the objectives. Modeling can require sector model.86 The outputs sought to identify the impacts substantial time and resources to be done well, which will of a carbon price on emission reductions and carbon likely mean policymakers must decide on the key impacts revenues and to provide a sector-level breakdown of they wish assessed. Understanding the key questions and changes in GVA87 and employment for different scenarios. impacts can help inform the type of model used. A number These results were presented separately for transport and of factors, including the objectives and context of the CPI electricity generation so that the government could assess (see Chapter 1) or concerns raised in the initial stakeholder the different impacts across industry and households. Further, reductions in air pollution were quantified to 86 Vivid Economics 2019a. 87 GVA is a measure of the value of goods and services produced within a specified area, for example within a sector. 42 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE Figure 13 Selecting a suitable model Jurisdiction Required outputs context and indicators Review Identify required jurisdiction indicators and outputs context Key policy Objectives of of modeling exercise Selecting questions modeling model types Identify key policy Establish the key Determine model questions to be aim of modeling types that meet Policy focus of modeling exercise Required identified context functionalities requirements Review policy Indicate preferred context model functionalities required in answering policy questions Note: More information on jurisdiction and policy context can be found in Chapter 2. Table 4 Mapping of modeling and other approaches to assess potential carbon pricing impacts Macro- Energy Market Household IAM Land use economic System models surveys* Businesses Demand and supply changes ü ü ü Production ü ASSESSMENT Commodity prices ü ü ü ü ü IMPACT International competitiveness ü Households Price and consumption impacts ü ü ü ü Employment impacts ü ü ü Government Climate impact ü ü Revenue impacts ü Options for abatement ü ü ü *Household surveys are not a type of modeling but are commonly used to estimate household impacts. illustrate the potential benefits from improved health impacts, such as agriculture and land use activities, would outcomes by applying the modeling outputs to cost and require a detailed data set on aspects such as activity mortality estimates from each pollutant. This showed both emissions, food price indices, crop/forest yields, water significant cost savings and reduction of deaths due to air availability, and expenditure shares or land use area metrics. pollution. Jurisdictions may not have all the required data The modeling options available to a jurisdiction may available. The existing data may not be specific or granular depend on the data available. Models require a minimum enough — if it is even collected at all in the jurisdiction. In level of data to run, with more detailed models requiring these cases, data gaps might need to be filled by using even greater inputs. Models covering the broad economic assumptions or evidence from applicable sectors or impacts of a carbon price are likely to have less-stringent countries, or by interpolating them based on existing trends. requirements on data granularity but wider breadth of different data inputs across all sectors and activities. For Successfully identifying the right modeling approach instance, economy-wide models often draw on detailed is important for developing a successful carbon price input-output tables or social accounting matrices that track recommendation. The model identification should be in detail the interactions between different broad economic guided by objectives that reflect the areas of concern sectors. In contrast, models looking at specific sectoral among policymakers and stakeholders, as well as IMPACT ASSESSMENT 43 addressing gaps in the rest of the impact assessment. Box 13 Case studies: Development of policy Quite often, models and the associated data will be scenarios designed or calibrated for a specific region, meaning a Policy analysis often assesses different policy model that is appropriate for one jurisdiction may not be scenarios based on alternative carbon pricing mixes. appropriate for another jurisdiction. Mexico examined four main policy options for carbon 3.2.5 Running the model pricing, built around the existing policies: a “Limited ETS,” an “ETS Only,” an “Overlapping Tax & ETS,” Modeling requires specifying scenarios, each of and a “Hybrid ETS.”88 These four options reflect which is a different state of the world the policymaker different levels of sectoral coverage and policy mix. is interested in. A model scenario is a package of different inputs, constraints, and assumptions that The Philippines also modeled a range of CPI design reflect a pathway that policymakers are interested in. For features, including scope, cap design, and legal example, one scenario may be a 1.5-degree scenario in and institutional requirements. The four CPI options which it is assumed the jurisdiction implements policies, aim to address the interplay of different sectoral including a sufficiently high carbon price, to be consistent coverages (extending a cap from the power to with 1.5 degrees of global warming. An example of the include major industrial emitters); absolute and interpretation of the model under this scenario would be intensity-based caps; and a range of legal options “What is the optimal coverage of the carbon price, given its for scheme compliance (from voluntary agreements price is consistent with a 1.5-degree warming scenario?” to those requiring primary legislation).89 The first scenario should be the reference scenario, which usually sets out the “business-as-usual” Finally, the impact assessment should include a projections for emissions, economic growth, or other sensitivity analysis. A sensitivity analysis can help to key variables. All policy scenarios are compared to the test the robustness of the modeling results by explicitly reference scenario to estimate the impacts of specified recognizing and assessing a range of assumptions and ASSESSMENT changes to policies. It is important that the reference uncertainties. It shows when results are highly sensitive IMPACT scenario accurately represents the current situation, to assumptions and when they are robust to a range including recent policy and economic developments. of circumstances. It can also identify the key drivers of Therefore, the reference scenario will likely include modeling outcomes. By highlighting the range of possible established commitments, such as those set out in outcomes, a sensitivity analysis can help identify the Nationally Determined Contributions or other policy inherent uncertainties regarding the outcomes of policy commitments. interventions. This can help ensure modeling results are Next, different policy scenarios can be defined that used appropriately. Sensitivity analysis will often focus on estimate the impact of implementing different policies, uncertain factors that are (largely) out of the control of the or in this case, CPI designs. These scenarios should be policymaker, which are often inputted as assumptions. designed to ensure that they are answering the question A discrete set of uncertainties is often used for inputs of interest to the policymaker. For instance, if the question where an extensive scenario analysis already exists. For relates to the cost of achieving different targets, then policy instance, this could include rates of technological change, scenarios may test different levels of carbon tax or ETS commodity prices, rates of economic growth, or exchange cap to estimate the relative economic cost. On the other rates. Simple approaches to sensitivity analysis, like hand, if the question relates to the benefits of broader or creating low, central, and high estimates of model inputs, narrower coverage, then the policy scenario might keep are often used. More complex methodologies can also the same level of cap reduction or the same carbon tax be used. For example, Monte Carlo simulations sample rate while altering assumed coverage. Modeling will often thousands or millions of variations in each uncertainty and include a scenario that uses alternative policies to carbon are therefore useful when the range of the input uncertainty pricing to achieve the same target. This is often critical is less well known. Further details on scenarios and to help make the case for carbon pricing; comparison sensitivity analysis are provided in Attachment 5 and in between reaching the same target with and without carbon the PMR’s Checklist on Establishing Post-2020 Emissions pricing will highlight carbon pricing being the least-cost Pathways.90 approach. Box 13 presents two case studies of developing CPI scenarios in Mexico and the Philippines. 88 GIZ GmbH 2017. 89 Economic Consulting Associates 2020. 90 PMR 2015b. 44 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 3.2.6 Interpreting and presenting results for real-life imperfections in policy implementation. Qualitative analysis may provide nuanced insight that Modeling results must be interpreted with care quantitative data cannot provide but may lack the scale because they represent simplified relationships of quantitative studies. When assessing the studies, operating under very specific assumptions. Each policymakers should consider if the outputs of the model is created with a specific use in mind. Therefore, analysis are of interest to the jurisdiction. understanding model results starts with understanding these assumptions. Users of the model must ensure they X Sources of data and context: Who was the analysis ask the right questions to correctly interpret the results and done by and what objectives could they be looking understand key outcome drivers and which relationships to achieve through the study? How applicable is the are captured within the model’s framework. Modeling is not setting compared against the jurisdictions? a prediction of the future but rather aids in understanding X The policy being analyzed: What similarities and how policies work and their key sensitivities. differences are there between the policy analyzed in the study and the policies of interest to the jurisdiction? Models can be sensitive to small changes in the underlying assumptions, which can make it difficult to Modeling results can provide compelling arguments precisely identify the likely scale of impacts. This could in support of carbon pricing and adds depth to an include a wide range of inputs such as price elasticities, assessment of how the carbon price operates in the business cost pass-through rates, and GDP growth rates. economy. Modeling can counter common concerns and Similarly, when rates of change are rapid, as in the case of misconceptions around carbon pricing. For example, renewable technologies, a single assumption on the cost the results may reveal that the economic transformation per unit of energy can lead to large modeling errors over stimulated by the carbon price is both possible and short time periods. These sensitivities should be explored, beneficial to the jurisdiction, and costs arising from the understood, and clearly communicated when modeling carbon price can be managed. Modeling can also identify results are presented. when design choices lead to adverse outcomes that may need to be mitigated with policy. However, modeling can It can be useful to compare modeling results with ASSESSMENT be incorrect or imprecise and needs to be viewed as one other pieces of evidence to draw on a broader set IMPACT input to the decision-making process. The reliance of of information. This may include comparing the results modeling on data, theory, and assumptions may generate to modeling studies with similar sectoral coverage, CPI misleading results if these inputs are not accurate. design assumptions, and reported outputs and indicators. Decisions based solely on modeling also ignore other While studies will inevitably differ in certain elements, a important considerations. The extensive work from earlier comparison can be useful to help check results. Other chapter topics, like mapping the local context, are equally evidence drawn from literature reviews, expert interviews, as important in the decision-making process. or country case studies can aid in assessing modeling results as well. Modeling cannot support effective policy unless it is effectively communicated. Clear and jargon-free A systematic way of comparing and contextualizing communication can help policymakers reach a wider modeling results is through a literature review. In some audience. Carefully considered presentation will increase cases, various models may be used to examine similar the impact of the results and improve the legitimacy of policy issues using a variety of assumptions and methods. the decision-making process. Some practices that can be Comparison of these results can illustrate a range of drawn on to ensure that modeling results are effectively possible outcomes from a given set of policy choices. This communicated include type of analysis was used in Canada’s Mid-Century Long- X Explaining scenarios: Any presentation of modeling Term Low-Greenhouse Gas Development Strategy, which results should first provide details on the scenario compared the outcomes of various existing modeling characteristics. For example, these might include the studies to identify a range of potential pathways for long- differences in carbon pricing design features like the term decarbonization.91 tax rate or cap stringency or underlying assumptions When comparing modeling results to other studies, like the GDP growth rate. The presentation of scenario points that should be considered include results should indicate how they differ from one another X The and why. This information should be clearly illustrated strengths and weaknesses of the analysis: via figures and/or tables. It is advisable to separate the Quantitative approaches through modeling may have presentation of central scenarios from sensitivities, empirical rigor but struggle with some of the challenges so that audiences can better focus on how the results mentioned in this chapter, such as struggling to account translate to policy recommendations. 91 Government of Canada 2016. IMPACT ASSESSMENT 45 X Establishing time frames: It should be clear what X Explaining key assumptions, sensitivities, and the time frame of the model is. This helps to identify methodological approach: A study should be clear the possible limitations of the modeling exercise; for on the key assumptions feeding into the model, the instance, potential limits in considering long-term rationale, and the sources for these assumptions, as benefits such as improvements in the health and well as an overview of the modeling methodology. productivity of the labor force.92 Results should clearly Explaining the assumptions made and the uncertainties explain how the key outputs of interest are likely to in the model — for instance, the economic growth rate change over time and why. This can help to assess or development and cost of renewables — can present whether costs are expected to fall over time or whether a clearer picture. The results can then be compared benefits are expected to accrue gradually over time or against other studies. The methodology discussions to peak after a certain number of years. should describe the reference scenario and provide X Providing sufficiently granular results: Ideally, the justification for its choice. reported results should be detailed enough so that Modeling complements and supports the wider they do not overlook important differences at more analysis and rationale for carbon pricing, but it should granular levels. This can shed light on aspects such not be the key factor driving policy decisions. The as distributional and geographical differences or if the policy recommendation paper should reflect this role, impacts are unevenly distributed across economic placing the modeling results in the wider jurisdictional sectors. A potential approach to presenting detailed context (see Chapter 2) and the broader evidence base results is to first present an overview of the results being considered. before going into the detail. However, granular results are not always feasible given resource and modeling constraints, and in these cases the limitation of high- 3.3 FURTHER GUIDANCE level results should be clearly outlined. X Using The following resources provide useful additional detail consistent units: Results should be reported in relevant to developing an impact assessment: commonly used units that allow for direct comparison. ASSESSMENT X PMR (Partnership for Market Readiness), and CPLC Further, it should be clear whether the outputs are IMPACT absolute or relative terms; for example, GDP or GDP per (Carbon Pricing Leadership Coalition). 2018. Guide to capita. Communicating Carbon Pricing. X Understanding X CPLC (Carbon Pricing Leadership Coalition). 2019. modeling scope: The presentation of results should be clear in terms of the type of sectors, Report of the High-Level Commission on Carbon stakeholders, and quantified impacts the model covers. Pricing and Competitiveness. Understanding the scope of the exercise can help X World Bank. 2019. Using Carbon Revenues (Technical assess the degree to which the actual benefits and note No. 16). costs of a carbon price may deviate from the modeling X CPLC (Carbon Pricing Leadership Coalition). 2020. results. Distributional Impacts of Carbon Pricing on Households. 92 See the PMR’s forthcoming The Development Benefits of Carbon Pricing and Hamilton et al. 2017. 46 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 4. REACHING A RECOMMENDATION Key takeaways: 9 Reaching a recommendation on carbon pricing involves identifying key jurisdiction-specific issues, and understanding the time frames for adopting a carbon price. 9 The design parameters of the recommended carbon pricing instrument (CPI) should reflect the jurisdiction’s objectives, context, and capacity. 9 Compelling policy papers will have a clear rationale for the CPI recommendations and demonstrate a good understanding of the key issues and how to address them. 9 Next steps, responsibilities, and timelines for implementation should be laid out alongside recommendations. This chapter sets out how to distill key inputs through a defined mechanism or review points established discussed in the previous chapters into a carbon at the introduction of the CPI. pricing policy recommendation, and how to communicate this recommendation effectively. While The following sections set out the steps for translating the specific structure of recommendations will differ across evidence into a persuasive policy recommendation: jurisdictions, there are some common elements. This will X Section 4.1 outlines the high-level process to usually include a discussion of the local climate policy systematically develop policy recommendations, context to set out the role a CPI may play in the broader including identifying key jurisdiction-specific issues, policy mix and in meeting its policy objectives. The key understanding their implications of the time frame for parameters of the CPI will usually be defined; for instance, adoption and implementation, and balancing competing the type of CPI, as well as its scope and ambition. This policy objectives to reach a recommendation; and recommendation should be backed by a rigorous analysis X Section4.2 identifies the material that should be of the jurisdiction’s policy landscape, stakeholder views, covered in a policy paper that makes the case for political constraints, institutional capacity, and possible carbon pricing. economic impacts. Once the decision to implement carbon pricing has been made, further work will be needed for RECOMMENDATION the detailed design and implementation of the CPI and 4.1 SYNTHESIZING EVIDENCE REACHING A to communicate with key stakeholders. While different Policymakers utilize a range of sources of qualitative jurisdictions may take different approaches to this process, and quantitative information to develop an appropriate the aim of such a recommendation is to get agreement carbon pricing recommendation. This includes the within government to spur action and kick-start a process elements outlined in this guide: stakeholder views and of policy development leading to implementation. concerns, considerations related to the jurisdictional The recommended CPI and the role it plays within context, and empirical evidence on the impact and the policy mix can and should evolve over time. performance of the different CPI design options. Jurisdictions have expanded coverage and increased These different factors must be brought together in ambition over time. The European Union (EU) emissions a systematic way to assess the options available. trading system (ETS), for example, started by covering This section suggests one such process, including the energy and industrial sectors and expanded to identifying key jurisdiction-specific issues (Section 4.1.1), include domestic aviation in 2012. New Zealand’s 2019 understanding the implications of the time frame for Climate Change Response (Zero Carbon) Amendment adoption and implementation (Section 4.1.2), and making Act increased the ETS’s ambition, legislating a 2050 net trade-offs between competing policy objectives to arrive at zero target for greenhouse gases (GHGs) (except biogenic a recommendation (Section 4.1.3). methane), and expansion of emissions trading to the agriculture sector is being investigated.93 Starting with a However, jurisdictions can adjust this to meet their simple instrument and a low carbon price can be a useful own needs. Singapore, for example, followed a systematic strategy to overcome political resistance to carbon pricing. approach to selecting a CPI, including assessing its local Scope and ambition can be expanded over