L-3 -

Quantitative analysis
of mitigation policies
NOVEMBER 29, 2022

Adolfo Barajas
Senior Economist, IMF
AT22.29V

This training material is the property of the International Monetary Fund (IMF) and is intended for use in the IMF
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 Agenda

 Analysis of mitigation policies

• Achieving Paris Agreements
• Case Study: Germany
• Case Study: China

 Political Economy of carbon pricing

• Carbon Pricing vs. Other Mitigation Policies
• Political Economy of Carbon Taxes vs. ETS
• Incidence of carbon pricing and other mitigation policies across household
and industry groups
• Efficiency and equity trade-offs in use of carbon pricing revenues
• Just transition measures (for low-income households, workers, regions)

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 Achieving Paris Agreement Targets

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 The Paris Agreement commits countries to keeping
temperature increase to “well below” 2 degrees C
• Legally binding international treaty on climate change.

• Adopted at COP 21 in Paris in 2015

• Quasi-universal: Signed by 197 parties

• As of 2022, 190 have ratified
• Only Turkey, Iran, Iraq, Libya, Eritrea, South Sudan and Yemen have not yet.

• Goal: limit global warming to well below 2, preferably to 1.5 degrees Celsius,
compared to pre-industrial levels.

• Reach global peaking of greenhouse gas emissions as soon as possible and

reduce emissions rapidly thereafter, aiming for global net zero emissions well
before 2100

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 The Intergovernmental Panel on Climate Change (IPCC) has
developed multiple potential temperature scenarios

Potentially
compatible with
Paris Agreement
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 The IPCC has also developed various emissions
pathways consistent with meeting Paris targets

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 The later the onset of deep GHG reductions, the more severe the
decline and the higher the need for Negative Emissions

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 Nationally Determined Contributions through 2030 are
inconsistent with Paris – steeper declines needed post 2030

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 Even reaching NDC targets could require carbon
prices above $75 in many OECD countries
Figure. 1.1. CO2 Reductions for 2030 Pledges/ From Pricing
CO2 Reductions in 2030 vs. baseline from Paris pledges & carbon pricing
0% 10% 20% 30% 40% 50% 60%
Argentina
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Italy
Japan
Mexico
Russia
Saudi Arabia
South Africa
Korea
Turkey
United Kingdom
United States
Percent emissions reductions vs. 2030 baseline
Emissions reductions from $25 carbon price Extra reductions from $50 carbon price

Extra reductions from $75 carbon price NDC target

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 Case Study: Germany

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 Germany is responsible for about 2% of current total
annual emissions, but cumulatively close to 5%...

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 ..but per capita emissions are among the highest
in the world

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 Total emissions have decreased by 41% since 1990, but
will need to decrease faster to meet Paris commitment

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 Germany has used a wide range of policies
Sector Key Mitigation Policy Notes
Multiple EU ETS Part of EU Emissions Trading Scheme
Multiple Carbon Price-> ETS for Introduced to supplement EU ETS, covers most sectors not in EU ETS
transport/buildings (fixed prices, then auctions under Cap and Trade)
Electricity Feed-in Tariffs For multiple renewable technologies; mostly phased out by 2021
Electricity Technology targets + auctions Replaced FITs for all but smallest systems, based on technology targets
Electricity Coal Phase Out Staged through 2038
Mobility Fleet level CO2 standards EU policy with high fines for non-compliance
Mobility EV purchase incentives Up to €9,000 (until end of 2022) (PHEV and BEV, PHEV phase-out)
Mobility EV Charging Infrastructure Up to 60% of cost of public charging infrastructure. €500 million total
Support support, targeting 50,000 charge points by 2025
Buildings Mandatory building codes
Buildings Information via Labeling
Scheme/consumer advice
Buildings Low interest loans for retrofits Up to €150,000 support, plus very low effective interest rates
Industry Investment grants
Multiple R&D (&D) Via grants and funding of Fraunhofer Institute etc.
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 Progress has been most pronounced in the power
sector, with a large shift towards renewables

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 In spite of progress to-date, Germany needs to
accelerate clean electricity development

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 Excursion: Feed In Tariffs (FIT)

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 Feed-in Tariffs have been the primary policy
instrument for renewable electricity

Government Difference between Consumers pay

Transmission
determines FIT compensation surcharge with their
System Operator
deployment target (TSO) buys metered and wholesale electricity bills
market value (potentially
electricity and
compensates at FIT excluding some
Government sets consumers)
FIT level
(deemed sufficient Government
to attract investment determines Government revises
Transmission renewables needed FIT level
Individuals/Compani System Operator to recover difference based on estimated
es install solar PV (TSO) sells changes to
systems. Output is electricity in technology costs
metered with wholesale market at and observed
p=? TSO collects
separate meter surcharge investment

