policy perspectives pricing carbon web

8/11/2019 Policy Perspectives PRICING CARBON Web

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Pricing

CarbonPOLICY PERSPECTIVES

2013


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There has been a huge amount of taxing and regulating

around carbon, but the outcome has been far from

optimal. Countries are pricing carbon in a multitude ofways sometimes too high, but often too low. This is a

chaotic landscape that sends no clear signal, and must be

addressed.

Angel Gurra, OECD Secretary-General


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OECDPOLICY PERSPECTIVESPRICING CARBON - 1

PRICING CARBON

KEY MESSAGES

There is a strong need for more ambitious policies to address climate

change. Given the size of the problem, we cannot afford inefficient

policies: least-cost solutions are needed to keep carbon prices as low

as possible.

However, current explicit prices that are put on carbon by means of

taxes or emissions trading systems are generally much lower than

those needed to limit the global average temperature increase to 2C

above pre-industrial levels.

Nevertheless, economic instruments like taxes and emission trading

systems have been shown to be the most cost-effective instruments

to limit greenhouse gas emissions by a significant margin. They could

be even more cost-effective if their design was improved. Frequent

exemptions for various energy products (e.g. coal) and different uses

(e.g. aviation, agriculture and energy-intensive sectors) should be

scaled back; the taxes on diesel should be set at least as high as the

taxes for petrol; and total caps in emission trading systems should

be made stricter, and permits auctioned.

Many other policy instruments in current use, such as subsidies for

biofuels and feed-in tariffs for renewables, implicitly entail very high

costs for abating carbon emissions. Some are intended to achieve

other policy goals, such as energy security or developing cleaner

technologies. Their cost-effectiveness in achieving these goals should

be carefully assessed, taking into account their interactions with otherpolicy instruments. If they are not cost-effective in these respects,

consideration should be given to phasing out the use of these

instruments and expanding the use of economic instruments.

Governments also need to reform the estimated USD 55-90 billion

of support provided each year to fossil fuel exploration, production

and consumption in OECD countries and the USD 523 billion in

energy subsidies in developing countries. While the stated objective of

subsidies for consumers are often for social reasons, they are usually

poorly targeted, expensive, often highly regressive and ultimately

undermine climate policy action.

To achieve the 2C goal, ambitious mitigation actions and non-

negligible carbon prices need to start now. Delaying actions until after

2020 would mean steeper emissions cuts thereafter to catch up and

higher carbon prices. Carbon prices fall rapidly once carbon markets

in different jurisdictions are linked or more sectors and gases are

included. Carbon prices needed to meet the same goal would need to

be higher if energy technology options become constrained.


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Limiting emissions of CO2and other greenhouse

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

major future changes to the climate. In this context,

carbon pricing is a central issue. However, this termcan have several different meanings:

Placing an explicit price on GHG emissions,

either by establishing taxes on the carbon

content of various fuels or on the emissions

of other GHGs, or by setting up an emission

trading system where the price of GHG emission

allowances represent the carbon price.

Placing an implicit price on carbonfollowing

the application of any other type of policy

instrument that has an intended or unintendedimpact on GHG emissions.

Placing a negative price on carbon, i.e.

subsidising actions that lead to emissions of

carbon dioxides in the form of subsidies or

support to fossil-fuel production or use.

The climate change challengewe face is so enormous that we

cannot afford inefficient policies:

countries need the most cost-

effective policy instruments.

2- OECD POLICY PERSPECTIVESPRICING CARBON

Introduction

This Policy Perspectives brochure gives an overview of

recent OECD findings on each of these forms of carbon

pricing. It documents the current use of different types

of carbon pricing and fossil fuel support, and finallyconsiders carbon prices for different policy approaches

that will be needed to reach internationally agreed goals

to limit climate change. The overall conclusion is that

explicit and implicit carbon prices vary considerably, both

within and across countries.


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Emissions trading

The largest carbon emission trading system in operation

is the European Unions Emission Trading System (EU

ETS). It has established an upper limit on the total

emissions from installations in selected sectors (e.g.electricity generation; oil refineries; the iron & steel, pulp

& paper, cement and aluminium sectors, intra-Union

aviation). In part due to the current economic crisis, the

prices of emission allowances are currently low (around

EUR 5 per tonne of CO2in early September 2013). In the

most recent phase of the scheme, an increasing share of

allowances is being auctioned.

Another large trading system has been established in

California, United States. It was recently agreed to link

the Californian trading system with its counterpart in

Quebec, Canada from 1 January 2014. In an auction that

took place in May 2013, the clearing price for allowances

for 2013 emissions was USD 14 per tonne of CO2.

New Zealand has a nation-wide GHG emission trading

system, Korea is preparing to implement one, and Chile

is considering whether to establish one. Tokyo, Japan

operates a local GHG emission trading system. China

has recently introduced 7 local or regional pilot emission

trading schemes.

1. OECDs database on instruments used for environmental policy provides a lot of

information on relevant taxes and trading systems; see www.oecd.org/env/policies/database.

2. OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction,

OECD Publishing.doi: http://dx.doi.org/10.1787/9789264122246-en.

OECD POLICY PERSPECTIVESPRICING CARBON- 3

Explicit carbon pricing

An increasing number of countries use carbon taxes

or emission trading systems to put a price on carbon

and thereby reduce their emissions. Carbon taxes put

an explicit price on a unit of carbon and the revenuesgenerated can be used for example, to lower distortive

taxes or to reduce public budget deficits. The amount

of carbon that will be abated under carbon taxes is

generally uncertain. In emission trading systems, the

amount of carbon to be abated is fixed, but the price

of carbon can fluctuate in order to meet that objective.