time, preferably context, conducting broad stakeholder consultations, 93 Parliamentary Council Office 2019. REACHING A RECOMMENDATION 47 learning from international best practice, and modeling on Singapore’s process of assessing options and its impacts of different policy options. Box 14 provides details decision to implement a carbon tax. Box 14 Case study: Singapore’s process for selecting a carbon tax Singapore introduced its carbon tax in 2018 after undertaking a well-structured process for evaluating its options. Policymakers considered both a carbon tax and an ETS and decided to implement a carbon tax of USD 5 per ton of carbon dioxide equivalent (tCO2e). The tax covers facilities emitting over 25,000 tCO2e a year covering all sectors, and the revenues raised in the first phase are earmarked for abatement projects. The National Climate Change Secretariat (NCCS) operated from the Prime Minister’s Office to coordinate across ministries and ensure that the decisions aligned with broader national objectives. The NCCS led strategic decision- making including regarding the choice of instrument and level of ambition, while implementation (such as monitoring, reporting, and verification [MRV] design) was handled by ministries with relevant technical expertise. Stakeholder engagement started early and continued throughout the design process. The government first indicated that carbon pricing was being considered as early as 2010, and soon after began a process of stakeholder engagement.94 This was first targeted at large emitters that would be most affected by the CPI, but then expanded to smaller emitters and those that would be indirectly impacted. This early engagement provided time for feedback well in advance of policy implementation. International experience was integrated into the evidence gathering process, with Singaporean policymakers meeting regularly with experts from other jurisdictions with CPIs. This helped build the capacity of policymakers and encouraged the sharing of key lessons. For instance, providing insights on how policies can evolve over time and the potential challenges that affect the functioning of the market, such as a small number of emitters in an ETS leading to low liquidity. An investigation of the country’s emissions profile and local policy context provided guidance on the most appropriate policy. Singapore’s emissions are highly concentrated in a small number of firms with oil refineries and natural gas used in electricity, accounting for over 60 percent of emissions.95 This concentrated market suggested a tax may be more appropriate. An ETS was likely to require more entities for a sufficiently liquid market and risked price distortions due to the market concentration in Singapore. A clear set of objectives guided Singapore’s CPI selection. Policymakers decided early on that they wanted a simple and easy to implement CPI that applied equally to all. It was also decided that the CPI’s goal was to help provide RECOMMENDATION a price signal rather than necessarily be the main driver of emissions reductions. These objectives, combined with REACHING A the country’s highly concentrated emissions profile and established governance and business capacity in taxation, pointed to a carbon tax. The carbon tax was designed alongside complementary policies to reduce emissions across the economy. This included energy efficiency standards for households and industry, investment in public transport infrastructure, and campaigns encouraging users to shift to less-polluting models of transport, as well as investments in renewable electricity generation. Modeling was used to assess potential socioeconomic impacts. Policymakers were concerned about possibly negative impacts on households and a Computable General Equilibrium model was used to assess cost pass- through and how household expenditure would be affected by a carbon price. Simpler scenario-based models and calculators supplemented this modeling to inform the design of the CPI and related support packages. There is also a clearly signaled plan for increasing the tax rate in the future, which allows businesses time to prepare. The tax will remain at USD 5/tCO2e till 2023, at which point it will be reviewed. The government has publicly stated that it intends to increase the tax to between USD 10/tCO2e and USD 15/tCO2e by 2030.96 94 Singapore’s Prime Minister Lee Hsien Loong announced that the country worked with a shadow carbon price that might be made explicit if there was a global move toward emissions reductions in a speech at the Singapore International Energy Week in 2010. See Straits Times 2017. 95 NCCS 2018. 96 National Environment Agency 2020. 48 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE 4.1.1 Prioritizing key jurisdiction-specific Key issues identified will in some cases have issues commonalities across jurisdictions but can also vary substantially. For instance, in Singapore the key issues Policymakers considering carbon pricing will face related to the challenges of implementing an ETS with a unique set of jurisdiction-specific conditions and a concentrated market and the desire for simplicity (see challenges. Part of the decision-making process is Box 14). This tilted the decision in favor of a carbon tax. identifying these factors and understanding which ones The UK’s decision was made against a broader set of are most relevant to carbon pricing policy. This entails issues following the UK’s exit from the EU, including the an assessment of the local environmental, economic, future trade relationship with the EU, the UK’s ambitious governance, and political context as well as institutions’ net zero policy and the limited implementation time frame capacity for implementation as described in Chapter 2. available. These factors are described in more detail in Of course, stakeholder views and the prevailing politics Box 15. play a role in all jurisdictions, with impact analysis helping to distinguish the scale of impacts on different groups, as discussed in Chapter 3. Box 15 Key issues in carbon pricing policy development in the UK Following the UK’s exit from the EU, the UK established a UK ETS to replace its participation in the EU ETS.97 The UK considered a range of options, including a UK ETS and a carbon emissions tax. Each option had a wide range of implications when considered against the UK’s existing policy context and constraints from the broader political environment.98 The UK and the EU have agreed to cooperate on carbon pricing in the future and to consider linking their respective carbon pricing systems.99 Some of the key issues and trade-offs of potential relevance in this context include: X Integrated markets. The EU is the UK’s largest trading partner. Closely aligning the UK ETS with the design of the EU ETS has advantages in avoiding competitive distortions and ensuring a more cohesive policy suite in Ireland (including the Irish Single Electricity Market). Policy alignment can also simplify potential linking of the UK ETS to the EU ETS, which would provide further benefits through access to an established, large, and liquid market and policy continuity for UK firms. However, depending on the terms of any linking agreement, this could mean less flexibility to tailor the carbon pricing mechanism to the UK’s context and additional constraints when considering collaboration with other carbon markets. UK’s 2050 net zero ambition. The UK government has adopted a target to reach net zero GHG emissions RECOMMENDATION X by 2050. Achieving this goal is challenging and will require the adoption and expansion of incipient and as yet REACHING A undeveloped technologies. In particular, the uptake of GHG reduction technologies at scale in the agriculture, industry, and energy sectors will be essential. The UK ETS can be aligned with a net zero pathway, meaning it can contribute significantly to achieving the net zero target. A linking agreement with any jurisdiction could have impacts on the UK’s ability to achieve Net Zero, depending on the way in which the systems are linked, the respective size of the markets, climate ambition and other relevant factors. Linking could also support delivery of Net Zero as it enables emissions to be reduced where it is most cost effective. X Ensuring a well-functioning market. A standalone UK ETS may face challenges in developing a robust carbon market. Given the relatively low levels of emissions covered by the UK ETS, it may be difficult to develop a liquid secondary market. Further, the close trade ties between the UK and the EU mean that managing competitiveness impacts from differential carbon pricing will be an important focus to avoid distortions. Linking with another market could reduce some of these challenges. X Timeframe for implementation. The government needed to implement its carbon price by January 2021. Given the short time frame for implementing this policy, an ETS design broadly in line with the existing design of the EU ETS was a relatively easily deliverable option. 97 See UK Government 2020a. 98 See for instance Vivid Economics 2019b. 99 See UK Government 2020b. REACHING A RECOMMENDATION 49 Analysis of the potential impacts of different design following factors might need to be considered in the short parameters can be important for assessing trade-offs run: in CPI design and in developing companion policies in X Capabilities and capacity to implement a CPI: For the broader climate policy package. For instance, the instance, it might be clear from an early stage that a modeling and impact assessment described in Chapter 3 lack of capacity of businesses would make an ETS can be used to identify the necessary level of ambition difficult to implement without significant capacity and the roles of mitigation in different sectors. It may also development. This might sway policymakers in favor of identify the need to put in place companion policies to a carbon tax in the short run, while retaining an option alleviate the impact of a carbon price on disadvantaged to move to an ETS in the future. and disproportionately affected stakeholders. The X Economic barriers like market concentration or jurisdictional context can also influence decisions insufficient market liquidity: This is a particular concern regarding scope of the CPI by identifying emissions for small economies, where there may be insufficient patterns and abatement options. market participants for efficient trading in an ETS. CPI design should evolve with a jurisdiction’s changing X Political barriers, particularly when there is a short context and maturing capacity. A CPI can be designed time frame to introduce a CPI: Given the greater to enable the ratcheting up of ambition over time, through complexity of an ETS, if a policymaker is seeking to either tightened cap trajectories for an ETS or an increased introduce a carbon price in a short political window of tax rate under a carbon tax. This is consistent with global opportunity, such as in the context of broader fiscal commitments outlined in the Paris Agreement. Gradually reforms, a carbon tax may be preferred. On the other increasing ambition can allow liable entities to familiarize hand, political aversion to taxes might mean a carbon themselves with the CPI. Sometimes a lack of capacity, tax is not viable in some jurisdictions. political barriers, or other context-specific factors can X Institutional or legal barriers to implementing a make it difficult to include certain sectors or sources certain instrument: These barriers could be overcome of emissions under a carbon price from the outset. with time, but in the short run may rule out a particular However, in the longer term, expanding coverage can help instrument. For instance, in federalized systems, improve the cost-effectiveness of mitigation, the certainty different (or multiple) levels of government may be regarding levels of emissions reductions, and the overall responsible for implementing a carbon tax and an ETS. functioning of an ETS. Similarly, if it is not possible to introduce offsets at the start of the program, a jurisdiction A focus on capacity building, education, and may choose to introduce offsets at a later stage. Offsets stakeholder outreach and engagement can help enable jurisdictions to spread carbon pricing incentives overcome many of these short-term constraints. further throughout the economy, but they can be complex This means jurisdictions can focus on longer-term policy RECOMMENDATION to design in a way that ensures environmental integrity. As objectives and considerations (see Section 1.1), which REACHING A such, these may be a feature that is only introduced after include the CPI has matured. X Certainty of emissions: An ETS allows policymakers to set a cap on emissions, thereby making sure that Detailed information on designing carbon taxes and emissions targets are met. This is a key benefit of an ETSs can be found in the Partnership for Market ETS, particularly as global ambition grows and targets Readiness’ (PMR) Carbon Tax Guide and ETS are tightened. A tax may achieve a similarly ambitious Handbook respectively. outcome, but it is more difficult to predict the level of emissions reductions for a given tax rate in advance. 4.1.2 Time frame for adoption and X Temporal flexibility: By allowing trade between entities implementation of a carbon price and across time, an ETS gives regulated entities greater The time frame for adopting and implementing a flexibility in their abatement choices. This means that an carbon price is a critical factor in decision-making, as ETS responds automatically to economic shocks and short- and long-run considerations may differ. These allows firms to reduce emissions at the time at which it factors are often known to policymakers from the outset or is least costly. are easily revealed through initial research on context and X Cooperation with regional or international partners: stakeholder impacts as described in Chapter 2. If cooperation is an important priority, an ETS may be preferred because it enables linking to carbon markets In the short run, a jurisdiction is more likely to have operating in partner jurisdictions without the need to its CPI choice constrained by capacity limitations or explicitly agree on a common carbon price. specific contextual factors, which often points to a X Price stability and innovation: A consistent price carbon tax as the preferred option. In particular, the signal helps provide assurance that carbon prices will remain in place to drive decarbonization, and 50 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE investments in innovative technologies are therefore to implement an alternative CPI design, with the option to required to operate effectively in the future. A carbon adjust this design at a later point in time. tax provides a stable, more predictable price that can provide greater certainty on investments. An ETS may 4.1.3 Balancing policy objectives improve price certainty through implementing a price or To reach a recommendation, policymakers often need supply adjustment measure (PSAM). to make trade-offs between various policy objectives X Predictability of carbon revenues: A carbon tax may and stakeholder views. For instance, a jurisdiction may be preferred if predictable revenue is an important have a short time window to implement a carbon price priority. However, an ETS with a suitable PSAM can also (which might incline it toward a carbon tax), but also achieve this. require the policy to deliver certainty over emissions X Policy simplicity: A carbon tax is preferable to an reductions (which is more easily achieved through an ETS). ETS if the jurisdiction desires a simple and familiar The jurisdiction might also receive conflicting preferences instrument. This may particularly be the case where from different stakeholders, or mixed opinions from the local firms have experience with other energy or same group of stakeholders. environmental taxes, or where the carbon tax can utilize an existing tax system such as excise taxes. Policymakers will then need to prioritize these factors and accommodate conflicting factors through policy Figure 14 summarizes the short- and long-term design to the extent possible. The eventual ranking of considerations that policymakers must balance to issues will often result from a process of contestation come to a recommendation on carbon pricing. among groups both within and external to government. However, some views and concerns will be more relevant These dynamics highlight the potential for a than others. All concerns should be taken seriously jurisdiction to move to a different CPI or evolve the and responded to, but not all inputs will require policy design of its CPI over time. For example, sometimes a adjustment. lack of capacity, political barriers, or other context-specific factors can make it difficult to include certain sectors or Some tensions in objectives can be allayed through sources of emissions under a carbon price from the outset. instrument design. For example, jurisdictions may want However, in the longer term, expanding coverage can help to achieve a certain emissions target while also raising a improve the cost-effectiveness of mitigation, the certainty certain amount of revenue. In this example, opting for an regarding levels of emissions reductions, and the overall ETS with a price floor or designing a carbon tax that can functioning of an ETS. Depending on the nature of the be flexibly adjusted could go some way toward achieving constraint faced, a jurisdiction may choose to take the time both these goals. Similarly, a jurisdiction may lack the to address it, for instance by building capacity or altering capacity to implement an ETS but find that a carbon tax RECOMMENDATION institutional arrangements, or the jurisdiction may choose would face significant political opposition. This might lead REACHING A policymakers to implement an ETS with limited scope, begin carbon pricing with Figure 14 Jurisdictions must balance short-term and long-term a time-limited, voluntary pilot ETS, or use considerations other companion policies while businesses and regulators build capacity. Policy simplicity Competing priorities can also be addressed by staging of policy changes to ensure the design of a CPI evolves Price stability in line with a jurisdiction’s longer-term objectives. For instance, a CPI could be Short time frame for implementation Predictability of revenues implemented gradually, initially starting with a relatively simple instrument design, Limited capabilities Regional/international and gradually increasing the complexity to & capacity cooperation address additional objectives as capacity Market concentration and experience build. Establishing a clear or insufficient liquidity Temporal flexibility time frame and plan for expanding coverage can enable the implementation of a CPI in Institutional or Certainty of emissions the short run, while these barriers to more political barriers reductions comprehensive coverage are addressed. Similarly, a CPI can be designed to have low Short-term considerations Long-term objectives impact in its initial years while participants and the general public adjust to these costs, REACHING A RECOMMENDATION 51 before ratcheting up ambition over time consistent with the that can be easily understood. The paper should address jurisdiction’s targets. This could be achieved either through any known points of contention in advance to preempt tightened cap trajectories for an ETS or an increased tax political pushback where possible. Finally, to avoid lags rate under a carbon tax. in implementation, the paper should also outline concrete next steps, assign responsibility, and suggest timelines. Ideally, through this process of balancing competing With this road map in place, a jurisdiction can move on objectives, jurisdictions should narrow their CPI design to developing the detailed policy design, processes, and options down to one option or a short list, which can institutions. be presented to stakeholders for formal consultation. The approach to soliciting early feedback on policies will Providing a transparent and comprehensive document differ across jurisdictions but requesting such feedback can generate confidence that the policy is well thought can be an important way of identifying potential issues through and is the best one for local circumstances. It before policy design has progressed too far. Jurisdictions can demonstrate that stakeholders’ concerns have been may choose to write an “options paper” detailing the taken into consideration. In addition, providing information CPI design choices under consideration, convene an on the expected sources of mitigation, planned use of intergovernmental task force, conduct opinion polls, have revenues, potential development benefits, and the effects consultations with individual groups of stakeholders, and/ on households and businesses can reduce uncertainty and or have a wider public consultation. highlights the various benefits of carbon pricing. This section sets out the key elements that should be 4.2 COMMUNICATING THE included in a recommendation paper, as summarized RECOMMENDATION in Table 5. Specifically, the rationale for policy intervention (Section 4.2.1); the policy options available The final policy recommendation, and the process (Section 4.2.2); stakeholder views (Section 4.2.3); the policy of developing this recommendation, typically needs recommendation (Section 4.2.4); and conclusions and next to be consolidated into a persuasive policy paper for steps (Section 4.2.5). These topics should be summarized government decision-makers. This paper distills the at the start of the recommendation paper in an executive internal process of policy development and the evidence summary and then discussed in detail in specific sections that backs up the recommendation into a clear narrative outlined in the table below. Table 5 Mapping between policy paper topics and content of this guide  Policy paper RECOMMENDATION Policy paper subtopic Corresponding section in this guide topic REACHING A Problem statement and global context Section 1.1. The case for carbon pricing Rationale for policy The government’s objectives, and jurisdictional context intervention (emissions profile, economic profile, sociopolitical context Chapter 2. The jurisdictional context and existing legal and regulatory framework) Types of policy instruments along with advantages and Section 1.2. Carbon pricing options disadvantages Quantitative impacts of each option on key stakeholders Section 3.2. Modeling the impacts of carbon pricing Policy options available Role of carbon pricing in the broader climate policy mix Section 1.3. The role of carbon pricing Section 1.5. Interactions of carbon pricing and other The CPI’s interaction with other companion policies policies Stakeholder Views and positions of key stakeholders Section 3.1. Stakeholder impacts views Policy recommendation and key design features Section 4.1. Reaching a recommendation Policy Rationale for the recommendation including key evidence Section 4.1. Reaching a recommendation recommendation International case studies Section 1.6. Learning from other jurisdictions Next steps are specific to a jurisdiction and the instrument chosen. Conclusions and Next steps of action if implementation is approved next steps Detailed guidance on instrument design is available in the PMR’s ETS Handbook and Carbon Tax Guide. 