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 FITs were initially set at high levels and frequently
adjusted (downwards) as costs declined

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 High FITs combined with declining costs lead to a
large increase in solar investment 2008-2012

Hydro Power Solar PV Onshore Wind

Offshore Wind Biomass for electricity Geothermal
Biomass for heat Solar Thermal

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 This in turn led to a substantial increase in
residential rates

Average residential retail rate (c/kWh)

Electricity tax

EEG Fee

Concession Fee

VAT

Network fees

Wholesale Power Cost

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 Arguably the large investment in solar PV also
contributed to the (global) decline in PV costs

Total Investment (billion Euro) Investment (Euro/kW)

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 The German FIT experience shows both the
benefits and pitfalls of using feed-in tariffs
 FITs are an easy and typically popular approach to supporting early state renewable
development
► Price certainty facilitates financing
► Targeted, limiting spill-over effects (carbon pricing needed to make renewables in
early stages cost-competitive would be very high and result in potentially significant
transfer payments
 Designing FITs that strike the proper balance between incentives and resulting costs is
hard
► Need to set FIT prices so that renewables become cost competitive
► If costs decline, risk of mismatch between actual and needed FIT level
◆Mismatch creates risk of boom bust cycles
◆If ratepayer funded, risk of unfair wealth transfers
◆Moving off FITs too early may choke off renewable development
 Alternatives to FITs have their own challenges
► Auctions a good solution, but compensation schemes can introduce uncertainty/risk
► Carbon pricing can be a substitute once “gap” is low enough, but revenue certainty
still important
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 Evaluation of German mitigation
policies

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 Beyond GHG mitigation, German policy aims to
benefit from the needed industrial transformation

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 The strategy is based on the belief that markets
for key mitigation technologies will grow rapidly

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 After FITs and the EU ETS, Germany is increasingly
using carbon pricing in uncovered sectors

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 Given the relatively high estimated abatement costs,
the contribution of carbon pricing remains uncertain

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 Germany – Summary

• Germany is an important historic and current GHG emitter and has committed to
Net Zero by (perhaps before) 2050

• Mix of mitigation policies including cross-sectoral and cross-national carbon pricing

and sector-specific policies
• FITs important early element of sectoral policies
• Mismatch between costs and FIT levels lead to “solar bubble”
• ETS as an important complement – now expanding to more sectors
• Move to broader carbon pricing may be easier over time
• FIT phase out and replacement with auctions, but not without issues

• Broader industrial policy objectives important determinant of mitigation policy mix

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 Germany – Potential Lessons Learned

• FIT can be a useful tool to foster renewable power growth

• Revenue certainty of FITs very helpful ,especially for early development phase
• Benefits beyond Germany (helped scale and lower costs)
• But: Timing of FIT adjustments important to avoid “bubbles” and limit consumer
costs

• Important distributional implications of subsidy financing

• Financing via electricity rate adder (and exempting trade sensitive industries) put
a high burden on moderate income households

• Industrial policy not without risks: large solar subsidies initially led to strong
domestic solar industry, but now mostly gone

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 Case Study: China

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 Since the 1980s, China has rapidly become the
world’s largest primary energy consumer…

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 ..and on a per capita basis is approaching Germany, in part
due to shift of production of energy intensive goods

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 The bulk of energy consumption growth to-date was
powered by fossil fuels, particularly coal

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 Energy intensity has decreased less than in the US and Germany,
likely due to shifts in the production of energy intensive goods

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 As an illustration, China produces ten times more
cement than the next biggest producer

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 Current Emissions are dominated by Power and
industry sectors and coal as a fuel

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 China’s GHG mitigation policy mix must be understood in the
context of the evolution of broader Chinese energy policy

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 In spite of the role of fossil fuel over time, China’s
installations of solar PV have grown very rapidly

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 China has also become by far the largest global
installer of wind

Range of
annual wind
installations
(US)

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 China continues to balance economic growth with GHG
mitigation and aims for Net Zero no later than 2060

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 China – Summary
 Mix of policies to pursue multiple objectives
▶ Economic growth, energy security, air pollution, GHG

▶ Command and Control, direct subsidies, market based solution

 “Evolution” of approaches
▶ Early mitigation policies more command and control

▶ Attempts to empower local/regional governments at times at odds with central government objectives