Emissions trading systems can also generate public

revenues, but only if emission permits are auctioned

and not distributed for free. Both of these approaches,

in principle, can promote a cost-effective achievement

of given abatement objectives but the practical design

of the taxes and trading systems in current use often

leaves significant scope for improvement.1The OECDs

Environmental Outlook to 2050contains an overview of

carbon pricing systems in place in different countries.2


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There is a direct link between the carbon content of a

given fuel and the CO2emissions that will result from

combustion of that fuel. This suggests that from a climate

perspective, the tax rates applied to different fossil fuels

should be set at a rate based on their carbon content.

However, available information shows that instead of

applying the same rate, countries apply different tax rates

per unit of carbon to different fuels, and/or to different

uses of a given fuel.

Figure 1 illustrates all taxes on fossil fuels, includingcarbon taxes as well as various excise taxes for six

Northern European countries. Each of these countries

apply taxes that are explicitly labelled as carbon taxes

and they are shown as the bottom parts of each vertical

bar for each fuel in question, with significant variations

within and among most of the six countries.3

In most cases, countries also apply other taxes on the

same fuels, and the distinction between the carbon

element and the other elements in the total taxes that

are levied on a given fuel is somewhat arbitrary. In

Figure 1, these other taxes are shown by the upper parts

of (most of) the vertical bars.

In addition to the countries shown in Figure 1, several

other jurisdictions apply explicit carbon taxes, including

Slovenia, Japan and the provinces of British Columbia and

Quebec in Canada.

Australia introduced a carbon tax in 1 July 2012, with

the intention of transforming it to an emission trading

system after three years. In July 2013, the Australian

Government proposed to convert the tax into a trading

system after two years instead. After a general election

in September 2013 where the outgoing government lostits majority in the Parliament, the tax is likely to be

abolished.

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

that will affect peoples use of the fuels and the related

CO2emissions; the names applied to the different taxes

are not important in this regard. Figure 1 illustrates

how it can be misleading to only consider the carbon

element of the taxes: Whereas Sweden has much higher

CO2taxes than the other 5 countries shown in the graph,

the total taxes on at least petrol and diesel do not stand

out as being particularly high.

Figure 1. Comparison of carbon taxes and othertaxes on selected fuels, EUR per tonne of CO

2

3. Figure 1 shows the main tax rates applied to the different fuels, but in several countries

there are (normally) lower rates for products used in certain sectors, etc. The rates shown forheating oils are those that apply to the household sector.

4. OECD (2013a), Taxing Energy Use: A Graphical Analysis, OECD Publishing.doi: http://

dx.doi.org/10.1787/9789264183933-en.

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

Notes: Other taxes include taxes levied on a per-volume or per-weight basis but does not

include ad valoremtaxes, such as VAT.


Carbon taxes

0

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100

150

200

250

300

350

Denmark Finland Iceland Ireland Norway Sweden

EUR

pertonneofCO2

DieselPetrolNatural gasCoalHeating oil


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Taxes on energy use

Figure 1 aggregates the various taxes applied to selected

fuels in the 6 countries included. The totals are an

estimate of the implicit carbon prices applied to those

fuels.

The OECD report, Taxing Energy Use: A Graphical Analysis,4

provides detailed maps of the energy taxes applied

in all OECD countries, with the tax rates expressed as

implicit rates per tonne CO2and alternately, per unit of

energy content. Figure 2 presents CO2

emissions on the

horizontal axis and the related tax rates on the vertical

axes, distinguishing between three broad categories

of energy use: transport; heating and process use; and

electricity.

As in most countries, energy products used in transport

(mainly gasoline and diesel) are taxed significantly more

than energy products used for heating or process use,

or to generate electricity (with an exception regarding

residential electricity use in Denmark). This is linked to

the broader range of policy goals that governments may

aim to address in the transport sector compared to other

areas of energy use. While the combustion of fossil fuel

emits CO2and certain air pollutants regardless of use,

fuels used in road transport also contribute to other

externalities, such as congestion, traffic accidents and

noise, which may have an even higher social cost than

these emissions.

In the absence of road pricing, which may be the best

approach, road fuel consumption may be a rough proxy

for these other external costs, since fuel use is correlated

with distance driven. In addition, a number of countries

formally or informally earmark road fuel taxes to fund

road construction and maintenance, or use motor fuel

taxes as a source of revenue more generally.


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

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

Implicit carbon pricing

Any type of policy that affects GHG emissions will implicitly define a carbon price. This section summarises some of

the findings of recent OECD studies that have analysed implicit carbon pricing.


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6- OECDPOLICY PERSPECTIVESPRICING CARBON

Taxing Energy Use: A Graphical Analysisalso allows

comparisons of the implicit tax rates applied to different

percentiles of total CO2emissions. In Figure 3, effective

tax rates for a few selected countries are presented from

the lowest to the highest tax rate. The horizontal axispresents the proportion of the tax base (in tonnes of

CO2), while the vertical axis presents the corresponding

effective tax rate on carbon. The graph shows the rates at

which different fractions are taxed.

The graph highlights the wide variance in effective tax

rates on carbon both within and across OECD economies.

In general, the highest levels on the right side of these

profiles represent the tax rates applied on transportation

fuels.