52 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE This report also includes an attachment on developing The policy paper should identify the government’s a policy paper (see Box 16). It captures best practices for objectives and describe how a carbon price and writing such a paper and the key set of evidence needed to the various CPI options align with these objectives. present a recommendation to adopting a CPI. The World Describing how a CPI can help meet government priorities Bank’s Guide to Communicating Carbon Pricing provides is a persuasive argument for carbon pricing. It also helps more detail on how policymakers should communicate decision-makers understand the trade-offs involved in to different audiences, including how to translate highly choosing a particular instrument or design element. technical concepts into simple persuasive language. Finally, this section should highlight how the jurisdictional context influences the recommendation. Box 16 Recommendation paper best practice It should underscore how the choice of policy instrument depends on the jurisdiction’s emissions and economic The recommendation paper best practice (see profile, legal and institutional considerations, political Attachment 7) provides guidance on developing a preferences, and business and regulatory readiness. The clear, concise, and persuasive document to present questionnaire (Attachment 2) provides a framework to the CPI recommendation to stakeholders. think about issues that should be addressed. It can also describe temporal dynamics, discussing the short-term constraints as well as long-term objectives. 4.2.1 Rationale for policy intervention The paper should start with a problem statement, 4.2.2 Policy options available explaining the need for this recommendation paper. This lays out a list of policy options suitable to Often this is the importance of action on climate change, the jurisdictional context. This may include relying and how urgent and coordinated action is needed. solely on regulatory instruments, which prescribe the Policymakers may also choose to position the issue technologies and standards required to reduce emissions, differently, focusing on the broader benefits of carbon using a carbon tax or ETS, a crediting mechanism, or pricing, such as revenue generation or reduction in air a combination of these approaches. It also lays out pollution. This helps frame the discussion, identify the the options for key design features such as scope problem policymakers are trying to solve, and highlight the and ambition. Policymakers may wish to provide brief positive impact of carbon pricing. qualitative reasoning to demonstrate why these options were chosen and others were not. This introductory section can also briefly outline the context for emissions reductions. This includes discussing Crucially, this section should explain the advantages the local and global impacts of climate change, global and disadvantages of each option. The qualitative and RECOMMENDATION environmental goals on mitigating the effects of climate REACHING A logical assessment of each option should be laid out change (for instance, through the Paris Agreement), and clearly. Where possible and where useful, this assessment the jurisdiction’s commitments to this end. For countries, should be substantiated with quantitative and modeling these commitments are typically in the form of a Nationally outputs. This should draw on analytical work done to Determined Contribution, which sets out commitments assess the impacts on stakeholders in addition to wider and requires policy instruments that support long-term evidence sources. It should distill the key results of the decarbonization and increased ambition over time. impact assessment (see Section 3), reporting high-level indicators such as effects on GDP, electricity prices, jobs, Policymakers should then establish a case for and health outcomes. Analytical evidence should be government action, describing how carbon pricing supported with a brief overview of the methodology and provides an incentive for businesses and individuals to uncertainties around the results. While it is important to reduce GHG emissions. It should describe what existing share quantitative evidence used for evaluation in order policies would achieve, gaps to achieving the jurisdiction’s to be transparent, presenting modeling outputs in the mitigation targets, and what the consequences of inaction body of the paper can be confusing and overwhelming are. It should also describe the potential benefits of a for nonexperts. The key messages from the analysis low-carbon economy for the jurisdiction, such as the should be presented but detailed outputs should be left growth of new sectors and job generation. The wider in an annex (see Attachment 7 for more information on objectives of the carbon pricing policy should also recommendation paper best practices). be clearly detailed, such as supporting low-carbon investment, reducing air pollution, raising revenue for Finally, this section should explain the role envisioned investment into social or environmental goals or removing for the CPI within the wider climate policy package. distortionary taxes, or facilitating international cooperation. This includes the extent to which the CPI drives decarbonization, as well as how it will interact with other companion policies. This may be of interest to other REACHING A RECOMMENDATION 53 government departments or ministries because it might 4.2.5 Conclusions and next steps affect the policies they have implemented. The policy The conclusion should summarize the outcomes of interactions attachment (Attachment 1) can be used as a the analysis undertaken in relation to the suitability of guide for discussing and presenting these interactions. a carbon price and its potential role in the policy mix, and the recommended instrument. 4.2.3 Stakeholder views It should clearly state what remains to be decided and This section summarizes stakeholder views and how the next steps in the process. This includes decisions the recommended policy has been shaped by these regarding the detailed design of the instrument, or issues views. This includes views from businesses, households, related to practical implementation. For example, if other government departments, and any other relevant policymakers have recommended a tax, implementation stakeholders. It should clearly set out how each group’s may only require small add-ons to existing policy views were taken into account in developing the policy, frameworks. Where MRV and other systems do not exist, and how any issues raised will be resolved (either through work will have to be done to establish them. If policymakers the choice or design of the CPI, or through companion have recommended an ETS, it will be necessary to design policies). infrastructure that facilitates issuance and tracking of The purpose of this section is to make clear the likely allowances. Policymakers should also highlight where positions of stakeholders and the balance of support additional stakeholder consultation or further impact and opposition to the proposed policy design. It assessments may be needed. Last, policymakers could recognizes that stakeholders should be active participants also schedule regular review periods to assess the in the policy-making process, and that they will bring progress toward implementation and determine whether specific interests and preferences to the policy discussion. the recommendation requires updating. CPI design is an These insights on stakeholder views complement the ongoing process that should be revisited as capabilities assessment of specific impacts of the policy on these and circumstances evolve. stakeholders and potential policies to mitigate negative Where possible, this section should identify effects outlined in the sections above. responsible entities to carry out the next steps and propose an implementation timeline. This gives 4.2.4 Policy recommendation impetus to decision-makers and provides a clear path to This section outlines the recommended CPI and implementation. It can also provide planning certainty for key design features and provides a synthesis of the business and other stakeholders. arguments supporting the decision. This section should synthesize the process followed for arriving at the Finally, it could collate resources to assist with RECOMMENDATION recommendation and any relevant evidence that was used implementation. This includes not only other guides REACHING A to make the decision. The rationale for the decision will and handbooks, but also recommendations for technical draw on different sources, and it is important to lay the experts and academics, institutions that may be able to arguments out clearly. provide guidance, and contacts for decision-makers in similar jurisdictions. Where possible, the recommendation should also set expectations for the long-term trajectory of the carbon pricing policy. This can include establishing 4.3 FURTHER GUIDANCE long-term targets and plans for evolution of the instrument The following resources may provide useful guidance on (for example, a timeline for increasing the scope, price, or developing and communicating a recommendation: stringency, or moving to a different type of CPI). X PMR (Partnership for Market Readiness), and CPLC Providing international case studies can also (Carbon Pricing Leadership Coalition). 2018. Guide to add credibility, particularly when the jurisdictional Communicating Carbon Pricing. contexts are similar. Case studies provide concrete, X Eden, A., M. M. De Oca, and C. Haug. 2019. Striving practical evidence on the effectiveness of carbon pricing. to Keep ETS Simple: Current Practices to Manage They can also help disseminate good practices and allow Complexity in Emissions Trading. for learning from others’ experiences designing and governing markets. 54 CARBON PRICING ASSESSMENT AND DECISION-MAKING: A GUIDE TO ADOPTING A CARBON PRICE REFERENCES Acworth, W., M. Montes De Oca, F. Gagnon-Lebrun, P. Gass, F. C. Matthes, C. Piantieri, and Y. Touchette. 2018. Emissions Trading and Electricity Sector Regulation. https://icapcarbonaction.com/en/?option=com_attach&task =download&id=566. Alves Dias, P., K. Kanellopoulos, H. Medarac, Z. Kapetaki, E. Miranda-Barbosa, R. Shortall, G. Mandras, V. Czako, M. Trombetti, T. Telsnig, H. Medarac, R. Lacal Arántegui, and E. Tzimas. 2018. 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Clean Energy Technologies in Coal Regions: Opportunities for Jobs and Growth. https://ec.europa.eu/jrc/en/publication/eur-scientific-and-technical-research -reports/clean-energy-technologies-coal-regions. 58 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ATTACHMENT 1: POLICY INTERACTIONS IDENTIFYING POLICY INTERACTIONS A1 Carbon pricing instruments (CPIs) operate within a Identifying the nature of the interactions will help improve complex policy mix and will interact with other policies. the design of the CPI, allowing it to be sensitive to the CPIs have a wide reach by design, often impacting much existing policy mix, and where existing policy may need to QUESTIONNAIRE of the economy. This means they will overlap in areas with change. existing environmental and economic policy. This attachment provides a framework to assess the A2 Policy interactions will alter the functioning of a CPI. policy landscape and how it will impact a CPI. Table 6 There are three forms of interaction between policy: provides examples of policies categorized by the most complementary, overlapping, and countervailing effects.100 prevalent form of interaction. Table 7 provides a blank table Complementary policies improve the functioning of a CPI. for policymakers to fill in to assess their own policy mix. Overlapping policies replicate the incentives provided by Table 8 provides a worked example of how a jurisdiction DATA TIP SHEET a CPI and overall do not impact the functioning of the CPI may assess the interactions between a CPI and existing or significantly. Countervailing policies are those that oppose upcoming policies. A3 incentives created by the CPI and worsen its functioning. A1.1 CLASSIFICATION OF POLICIES ASSESSMENT TOOL Table 6 Indicative examples of policies that interact with the CPI Category Policies A4 Complementary X Electricity market reform to allow cost pass-through and ensure the carbon price signal is reflected in electricity dispatch and future market investments X Land tenure reform to provide clear property rights X Energy efficiency financing to reduce financial barriers to uptake X Low-carbon industry financing to address financial barriers to uptake MODELING SUMMARY X Incentives for flexible grids (smart grids, demand side response, storage) X Weather forecasting services for renewables A5 X Support for electric vehicles charging infrastructure X Financial market regulations for secondary emissions markets Overlapping X Fuel and energy taxes X Renewable energy support measures such as feed in tariffs X Energy efficiency support measures such as green certificates X Waste management and landfill regulations EXAMPLE TOR X Environmental emissions regulations and standards Applying a social carbon price in regulatory investment decisions A6 X X Regulation of land use and forestry/deforestation X Payments for ecosystem services (e.g., paying farmers for biodiversity outcomes) Countervailing X Fossil fuel subsidies X Industry support mechanisms that promote expansion of high carbon production X Subsidies for land use change such as forest clearing for agriculture BEST PRACTICE X Subsidies for private cars and transport X Tax rebates on high-emission cars A7 X Disproportionate planning barriers for renewables projects 100 World Bank, Ecofys, and Vivid Economics 2016. ATTACHMENT 1: IDENTIFYING POLICY INTERACTIONS 59 A1.2 POLICY INTERACTIONS TEMPLATE FOR POLICYMAKERS POLICY INTERACTIONS The blank table below has been included for the policymakers to fill in. This should prompt consideration of how a CPI would fit into the current policy landscape. A1 Table 7 Policy interactions template to fill in Sector Policy Type Potential Interaction with CPI QUESTIONNAIRE A2 DATA TIP SHEET A3 ASSESSMENT TOOL A4 MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 60 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A1.3 WORKED EXAMPLE POLICY INTERACTIONS The table below provides a worked example of potential policy interactions for a hypothetical jurisdiction. The table is written with the assumption that emissions in a given sector are also covered by a CPI. Some policies might be A1 complementary or overlapping in different circumstances; where this is the case the table below focuses on examples of overlapping policies as these require careful management. This aims to guide the areas that policymakers should consider when thinking about the interactions. Table 8 Worked example of policy interactions for a hypothetical jurisdiction QUESTIONNAIRE Sector Policy Type Potential Interaction with CPI A2 Financial market Complementary Applying financial market regulations to the operation of the secondary carbon Financial regulation of market could improve confidence in the market, spurring greater liquidity and carbon markets improving secondary market functioning. Electricity market Complementary Enabling cost-reflective electricity dispatch and allowing cost pass-through, reform which allows downstream consumers of electricity to respond to the carbon price signal, which is reflected in greater emissions reductions under a carbon tax and/or lower carbon costs under an emissions trading system (ETS). DATA TIP SHEET Fuel taxes Overlapping Raising the price of fuel prompts consumers to use less of it, or switch to A3 renewable energy technologies. This provides the same incentives as the CPI Electricity (in the short term) to reduce fuel use, which is reflected in greater emissions generation reductions under a carbon tax and/or a lower carbon cost under an ETS. Electricity Countervailing Electricity consumption subsidies act as a negative carbon price, making subsidies it cheaper for actors to undertake activities that increase emissions. These subsidies decrease the incentive to reduce electricity consumption and can ASSESSMENT TOOL hinder the effect of a CPI, reducing the level of abatement that occurs under a tax or increasing cost under an ETS. Energy efficiency Overlapping These standards ensure that buildings have a minimum level of energy A4 standards for (and efficiency, reducing direct and indirect emissions from buildings. This can buildings complementary) duplicate the incentives provided by the CPI to reduce energy consumption. However, it may also complement a CPI by addressing behavioral barriers to Buildings investment that the CPI does not address. and construction Building ambient Countervailing Ambient temperature standards for buildings may result in increased fuel MODELING SUMMARY temperature consumption from air conditioning or heating. Regulations to maintain specific standards temperatures are often essential for comfort, health, and safety of workers. Nonetheless, these partly counteract the impact of a CPI, thereby reducing overall mitigation and/or increasing costs. A5 Vehicle emission Overlapping Vehicle emission standards introduce an implicit financial cost for carbon- standards (and intensive vehicles that duplicates the incentives provided by a CPI. complementary) However, these standards can complement a CPI by supporting technology development and uptake. Standards can result in larger emissions reductions under a carbon tax and put downward pressure on prices in an ETS. Transport Tax rebates on Countervailing Tax rebates for high-emission cars would work in opposition to a CPI because EXAMPLE TOR high-emission they reduce consumers’ incentives to switch to more sustainable alternatives cars and avert emission reductions efforts. This reduces the abatement that occurs A6 under a tax and increases the price of allowances in an ETS. Financing for Complementary Uptake of low-carbon industrial technologies or processes is often hindered by low-carbon high up-front and financing costs even if socially cost-effective. Governments technology may provide financing to support the uptake of these technologies. This would lead to greater emissions reductions in a carbon tax and placing downward pressure on the carbon price in an ETS. Industry BEST PRACTICE Industry Countervailing Support to increase production from emissions-intensive industries without expansion reductions in emissions or emissions intensity will encourage an increase in support production that counteracts the incentives created by the CPI. This will reduce A7 the level of abatement that occurs in a carbon tax and create upward pressure on prices in an ETS.  