◆ Local approval of new coal fired power plans vs. central government objective to reduce reliance on
coal
▶ Early feed-in tariffs (FITs) effective at building renewable capacity, but

◆ Often without access to transmission

◆ Often curtailed due to fossil dispatch priority
◆ Boom bust cycles due to misalignment of FIT with cost (like Germany)
▶ Introduction of ETS (after regional pilots) as a sign to move towards more market based mitigation

▶ Central government investment in supporting infrastructure, not always in synch

◆ Grid, high speed rail, EV charging infrastructure

◆ Public procurement (EV buses)

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 China –Potential Lessons Learned

 Supporting investment in renewable energy important, but alone not sufficient

▶ Need investment in complementary assets such as transmission

▶ Need regulatory/market frameworks to allow efficient production of carbon free

electricity from renewable investments
 Gradual introduction of carbon pricing to complement/replace sectoral policies may
be easier to implement than carbon pricing alone
▶ FIT important early part of mitigation policy

▶ ETS only introduced nationally very recently, and not (yet) stringent enough to be
binding
▶ Can see gradual strengthening of the ETS price signal to ultimately replace
sectoral approaches
 Central government investment is an important complement to market-based
mitigation
▶ Timing of investments important – needs to be in sync with other mitigation efforts

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 Case Studies: Lessons Learned about GHG
Mitigation policies
• A mix of policies (carbon pricing, direct investment, sector targets and support, R&D,
regulatory and market reforms)

• Carbon pricing eventually a part of GHG mitigation

• Typically not dominant in the beginning, but strengthening over time (scope and
price)

• Sector specific support mechanisms important early

• Simple FIT schemes transitioning to more market-based mechanisms
• Success depends on design and existence/strength of complementary
systems/investments
• Electric grid
• Wholesale electricity markets

• Factors other than climate matter in choice of mitigation policies

• Energy Security, economic development, industrial policy

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 Political Economy of Carbon
Mitigation

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 GHG mitigation policies need to consider the political
context in which they are designed and implemented

https://www.bbc.com/news/world-europe-46424267 Then-Rep. Ed Markey speaks in 2009 as, left to right,

Reps. Henry Waxman, Steny Hoyer, James Clyburn, and
House Speaker Nancy Pelosi listen during a news
conference after a vote on the Clean Energy and Security
Act on Capitol Hill. Alex Wong/Getty Images

https://www.vox.com/22537509/democrats-climate-bill-
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biden-waxman-markey 46
 Political economy considerations affect the choice of pricing vs.
non-pricing approaches as well as the type of pricing

Carbon Tax
Sectoral and
non-price
policies
ETS

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 The choice of carbon pricing vs. non-pricing
policies depends on more than efficiency
Issue Carbon Pricing Other
Efficiency • In theory efficient in a “first-best” • In theory less efficient (in first best world)
world • Able to address other market failures (R&D,
network, bounded rationality, etc.)
Equity • Creates potentially large pool of • Depends on measures
money – equity impact depends on • Ratepayer funded programs tend to be
use of funds regressive
• Tax-funded programs tend to be
progressive
Political • Perceived as a tax and taxes not • Some measures more popular, even if more
Economy popular costly (e.g. renewable support)
• Hard to implement taxes high • Easier to craft policies to fit constituancies
enough to create deep reductions
of GHG

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 Among pricing options, carbon taxes vs. ETS depends both
on practical implementation and perception issues

Issue Carbon Tax ETS

Price volatility • No price volatility • Can be very volatile,
unless mitigation
measures (floors, ceilings,
strategic reserves)
Long-term price certainty • In theory yes, but depends • In theory yes, but depends
on forward commitment by on forward commitment by
legislation legislation
Coverage • Relatively easy to be • Has tended to be narrow,
broad gradually expanding
Political Economy • Perceived as a tax • Perceived as a tax AND
perceived as giving
polluters the right to
pollute

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 Choices (and communication) related to the use of carbon
pricing funds have important implications for acceptance...
Use Pros Cons
Reduce other “distortionary” • Reduces distortions and • Is (perceived to be) regressive
taxes such as personal income hence, in theory, increases • No additional emissions
taxes GDP/welfare benefit
Fund GHG mitigation R&D or • Increases GHG mitigation • Net tax increase, risks
complementary infrastructure opposition
Refunds to lower income • Reduces inequality • Not obvious that it is
households perceived as helping the
poor(er)
• No additional emissions
benefit
Support for populations • Helps with just transition and • No additional emissions
negatively affected by transition could result in more support benefit
from affected populations