Figure 3. Effective tax rates on a carbon-emission

basis in selected countries

Source: OECD (2013a), Taxing Energy Use: A Graphical Analysis, OECD Publishing.

doi: http://dx.doi.org/10.1787/9789264183933-en.

Within the heating and process use category, many

countries tax energy products used for industrial or

energy transformation purposes at lower rates than the

same energy products used for residential or commercial

purposes. This is often motivated by the interest of not

undermining industrial competitiveness. In a number

of other countries, however, the reverse holds, andenergy used in industry and power generation is taxed

at a higher rate than in the residential and commercial

sectors. This is often linked to concerns about the social

impacts of high energy prices and the desire to protect

poorer households. However, policies that reduce energy

prices for particular sectors can distort energy use in

an environmentally damaging manner, and there are

usually better mechanisms for addressing the concerns

motivating these policies. For example, it is usually

more effective from an environmental point of view to

preserve the price signal sent by fuel taxes and address

the impacts on industry or low-income families by more

direct means, such as cash transfers that do not directly

subsidise energy use.

The third category shown in each country profile is

electricity generation. Electricity is a secondary energy

product generated from some primary energy source,

like natural gas, coal or wind. To take account of this,

the maps show the fuels used to generate electricity.

This enables both the primary energy production and

the significant amount of energy lost in converting

fossil energy into electricity to be captured. Countries

tax electricity in two ways: by taxing the fuels used to

generate electricity, and/or by taxing the consumptionof electricity. The country profiles take into account

both types of tax. Where the consumption of electricity

is taxed, the effective tax rates are calculated as if the

electricity tax were an implicit tax on the underlying

fuels used to make electricity, according to their relative

proportions in the mix of primary energy used for

electricity generation in the particular country.

AUS

ISR

SWE

JPN

USA

DEU

0

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100

150

200

250

300

350

400

450

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

EUR per tonne CO2

Proportion of all energy use in each country (tonnes of CO2)


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5. Some policy instruments, such as subsidies to fossil fuels, can contribute to increasing

GHG emissions. The implicit carbon prices are in such cases negative. These are d iscussed

further in the section below.

6. The book uses a methodology developed in a 2011 report by the Australian Productivity

Commission, Carbon Emission Policies in Key Economies, cf. www.pc.gov.au/projects/study/

carbon-prices/report.

Comparing implicit carbon

pricing via different types of

policy instruments

Not just taxes, but any sort of policy instrument that

intentionally or unintentionally has an impact on CO2

emissions, will implicitly establish a carbon price; that

is, the cost to society of abating a tonne of CO2using this

instrument.5

Another 2013 OECD publication, Effective Carbon Prices,

estimated the costs to society of a broad range of

policy instruments applied in electricity generation,

road transport, pulp & paper and cement, as well as

households domestic energy use in selected countries;

the amount of CO2eq emission reduction each of the

instruments contributed to; and, hence, the cost pertonne of CO

2eq per instrument.6

The report provides a snapshot of the post-policy

situation compared to a counterfactual snapshot

of no policy. It gives an indication of the relative

incentives to abate carbon in 2010 within and across

the countries examined. In spite of methodological and

data limitations, the differences in magnitude of the

abatement incentives are sufficiently large to provide

a good level of confidence about the lessons to be

drawn about the cost-effectiveness of different policy

instruments in abating GHG emissions.

The 2013 OECD publication, Effective Carbon Prices found

large differences in effective carbon prices:

1. Withina given sector, across the countries covered.

2. Across the different sectors, withineach of the

countries.

3. Acrossthe different instrument types, acrossall the

countries covered.

In many respects, the last two findings are the most

interesting and robust. There are a number of caveatsthat should be kept in mind when analysing the

estimates. However, while there may be some uncertainty

regarding the ranking of carbon prices within a given

sector across countries, it is very unlikely that any caveat

could explain away the latter two main findings and

they do not seem very sensitive to the exact year of study.


While carbon pricing via carbon taxes

and emission trading systems is more

visible, the costs to society of reducing

greenhouse gas emissions via other

types of policy instruments can be many

times higher.


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Source:OECD (2013c), Effective Carbon Prices, OECD Publishing.


Note: Ranges shown for some countries reflect diff erent choices about assumptions used in the estimates. All the Other

regulations covered in the electricity generation sector are renewable portfolio standards.

Figure 4.Estimated average effective carbon prices in the

electricity sector, by instrument type

2010 EUR per tonne of CO2abated


Figure 4 shows the average effective

carbon prices in the electricity sector, by

instrument type. It clearly demonstrates

that feed-in tariffs and various (other)

subsidy schemes entail the highest

costs to society per tonne of CO2eq

abated, in some cases by a considerable

margin. Trading systems dominate the

low-cost part of the graph.

Even if motor fuel taxes were not

introduced with the aim of reducing

greenhouse gas emissions, they in

practice do so at a much lower cost

per tonne abated than any other policy

instrument.