ATTACHMENT 1: IDENTIFYING POLICY INTERACTIONS 61 Table 8 Worked example of policy interactions for a hypothetical jurisdiction (continued) POLICY INTERACTIONS Sector Policy Type Potential Interaction with CPI Payments for Overlapping Policies incentivizing farmers or landowners to manage their land in a way A1 ecosystem goods that provides ecosystem services (e.g., water purification, flood mitigation, or and services carbon sequestration) might duplicate some incentives provided by the CPI, leading to greater emissions reductions under a carbon tax and downward pressure on prices under an ETS. Agriculture Land use change Countervailing Deforestation is a significant cause of biodiversity loss and carbon emissions. (forest clearing) Subsidies for land use change, for instance to support expansion of QUESTIONNAIRE subsidies agricultural production, would countervail the impact of a CPI that provides incentives to reduce deforestation. This would increase emissions under a carbon tax and prices under an ETS. A2 Food waste Overlapping Food waste diversion can duplicate incentives provided by CPIs by reducing diversion the quantity of waste going to landfill, which is reflected in greater emissions regulations reductions under a carbon tax and/or lower carbon costs under an ETS. Mandatory Overlapping Landfills create methane emissions, a potent greenhouse gas (GHG). The Waste methane capture combustion of methane creates carbon dioxide and reduces the overall GHG and combustion intensity of landfills. Capture and combustion technologies are sometimes DATA TIP SHEET not adopted due to up-front costs or unclear incentives for municipal landfill operators. Mandating these processes duplicates incentives provided by a A3 CPI, which would reduce emissions under a tax and reduce prices under an ETS. ASSESSMENT TOOL A4 MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 62 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ATTACHMENT 2: POLICY INTERACTIONS QUESTIONNAIRE ON A1 JURISDICTIONAL CONTEXT This questionnaire helps policymakers build a X Role of carbon pricing. This includes the potential QUESTIONNAIRE structured understanding of their jurisdictional context objectives of the CPI in the broader policy mix. It and how it feeds into decision-making. It outlines is important that policymakers set clear long-run A2 potential areas of focus alongside a brief description objectives for carbon pricing. Topics may include of why they matter for carbon pricing instrument (CPI) meeting a jurisdiction’s climate targets, raising carbon selection. Policymakers should consider each of these revenues, generating broader benefits, supporting questions and their impact on the appropriate climate green growth and competitiveness, and meeting policy mix before selecting an instrument. any political commitments. Outlining long-term targets and some indication of future changes is also DATA TIP SHEET This questionnaire seeks to build a profile of the desirable to provide predictability about the direction jurisdiction based on the following areas of interest: of the program. A clear understanding of the role and A3 X Economic profile. The economic profile will determine objectives of carbon pricing will guide the design of the how jurisdictional circumstances affect the feasibility CPI to best meet those objectives. and desirability of each CPI option. Answers should X Identify capacity and implementing institutions. highlight general economic impacts, potential risks of Understanding current capacity and implementing carbon leakage, risks of constraining economic growth, institutions can help identify how existing institutions ASSESSMENT TOOL distributional impacts, loss of competitiveness, and can be utilized to implement a CPI and where capacity potential political challenges. Awareness of these is is lacking. Establishing a carbon price requires both A4 important to guide design of CPIs and policies such supporting technical and institutional regimes, such as revenue recycling that can address potential risks as for monitoring, reporting, and verification (MRV). and help prevent/mitigate negative effects of CPIs on Existing institutions can sometimes be used but this different stakeholders. often requires the creation of new agencies, adoption X Emission sources and trends. The emissions profile of new processes, and capacity building. Operational MODELING SUMMARY shows the sectors that are often most affected by a CPI. capacity refers to the actual capacity of administrative It is important to identify emissions-intensive industries bodies, personnel, and new practices required to and emission trends to build a clear understanding implement a CPI. A5 of the key sectors for CPI operation. This informs X Public acceptance. Acceptance is crucial for the decisions on, for example, sector coverage and the long-run effectiveness and continued operation of a potential use of offsets. Awareness of the emissions CPI. Early engagement and communication on the profile can help guide where additional policies may carbon price can help policymakers gauge people’s be needed to reduce negative distributional impacts priorities, concerns, and preferences. This can also of CPI options, or where additional policies to address feed into the CPI design. Transparently communicating EXAMPLE TOR nonprice barriers to mitigation are needed. a CPI’s objectives and impacts through stakeholder A6 X Ensuring policy coherence. Interactions with consultation can increase public support. Additionally, companion policies can boost the effectiveness of the demonstrating the visible benefits of a carbon price, CPI (complementary policies), duplicate incentives for instance, through how the revenue is used, can provided by the CPI (overlapping policies), or in play a powerful role in increasing public acceptability. some cases, offset incentives provided by the CPI Awareness of the level of support across stakeholder (countervailing policies). As such, policy coherence groups for the CPI can help target stakeholder BEST PRACTICE is essential to strengthening carbon pricing policies. engagement and communications to where it is most Interaction with other policies includes subsidies, needed. A broader understanding of public support for A7 fuel taxes, energy prices, and other environmental/ different policies can help policymakers anticipate the mitigation policies. These are discussed further in the level of opposition they may face. Policy Interactions Attachment. ATTACHMENT 2: QUESTIONNAIRE ON JURISDICTIONAL CONTEXT 63 Table 9 Questionnaire POLICY INTERACTIONS Theme Questions Relevant considerations What are the key sectors These sectors are likely to be the focus for policymakers and political actors A1 contributing to GDP? and can be prioritized for analysis. How diverse is economic activity? A broad-based economy with a robust service sector is less likely to be Understanding adversely affected by increased costs from carbon pricing. economic profile Which sectors are the main drivers Industries that are sources of economic growth are more important for Structure of the of economic growth? increasing future prosperity, and may be considered more important than economy industries not growing. QUESTIONNAIRE How competitive/concentrated are Concentration of markets determines competition and liquidity of emissions A2 local markets? markets; a highly concentrated market is more at risk of market abuse or misfunction. How open is the economy to The openness of the economy will influence consumers’ ability to substitute Understanding international trade? local carbon-intensive goods with imports, thus increasing the risk of carbon economic profile leakage. Trade Which sectors are trade exposed? Trade-exposed sectors may have reduced ability to pass on cost increases DATA TIP SHEET in the form of higher prices and may be at higher risk of carbon leakage. What is the current electricity The higher the share of fossil fuel-based generation, the higher the A3 generation mix? compliance costs faced by the power sector and higher the costs passed through to electricity consumers. How is the electricity market Regulations can affect how electricity from power plants is dispatched and regulated? whether dispatch is based on a power plant’s economic merit. Regulated prices affect the ability of generators to pass through the carbon price to Understanding downstream users of electricity via higher energy bills. This means that ASSESSMENT TOOL economic profile downstream users will be less likely to change their consumption behavior. Power sector How many companies operate in The number of operators determines the market power held by each A4 the power supply sector? company and therefore their ability to pass on prices. For an ETS, the number of firms can also affect secondary market liquidity and market behavior. Is the power sector open to private This impacts the level of revenue raised, as well as source of financing for firms? abatement. MODELING SUMMARY What is the greenhouse gas High-emissions sectors will likely be the focus for policymakers and political emission profile and what are the actors and can be targeted for analysis. main emissions sources? A5 How have emissions evolved over The growth of emissions from rapidly expanding sectors (such as aviation) time and how are they expected to may be important to curtail to meet future emissions objectives. evolve in future? Understanding emission sources What are the key abatement Available abatement options will influence the level of carbon price needed and trends options? Do key players in each to reduce emissions, as firms will only change their behavior or investments sector have access to these if it is cheaper to do so than to pay the carbon price. Policymakers may technologies? wish to consider additional policies to supplement the carbon price where EXAMPLE TOR abatement is expensive. A6 How is your jurisdiction planning to CPI design should accommodate future policy aimed at reducing emissions reduce emissions in the future? (e.g., with a tighter cap).  BEST PRACTICE A7 64 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE Table 9 Questionnaire (continued) POLICY INTERACTIONS Theme Questions Relevant considerations What are the short-, medium-, and The objectives of the jurisdiction implementing the CPI will influence the A1 long-term objectives of the CPI? eventual CPI selection and design (see Section 2.2.1 of the guide). Is there a comprehensive national The role of the CPI in meeting emissions reductions targets, including or jurisdictional mitigation plan? nationally determined commitments, will influence CPI selection and design Are there decarbonization plans for (see Section 2.2.1 of the guide). Other strategies, such as national energy specific sectors? Is the role of a strategies, may also be relevant to ensure policy coherence. CPI in these plans clear? QUESTIONNAIRE Ensuring policy coherence Could other regulatory rules or Price signal distortions will reduce the effectiveness of the CPI. laws impede price signaling in Countervailing policies will need to be reviewed (see Section 2.2.2 and the A2 electric and transport markets attachment on Policy Interactions). (e.g., electricity price regulation)? Have you assessed the set of Policy interactions will affect the functioning of the CPI, as well as of companion policies (which may be the companion policies (see Section 2.2.2 and the attachment on Policy complementary, overlapping, or Interactions). countervailing)? DATA TIP SHEET Are institutions (e.g., environmental This determines the type of CPI that is feasible and the speed at which it regulators) in place that could can be implemented (see Rapid Assessment attachment). For instance, an Identify A3 administer a CPI? If not, does the existing regulator may have greater capacity to administer and enforce CPI capacity and capacity to administer a carbon policy and processes. implementing tax or ETS exist or be developed? institutions (Governance and Do you have an MRV system in MRV is integral to any CPI, and the readiness of the MRV system will be a MRV) place that can be adapted for use limiting factor on the timeline for implementing the CPI. Often existing fuel in a CPI (e.g., for fuel taxes or local tax systems or other environmental policies will be built on to develop locally pollution tracking)? appropriate MRV systems. ASSESSMENT TOOL Does your jurisdiction have any Government experience with setting up and regulating secondary markets, experience with market-based as well as business experience with engaging in these markets, can help A4 Identify environmental policy instruments? build capacity for an ETS (see Rapid Assessment Tool). capacity and Have you established an emission A registry is needed for an ETS. If not, other policy mechanisms like implementing registry or similar functionalities for renewable energy or energy efficiency trading systems may provide similar institutions other policies? functionality. (Secondary markets) Does your financial sector trade Experience delivering financial services can help with smooth functioning of MODELING SUMMARY in regulated commodities (e.g., secondary markets for an ETS. electricity)? A5 Is there general public support for High public support means a more ambitious CPI (e.g., more extensive environmental and climate change scope) could be implemented at a more rapid pace. Low support could policies and regulation? hinder the success of any CPI. Is there a public preference for one Public opinion may make certain forms of CPI very challenging to carbon pricing instrument over implement. For instance, opposition to taxes or trading systems have another? influenced the choice of CPIs and their longevity in several jurisdictions. What is the perceived acceptance The extent and sources of industry opposition, and the issues raised, will EXAMPLE TOR of carbon pricing or climate policy influence the areas of focus for stakeholder engagement, and potentially CPI from industry? choice and design. A6 Public acceptance What are the key concerns This could include sensitivities regarding impacts on interest groups, and regarding the social impacts of the the need to ensure a “just transition.” It can help to identify areas of focus introduction of a CPI? for additional supporting policies, modeling, the communications campaign, and stakeholder engagement. Are there constraints on This could affect the choice of instrument (these restrictions are usually earmarking or revenue use associated with taxes) and the extent of public support. BEST PRACTICE generated by a potential CPI? Could a CPI negatively affect This could determine the CPI’s sectoral scope, design options (e.g., A7 certain socioeconomic groups or considering revenue recycling) and varied public support across regions? socioeconomic groups and/or regions. ATTACHMENT 3: DATA TIP SHEET 65 ATTACHMENT 3: POLICY INTERACTIONS DATA TIP SHEET A1 There are multiple sources of evidence that can In analyzing the evidence available jurisdictions can provide information to understand potential carbon make use of several analytical tools and methods to pricing instrument (CPI) impacts: assess the potential implications: QUESTIONNAIRE X Literature reviews represent a rigorous, evidence- X Qualitative analyses can be used to assess the focused method to map the evidence base in an strengths and weaknesses, opportunities, and A2 unbiased way, and to assess the quality of the threats. This tool facilitates comparative analysis evidence and synthesize it.101 Relevant research between different options and CPIs and allows findings can prompt recommendations to be put into policymakers to assess the strengths and weaknesses action. For instance, systematic literature reviews can of different instruments in a systematized way. report on the factors that shape the price of carbon,102 X Issues trees can provide policymakers with a visual DATA TIP SHEET compare different carbon pricing mechanisms103 and walk-through of the options for pricing carbon policy mix,104and inform on public acceptability.105 As and the types of impacts. Such a diagram can help A3 such, systematic literature reviews are a key tool for in exploring a range of carbon price impacts, key evidence-informed policymaking. decisions ahead, and potential CPI design and policy X Statistical materials and methods can provide a options. solid foundation for assessing potential quantitative X Rapid evidence assessments can also be used to effects of a CPI on certain groups. National statistical support decision-making processes by providing ASSESSMENT TOOL agencies will often collect data that can be used to rigorous and policy-relevant syntheses of evidence. assess the potential channels of impact of a CPI on They offer a more structured and rigorous search and different stakeholders and guide policy decisions A4 quality assessment of the evidence than a literature accordingly. For instance, household survey data can review but are not as extensive and exhaustive as a be used as a tool to measure people’s reliance on systematic review. carbon-intensive energy sources and thereby help to limit negative impacts on vulnerable households. Policymakers will require data throughout the Similarly, data on trade can help identify potential selection process. Building an understanding of the MODELING SUMMARY to barriers in passing on carbon costs in certain local context may require the use of external data industries. International data sources could be used to sources. Table 10 provides suggestions for data sources, A5 understand economic, government finance, business, categorized by topic, that may support or supplement and household impacts. domestic sources such as data from the national X Opinion polling and surveys can provide information environmental or energy agency or ministry and the on stakeholder views and concerns. Opinion polling national statistics agency. and surveys can help identify potential responses to CPIs from key stakeholders, including expected EXAMPLE TOR behavior, practices and barriers to the implementation, and perceived or actual risks of negative effects. For A6 instance, in China, a survey of stakeholders found that 77 percent of these expect the emissions trading system (ETS) to affect investment decisions and cause price levels to rise significantly by 2030, suggesting that it would mobilize real behavioral change.106 BEST PRACTICE A7 101 Department for International Development 2013. 102 Chevallier 2011. 103 Narassimhan et al. 2018. 104 Narassimhan et al. 2017. 105 Maestre-Andrés et al. 2019. 106 Slater et al. 2018. 66 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE Table 10 Data tip sheet POLICY INTERACTIONS Topic Data Sources World Bank Carbon Pricing Dashboard A1 ICAP ETS summaries Carbon pricing Developments World Bank State and Trends of Carbon Pricing reports IETA carbon market resources IEA country/region reports and World Energy Balances WHO Ambient air pollution QUESTIONNAIRE Emissions Sources of emissions UNFCCC GHG data from UNFCCC IPCC IAMC Pathway Database A2 Climate Action Tracker NDC assessments Climate Policy Database Overview of LSE Climate Change Laws of the World Regulation: Climate climate action IEA Policy Database UNFCCC for NDCs and BURs DATA TIP SHEET IRENA Renewable Power Generation Costs USAID country dashboard A3 Regulation: IEA Policy Database Policy overview Local policy World Bank RISE Index ND-GAIN vulnerability and resilience National private and public providers Political context Public opinion Links to comparative datasets compiled by Oxford University and Princeton University ASSESSMENT TOOL Institutional context Policy responsibility World Bank Governance indicators A4 Climate Policy Database Carbon pricing Institutional context World Bank Country Policy and Institutional Assessment readiness World Bank Doing Business World Bank statistics IEA energy statistics MODELING SUMMARY Economic context General indicators IMF Staff Country Reports USAID country dashboard A5 OEC trade flows and economic complexity Economic Economic context Atlas trade flows and economic complexity composition WEF Global Competitiveness Report Economic context National statistics UN partner country list OEC trade flows and economic complexity EXAMPLE TOR Potential impacts: COMTRADE trade data platform Trade data Competitiveness Atlas trade flows and economic complexity A6 WITS trade database Potential impacts: Distributional World Inequality Database Distributional BEST PRACTICE A7 ATTACHMENT 4: CAPACITY ASSESSMENT TOOL 67 ATTACHMENT 4: POLICY INTERACTIONS CAPACITY ASSESSMENT TOOL A1 Understanding regulatory and business capacity in a developed capabilities (green), capabilities need moderate jurisdiction is vital to selecting an appropriate carbon development (amber), or capabilities need significant pricing instrument (CPI). Different CPI options have development (red). Blank templates for policymakers QUESTIONNAIRE differing levels of complexity. The capacity requirements for to use are provided in Attachment 2 and Section A4.2, some CPI designs may not align with existing government Section A4.3, and Section A4.4 provide worked examples A2 capacity. In this case, policymakers may wish to build of how this assessment would be carried out for capacity before an instrument is implemented or opt for governance capacity and business capacity, respectively. a less complex instrument. A mapping of jurisdictional These tables include examples of potential sectors to capacity against CPI requirements will aid in understanding consider and are not exhaustive. Other elements can where capacity gaps exist, and therefore what CPI designs be added to the tables to best suit the needs of the are currently possible and areas to develop. jurisdiction. DATA TIP SHEET This tool maps broad CPI requirements against A3 key attributes of capacity for both regulators A4.1 TEMPLATES: GOVERNMENT and businesses to assist in identifying capacity CAPACITY development needs. Policymakers should assess the capacity of both government and business to build a The ability of governments to effectively implement a picture of the existing capacity. This will aid in identifying CPI depends on their underlying governance capacity gaps in capacity and what capacities need to be developed and ability to manage trade. Section A4.1.1 addresses ASSESSMENT TOOL ahead of CPI implementation. Capacity-building needs will governance readiness, including the ability to enforce vary across CPI options. Carbon taxes have the narrowest compliance and the strength of MRV capabilities. A A4 requirements, needing capacity in monitoring, reporting, robust and well-functioning MRV system is the foundation and verification (MRV) and compliance. An emissions for any carbon price; carbon taxes and ETSs will also trading system (ETS) has the broadest requirements for require the regulator to enforce domestic compliance. readiness, with governance and market capacity needing Section A4.1.2 considers a government’s ability to manage to be in place. Crediting mechanisms require capacity in trade, including facilitating trade, regulating secondary MODELING SUMMARY MRV, market oversight, and trade infrastructure. markets, and supporting allocations. In addition to MRV and compliance, ETSs and crediting systems require the Limited existing capacity should not discourage CPI capacity to implement and operate a secondary market for A5 implementation. This assessment is intended to identify trading allowances. This includes the necessary trading gaps in capacity, so upskilling can be targeted. Capacity infrastructure, capacity for market oversight, and capacity can be built up over time and CPI design can be simplified to allocate allowances. in some