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 …and the link to just transition issues is central

 The costs of GHG mitigation are not equally distributed

► Net costs place a higher burden on lower income groups

◆Taxes and utility rates

● If tax systems are progressive, tax-funded mitigation efforts less regressive than
utility bill funded efforts
● Shift tax collection from electricity (or at least tax fossil energy use equally)
• Example: Germany is transitioning its renewable support payments
from utility rates to the Federal budget in 2023
 Geographic and sectoral employment impacts will typically be uneven
► Extractive (fossil) industries often regionally concentrated

► Loss of local tax base from fossil power plants

► Policy can support economic health during transition (allocate carbon tax revenues,
complementary transition investments (incl. training), strategic location of “new
energy” activity, compensation for affected workers, restoration and reclamation
efforts)

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 CPAT

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 The Carbon Pricing
Assessment Tool (CPAT)

Rapid estimation of multiple effects of carbon

pricing and fossil fuel subsidy reform:
 energy & emissions
 macroeconomic
 distribution & incidence
 development co-benefits

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 CPAT: ‘Model of models’
energy consumption changes
user inputs Mitigation Air pollution
Dashboard
module module
A chart-driven, user-
friendly interface A reduced form A reduced form air pollution and
energy-macro model health model

Distributional
module
A cost-push microsimulation
model for estimating effects on
equity & industries

Manual Transportation
inputs module
An optional tab for A reduced form model estimating effects on fatalities
advanced users & congestion from motor fuel price changes
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 Select fossil fuel subsidy reform,
exemptions, and revenue use

Select country,
select policy,
define coverage

See results in charts

here onwards

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 Backup Slides

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 Energy Efficiency +Energy Security +
Energy Efficiency Energy Efficiency +Energy Security
Environment
FVP 6-9 FVP 10-11
FVP 12-13
1981-2000 2000-2010
2010-2020
• Reduce energy consumption per • Ramp up domestic production and • “Green Revolution”
oil/gas imports to provide energy • Focus on fighting climate change equal to fighting
unit by 2.6%-3.5% p.a.
FYP6

local pollution
• Significant investment in Energy security • Reduce energy intensity by 16%
Conservation Capital (7-10% of • Construction of a strategic reserve for •

FYP10
Carbon Intensity Target: Reduce carbon intensity by

FYP12
total) oil 17%
• First plan for new and renewable • Increase share of non-fossil resources from 8.6% to
• Reduce energy intensity of GDP energy 11.4%
FYP7

(1.29 to 1.14 tce per 1,000 RMB)
• Focus on increased coal, oil and
gas production
• Focus on economic growth
• Emphasize domestic coal
FYP8
• Continued energy intensity targets
• List of priority technologies
• Intensity targets in FYP not achieved
• Focus on intensity targets without
• Absolute cap on energy consumption
• Ten-Thousand Enterprises Energy Conservation
Program
• First experimental carbon markets
• Shift of focus on market-based mechanisms
• “New Era”

production regard to environment • Green Development one of five pillars of economic

• Exploring for domestic oil/gas • Top 1000 Enterprises Energy development
•
FYP11

Building power generation (fossil, Conservation Action Program • Made in China 2025 (2015)

FYP13
hydro) • Continue diversification • Green Finance Pilot Zones (2017)
• Nuclear Power • Minimum renewable usage targets
• • Various EV support policies (rebates, licensing rules)
• First law on energy savings Invest in renewable power
FYP9

• Further reductions in energy and carbon intensity

• First reference to “sustainable
development”
• Energy intensity of GDP almost
halfed
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• Golden Sun Program for solar
(subsidies of 50% to 70% for solar
projects
• Energy efficiency efforts pushed to
regions
• Climate Change emerges as a topic
• Funding for innovation in low-carbon technologies
• Cut share of coal in energy mix (via policies to
improve performance of coal-fired power plants)
• Top 30,000 Enterprise Program
61
 United States

China

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 A well-designed and communicated carbon pricing approach can
help meet efficiency and just transition goals
Impact of a 50 USD Carbon Tax Under Different Recycling Options for Revenues
Consumption of Bottom Two Quintiles (percent deviation from baseline)
Low-energy government spending
Universal transfers
6 Targeted to bottom two quintiles

-2

-4

-6
Bottom Second-bottom Bottom Second-bottom
quintile quintile quintile quintile
United States China

Source: IMF October 2020 WEO, Chapter 3;.

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