-100 0 100 200 300 400 500 600 700

2010 EUR per tonne of CO2abated

GBR Feed-in tariff, PVKOR One Million Green Homes programme

GBR Feed-in tariff, wind

KOR Regional Deployment Subsidy programme

KOR General Deployment Subsidy programme

CHN Jiangsu PV feed-in tariffs

KOR Feed-in tariffs

ESP Premiums for renewable energy genera tion

JPN National PV capital subsidies

JPN Tokyo PV capital subsidies

JPN Solar PV feed-in tariffs

GBR Feed-in tariff, hydroelectricity

GBR Feed-in tariff, anaerobic digestion

JPN Renewable Portfolio Standards

JPN Promoting the local introduction of new energy

JPN Supporting new energy operators (debt guarantee)GBR Feed-in tariff, micro CHP

GBR Renewable energy certificate scheme

CHN Golden Sun demonstration scheme

GBR Feed-in tariff, existing micro-generators

GER Renewable Energy Sources Act (feed-in tariffs)

GBR Climate Change Levy exemption, renewables

CHN Subsidy for solar PV in buildings

FRA Feed-in tariffs

EST Renewable Energy and Cogeneration Support

AUS Renewable energy certificates (RECs)

CHN Biomass feed-in tariffs

DNK EU ETS Indirect subsidy to renewable energy

DNK Subsidies for renewable energy generation

GER Feed-in tarif f for combined heat and power

CHN Wind feed-in tariffsCHN Value added tax exemption for wind power

GBR EU ETS, coal-to-gas substitution

BRA Feed-in tariff: biomass

BRA Feed-in tariff: wind

GBR Climate Change Levy exemption, CHP

FRA EU ETS Supply-side effect

GER EU ETS, fuel switching

DNK EU ETS coal-to-gas switching

AUS Queensland Gas Scheme (certificate trading)

BRA Feed-in tariff: small hydro

EST Increased electricity prices from several policies

NZL ETS

KOR Korea Certified Emission Reduction Scheme

AUS Greenhouse Gas Reduction Scheme

CHN Large Substitute for Small Programme

775

800

Other subsidies

Taxes

Tax preferences

Trading systemsFeed-in tariffs

Other regulations


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OECD POLICY PERSPECTIVES PRICING CARBON- 9

Figure 5. Estimated effective carbon prices in the road

transport sector, by instrument

Source:OECD (2013c), Effective Carbon Prices, OECD Publishing.


Note: Ranges shown for some countries reflect different choices about assumptions used in the estimates.

Figure 5 shows the estimated

effective carbon prices in the road

transport sector by instrument type.With a few exceptions, fuel taxes

dominate the low-cost, bottom side

of the graph. Tax preferences,

Capital subsidies and Other

regulations all entail higher costs to

society per tonne of CO2abated and

in many cases, very substantially so.

The lower effective price of abating

carbon achieved by taxes and

emission trading systems compared

with other instrument categories

can be explained by their higher cost

effectiveness.

With the exception of a support

scheme for electrical vehicles in

Estonia, policies promoting biofuels

were the most costly policies

for abating CO2in the transport

sector. The calculations probably

underestimate the cost involved,

inter alia because indirect land-use

changes related to the production of

biofuels were not taken into account.

2010 EUR per tonne CO2abated

2000 400 600 800 1 000 1 200

EST Support for electric vehicles

DNK Biofuel mandate Impact on diesel pricesDNK Biofuel mandate Impact on petrol pri ces

USA Biofuel policiesJPN Biofuel tax preferences Ethanol

KOR Biofuel tax rebateCHN Tax preferences Biodiesel

AUS Ethanol production grantsNZL Fuel tax exemption Ethanol

GER Tax exemption and fuel mandate EthanolGBR Renewable Transport Fuels Obligation Ethanol

GBR Renewable Transport Fuels Obligation BiodieselBRA Fuel mandate Biodiesel

BRA Fuel mandate Anhydrous ethanolGER Tax exemption and fuel mandate Biodiesel

BRA Fuel mandate Hydrous ethanolFRA Biofuel tax preferences Ethanol

RUS Petrol taxesGER Tax exemption and fuel mandate Vegetable oil

RUS Diesel taxesAUS Cleaner Fuels Grants Scheme

NZL Grants scheme BiodieselDNK Petrol taxesGBR Petrol taxesGER Petrol taxes

ESP Petrol taxes LeadedESP Petrol ta xes Unleaded, 97 octane or more

FRA Petrol taxesESP Petrol taxes Unleaded, other

GBR Diesel taxesFRA Biofuel tax preferences Biodiesel

KOR Petrol taxesJPN Petrol taxes

RUS Fuel levy exemption BioethanolDNK Diesel taxesFRA Diesel taxesEST Petrol taxesGER Diesel taxesESP Diesel taxesEST Diesel taxes

GBR LPG taxesNZL Petrol taxesKOR Diesel taxesCHL Petrol taxesJPN Diesel taxesAUS Petrol taxes

KOR LPG taxesAUS Diesel taxesBRA Petrol taxes

RUS Fuel levy exemption BiodieselGER LPG taxesJPN LPG taxesCHN Fuel taxesNZL LPG taxes

USA Petrol taxesFRA LPG taxesUSA LPG taxes

USA Diesel taxesCHL Diesel taxesBRA Diesel taxes

ESP Boethanol taxesNZL Diesel taxes

Taxes Tax preferences Other subsidies Other regulations

1 532

1 6131 205


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Figure 6. Estimated effective carbon prices in the different

sectors,by country, 2010 EUR per tonne of CO2abated

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

7. The bars in Figure 6 represent weighted averages of the effective carbon prices found for different instruments applied in a given sector in the different

countries. The amounts of abatement that each instrument is estimated to have contributed are used as weights in the calculation of the averages. The

bars on the far right end of the graph show weighted averages of these averages, calculated across the countries for which effective carbon prices have

een calculated, using emissions in the various sectors in the given countries as weights.

Figure 6 illustrates another important finding of the

study; namely that very large differences in the effective

carbon prices were found across different sectors of the

economy.7 In all the countries, the effective carbon prices

in the two industrial sectors studied (pulp and paper, and

cement) are a small fraction of those in the other sectors.