respects. Capabilities can be improved through capacity-building exercises for key stakeholders (for Government capacity can be developed. These tables example, training third-party verifiers), or investment in will aid in identifying gaps in capacity where capacity EXAMPLE TOR infrastructure. For example, the Regional Greenhouse Gas building can then be targeted. These tables include examples of potential capabilities to consider and are not A6 Initiative and the California Independent Emissions Market Advisory Committee were able to build agency capacity exhaustive. Other elements can be added to the tables to quickly once gaps in capacity were identified. best suit the needs of the jurisdiction. The tool requires policymakers to reflect on various elements of capacity and classify their jurisdiction into relevant categories. These categories are BEST PRACTICE A7 68 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A4.1.1 Governance capacity POLICY INTERACTIONS Table 11 Governance assessment: Template A1 Compliance Rationale: Lack of capabilities in compliance will make enforcing an ETS or tax challenging Capabilities Rating Assessment Processes to investigate potential misreporting or noncompliance QUESTIONNAIRE Enforcement and judicial capacity for timely and regular enforcement A2 Ability to levy punitive punishments as incentives to reduce adverse behavior MRV Rationale: Accurate MRV is needed to ensure that mitigation incentives are well targeted and for the overall credibility of the system DATA TIP SHEET Capabilities Rating Assessment A3 Measurement of sufficient accuracy (for example Scopes 2 and 3 emissions) across key sectors and sources of emissions Reporting systems that can be utilized for frequent (annual) credible updating of emissions or other relevant outcomes Verification systems to ensure reporting is accurate to a ASSESSMENT TOOL reasonable degree of certainty (e.g., auditing or third-party verification) A4 A4.1.2 Capacity to manage markets Table 12 Capacity to manage trade assessment: Template MODELING SUMMARY Trade and market readiness Rationale for assessment: Lack of market readiness may limit the efficiency of markets and creates risks of misconduct A5 Capabilities Rating Assessment Trade infrastructure Registries capable of supporting (ETS) frequent market trade Regulation of markets that detects and Market oversight punishes misconduct EXAMPLE TOR Allocations (ETS) A6 Rationale for assessment: Lack of capabilities may limit allocation options in the short term Capabilities Rating Assessment Data collection regarding emissions Free allocations and production if needed for allocations BEST PRACTICE Auctions mechanism to enable sale of Auctions allowances A7 ATTACHMENT 4: CAPACITY ASSESSMENT TOOL 69 A4.2 TEMPLATES: BUSINESS CAPACITY POLICY INTERACTIONS The broader business capacity can help determine the success or otherwise of a CPI. Key business capabilities include the availability of support and services to aid compliance, the ability to follow MRV requirements, and, in the case A1 of ETSs, the ability to participate in trading. Some services may be more relevant for certain CPI options. For example, brokerage firms will not be required for a carbon tax as there is no secondary market for trading emissions reductions. Generally, the potential to cover a given sector can be considered based on the potential of sector participants to comply with MRV requirements. A mapping of these capabilities can then shed light on capacity building needs and their short-term appropriateness for coverage in a carbon price. There may be multiple ways in which a sector can be covered; QUESTIONNAIRE hence the guide considers coverage options both at the point of emission as well as upstream and downstream. Business capacity can be developed. These tables will aid in identifying gaps in capacity where capacity building can A2 then be targeted. These tables include examples of potential capabilities and sectors to consider and are not exhaustive. Other elements can be added to the tables to best suit the needs of the jurisdiction. A4.2.1 Enabling environment assessment DATA TIP SHEET A3 Table 13 Enabling environment assessment: Template Business capacity Rationale for assessment: A lack of business capacity may limit engagement, increase transaction costs, and reduce the overall efficiency of the market ASSESSMENT TOOL Capabilities Carbon tax Crediting ETS Assessment Compliance Legal advisory services A4 MRV Auditors and/or verifiers Brokerage or over-the-counter trade Trade Exchange-based trade infrastructure MODELING SUMMARY Project developers for origination A5 A4.2.2 Sector capacity assessments Table 14 Sector capacity assessments: Template MRV potential EXAMPLE TOR Rationale for assessment: Lack of business capacity for MRV in points of the supply chain may limit point of regulation options in the A6 short term, increase transaction costs, and reduce the overall efficiency of the system Potential covered sectors Upstream Point of emission Downstream Assessment Power Industry Buildings BEST PRACTICE Transport A7 Aviation (domestic) Waste Forestry Agriculture 70 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A4.3 GOVERNMENT CAPACITY ASSESSMENT WORKED EXAMPLE POLICY INTERACTIONS This section provides a hypothetical example of how the tool can be used to assess government capacity. Section A4.3.1 provides an example of assessing governance capacity, while Section A4.3.2 provides an example of A1 assessing the capacity to manage trade. A4.3.1 Governance capacity The worked example in Table 15 shows that, for this hypothetical jurisdiction, there are gaps in both the compliance and MRV systems. The first table shows that a lack of sufficient punishments for noncompliance risks undermining enforcement of the system, while the second table shows that the lack of a robust verification system calls QUESTIONNAIRE into question the integrity of the MRV system. While this jurisdiction may not be immediately ready for a carbon price, these A2 capacity gaps can be filled in and addressed. The findings suggest capacity should be built in those two areas to support CPI implementation. For instance, strengthening punishments for noncompliant behaviors can increase the credibility of the compliance system, while training of third-party verifiers could improve the capacity of the MRV system. Early identification of capacity building needs and utilizing frameworks developed from existing CPIs will prevent these constraints from delaying implementation. DATA TIP SHEET A3 Table 15 Governance assessment: Worked examples Compliance worked example Rationale for assessment: Lack of capabilities in compliance will make enforcement challenging Capabilities Rating Assessment of capabilities ASSESSMENT TOOL Processes to investigate potential  Developed  Processes in place including spot-checks and targeted misreporting or noncompliance capabilities investigations A4 Enforcement and judicial capacity  Developed  Sufficiently established rule of law and competent for timely and predictable enforcement capabilities enforcement authorities Ability to levy punishments  Capabilities L  ow cost of punishments fails to punish noncompliance need moderate and change behavior as incentives to reduce adverse behavior development MODELING SUMMARY MRV worked example A5 Rationale for assessment: Accurate MRV is needed to ensure that mitigation incentives are well targeted and for the overall credibility of the system Capabilities Rating Assessment Measurement of sufficient accuracy (for example  Developed  Measurement methodologies are tailored to local Scope 2) across key sectors and sources of capabilities circumstances and within a reasonable uncertainty emissions range and without bias EXAMPLE TOR Reporting systems that are credible and can be  Developed  Reporting systems established through taxation utilized for frequent (annual) updating of emissions capabilities systems can be utilized A6 or other relevant metrics Verification systems to ensure reporting is C  apabilities A  lack of sufficiently robust verification systems accurate to a reasonable degree of certainty (e.g., need significant undermines confidence in reported outcomes auditing or third-party verification) development BEST PRACTICE A7 ATTACHMENT 4: CAPACITY ASSESSMENT TOOL 71 A4.3.2 Capacity to manage markets POLICY INTERACTIONS The worked example in Table 16 shows that, for this hypothetical jurisdiction, allowance allocation capacity needs to be built to effectively implement an ETS. The first table shows that sufficient trade infrastructure is in place as it relates to functioning registries and market oversight systems. The second table shows auctioning capacity needs to be A1 developed if an ETS is pursued. In the short term it may choose to outsource to third-party providers while it builds up internal capacity. Table 16 Capacity to manage trade assessment: Worked examples QUESTIONNAIRE Trade and market readiness worked example A2 Rationale for assessment: Lack of market readiness may limit the efficiency of markets and creates risks of misconduct Capabilities Rating Assessment Trade infrastructure Registries capable of supporting  Developed  Electronic registry in place for renewable (ETS) frequent market trade capabilities certificates, which can be adapted for use in an ETS Regulation of markets that detects  Developed  Effective and well-resourced market oversight Market oversight and punishes misconduct DATA TIP SHEET capabilities agencies A3 Allocations worked example Rationale for assessment: Lack of capabilities may limit allocation options in the short term Capabilities Rating Assessment Data collection regarding  Developed  Data available for developing benchmarks and Free allocations emissions and production if capabilities providing free allocations ASSESSMENT TOOL needed for free allocations Auctions mechanism to enable C  apabilities L  ack of capacity to run auctions of allowances A4 Auctions sale of allowances need significant development MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 72 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A4.4 BUSINESS CAPACITY ASSESSMENT WORKED EXAMPLE POLICY INTERACTIONS This section provides a hypothetical example of how the tool can be used to assess business capacity. Section A4.4.1 provides an example of assessing the enabling environment, while Section A4.4.2 provides an example of A1 sector capacity assessment. A4.4.1 Enabling environment assessment Table 17 provides a worked example for a hypothetical jurisdiction, identifying the capabilities of the enabling environment. In this example, the jurisdiction has a broadly strong business ecosystem but lacks existing environmental exchange-based trade capabilities. A strong business ecosystem will help regulated entities engage and comply with a QUESTIONNAIRE carbon price. A2 Table 17 Enabling environment assessment: Worked example Business ecosystem capacity worked example Rationale for assessment: A lack of capacity in the business ecosystem may limit engagement, increase transaction costs, and reduce DATA TIP SHEET the overall efficiency of the market Capabilities Carbon tax Crediting ETS Assessment A3 Legal advisory  Developed  Developed  Developed  Wide range of service providers Compliance services capabilities capabilities capabilities available Auditors and/or  Developed  Developed  Developed  Established verification and MRV verifiers capabilities capabilities capabilities auditing services ASSESSMENT TOOL Brokerage or OTC  Developed  Developed  Several brokers for energy/ trade capabilities capabilities environmental products A4 Exchange-based C  apabilities N  o exchanges for energy/ Trade trade need significant environmental products infrastructure development Project developers  Developed  Project origination well for origination capabilities developed from Clean Development Mechanism MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 73 A4.4.2 Sector capacity assessments Table 18 considers the MRV potential, describing the capacity to measure and report emissions at different points in the supply chain. For example, the waste sector has low MRV potential upstream due to the numerous and disparate sources of waste. MRV potential improves lower down the supply chain, at the point of emissions (that is, at the landfill level). Table 18 Sector capacity assessments: Worked example MRV potential worked example Rationale for assessment: Lack of business capacity for MRV in points of the supply chain may limit point of regulation options in the short term, increase transaction costs, and reduce the overall efficiency of the system Potential covered sectors Upstream Point of emission Downstream Assessment  Developed  Developed C  apabilities  Able to deal with upstream or point Power capabilities capabilities need moderate of emission regulation development  Developed C  apabilities  Able to deal with point of emission Industry capabilities need significant regulation development  Developed C  apabilities C  apabilities  Able to deal with upstream Buildings capabilities need moderate need moderate regulation development development  Developed C  apabilities  Able to deal with upstream Transport capabilities need moderate regulation development Aviation (home)  Developed  Developed  Able to deal with upstream or point capabilities capabilities of emission regulation  Capabilities  Developed  Able to deal with point of emission Waste need moderate capabilities regulation development C  apabilities C  apabilities C  apacity building required for Forestry need significant need significant forestry MRV capabilities if included development development in carbon price  Developed C  apabilities C  apabilities  Able to deal with upstream Agriculture capabilities need significant need significant regulation for fertilizers; otherwise (Fertilizers) development development requires capacity building 74 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ATTACHMENT 5: POLICY INTERACTIONS MODELING TECHNICAL SUMMARY A1 This attachment seeks to provide more detail on key steps required in modeling to more depth than in the the development and implementation of a modeling main report. approach. Once the jurisdictional context is understood, We then provide a detailed model summary sheet QUESTIONNAIRE policymakers should start on the impact assessment. Modeling is often an important source of evidence in the that aims to match models to desired objectives and deliverables of the model. A2 impact assessment. This attachment explores some of the A5.1 MAPPING POLICY QUESTIONS TO MODEL SELECTION Table 19 provides examples of how policy topics can be mapped to required model outputs and functionalities. DATA TIP SHEET A3 Table 19 Linking policy questions to modeling output and functionality requirements Carbon pricing Examples of outputs and instrument (CPI) Subtopics Model functionality required indicators policy topics What is the performance of different Cost-effectiveness (total Explicit representation of different ASSESSMENT TOOL instruments in reducing carbon abatement cost ($) / total size policy instruments (CPIs and other) How do CPIs emissions? How will a CPI and of abatement [carbon dioxide across the economy perform against other instruments interact with other equivalent]) A4 other instruments? policies? Cost efficiency (abatement cost and saved damages [$]) What are the economic costs and GDP impacts; energy prices; Ideal requirement: macroeconomic/ What are the broad benefits of a given CPI? How will regional impacts ($) general equilibrium module; economic impacts sectoral economic output and minimum requirement: economic Output and prices for economic of CPI instruments? composition change? costs MODELING SUMMARY sectors ($) What government revenue is Government revenue from different Macroeconomic module including What are the expected under different CPIs? CPIs ($) representation of government A5 implications What are the wider economic spending impacts, or systems for government impacts of different government model with price/cost and finance? revenue policies? emissions What are the broader benefits in Air quality impacts; soil Health and broader environmental addition to greenhouse gas (GHG) improvements; water and benefits require specific (non- What are the mitigation, such as human health, biodiversity impacts; energy economic) model (e.g., dispersion broader benefits of environmental protection, or energy imports models for air pollution); energy EXAMPLE TOR carbon pricing? security? security benefits require specific functionality on trade balance of A6 energy and fuels How will the CPIs change Technology costs ($); sectoral Sectoral representation of How will a given technologies, practices, or energy/resource use and fuel technologies, practices and sector respond to a behaviors? How will energy and consumption (terawatt-hour; tons) behaviors; elasticities of demand CPI instrument? nonenergy inputs change? How will for fuels businesses comply? BEST PRACTICE What is the impact on sectoral Carbon leakage rates (emissions’ Ability to assess global trade effects How will a CPI competitiveness? What is the increase in one jurisdiction/ and technological response of carbon leakage? emissions’ decrease in other individual industries A7 affect international competitiveness? jurisdiction); production and output losses  ATTACHMENT 5: MODELING TECHNICAL SUMMARY 75 Table 19 Linking policy questions to modeling output and functionality requirements (continued) POLICY INTERACTIONS Carbon pricing Examples of outputs and instrument (CPI) Subtopics Model functionality required indicators A1 policy topics What are What is the distributional impact on Energy bills across household and Ability to disaggregate households/ distributional householders and consumers? What businesses types ($) businesses to different groups impacts of different are the impacts across different (income, behavior, turnover) CPIs? business sizes? How will the market operate under Volume of trading activity and Targets and market allowance QUESTIONNAIRE How will the carbon different CPI options? How will market prices ($); emission setting; different trading types’ market operate? it react to increased targets or to abatement and cost-effectiveness behavior; marginal abatement cost external shocks? ($/tCO2-e) curves A2 What level of action is appropriate to Social cost of carbon ($/tCO2-e), Integrated mitigation costs and match climate costs and benefits? mitigation scenarios (GHGs and climate benefits or detailed techno- What is the right What is required to meet current mitigation cost by sector) economic representation of sectors level of ambition? and future Nationally Determined Contribution (NDC) targets? DATA TIP SHEET A5.2 SCENARIOS AND SENSITIVITY A3 Further details on developing reference and policy ANALYSIS scenarios for jurisdictions can be found in the Partnership for Market Readiness’ (PMR) Checklist on A5.2.1 Defining a reference scenario Establishing Post-2020 Emissions Pathways.107 The reference scenario models what would happen A5.2.2 Defining a policy scenario ASSESSMENT TOOL without a CPI in place. This provides a comparison, or reference point, to assess the results of the policy This process allows the establishment of a list of scenarios against. Without a reference scenario, the impact policy scenarios that are mutually exclusive, directly A4 of a CPI on outcomes cannot be assessed. The reference comparable, and sufficiently differentiated to assess scenario outputs are the same as those that will be used the policy options in question. To create a set of in the policy scenario. The difference in outputs between possible policy scenarios, policymakers need to identify the reference and policy scenarios form the basis of the the most important policy variants that need testing. analytical approach as to how modeling assesses the These variants should directly relate back to answering MODELING SUMMARY impact of CPI. the policy questions that were established in Section 3.1.1 of the guide and the modeling objectives discussed in The ambition of the reference scenario can differ and A5 this annex. If multiple scenarios are being tested, these should be decided on early. One option is to model what should be defined to test preferred options to enable direct would happen in a world where neither a CPI nor any new comparison of the subset of viable options. Alternatively, policies past already committed policy are developed. This modeling can be defined in terms of testing boundary is referred to as the “business as usual” (BAU) scenario. conditions, particularly where there is likely to be a An alternative scenario is to model the achievement of the predictable relationship between the policy variable and objectives without the introduction of a CPI. This would EXAMPLE TOR the outcome of interest. mean alternative policy measures would be implemented. A6 Most modeling uses the BAU as the reference scenario so Certain underlying assumptions should be held that multiple policy scenarios can be compared with each constant between a reference and policy scenarios. other and with the option of no further action on climate This is to ensure comparability between different scenarios mitigation. Under the BAU scenario, existing policies will and to maintain the integrity of the modeling. Aspects that likely not achieve the NDC objectives. In these cases, the may be held constant could be the wider socioeconomic NDC can be a policy scenario. The policy scenarios will trends or demand projections in unaffected industry. These BEST PRACTICE draw on aspects of the reference scenario; for example, may be tested in sensitivity analyses (discussed below). how energy demand is expected to develop in the future A7 will be a required input in both reference and policy Any defined policy scenarios, as well as reference scenarios. scenarios, are not a precise prediction of future outcomes given the uncertain nature of future events. The