Input to the High-level Economic Commission on Carbon Prices by Christina Hood

Input to the High-level Economic Commission on Carbon Pricing

Christina Hood (as requested in personal capacity; this input does not reflect the views of the International Energy Agency

Head of Unit, Environment and Climate Change, International Energy Agency

This input focuses on IEA analysis of the role of carbon pricing in low-carbon transition of the energy sector. Two low-carbon scenarios are discussed: the “450 Scenario” from the annual World Energy Outlook publication, and the “2DS” from the Energy Technology Perspectives publication. These scenarios incorporate best information on countries’ energy policies, and energy technology costs and trends. A third scenario, the “New Policies Scenario” incorporates only policies that have already been announced, so is in line with the lower level of ambition reflected in the current Nationally Determined Contributions (NDCs) of the Paris Agreement.

1. Carbon price levels in the IEA Scenarios

In the 450 Scenario, carbon prices in 2030 rise to US$100/t in OECD regions and US$75/tCO2 in China, Russia, Brazil and South Africa in the power and industrial sectors, accompanied by a phase-down of fossil fuel subsidies. The transport sector is not directly included in the assumed carbon price, but by increasing the level of fuel taxes and by phasing out fossil-fuel subsidies it is ensured that end-user prices in the 450 Scenario are kept at a similar level as in the central scenario (the “New Policies Scenario”). The carbon price is part of a package of policies in each region including performance regulations, government mandates, and subsidies.  

Source: World Energy Outlook 2016

Rather than assuming explicit carbon prices, the Energy Technology Perspectives scenarios use the marginal abatement cost of various technology options to construct least-cost scenarios. In some cases it will be regulations, mandates or subsidies that lead to deployment of these technologies rather than explicit carbon prices. The Table below indicates the most expensive (marginal) technologies that are deployed in various time periods, following the general principle that less costly technologies are deployed before more expensive ones.

Decisions in the model on the timing of technology deployment are not based solely only on current marginal costs however: the goal is rather a cost-effective long-term transition to 2050. In some cases early deployment of high marginal-cost technologies is cost-effective over the longer-term if it leads to technology costs being reduced, or if it is necessary to achieve the scale of deployment required in later years. A short-term analysis based on a single marginal cost would miss this important dynamic efficiency.

Source: Energy Technology Perspectives 2012

The high marginal abatement costs show in the table above disguise the fact that the majority of abatement comes at much lower cost. For example in the electricity sector, while the marginal abatement cost is $150/tCO2 in 2050, around 90% of abatement comes at a cost below $60/tCO2 with one third at virtually no cost (predominantly cost-effective energy efficiency interventions). This has important implications for assessment of “ideal” carbon prices: if it is envisaged that a carbon price would form part of a package of policies where subsidy or regulation could support the most expensive technologies, then a lower explicit carbon price would be needed in this sector.

Marginal abatement cost curves are dynamic, evolving over time with two offsetting effects: as emissions reductions get deeper costs generally increase, but technology costs also decline with learning. Support for research, development, demonstration and early-stage deployment of technologies is a critical element in bringing down long-term costs.

Source: Energy Technology Perspectives 2012 

2. Switching prices

The recent IEA publication “Energy, Climate Change and Environment: 2016 Insights” (ECCE2016) explored coal/gas/wind switching prices[1]. It finds that switching carbon prices vary widely between regions, given differing fossil fuel prices, plant technologies, capital costs, and whether competition is between existing plants or for new build. A higher carbon price is needed to displace existing assets where capital is sunk, compared to the case where competition is between two new options for generation investment.

Source: Energy, Climate Change and Environment: 2016 Insights

In regions with surplus generating capacity, carbon prices influence the dispatch of existing plant and therefore decisions on which surplus plants to retire/mothball. In the EU emissions trading system, the combination of low coal prices, high gas prices and low carbon prices have led to a coal-to-gas switch from 2012 to 2015. In 2016 in the United Kingdom this situation has substantially reversed, due to significant movements in fossil fuel prices coupled with the “carbon price support” policy that sets a carbon price floor of GBP 18/tCO2 in the United Kingdom. If fossil fuel prices were to revert to previous levels, a higher carbon price would be needed to maintain this switch away from coal generation.

Source: Energy, Climate Change and Environment: 2016 Insights

This is reinforced by latest analysis in World Energy Outlook 2016 of coal-gas switching prices in the “New Policies Scenario” (consistent with the Paris Agreement NDCs) in 2025, which sees little incentive for coal to gas switching in existing plant outside the United States, even with carbon prices reaching $30/tCO2 in Europe at that time. New coal-fired generation remains a competitive option for investment in Asia in this scenario.

Source: World Energy Outlook 2016

A further consideration in switching discussions is the cost at which carbon capture and storage becomes cost effective. In ETP 2014 analysis, carbon prices ranging from $70/tCO2 to $100/tCO2 result in deployment of CCS in either gas or coal-fired generation, depending on the prevailing fuel prices for coal and gas.

Source: Energy Technology Perspectives 2014

3. Energy-Climate Policy Packages

Even where carbon pricing reaches high levels there are benefits of accompanying carbon pricing with complementary policies. Although the details of a cost-effective policy package will vary among countries and regions, in general there is a case for supplementing carbon pricing with

·       cost-effective energy efficiency policies and other performance mandates to unlock potential that is blocked by non-economic barriers, and

·       technology policies (i.e. RD&D support and deployment policies) to improve the long-term cost-effectiveness of emissions reductions by reducing technology costs and supporting timely scale-up of new technologies.

Source: Energy Technology Perspectives 2012 

If carbon prices do not reach high levels but remain more moderate (e.g. at levels found in the New Policies Scenario rather than the 450 Scenario), a greater reliance on other elements of the policy package (performance standards, mandates, subsidies) would be needed to achieve the same level of emission reductions in operations, investment and disinvestment decisions.

A further motivation to considering complementary policies is that in order to attract investment in low-carbon technologies, it may be necessary to both improve the expected NPV of an investment, and to mitigate risks. Carbon pricing works to improve the NPV, but does not reduce the risk (the distribution of possible NPVs) and in the case of carbon markets uncertainty in the carbon price can add to NPV risk. The expected future level of carbon prices plays an important role in decisions on long-lived investments: if there are not credible expectations of high carbon prices in 2030 and 2040, then complementary policies to guide today’s investment and retirement decisions may be needed.



Energy Climate Change and Environment: 2016 Insights

Energy Technology Perspectives 2012

Energy Technology Perspectives 2014

World Energy Outlook 2016

[1] This analyses uses 2015 information on fossil fuel prices and renewables costs. It is intended to illustrate the policy implications of varying circumstances rather than to provide up to date switching costs.