This may be linked to concerns about loss of internationalcompetitiveness.

From an economic point of view, reducing carbon

emissions would be more efficient if different sectors

faced similar abatement incentives. In addition, costs

would be reduced if the most cost-effective types of policy

instruments to limit CO2emissions were applied. The

recent empirical analysis conducted by OECD suggests

that many of the policy instruments applied to reduce

carbon emissions are cost-ineffective.

It may be debated that some policy instruments, for

example subsidies for house insulation were not intended

primarily to abate carbon emissions, and, that as a

result, judging their performance in terms of costs

per tonne of CO2abated is unfair. Clearly the objective

of the policy instrument is an important consideration

in judging its effectiveness. However, all policies whichhave an impact on CO

2emissions were included in the

analysis. For some of the instruments with very high

effective carbon prices (e.g. measures put in place to

promote biofuels and other renewable energy sources),

carbon abatement has indeed been one of the main

arguments applied in public debates in favour of their

introduction.

0

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2010EUR

pertonneCO2

abated

Electricity generation

Road transport

Pulp & paper

Cement

Households


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OECD POLICY PERSPECTIVESPRICING CARBON - 11

Explicit and implicit carbon pricing policy measures do

not operate in a vacuum. OECD work shows a wide range

of budgetary transfers and tax expenditures in place

that encourage the production and use of fossil fuels.

As a result, governments often have a policy package

that explicitly and implicitly puts a positive price on

carbon on the one hand, while pursuing mechanisms

that subsidise fossil fuel production and use on the other.

Such policy arrangements are not mutually supportive

and can significantly undermine the effectiveness of

overall climate policies. This argues strongly in favour of

removing fossil fuel subsidies, which would also have the

benefit of reducing public spending and increasing tax

revenues. Over time, such reforms contribute to a shift

away from fossil-fuelintensive activities and towards

low-carbon technologies.

IEA estimates that fossil fuel consumption subsidies in

developing and emerging economies amounted to

USD 523 billion in 2011. The OECD (2013b) has identified

over 550 individual support mechanisms that directly

or indirectly encourage the production or consumption

of fossil fuels across OECD countries. Producer support

mechanisms include: i) government intervention in

market mechanisms to alter costs or prices; ii) transfers

of funds to producers; iii) reduction, rebate or removal of

certain taxes; and iv) the government assuming part of

the production risk. Examples of consumption support

include direct transfers, tax relief, and rebates on energy

products. A few country examples of consumption and

production support mechanisms are summarised in

Box 1.

Box 1.Examples of consumption and production support to fossil fuels

Mexico Consumption support in Mexico is provided through a floating excise tax on transport fuels. The tax rate is designed to

respond to changes in international benchmark prices, so that when international prices increase, the tax rates for diesel and gasoline

decrease, and even become negative (i.e. a subsidy) when oil prices are particularly high. For example, when the cost of crude oil

in 2008 averaged USD 100 per barrel, the total value of consumer support amounted to MXN 223 billion (USD 20 billion) or around

1.8% of GDP. In response to the governments strategy to cut greenhouse gases by 50% by 2050 compared to the 2000 baseline,

efforts are underway to better target energy subsidies and bring prices in line with costs. A new cash-transfer scheme was intro-

duced to help poor households cover their energy needs, which is considered less distortionary than the floating excise tax. The

2013 Fiscal Reform proposed by the Mexican President includes the phase-out of gasoline subsidies, and electricity subsidies are

being examined closely through the Energy Reform proposals.

PolandIn Poland the coal industry receives the majority of the government support available to the energy sector. Over the period

1999 to 2011, that support exceeded PLN 25 billion (USD 7 billion). During the communist era, the coal industry benefitted from

various social benefits for coal miners and the regulation of coal prices. During the economic transition in the 1990s, the coal sector

was gradually restructured through a series of capacity-adjustment programmes that brought about the closure of unprofitable mines

and reduced the level of employment in the coal sector. These programmes, however, failed to bring about an effective restructuring

of the sector. Since 2011, in line with EU Council regulations, government support has been limited to the closure of mines, thetreatment of health damages sustained by miners, and environmental liabilities related to past mining.

SwedenProducer support measures in Sweden are negligible since it only produces a small amount (about 1.2 million tonnes of coal

equivalent) of peat for energy use; oil, natural-gas and coal are imported. Sweden, however, does provide consumer support through

exemptions and reductions from energy- and CO2-taxes for particular users and uses of fossil fuels. In 2011, this amounted to about

SEK 19.1 billion (USD 2.9 billion). It is estimated that 69% of the tax exemptions were linked to the consumption of diesel that is

taxed at a lower rate than gasoline for transport purposes. Plans are underway to review the support mechanisms in order to reduce

government tax expenditures.

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

Support to fossil-fuel production or use


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Consumer measures accounted for two thirds of total

support over the 2005-11 period, though there remain

considerable differences at the country level reflecting

countries resource endowments, tax rates and otherfactors. For example, producer support remains

significant in many countries that possess abundant

fossil resources while several other OECD countries are

large consumers of fossil fuels and do not produce any

significant amounts of coal or hydrocarbons (e.g. France,

Italy, Japan and Sweden). Overall, almost half of the

measures listed in the OECD inventory directly target the

end-use of fossil fuels while around a third benefit fossil-

fuel extraction, with only a few supporting intermediate

stages of the supply chain (i.e. transportation, refining

and processing).