main aim of modeled scenarios is to facilitate the representation of different policy decisions regarding, 107 PMR 2015b. 76 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE for example, time and risk preference; uncertain nature entities and policy revenue or industry capacity to comply POLICY INTERACTIONS of the future regarding aspects directly relevant to the with regulation. Ultimately this could mean that the CPI CPI, like technology, market prices, or stakeholders’ objectives are not met. Therefore, stress testing provides behavior; uncertain nature of wider trends such as GDP a way for policymakers to understand how sensitive the A1 and population growth. Scenarios should therefore be impacts of the CPI are to large shocks. This understanding interpreted as a projection, rather than a forecast, of coupled with local knowledge on the risk of large shocks expected policy and wider economic outcomes given a occurring can help to guide policymakers in whether range of uncertainties and assumptions. complementary policy is required. It may be worthwhile testing the design of scenarios QUESTIONNAIRE with stakeholders as part of the consensus building. A5.3 AVOIDING COMMON CHALLENGES Any modeling exercise will be based on a variety of data THAT OCCUR IN MODELING A2 sources and modeling assumptions. Where useful in building common understanding across different groups Economic models can be complex, resulting in (for instance, government departments), a summary of key modeling projects often facing a range of challenges scenario assumptions can be discussed and tested with that can be anticipated. Some common challenges are X Poor input data: Modeling projects can face issues the main policymakers. Further, assumptions should be available in the impact assessment report to increase the with compiling enough granular data. Thus, the DATA TIP SHEET transparency of the quantitative analysis. practitioners should check expected data needs and data availability prior to procuring modeling exercises A3 and try to align modeling approaches with the data A5.2.3 Defining sensitivity analysis available. Alternatively, they may choose to not specify A sensitivity analysis assesses how responsive a modeling approach but ask for clear enumeration of the model outputs are to changes to inputs and the data sources that will be utilized in the modeling assumptions. Model results carry with them a degree process and contingency plans to address data gaps. of uncertainty; sensitivity analysis helps to assess where ASSESSMENT TOOL Further, processes to identify and validate input data the uncertainty comes from and the range of uncertainty. early in the modeling process can help avoid problems. These can arise, for instance, due to Depending on budget and resources, primary data A4 X uncertainty related to input data; collection may be required to supplement or update X inherentuncertainties in the market and wider existing data sources to be utilized. economic reaction to different CPI designs; or X Model suitability: The practitioners should ensure that X general uncertainties regarding future economic and the model being proposed is appropriate to answer MODELING SUMMARY societal outcomes, such as growth rates of GDP and the policy question being asked. For instance, an exchange rates as a result of external shocks such as econometric model relying on historical data may not be the global coronavirus pandemic. suited to evaluate likely outcomes in a rapidly changing A5 sector. Thus, through the procurement, the practitioners This first requires that a set of uncertainties be should ask for details on how a given modeling approach represented in the model. These uncertainties may was used, or is suitable, in answering similar questions. relate to factors that are (largely) out of the control of the X Model enhancements: Often, existing models are policymaker. For instance, this could include rates of not sufficient to answer the policy questions and will technological change, commodity prices, rates of economic require certain model enhancements, such as further EXAMPLE TOR growth, or exchange rates. These uncertainties need disaggregation of sectors, baseline, and data updates. to then be modeled. This can be done through simple A6 Thus, it is important to capture these necessary model methods, like creating low, best, and high estimates of requirements from the onset of the impact assessment model inputs. A discrete set of uncertainties is often used project to understand the risks and challenges of tailoring for inputs where extensive scenario analysis already exists, the model to a given context and policy questions. such as fossil fuel prices. More complex methodologies like X Scope creep and moving goalposts: Given the Monte Carlo simulations can sample thousands or millions uncertainty in modeling future outcomes, modeling of variations in each uncertainty and are therefore useful BEST PRACTICE exercises can result in a long set of scenarios that were when the range of the input uncertainty is less well known. considered only at a later stage of the project. This is A7 Policymakers may wish to stress test the models to likely to result in missing initial timelines and expected assess extreme scenarios. There are numerous potential resource needs. Thus, it is critical to invest enough sources of large shocks; for example, large economic time in the initial stages of the modeling project so recessions disaster risks. These can have an impact on that a clear definition of objectives and scenarios is the effectiveness of the CPI through channels such as established. Further, practitioners should put in place reducing activity, thereby reducing the number of covered operational processes to manage a shifting scope, such ATTACHMENT 5: MODELING TECHNICAL SUMMARY 77 as contingency arrangements or provisions for further Table 20 illustrates good practice in mapping policy POLICY INTERACTIONS scenarios or sensitivity analysis. Finally, securing early options while explaining key assumptions. This buy-in from stakeholders regarding policy objectives approach can help ensure that the modeling scope is well and modeling scenarios can help prevent later changes specified given the most pressing objectives. A1 in scope. Table 20 Example of a good practice in defining modeling policy scenarios Point of regulation Emission Scenario Permit Threshold Instrument Sectors Offsets reduction QUESTIONNAIRE reference allocation (electricity) Electricity Transport vs BAU A2 Electricity, Scenario 1 Carbon tax No N/A Upstream Upstream N/A 20% transport Electricity, Scenario 2 Carbon tax Yes N/A Upstream Upstream N/A 20% transport Free allocation Electricity, Scenario 3 ETS Yes to 2025; then Downstream Upstream 20 MW 20% transport DATA TIP SHEET auctioning A3 ASSESSMENT TOOL A4 MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 A7 A6 A5 A4 A3 A2 A1 BEST PRACTICE EXAMPLE TOR MODELING SUMMARY ASSESSMENT TOOL DATA TIP SHEET QUESTIONNAIRE POLICY INTERACTIONS 78 A5.4 MODEL SUMMARY SHEET The model summary sheet below seeks to models that are commonly used in climate policy type and what the model type presents as outputs. help policymakers decide whether modeling is analysis, categorized by the differing focuses of The table aims to help policymakers identify which needed and, if so, the most appropriate model models. The table provides a brief description of types of model may be best suited to their needs to use to assess the operation and impacts of what the model type does and how it works before and should be used in conjunction with Chapter 3 of CPIs. It outlines different types of techno-economic outlining the strengths and limitations of the model the guide, “Impact Assessment.” Model subtypes Examples Brief description Analytical approach Strengths Limitations Typical outputs Integrated assessment models (IAMs) DICE, PAGE Very long term IAMs calculate the optimal X Simple model allows for X Tend to be highly Economic outcomes, Cost-benefit Simple economic and path for investment decisions multiple runs of different aggregated, with no sectoral carbon emissions, given the economic benefits scenarios quickly disaggregation global temperature rise, physical climate models and costs that arise from X Models operate over very long X Not well suited for short-term abatement costs, social to evaluate scenarios for climate impacts and climate change. Economic time period, often hundreds of analysis cost of carbon, and theory and evidence are used carbon prices mitigation pathways years, to consider long-term X Results can have large by comparing costs of to set up the parameters societal issues for the model. They simplify uncertainties climate impacts and X complex economic and Able to incorporate more X Can be very sensitive to benefits of mitigation. detailed sector-specific models geophysical relationships to changes in assumptions produce quickly computable, in some cases highly aggregated results. REMIND- Long term These models integrate the X Explicitly models climate X Very technical and Wide-ranging outputs Global system models MAgPIE, costs of climate change change computationally expensive that include economic Complex technological, MESSAGE- calculated through detailed X Captures feedback loops X Climate tipping points and outcomes, climate biophysical, and GLOBIOM physical and climate-based between climate and economic their impacts are challenging outcomes, energy economic models models in addition to models impacts to model accurately pathways, and land use; that develop detailed used in conventional cost- exact outputs will depend scenarios for mitigation X Comprehensive modeling of benefit IAMs. on the additional models options, often different sectors incorporated combining energy X Comprehensive set of outputs system and land use considering a range of sectors models.  CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE Model subtypes Examples Brief description Analytical approach Strengths Limitations Typical outputs Macroeconomic ViEW, Medium to long term “Predictive approach” based X Predict values for many X Assumes specific economic GHG emissions Computable General IGEM, on historical data economic variables including relations, which might be (economy-wide GHG, Detailed economic Equilibrium ADAGE GDP unrealistic covered-sector GHG, representations of Top-down approach with (CGE) X Consider policy interaction X Assumption of rational carbon leakage), relationships between a key focus on economy- with other sectors at a good behavior and single economic aggregates industry sectors, wide impact, carbon degree of granularity representative agent (GDP/GNI), sectoral consumers, and leakage analysis, and impacts (output, international markets. competitiveness analysis. X Theoretically rigorous through X Doesn’t capture specifics of GVA, employment), CGE models are built to its incorporation of economic technological change within prices (carbon price, capture feedback loops theory sectors energy prices), social between different sectors. X Consider distributional impacts X Can be hard to capture the (distribution, carbon Therefore, they will capture X Able to capture resource limits impact of economic shocks revenues) the knock-on impact of since it looks at a closed X Data- and time-intensive carbon price across whole system economy. These models place structure on the data using economic theory. G-cubed, Medium to long term Similar to CGE models in X Intertemporal decisions are X Assumes specific economic GHG emissions Dynamic Stochastic GCAM placing a structure on the captured, with decisions relations, which might be (economy-wide GHG, Assess interactions General data using economic theory. made that are forward looking. unrealistic covered-sector GHG, between the financial Equilibrium They are dynamic in the This means that time-varying X Assumption of rational carbon leakage), sector and other (DSGE) sense that it accounts for optimal CPI pricing can be behavior and single economic aggregates sectors of the time, capturing business solved representative agent (GDP/GNI), sectoral economy (businesses, cycle dynamics and the X impacts (output, government, and Incorporates economic shocks X Sector-level breakdown of associated policy responses. from different sources (not GVA, employment), consumers), taking into limited granularity This introduces uncertainty normally done in CGE models) prices (carbon price, account the business X about the future. Doesn’t capture specifics of energy prices), social cycle. X Can be extended to include technological change within (distribution, carbon additional countries sectors revenues) X Data- and time-intensive E3ME Medium to long term Takes a top-down and X Predict values for many X Technology level assumed GHG emissions Macro- econometric predictive approach based economic variables constant due to reliance on (economy-wide GHG, Uses historical on historical data. Places X Considers indirect effects historical data covered-sector GHG, data to estimate less restrictions on the data, X carbon leakage), relationships between X No need to assume specific Omits consumers’/ letting the data “talk” as producers’ behavior economic aggregates key macroeconomic economic relations opposed to CGE, which (GDP/GNI), sectoral parameters for X puts structure on the data. X Flexible in terms of the Data defines structure and impacts (output, GVA), forecasting purposes. so requires checking that The historical patterns of variables that can be included prices (carbon price, assumptions are based on economy-wide responses in X Can consider policy interaction energy prices), social the data are key exogenous causal relations (carbon revenues) X variables, which are then Capture general equilibrium X Very data-intensive effects used to predict future X Potential for data mining changes. This approach does not require market clearing.  ATTACHMENT 5: MODELING TECHNICAL SUMMARY 79 BEST PRACTICE EXAMPLE TOR MODELING SUMMARY ASSESSMENT TOOL DATA TIP SHEET QUESTIONNAIRE POLICY INTERACTIONS A7 A6 A5 A4 A3 A2 A1 A7 A6 A5 A4 A3 A2 A1 BEST PRACTICE EXAMPLE TOR MODELING SUMMARY ASSESSMENT TOOL DATA TIP SHEET QUESTIONNAIRE POLICY INTERACTIONS 80 Model subtypes Examples Brief description Analytical approach Strengths Limitations Typical outputs Energy system MESSAGE, Medium to long term Takes a bottom-up approach, X Consider technological X No connection with other Energy system costs Whole energy system REMIND, with inputs of baseline energy adaptations and sectors unless linked to and all GHGs, energy Represent energy optimization TIMES< service demands, existing developments, unlike another model investment, and energy system in detail, often at NEMS stock of energy technologies, economy-wide models X Energy demand is often system technologies a global level, to identify the characteristics of future X Can measure response to a exogenously determined key interactions and technologies available, assess costs of different change in demand X Assumes cost minimization, and a projection of future X energy technologies. Detailed outputs on the energy which may not be realistic energy supply and trade. It then optimizes the level of sector trends investment and operation of energy system technologies and fuel supply/trade in order to minimize total system cost subject to technical, environmental, and economic constraints. WeSIM Long term Electricity system X Identifies optimal investment X Limited connection with other Generation capacity Electricity system optimization model that as well as dispatch sectors and other subsectors by technology, hourly Long-term electricity optimization characterizes the investment X Can provide detailed, of the energy sector generation by technology, models that assess options for electricity in and operation of the temporally disaggregated X Requires detailed data on fuel consumption, CO2 electricity system resources results by technology in electricity networks for full emissions, electricity generation and needed to meet energy addition to system-wide functionality system cost distribution to assist in network planning and demand and minimize the results investment. overall cost of the electricity system, while maintaining security of electricity supply. PLEXOS, Short to medium term Bottom-up approach X Details of key effects over X Indirect effects are not Hourly generation Electricity dispatch IPM consumption and prices considered by technology, fuel Models that seek to Identifies least-cost dispatch X Flexible, low cost, based on X Very sensitive to parameters consumption, CO2 model the electricity given merit curve, hourly simple data (e.g., supply elasticities) emissions, electricity sector in very short time demand, and wind and solar system operating cost steps to shed light on generation profiles. X Many of the benefits from X Does not consider optimal operational decisions technology-specific models investment or network and short-term system infrastructure needs balancing.  CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE Model subtypes Examples Brief description Analytical approach Strengths Limitations Typical outputs MUSE Short to medium term Looks at how agent behavior, X Individual decision-making, X Empirical validation/small System costs and Agent-based simulation viewed at a micro-individual including for complex actors changes in parameters have composition, spatial Bottom-up behavioral view, can impact carbon like financial investors large effects on results breakdown of energy models that represent pricing. The models, unlike X Inclusion of investors helps to X Reducing complex problems resources, infrastructure the behavior of top-down models, have provide input on abatement means that correct costs and the distribution heterogenous agents to assess likely responses heterogenous agents with investment opportunities specification is hard to agree of demand and impacts different characteristics on climate (CO2 to changed incentives. X Acts as bridge between on and attributes, in addition emissions, etc.) disciplines with detailed X Interpretation of results can to detailed modeling of the energy system. modeling of actors and the be challenging because energy system models do not provide a mathematical solution, so the model cannot be generalized Technology Medium to long term A bottom-up approach, X Details of technology X Indirect effects are not Varied depending on Technology- specific (e.g. solar, considering substantial development, giving explicit considered/secondary the specific technology, Models of various forms wind, changes in technologies or technological representation impacts are missing but generally includes developed to assess battery, practices. It can be used to X Identification of potential X Difficult to define the technology prevalence specific technologies, EVs) build up marginal abatement contribution in emissions reference case when and cost their pathways, costs, cost curves (MACCs). reduction technologies are new and mitigation potential. X Easy to interpret, the MACCs X Cannot model complex that get built are easy to energy systems (e.g., understand electricity) X Simpler to construct than X Individual models can vary complex economic models significantly in approach and X Focus on specific activities, quality which can help focus investment into those that are most cost-effective and to help guide where the scope of the CPI may be needed/supported Land use allocation MAgPIE, Medium to long term Top-down in that the X Spatial results across time X Limited consideration of Model derives specific Allocation optimization GLOBIOM, objective function is to capturing something that human decision-making/ land use patterns, Dynamic recursive MARKAL is poorly modeled/not institutional factors yields, and total costs of partial equilibrium model minimize total costs. considered in other models X Inputs like GDP forecasts will agricultural production for that allocates land to The objective function of the likely need another model each grid cell optimal use to meet land use model is to minimize demand for food, feed, total costs for a given to generate these (GDP and fodder given spatial amount of regional food and exogenous input into model) biophysical constraints bioenergy demand. Inputs and economic, climate, often from other models or and policy scenarios. studies rather than recovered using the data for the model.  ATTACHMENT 5: MODELING TECHNICAL SUMMARY 81 BEST PRACTICE EXAMPLE TOR MODELING SUMMARY ASSESSMENT TOOL DATA TIP SHEET QUESTIONNAIRE POLICY INTERACTIONS A7 A6 A5 A4 A3 A2 A1 A7 A6 A5 A4 A3 A2 A1 BEST PRACTICE EXAMPLE TOR MODELING SUMMARY ASSESSMENT TOOL DATA TIP SHEET QUESTIONNAIRE POLICY INTERACTIONS 82 Model subtypes Examples Brief description Analytical approach Strengths Limitations Typical outputs LURNZ Medium to long term Estimates demand and X Provides spatial results across X Inaccurate for large changes Spatial changes in Econometric allocation supply through aggregation time from historical conditions land use, water quality Models that use of individual choice modeling. X Builds on historical data X Requires estimates of future (in LURNZ), changes historical data to try to Uses econometric methods regarding response to changed commodity prices to make in prices and yields. identify likely behavioral to recover the parameters circumstances forecasts Provides GHG emissions responses of land use to changed incentives. used in the model. X X spatially By modeling processes Data gathering can be explicitly, it accounts for challenging given the endogeneity of prices and relationships between spatial other market-level or non- and temporal scales market feedbacks Market Various Medium to long term Explicitly represents firm-to- X Does not assume perfect X Data requirements are high, Cost pass-through and Competition models proprietary firm and consumer-to-firm competition given need for firm-level data changes in market prices, Seek to assess likely models interactions encompassing a X Can uses publicly available X Does not capture wider total reduction in sector production decisions range of differing behaviors data if firm-level data is not effects of carbon pricing, output and profit, firm given policy and cost (profit-maximizing and available including “multipliers” that exit, total increase in scenarios for products/ sales-maximizing). Based foreign output and profit, sectors when firms have X Wide range of output metrics may counteract demand on popular competition reductions carbon leakage rate, level market power. X economic frameworks Can be calibrated audited and of abatement X Analysis is focused on large (Cournot/Bertrand, etc.). subject to sensitivity analysis firms in established markets; X Allows for entry and exit, smaller firms or markets with capturing potential carbon differentiated products less leakage easy to analyze X Can incorporate free allowance allocation and indirect carbon costs Proprietary Short term Defines ETS attributes X Flexible in the varying aspects X Narrow in its considerations: Demand, supply, and Allowance market models models (market size, technology, of ETS, can assess impacts only the development of prices of allowances, as Predict behavior and e.g., by shock distribution), then from e.g. linking, thereby supply, demand, and prices well as estimating the prices in secondary BNEF, ICIS, models emissions trading allowing exploration of differing over time; and abatement of interactions that occur markets given policy Refinitiv systems with varying degrees ETS design covered sectors within the market and economic settings. of policy (e.g., banking, supply adjustment measures, linked ETS systems). CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ATTACHMENT 6: EXAMPLE TOR 83 ATTACHMENT 6: POLICY INTERACTIONS EXAMPLE TOR A1 Many jurisdictions will rely on external experts for the This attachment provides an overview of the key development and operation of quantitative models sections to include in a TOR. It first provides a to assess climate policy impacts. Like all public description, in italics, of what constitutes good practice QUESTIONNAIRE procurements, this requires a clear and open process that for a given section, including key elements and why the aligns country needs with the potential delivery of services section is important. Also provided for each section is an A2 from potential providers. annotated example from a previous Partnership for Market Readiness (PMR) TOR (in original form or lightly edited) that In engaging with external experts, a clear and embodies these good practices. well-presented terms of reference (TOR) is hugely beneficial. A clear TOR allows bidders to understand what Requirements for TORs will differ in different is required in the project and its core objectives. From this, jurisdictions and contexts. The sections below DATA TIP SHEET they can assess whether they can fulfill the demands of use excerpts from a PMR template used by different the project. It also means that bidders can write a proposal jurisdictions as examples, and outline good practices for A3 that is tailored to the requirements of the jurisdiction. This standard sections included in a TOR, including means that the jurisdiction benefits from a targeted pool of X Background, higher-quality proposals to select from. Poorly presented X Project Objective and Scope, TORs risk bidders missing key information to include in X Tasks, their submission and creating misconceptions about the project objectives. X Deliverables, ASSESSMENT TOOL X Coordination Provisions, and Expert reviews of proposals are important to pick A4 X Other Provisions. the most appropriate submission. Once submissions have been received, jurisdictions should ask for carbon pricing experts to review the proposals. This is particularly important for identifying the extent to which the model can answer core questions through a demonstrated track MODELING SUMMARY record, how well the bidder has discussed risks of the project, the limitations of their submission, and whether the bidder has made suitable provision of expert resources for A5 their project. EXAMPLE TOR A6 BEST PRACTICE A7 84 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A6.1 BACKGROUND POLICY INTERACTIONS This section should provide contextual information so potential bidders understand why the project is being undertaken and whom the project is for. The following are some possible components of the Background section, A1 although the tenderer should tailor these to local circumstances, which may not require such detailed description: X Country context: This should outline the current policy efforts made toward reducing emissions, which will likely include the Nationally Determined Contribution (NDC) commitments. X Information on the PMR: With the PMR as the coordinator of the project it is recommended to provide background information on why the PMR is involved in and its overall objectives. QUESTIONNAIRE A2 A6.1.1 Sri Lanka example: Country context Example drawn from a Sri Lanka is a rapidly growing lower middle-income country with a total population TOR developed by the PMR of 21.0 million people and per capita income of USD 3,924 in 2015. Following and the Government of Sri Lanka a 30-year civil war that ended in 2009, Sri Lanka is considered to be, in many respects, a development success story. For example, growth has averaged over 6 DATA TIP SHEET percent per year in the past decade and poverty rates have declined dramatically, Background on the from 22 percent in 2002 to 9 percent in 2010.108 country. If bidders wish A3 for further information, Sri Lanka’s greenhouse gas (GHG) emissions in 2012 were approximately 0.78 they can consult external tons of carbon dioxide equivalent (tCO2) per capita, far below the world average resources. value of 4.44.109 According to Sri Lanka’s Second National Communication on Climate Change Submissions to the United Nations Framework Convention on Climate Change (UNFCCC), the energy sector, which accounted for 61.4 percent Summary of jurisdiction’s ASSESSMENT TOOL of total GHG emissions in 2000, represented the largest share of total national GHG profile shows key GHG emissions. The agriculture sector was the second highest GHG emitter, economic sectors. A4 representing 25 percent of total emissions. This was followed by the waste sector (10.8 percent) and the industry sector (2.6 percent). Sri Lanka has set the following GHG emission reduction targets under its NDC for the Paris Agreement: (a) by 2030, reduce GHG emissions in the energy sector Overview of the country’s NDC, outlining the key MODELING SUMMARY against business as usual (BAU) scenario by 4 percent unconditionally and an emissions reduction goals. additional 16 percent conditionally; and (b) by 2030, reduce GHG emissions against BAU scenario by 10 percent in other sectors by 3 percent unconditionally and an A5 additional 7 percent conditionally. Under the NDC, the Government of Sri Lanka has mapped out a comprehensive Details of the NDC that are set of actions to reduce emissions in the five priority sectors — energy (specifically important to the project focusing on electricity generation), transport, industry, forestry, and waste — to build understanding of and has already developed a number of policies and plans to support their policies that may need to be EXAMPLE TOR implementation. Activities under the building blocks (BBs) of the Market Readiness included in modeling. Proposal are summarized in the figure below. A6  BEST PRACTICE A7 108 For more information, please refer to the World Bank’s Overview of Sri Lanka 2020b. 109 For more information, please refer to Sri Lanka’s Organizing Framework for Scoping of PMR activities (Ministry of Mahaweli Development and Environment 2016). ATTACHMENT 6: EXAMPLE TOR 85 POLICY INTERACTIONS BB2 Figures can help bidders ► Analytic work to select appropriate CPI(s) for NDC implementation ► Road map for the piloting and implementation of new CPI to visualize certain aspects of the project. This figure A1 visualizes the framework to enhance the role of CPI(s) in achieving the NDCs. BB3 BB4 ► Needs assessment to inform the ► SLCCS Strategy and Design Study design of the MRV* and registry to strengthen the design of the scheme QUESTIONNAIRE systems ► Design the institutional, legal, and ► Design the MRV and registry systems technical framework of SLCCS Pilot the MRV system at the Pilot the enhanced SLCCS A2 ► ► project/facility level; enhance ► Technical and financial studies on capacities for the operation of the new CPI registry; final evaluation and ► Road map for the piloting and recommendation implementation of the CPI DATA TIP SHEET BB5 PMU, communications/capacity building strategy, consultations, general outreach, capacity building activities, ME&E, and risk management A3 *monitoring, reporting, and verification Sri Lanka’s power sector ASSESSMENT TOOL The power sector is a critical component of any future climate policy for Sri Lanka. According to the Sri Lanka Sustainable Energy Authority, Sri Lanka’s GHG Further details on specific A4 emissions for the energy sector (both energy and end-use sectors) nearly doubled sectors of interest clearly from 5,447 in 1994 to 10,430 GgCO2e in 2000. Within the energy sector, electricity establish the context and generation accounted for 26.6 percent of emissions. Furthermore, Sri Lanka relies focus for the project. entirely on imports to meet its fossil fuel demand; and the cost incurred from fossil fuel imports are significant, covering approximately 50 percent of Sri Lanka’s export income. Mitigation efforts in the power sector therefore has significant MODELING SUMMARY development benefits for the country by reducing its reliance on fossil fuel imports and enhancing the country’s fiscal resilience. A5 The current draft of the Long-Term Generation Expansion Plan includes a proposal for the total addition of renewable energy within in the next 20 years of 1,205 megawatts of wind power, 1,232 megawatts of solar power, 200 megawatts of mini- hydro power and 80 megawatts of biomass power. This would be a 640 percent increase from the current nonconventional renewable energy capacity of 422 megawatts. The Government of Sri Lanka needs to develop new policy instruments EXAMPLE TOR and identify sources of financing to expand the renewable power sector at this rate. A6 Sri Lanka’s transport sector According to Sri Lanka’s Second National Communication on Climate Change, emissions from the transport subsector represented 35 percent of Sri Lanka’s net tCO2e emissions, and almost half of emissions from the energy sector in the year 2000. The transport sector in Sri Lanka (both passenger and freight) is BEST PRACTICE predominantly dependent on road transportation. Therefore, gasoline and diesel A7 are the two major sources of energy used to meet transport demand. Due to a lower rate of rail utilization, efficiency in energy use for transport demand is lower than expected. Given the expected economic growth and growth rate of private small passenger vehicles like cars, two-wheelers, and three-wheelers in the country, the modal share is expected to shift drastically toward private vehicle driven passenger-kilometers compared to public vehicle. 86 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A6.1.2 Example: Information on the PMR Example drawn from a TOR POLICY INTERACTIONS The PMR, which brings together more than 30 countries, provides funding and developed by the PMR and technical assistance for supporting countries to prepare and implement cost- Government of Costa Rica effective instruments, including carbon pricing policies. Since its launch in 2011, A1 the PMR has been supporting the PMR implementing countries in preparing their Market Readiness Proposals, which lay out a country’s readiness plan for An overview of the PMR. developing and implementing carbon pricing and other mitigation instruments. To This helps bidders to complement the countries’ domestic efforts, the PMR has developed a Technical understand why the project Work Program that includes technical components such as MRV, baseline setting, is being tendered. QUESTIONNAIRE data management, and registry. A2 A Policy Analysis Work Program under the PMR has been set up to support implementing country participants identify a suitable package of climate mitigation Details on what the PMR policies and measures. This includes assessing the role and impacts of (and does. Bidders can begin to barriers to) explicit carbon pricing instruments, in the context of the preparation and understand how the project implementation of NDCs. The Work Program is delivered through the development is expected to be delivered. and application of modeling tools and approaches, the modeling and analysis of DATA TIP SHEET policy impact/interaction and design options, and capacity building and training in modeling and policy analysis. A3 In collaboration with the World Bank’s Energy Sector Management Assistance Program, the PMR Policy Analysis Work Program supported Costa Rica’s Ministry of Details on how the PMR Environment and Energy (MINAE) with just-in-time analytical input as part of MINAE’s has worked with the intended NDC determination process in 2015. The work, carried out by an ad hoc jurisdiction. This helps team anchored at MINAE’s Climate Change Directorate, focused on bottom-up ASSESSMENT TOOL bidders to understand the modeling and analysis comprising (i) development of preliminary reference scenarios relationship between the for sector activity and associated GHG emissions in five sectors (energy, transport, PMR and the jurisdiction. A4 forestry, agriculture, waste management); (ii) assessment of a subset of (current/ planned) emissions mitigation options by sectors and subsequent development of marginal abatement cost curves; and (iii) exploration of alternative emissions reduction scenarios to reach different levels of mitigation ambition by 2030. MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 ATTACHMENT 6: EXAMPLE TOR 87 A6.2 PROJECT OBJECTIVE AND SCOPE POLICY INTERACTIONS This section provides a very brief overview of the project objectives and scope. This is an important snapshot of the objective and main tasks of the project. Bidders may be looking at multiple projects and may only read this section to A1 decide if the project is appropriate to bid on. Therefore, it should be well written and clearly convey what is desired out of the project and the project’s scope. Further details on the project scope and tasks are then provided in the next section. The project objectives should be grounded in the jurisdiction’s policy goals. The section should link the project objectives to key impacts and desired indicators that will allow jurisdictions to understand how their policy goals can be achieved. QUESTIONNAIRE A2 A6.2.1 Colombia example: Project objective Example drawn from a The objective of this activity is to provide just-in-time advisory assistance to the TOR developed by the PMR government of Colombia in the assessment of carbon pricing policy instruments to and the Government of implement national GHG emissions reductions targets in Colombia. In the context Colombia of Colombia’s participation in the PMR, the World Bank is contracting consulting DATA TIP SHEET services to support the technical team of the National Planning Department (DNP) Brief outline of the project and the Ministry of Environment and Sustainable Development (MADS) in Bogota, A3 objective and who the Colombia, currently in charge of carrying out this assessment. project is for. It should be noted that there has been no political decision whether to set up a particular explicit carbon pricing instrument in Colombia. The specific objective of Text noting how outputs this assignment and its outputs is to inform key stakeholders, which will use them may be used can guide ASSESSMENT TOOL to build informed dialogue and facilitate the relevant decision-making. responses. A4 A6.2.2 Thailand example: Project scope Example drawn from a TOR This assignment comprises the following tasks: developed by the PMR and MODELING SUMMARY Government of Thailand 1. Review and develop economic modeling for carbon tax and emissions trading system (ETS) with and without crediting mechanism to determine the potential A5 contribution to Thailand’s NDC mitigation goal. 2. Model and assess the interaction and consistency between the carbon pricing Brief outline of the key policy (carbon tax/ETS) and national existing policies and regulations. tasks of the project. The 3. Support capacity building and dissemination of the knowledge and text clearly states the understanding of the effectiveness of the carbon pricing instruments for the project tasks. mitigation goal achievements. EXAMPLE TOR A6 BEST PRACTICE A7 88 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A6.3 TASKS POLICY INTERACTIONS This section provides detailed information on the tasks expected from the bidder. This section is used by the bidder to further their understanding of the project and to build their methodology. The task breakdown should build on the project A1 scope outlined in the previous section. Often, the tasks are broken down further into subtasks with each subtask having a bullet point outline of what is expected from the bidder. The jurisdiction should specify any key methodology elements required from the bidders in this section. For example, the jurisdiction should specify if there are any scenarios or sensitivities that must be modeled, or any key outputs that must be included in the modeling results. The jurisdictions can summarize the minimum and desirable outputs of the QUESTIONNAIRE analytical exercise. Expected touch points over the time frame of the project should also be included in this section; for example, interim project reports. A2 When specifying tasks, desired features, and outputs the tender should recognize existing capabilities and limitations of modeling frameworks. Some of the tasks may be overly ambitious and require modeling design features that are not commonly available. This can create issues further down the project that could have been avoided. The jurisdictions should refer to the main guide (Section 3.2) and Model Summary Sheet attachment when drafting tasks related to specific modeling output requests and consider their feasibility given existing capabilities and available resources. DATA TIP SHEET A3 A6.3.1 Colombia example: Task breakdown for an activity Example drawn from a TOR developed by the PMR and Task 1: Provide expert advice and input for the adaptation of MEG4C model Government of Colombia to assess the macroeconomic impact of carbon pricing instruments The objective of this task is to provide expert advice to DNP and MADS in the process ASSESSMENT TOOL of adapting DNP’s Modelo de Equilibrio General Computable de Cambio Climático para Colombia (MEG4C) in order to introduce proper and robust capabilities that A4 will allow the assessment of sectorial and macroeconomic effects caused by the introduction of carbon pricing instruments in determined sectors of the Colombian A brief summary of what economy. This Computable General Equilibrium (CGE) model was developed by this task looks to achieve. DNP, based on the Organisation for Economic Co-operation and Development GREEN model, and was built for the assessment of the economic consequences MODELING SUMMARY of climate change in Colombia as well as the various public policies and response measures that can be proposed to address climate change. The adjusted MEG4C model should allow testing different sectorial scopes of application of carbon A5 pricing instruments, namely a carbon tax and a cap and trade system. It will be important to ensure that the MEG4C model is able to simulate distinct allocation criteria (e.g., grandfathering, auctioning schemes, etc.) and different options to set caps (i.e., relative or absolute targets). (a) Economic impact of a plain shock of either (i) applying a carbon tax The jurisdiction has some EXAMPLE TOR without recycling revenues, or (ii) applying GHG emissions caps without desired features for the trading features. This scenario is necessary to measure the relative benefits of A6 modeling, which are clearly revenue recycling and/or trading features. The MEG4C model should be capable to detailed here. assess impacts of (i) a carbon tax and (ii) emissions caps expressed in tCO2e, on all or part of the following variables: X gross domestic product, X consumption of goods by production sectors, BEST PRACTICE X household consumption of goods, labor demand and supply, A7 X X wage rate, X prices, X terms of trade,  ATTACHMENT 6: EXAMPLE TOR 89 POLICY INTERACTIONS X imports and exports of goods and services, X investment, capital income, A1 X X taxes and subsidies, X total government revenue, and X government debt. Special attention would be given on measuring impact on, inter alia: Specific desired outputs QUESTIONNAIRE X GDP growth, from the modeling can be detailed here. A2 X job creation, X distributional impacts, in particular on households, and X competitiveness of affected sectors. (b) Mitigation of the economic costs of introducing a GHG emissions reduction target shock. The MEG4C model should be capable of assessing variations DATA TIP SHEET on the above mentioned variables, when comparing the initial plain shock with consideration of A3 i) recycling options of the revenues from a tax, or selling of allowances; and ii) select trading features. The consultant/s will thus work with the DNP modeling team in charge of Colombia’s MEG4C model to carry out the following subtasks: ASSESSMENT TOOL 1.1. Review of other CGE carbon pricing models (carbon tax/ETS): Desk review Where possible, and A4 of international experiences of cap and trade/carbon tax design, mechanics, and functionalities in other CGE models in order to gather insights for the critical to project success, the request can provide definition of the implementation plan of carbon pricing and trading features in a clear breakdown of the MEG4C model. subtasks. 