Despite the arguments in favour of reforming or

eliminating special tax exemptions or outright fossil-fuel

subsidies, it is in practice politically challenging to do

so. This is in part due to the strong lobbying capacity of

large companies benefitting from such exceptions, but

also because of the potentially negative impacts reform

can have on vulnerable households.

While the evidence clearly shows that subsidies to fossil

fuel consumption are generally poorly targeted, and thus

the majority of the subsidy tends to accrue to high or

middle income households, potential impacts of reforms

on poor households still need to be addressed.

Experience from countries that have successfully reduced

fossil fuel and electricity subsidies show four common

strategies for success (IEA/OPEC/OECD/World Bank, 2011):

Increase the availability and transparency of supportdata to facilitate an informed debate between partiesin favour of and against such policies. Good data canalso support peer review processes and encouragecompliance with future subsidy reforms.

Provide carefully targeted, temporary andtransparent financial support to vulnerable groupsduring the transition period.

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

Demonstrate the governments commitment tocompensate vulnerable groups and to use freed-up public funds in a beneficial way. This can beachieved through broad communication strategies,appropriate timing of subsidy removal, andimplementation of compensatory social policies.

The overall value of the support mechanisms identified

in the OECD inventory is estimated between USD 55 and

USD 90 billion a year for the period 2005-11. Petroleum

products (i.e. crude oil and its derivative products)

have generally been the primary beneficiaries of these

measures, accounting for about two-thirds of the

total. This reflects the importance of oil in the OECDs

total primary energy supply and the relatively higher

taxes that are generally levied on refined oil products.

The 2008 peak in Figure 7 can in part be explained by

transfers provided through Mexicos floating tax, as the

international oil price reached a high of USD 140 per

barrel.

Figure 7. Support to fossil fuels in OECD

countries by year and type of fuel

Source: OECD (2013a), Taxing Energy Use: A Graphical Analysis, OECD Publishing.


0

20 000

40 000

60 000

80 000

100 000

2005 2006 2007 2008 2009 2010 2011

Coal Petroleum Natural Gas

Millions of current USD


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The above sections focussed on the empirical evidence

on carbon pricing in OECD and other countries. Lookingforward, what carbon pricing will be needed in the future

to tackle climate change? The international agreements

on climate change under the United Nations Framework

Convention on Climate Change (UNFCCC) recognised

the need for deep cuts in global GHG emissions in

order to limit the global average temperature increase

to 2 degrees Celsius (2C) above pre-industrial levels.

Research suggests that if the world could stabilise GHG

concentrations at 450 ppm CO2eq, the chance of keeping

the global temperature increase under 2C would be

between 40% and 60%.

Using model-based simulations to estimate carbon prices

to achieve certain climate mitigation goals can provide

the relative costs and benefits of different policy actions.

The OECD Environmental Outlook to 20508analysed

three hypothetical scenarios that could keep GHG

concentrations at the end of the 21st century below 450

ppm. The 450 Core scenario assumes full flexibility in the

timing of emission reductions up to the year 2100, and

the use of mitigation options including biomass energy

with carbon capture and storage (CCS) known as BECCS.

It further assumes that global co-operation is achieved

for tackling climate change, and thus emission reductionis implemented through a fully harmonised carbon

market that encompasses all regions, sectors and gases.

As all least-cost mitigation options are included, this

scenario acts as the cost-effective reference point against

which to compare the other scenarios. The 450 Accelerated

Actionscenario assumes greater mitigation efforts in the

first half of the century, and less reliance on unproven

emissions reduction technologies (like BECCS) in later

decades. The 450 Delayed Actionscenario reflects the

current situation in that the level of mitigation is limited

to the high end of the pledges that countries made in the

Copenhagen Accord and Cancn Agreements (with strict

land-use accounting rules and no use of surplus emission

credits from the Kyoto Protocol commitment period).

This leads to less mitigation in the first half of this

century compared to the 450 Core scenario, and significant

additional mitigation efforts will have to be made after

2020 to catch up. It also assumes that the various

domestic carbon markets are not linked until 2020.

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

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

Using carbon pricing to achieve international

climate policy objectives


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14 - OECD POLICY PERSPECTIVESPRICING CARBON

The OECDs model-based analysis projects rapidly

increasing carbon prices in these scenarios to keep

GHG concentrations below 450 ppm at the end of the

21st century. In the least-cost 450 Core scenario, curbing

global emissions beyond 2020 would require a carbon

price increasing to USD 325 per tonne of CO2eq in 2050

(in constant 2010 USD PPP exchange rates). The largermitigation efforts in the 450 Accelerated Actionscenario

imply lower environmental risks but higher carbon prices

than the 450 Core scenario, at least in the first decades.

By 2030, carbon prices would be about 50% higher in the

450 Accelerated Actionscenario than in the 450 Core. In the

450 Delayed Action scenario, carbon prices vary between

regions until 2020, ranging from zero for regions that do

not have a binding pledge to more than USD 50 per tonne

of CO2eq for the combined Japan and Korea region. These

numbers depend on a number of crucial but uncertain

assumptions about the interpretation of the pledges

countries have made.

Without the possibility to trade permits, many low-cost

mitigation options would remain unexploited, driving

up the economic costs in the 450 Delayed Actionscenario

relative to the 450 Core scenario. In the longer run (to 2050),

the 450 Delayed Action scenario requires more ambitious

mitigation efforts to bring concentration levels back down

to the 450 ppm target before the end of the century. For

countries with an initially low carbon price, this implies a

very rapid increase from 2020 onwards, whereas for other

regions, the transition is a bit smoother. Nonetheless, by

2050, the global carbon price is higher in this scenario

compared to the other two scenarios.