1.2. Discussion and definition of pricing and trading features: Propose and MODELING SUMMARY substantiate a preliminary list of desired trading features to be potentially prioritized and implemented in the MEG4C model. Following discussions with A5 DNP and MADS, elaborate a strategy for the incorporation of caps and trading features in the MEG4C model. This will guide the coding of trading features. 1.3 Review of GHG emissions parameters, sector database, and mechanisms: Review the GHG capabilities of the MEG4C model. As may be identified, provide DNP with recommendations to enhance those GHG capabilities, in order to enable sound execution of simulations and production of results. 1.4 Suggest methods and provide technical input to DNP for the soft-linking EXAMPLE TOR A6 of MEG4C and LEAP-Colombia models. Such support may include support DNP in the definition and estimation of linking variables. The purpose of the linking is to improve the analysis of economy-wide implications of carbon tax and cap and trade schemes. 1.5 Guidance for the implementation of (possible) new functionalities: Based BEST PRACTICE on the recommended implementation plan, provide technical guidance to assist in the coding of carbon pricing and trading features in the MEG4C model. A7 90 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A6.4 DELIVERABLES POLICY INTERACTIONS This section should provide a clear summary of the deliverables expected from the winner of the project. These should build on the tasks outlined in the previous section. While there may be some overlap in the content of this section A1 and the previous section, it is important that there are no contradictions. Bidders will use the deliverables as the framework to build out their methodology and project timelines. Included in this section should be an indication on the level of effort required for the project’s deliverables. This is often done through providing a timeline of project deliverables and when they are expected to be completed. This helps the bidder to gauge the resources required for the project, and whether they can meet this. QUESTIONNAIRE A2 A6.4.1 Thailand example: Deliverables and timeline Example drawn from a TOR developed by the PMR and The consultant will deliver the output as following: the Government of Thailand Tentative Activity Output(s) deadline DATA TIP SHEET Activity 1: Economic X Economic model and coding or relevance. June 2018 modeling and scenario X Analytical report including technical briefs A summary of the A3 analysis of carbon pricing and recommendations. deliverables expected by instruments the bidder, along with the Activity 2: Interaction X Analytical report including implementation March 2018 associated deadline. and consistency between plan and recommendations. the country’s ETS/carbon tax and existing policies ASSESSMENT TOOL Activity 3: Support to X Organize at least four workshops, or March 2019 cross-sectoral, inclusive dissemination materials on modeling policy development and capacity and application of modeling. A4 dialogue for the carbon X Organize at least three dialogues to pricing instruments relevant ministries and key stakeholders to understand role of carbon pricing instruments in supporting NDC achievement. X Slide deck/presentations/minutes of the MODELING SUMMARY meeting and summary notes. A5 The Consultant shall prepare the reports as following: Report Content Tentative deadline 1. Inception Work plan and timeline. 1 month after report contract signing A summary table of the project reports expected 2. Progress Framework and economic model for Activity 1 4 months after from the bidder; the EXAMPLE TOR report (1) and results of scenario analysis 1 and 2. inception report submission progress reports underline Outputs of Activity 2. the communication A6 3. Progress Outputs of Activities 1 and 2. 6 months after the expectations. report (2) Framework for Activity 3. first progress report submission Report some part of Activity 3, operated within this phase (summarize comments from trainings, workshops, or dissemination).  raft final 4. D Report some part of Activity 3, operated within 4 months after BEST PRACTICE report this phase (identify key finding/learning and second progress summarize relevant comments from trainings, report submission A7 workshops, or dissemination). 5. Final report All elements from Activities 1-3. March 2019  ATTACHMENT 6: EXAMPLE TOR 91 POLICY INTERACTIONS The consultant is expected to provide the deliverables on the following timetable: Timeline for activity completion and report submission A1 Activity Q4 Q1 Q2 Q3 Q4 Q1 Gantt charts provide a Inception clear guide for the expected report * timetable for deliverables. Activity 1 Activity 2 QUESTIONNAIRE Progress * A2 report (1) Activity 3 Trainings, workshops (Activity 3) Progress DATA TIP SHEET report (2) * A3 Draft final report * Final report * All reports should be submitted in English. ASSESSMENT TOOL Required language of the Reports mentioned in 1-3 should be full reports in English. deliverables. A4 Draft final report and final report should be submitted in English. MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 92 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A6.5 COORDINATION PROVISIONS POLICY INTERACTIONS This section should define how bidders are expected to coordinate with the jurisdiction and PMR teams. This helps to guide bidders on the level of local expertise they need to bring to the project, and how they are expected to work with the A1 jurisdiction and PMR teams. The jurisdiction will likely be able to provide inputs pertaining to local context. This may include local consultants who can support data collection or help organize workshops with stakeholders. The PMR team may be able to provide technical input and insight on modeling from previous experience. Other coordination considerations should be outlined. This can include X the expected schedule for project progress meetings over the course of the project, X expected inputs from stakeholders that the bidder should plan to incorporate into the project, and QUESTIONNAIRE X the extent of stakeholder engagement expected, beyond that detailed in project tasks. A2 A6.5.1 Colombia example: Inputs provided by the Word Bank Example drawn from a team TOR developed by the PMR and the Government of DNP, the Colombian counterpart agency housing and managing the MEG4C CGE DATA TIP SHEET Colombia model, and MADS, the Colombian counterpart agency in charge of coordinating Colombia’s low-carbon development strategy and NDC implementation strategy, A3 will provide, as applicable, the following input and further grant/facilitate access to underlying policy documents, technical reports, technical/data appendices, and/or Brief outline of the inputs process reports, including that can be provided to the 1. Modelo de Equilibrio General Computable de Cambio Climático para Colombia bidder to aid delivery. This (MEG4C); example includes links for ASSESSMENT TOOL further information. 2. Colombian Baseline and Emissions Scenarios (MADS, developed in 2015); 3. Macroeconomic impact assessment of emissions scenarios (DNP 2015); A4 4. Preliminary assessment of mitigation policy instruments (MADS 2015); 5. Set of marginal abatement cost curves (updated in 2015), including identification and prioritization of mitigation measures, by sectors, and associated abatement potentials and costs; and MODELING SUMMARY 6. Previous DNP papers about preliminary carbon tax modeling using the MEG4C model. A5 A6.5.2 Colombia example: Other coordination provisions for the Example drawn from a assignment TOR developed by the PMR EXAMPLE TOR This assignment aims to provide advice and support to DNP and MADS in carrying and the Government of Colombia A6 out the outlined modeling and analytical work. The consultant shall account for and respond to the orientations and requests, within the original scope of the assignment, received from the technical team designated by DNP and MADS, in close consultation and under supervision of the World Bank team. The philosophy to be pursued under this assignment is therefore to multiply interactions and Clearly outlining where consultations with the technical team at DNP and MADS, as a way to maximize the bidders are expected to BEST PRACTICE capacity building benefits and the integration of the produced knowledge in the coordinate with the PMR government decision process, during and beyond the assignment period. team and the jurisdiction’s A7 local team. Envisaged technical missions to Bogota will be scheduled with DNP and MADS, to secure proper dedication of DNP and MADS experts and coherent mission objectives/activities vis-à-vis progress made along the assignment’s work plan. ATTACHMENT 6: EXAMPLE TOR 93 A6.6 OTHER POLICY INTERACTIONS This section contains important information to the bidder that does not directly relate to the contents of the project. This section should include A1 X Level of effort: While this may be detailed in the deliverables section it also should be detailed here because budget and resourcing is a key consideration for bidders on whether they are able to carry out the project and their price competitiveness for the project. X Team composition/qualification requirements: This details the minimum requirements and desired characteristics of the bidder. This will stipulate, among other details, the qualifications and experience required from the bidding team, whether past experience with similar topics is needed, or language requirements. QUESTIONNAIRE X Budget and contract duration: This is vital for bidders to properly resource their proposal and complete their financial A2 proposal and will aid with the administration of the contract. The contractor may also ask for a specific date rate per project team member. A schedule of payment should also be included here. X Contacts: This should include at least one contact from the PMR and one from the jurisdiction. DATA TIP SHEET A6.6.1 Morocco example: Level of effort Example drawn from a TOR developed by the PMR and A3 This activity is expected to be undertaken by a team with a combined effort of approximately 200 person days, as estimated in Section C (Main Tasks/Activities). the Government of Morocco The work is expected to be carried out between April 2017 and May 2018. The firm will prepare a detailed budget and timeline to carry out the activities necessary to An overview of the level of deliver the outputs specified in Section E, including number and profile of all team effort and how the bidder members, and planned field trips to Morocco (three field trips/missions expected), ASSESSMENT TOOL should evidence the level of following the World Bank procurement template. The resulting contract will be a effort in their submission. lump sum contract, including expenses. The remuneration will be paid as per the A4 deliverable-based payment schedule provided in Section E. MODELING SUMMARY A6.6.2 Costa Rica example: Qualifications Example drawn from a The consultant team shall meet the following criteria: TOR developed by the PMR A5 and the Government of X Excellent track record of successful development and dissemination of new/ Costa Rica original bottom-up modeling tool for the energy and transport sectors in developing countries and in small/midsize countries, ideally in Costa Rica; X Extensive track record working in developing countries and in small/midsize countries, ideally in Costa Rica, on low-emissions development policies and Clear specification of the instruments, including policy-relevant advisory work pertaining to low-carbon requirements of the bidding EXAMPLE TOR team or firm. development strategies, sector mitigation plans, and/or GHG emissions A6 reduction goal setting; X Extensive experience in the design and delivery of capacity building and training programs on modeling/analytical tools; X Sound knowledge of international climate policy, including the background, state, and prospects of the UNFCCC negotiation process, including Costa Rica’s priorities and interests within that multilateral process; BEST PRACTICE X Demonstrated ability to draft clear and concise technical and policy papers and A7 ability to present technical concepts clearly to both technical and nontechnical experts; X Capacity to work with and take into account feedback from multiple sets of experts and policymakers from diverse backgrounds; and X Experience in performing contracts for government authorities and international organizations.  POLICY INTERACTIONS 94 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE The team leader shall meet the following criteria: Details on the requirements X Will act as project coordinator and serve as main point person for MINAE and of the team leader for the the World Bank; project, including past A1 X Advanced academic degree in the field of economics, energy, environment, experience, qualifications, with at least 10 years of relevant professional experience; and language requirements. X Proven track record in energy/economic/climate research project management, with at least five years of relevant experience; and X Fluency in Spanish is desirable, including the ability to present technical QUESTIONNAIRE concepts clearly to both technical and nontechnical experts. A2 The team composition shall ensure that the following is covered: Details on the requirements X Sector expertise for the energy and transport sectors, with at least five years of of the bidding consortium relevant advisory and analytical experience; and composition. This relates directly to the proposed X Hands-on country-specific modeling experience with bottom-up modeling team for the project. frameworks, with at least five years of relevant experience. DATA TIP SHEET A3 A6.6.3 Colombia example: Budget and contract duration Example drawn from a TOR developed by the PMR and Recommended indicative pricing for this contract is up to USDX. The consultant the Government of Colombia team is required to identify a budget and timeline to carry out the activities described ASSESSMENT TOOL in detail above and overall budget should fall in the recommended range. Also, the consultant team must provide a profile of each team member/s. Clearly indicates the budget of the project and that a A4 The resulting contract will be a lump sum contract, including all fees and expenses. breakdown of the proposed The selected consultant team will be required to complete the work stated in its project cost should be proposal. Payments will be made on the delivery of the contractually agreed outputs: provided by the bidder. X 10 percent upon signing the contract and inception report submission, 20 percent on consultants’ submission and the client’s acceptance on the MODELING SUMMARY X Clear breakdown of when completion of progress report (1), payments will be made. X 30 percent on consultants’ submission and the client’s acceptance upon A5 completion of progress report (2), X 20 percent on consultants’ submission and the client’s acceptance upon completion of draft final report, and X 20 percent on consultants’ submission and the client’s acceptance upon completion of final report. EXAMPLE TOR Total duration of this contrast is 17 months, with expected launch of activities by A6 November 2017. BEST PRACTICE A7 ATTACHMENT 6: EXAMPLE TOR 95 A6.6.4 Colombia example: Contacts Example drawn from a POLICY INTERACTIONS The consultant team will report to TOR developed by the PMR and the Government of Focal point at National Planning Department (DNP): Colombia A1 X NAME X, Deputy Director of Environmental Sustainable Development, National Planning Department (DNP), EMAIL X Contact details provided for each party involved. Focal point at Ministry of Environment and Sustainable Development (MADS): X NAME Y, Director, Climate Change, Ministry of Environment and Sustainable QUESTIONNAIRE Development (MADS), EMAIL Y; or his technical delegate. A2 Focal point at World Bank: X NAME Z, PMR Secretariat, World Bank, EMAIL Z DATA TIP SHEET A3 ASSESSMENT TOOL A4 MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7 96 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE ATTACHMENT 7: POLICY INTERACTIONS RECOMMENDATION A1 PAPER BEST PRACTICE This attachment provides guidance on developing a clear, concise, and persuasive document to present the QUESTIONNAIRE carbon pricing instrument (CPI) recommendation to stakeholders. The practices outlined here can help ensure that the structure and style of the paper allow easy navigation, while the content and analysis provide clear, actionable insights. A2 Specifically, it describes best practice related to X Structure and style of the paper (Section A7.1), X Communicating the policy recommendation (Section A7.2), and X Presenting the technical evidence base in an annex (Section A7.3). DATA TIP SHEET A7.1 STRUCTURE AND STYLE A3 X Adopt a simple, logical structure broadly aligned with that described in Section 4.2. X Use annexes or appendices for technical content and details on modeling conducted. X Use short sentences and avoid economic jargon. ASSESSMENT TOOL X Signpost contents or findings discussed at the start of each paragraph for clear narrative flow. X Use visualizations or graphics to communicate complex analysis or relationships. A4 The use of a clear and simple structure ensures ease Technical content, including methodological and of navigation through the paper. Short sentences and modeling details, should be addressed in annexes. This accessible language improve readability and deliver a ensures that the narrative remains succinct and allows the MODELING SUMMARY concise message. Use of overly technical language and reader to focus on the key points of the paper. long, complex sentences can make the paper difficult to follow. Use plain language that targets a nonspecialist A5 audience to support engagement with the material. The report should start with an executive summary that captures the key points made in the paper. It Try to capture key points at the start of the paragraph. should be a self-contained section that can be read This can help readers follow the main arguments if they are independently of the rest of the report. This is useful for skimming the paper and helps ensure that each paragraph readers who require a high-level summary of issues. has a coherent purpose. Further detail in the paragraph should expand on or justify the summary sentence. EXAMPLE TOR Chapters should follow a logical flow. For instance, A6 defining concepts and providing context on the modeling Use clear visualizations to illustrate options and question before introducing technical details is important findings. For example, the changing capacity mix of for clarity. electricity generation in the Philippines under different scenarios, as shown in Figure 15: BEST PRACTICE A7 ATTACHMENT 7: RECOMMENDATION PAPER BEST PRACTICE 97 Figure 15 Visualizations can help clarify key findings POLICY INTERACTIONS Baseline Scenario CPI Scenario A1 Hydro Hydro Solar + Wind + Biomass + 2.0% 4.1% Geothermal Batteries + Pump Storage Batteries + Pump Storage 0.0% 4.1% 0.1% Solar + Wind + Biomass + Geothermal Gas 17.3% QUESTIONNAIRE 7.8% Coal A2 52.8% 354 337 TWh Coal Gas TWh Coal 85.9% 25.8% 52.8% DATA TIP SHEET A3 Source: Adapted from ECA 2020 Philippines: Policy Support for Low Carbon Development of the Energy Sector. A7.2 COMMUNICATING THE POLICY RECOMMENDATION The paper should clearly communicate the suite of be an explanation why it was originally included and the ASSESSMENT TOOL policy approaches considered. If modeling is used, reasons for it not being the final recommendation. If certain the scenarios that were modeled should be presented. CPI options are excluded from the outset, the reasoning A4 Table 21 presents an example of a clear way to present behind the exclusion should be included here. each scenario. For each policy/scenario, there should Table 21 Example of the effective communication of scenarios MODELING SUMMARY Point of regulation Threshold Target Permit Scenario Instrument Offsets (Electricity (reductions allocation Electricity Transport only) against BAU) A5 Scenario 1 Carbon tax No N/A Upstream Upstream N/A 20% Scenario 2 Carbon tax Yes N/A Upstream Upstream N/A 20% ETS Yes Free allocation Downstream Upstream 20 MW 20% Scenario 3 to 2025; then 50% auctioning EXAMPLE TOR Scenario 4 Carbon tax No N/A Upstream Upstream N/A 30% A6 Scenario 5 Carbon tax Yes N/A Upstream Upstream N/A 30% ETS Yes Free allocation Downstream Upstream 20 MW 30% Scenario 6 to 2025; then 50% auctioning Source: Adapted from Climate Focus 2019 PMR: Exploring the Role of Carbon-Pricing Instruments (CPIs) in Decarbonizing the Power and Transport Sectors in Sri Lanka. BEST PRACTICE A7 98 CARBON PRICING ASSESSMENT AND DECISION MAKING: A GUIDE TO ADOPTING A CARBON PRICE A7.3 TECHNICAL ANNEX POLICY INTERACTIONS X Provide detail on the models used and assumptions made. A1 X Clearly communicate the key differences between modeling scenarios, for instance using figures and tables, and explain their role in the broader policy analysis. The technical annex should provide further detail the main text, for example complete model results in data on the modeling used in the report. This detail aids tables. QUESTIONNAIRE transparency and is not part of the core evidence base for the selection decision. The annex should include If several scenarios are presented, the paper A2 a discussion of the models used along with the key should clearly communicate the dimensions in assumptions of each, with technical detail going beyond which scenarios differ and why. Scenarios should be the main report. Additionally, it should include a more mapped against policy options that were tested or key detailed discussion of the modeling results than what is in uncertainties that could affect the function of a policy. This allows readers to understand the impacts of specific recommendations. DATA TIP SHEET A3 ASSESSMENT TOOL A4 MODELING SUMMARY A5 EXAMPLE TOR A6 BEST PRACTICE A7