Clarke et al. (2009)9 compare carbon prices across a range

of different models for harmonised scenarios, including

450 ppm stabilisation scenarios. The report shows a

range of global carbon prices in 2020 of USD 15263 (2005

USD). Also noteworthy is that many models were not

able to simulate a 450 ppm stabilisation scenario without

temporary overshooting of the target, or with incompleteparticipation. Clarke et al. noted that the exclusion of

models that were not successful in producing the more

challenging climate-action cases inherently biases the

reported carbon prices and economic costs downward.

However, more recent model comparison exercises

(Kriegler et al., 2013) suggest that most model simulations

by different modelling groups are able to project 450 ppm

stabilisation scenarios.10

One way to keep mitigation costs as low as possible

is through the linking of carbon markets. The OECD

report Addressing the competitiveness and carbon

leakage impacts arising from multiple carbon markets:

a modelling assessment illustrates how direct linking

of carbon markets can ensure that all low-cost options

are exploited.11 By harmonising carbon prices, relatively

expensive reduction options in certain regions are

replaced by relatively low-cost options in other regions.

This result can also be reached through indirect linking,

where several emission trading schemes allow credits

from a common pool of offsets. A second way to keep

carbon prices as low as possible is to include more sectors

and gases in the mitigation policy. Table 1 illustrates how

carbon prices fall rapidly once carbon markets are linked

or more sectors and gases are included.

Table 1. Carbon prices in acting Annex I and OECD countries in multiple carbon markets scenarios

2020, USD 2007 per tonne of CO2eq

Region Partial Offsets Link Offsets &

Link

Incl. Agri. Incl. Fin.

Dem.

Incl. Non-

CO2gases

All

sources

Australia & New

Zealand 75 44 40 24 74 60 35 18

Canada 117 76 40 24 112 79 57 36

EU & EFTA 86 55 40 24 83 52 28 17

Japan & Korea 259 159 40 24 257 187 178 124

Other European

Annex I countries 21 14 40 24 21 11 3 2

Russia 0 0 40 24 0 0 0 0

USA 64 41 40 24 59 47 26 19

Average, all acting 114 72 40 24 111 81 60 41

Source: Lanzi, E., et al. (2013), "Addressing Competitiveness and Carbon Leakage Impacts Arising from Multiple Carbon Markets: A Modelling Assessment",

OECD Environment Working Papers, No. 58, OECD Publishing. doi: http://dx.doi.org/10.1787/5k40ggjj7z8v-en.

Note: World carbon prices for each of the scenarios are calculated as an average over acting countries, and weighted by emission reductions. As these carbon

prices are based on different base years for exchange rates, they cannot directly be compared to the carbon prices reported in the Environmental Outlook to 2050.

10. Kriegler, Weyant, Blanford et al. (2013), The role of

technology for achieving climate policy objectives: overview of

the EMF 27 study on technology and climate policy strategies,

Climatic Change, forthcoming.


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11. Lanzi, E., et al. (2013), Addressing Competitiveness and Carbon Leakage Impacts

Arising from Multiple Carbon Markets: A Modelling Assessment, OECD Environment Working

Papers, No. 58, OECD Publishing. doi: http://dx.doi.org/10.1787/5k40ggjj7z8v-en.

The reference point for the analysis behind

Table 1 is a stylised hypothetical Partial policyscenario

where only a smaller group of countries act, and with

some types of emissions excluded. This scenario is

based on the pledges made by Annex I countries in the

Copenhagen Accord; international permit trading is not

allowed. All the scenarios in Table 1 are based on the

Partial policyscenario, but either add linking options orinclude certain sectors or gases. The Offsets scenario

includes indirect linking of carbon markets through the

use of a common offset scheme. By assumption, only

sectors in non-acting countries that are covered by ETS

in acting countries are considered as eligible sources

for offsets, with a cap on equal to 20% of the emissions

reduction in the Partialscenario. The second response

policy considered is a direct linking (Link scenario) among

the domestic ETSs of acting countries, where regulated

entities can trade emission allowances with another. The

allocation of allowances across participating countries

corresponds to the domestic targets defined in the Partial

scenario. These policy responses are implemented in the

model in a stylised way, since the model cannot consider

all frictions that are present in the markets, etc.

TheIncl. Agri.scenario includes emissions from the

agricultural sectors; similarly, final demand emissions

(emission related to households and government) are

included in the scenarioIncl. Fin. Dem. Finally, the most

inclusive scenario (All sources) includes all emission

sources and sectors in the climate policy. A crucial

assumption in all these scenarios is that the same

economy-wide emission reduction needs to be achieved,

i.e. any low-cost mitigation efforts by sectors or gases

that are excluded in the Partialscenario need to be

compensated by increased efforts in reducing the

emission sources that are covered by the scheme.

Sensitivity analysis on the availability of different

technology options for the Environmental Outlooks

450 Accelerated Action scenario shows that, to keep thecost of mitigation as well as carbon prices low, multiple

technology options are needed in transformation

pathways towards a carbon-free energy system (using

nuclear energy and carbon capture and storage (CCS),

and speeding-up technology developments for energy

efficiency and renewables). Limiting any of these

technology options would lead to higher carbon prices, as

illustrated in Figure 8 using the ENV-Linkages model. The

450 scenario (all technologies) refers to the 450 Accelerated

Actionscenario, where all technologies are available

for keeping mitigation costs as low as possible (within

boundaries set by capacity constraints). Compared to the

default assumptions in the 450 Accelerated Action scenario,

the Low efficiencyand renewablesscenario assumes

less energy-efficiency improvement in energy use in

production, and slower increases in renewable energy

production. The Nuclear phase-outscenario assumes that

after 2020, no new nuclear unit will be built, so that the

world total nuclear capacity by 2050 will be reduced

because of the natural retirement of existing plants.

Finally, the No CCSscenario assumes no greater use

of CCS technologies beyond the levels projected in the

Baseline. Kriegler et al. (2013) present similar scenario

analysis for a much wider group of models.

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

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

Notes: OECD-A1 = the group of OECD countries that are also part of Annex I of the Kyoto Protocol.

RestA1 = rest of Annex I countries not included in the OECD group

BIICS = Brazil, India, Indonesia, China and South Africa

ROW= rest of the world

0

-5

-10

-15

-20

-25

-30

600

500

400

300

200

100

0

Rest of the world

OECD AI

World

Russia and rest of AI

% impact on real income in 2050 Carbon price in 2050 (USD/tCO2e)

Panel A. Economic impacts of the technology choices in 2050

450 scenario(all technologies)

Low efficiencyand renewables

Nuclear phase-out No CCS

Carbon price (right axis)

Rest of BRIICS


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16 - OECD POLICY PERSPECTIVESPRICING CARBON

Ambitious mitigation actions and non-negligible

carbon prices are needed starting now to limit the

global average temperature increase to 2 degrees

Celsius (2C) above pre-industrial levels at least cost.

Given the size of the problem, we cannot afford

inefficient policies: least-cost solutions and market-

based instruments are needed to keep carbon prices

as low as possible.

Delaying actions until after 2020 would mean steeper

emissions cuts thereafter to catch up and higher

carbon prices.

Carbon prices fall rapidly once carbon markets in

different jurisdictions are linked or more sectors and

gases are included.

Carbon prices needed to meet the same goal would

need to be higher if energy technology options

become constrained.

It should be stressed, however, that in such modelling

exercises, the projected carbon prices are relatively

sensitive to model assumptions regarding baseline

emission developments; developments in the energy

system, including on improvements in energy efficiency;

and the speed with which households and firms can alter

their behaviour in light of the higher carbon pricing. This

sensitivity is not least due to the fact that carbon prices

reflect the situation at the margin (i.e. the marginal

cost of emission reductions), whereas other indicators

of climate costs, such as real income losses, reflect an

aggregated cost of emission reductions. Figure 8

illustrates this: cost of mitigation in terms of reductionin global real income is particularly detrimental; for

slow developments of energy efficiency and renewable

power technologies, whereas a lack of availability of

CCS increases carbon prices most. In sum, model-based

simulations of different mitigation pathways in the

coming decades indicate that:


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Relevant OECD References

OECD (2012), OECD Environmental Outlook to 2050: The Consequences of Inaction, OECD

Publishing. doi: http://dx.doi.org/10.1787/9789264122246-en.

OECD (2013a), Taxing Energy Use: A Graphical Analysis, OECD Publishing.


OECD (2013b), Climate and Carbon: Aligning Prices and Policies,

OECD Environment Policy Papers, No. 1, OECD Publishing.

doi: http://dx.doi.org/10.1787/5k3z11hjg6r7-en.

OECD (2013c), Effective Carbon Prices, OECD Publishing.


OECD (2013d), An OECD-Wide Inventory of Support to Fossil-Fuel Production or Use, OECD

Publishing, Paris, available at: www.oecd.org/iea-oecd-ffss.

OECD (2013e), Inventory of Estimated Budgetary Support and Tax Expenditures for FossilFuels 2013, OECD Publishing. doi: http://dx.doi.org/10.1787/9789264187610-en.

Lanzi, E., et al. (2013), Addressing Competitiveness and Carbon Leakage Impacts Arising

from Multiple Carbon Markets: A Modelling Assessment, OECD Environment Working

Papers, No. 58, OECD Publishing. doi: http://dx.doi.org/10.1787/5k40ggjj7z8v-en.

OECD Contact

BRAATHEN Nils Axel, ENV/EPI, [email protected]

For more information:

www.oecd.org/env/tools-evaluation/carbon-prices.htm

OECD POLICY PERSPECTIVESPRICING CARBON - 17
http://dx.doi.org/10.1787/9789264122246-enhttp://dx.doi.org/10.1787/9789264183933-enhttp://dx.doi.org/10.1787/5k3z11hjg6r7-enhttp://dx.doi.org/10.1787/9789264196964-enhttp://www.oecd.org/iea-oecd-ffsshttp://dx.doi.org/10.1787/9789264187610-enhttp://dx.doi.org/10.1787/5k40ggjj7z8v-enhttp://www.oecd.org/env/tools-evaluation/carbon-prices.htmhttp://www.oecd.org/env/tools-evaluation/carbon-prices.htmhttp://dx.doi.org/10.1787/5k40ggjj7z8v-enhttp://dx.doi.org/10.1787/9789264187610-enhttp://www.oecd.org/iea-oecd-ffsshttp://dx.doi.org/10.1787/9789264196964-enhttp://dx.doi.org/10.1787/5k3z11hjg6r7-enhttp://dx.doi.org/10.1787/9789264183933-enhttp://dx.doi.org/10.1787/9789264122246-en


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