China is just one country, though a crucial one, pursuing sustainable energy transitions through a complex mixture of policies that cover multiple aspects of energy transition. VideoBlocks.com photo.

This article was published in the International Energy Agency blog on July 9, 2018.

Carbon pricing a cornerstone of energy transition

By Anita Hafner, Peter Janoska and Caroline Lee

Last December, China announced a roadmap for establishing the largest carbon market in the world: an emissions trading system (ETS) that will start at 1.5 times the size of the European Union ETS, and very likely expand further.

For the world’s largest energy consumer and greenhouse gas emitter, this national ETS is set to form a key element of its multi-layered policy approach to driving sustainable energy transition: a transition with aims not only to reduce greenhouse gas emissions, but also improve air quality, spur green economic development and enhance energy security.

China is just one country – though a crucial one – pursuing sustainable energy transitions through a complex mixture of policies that cover multiple aspects of energy transition. These policies need to drive change in all energy sub-sectors, act in both the short- and long-term, be cost-effective and support innovation and diffusion of clean technologies.

Carbon pricing is a cornerstone that can support many of these goals. As of September 2017, over 40 countries and 25 provinces and cities have adopted carbon pricing policies.

Taken together, these cover nearly a quarter of global greenhouse gas emissions. However compared to prices that would have a transformative impact on energy systems, carbon prices remain low in the vast majority of countries.

For example, in IEA’s World Energy Outlook model, carbon prices reach USD 75-100/tCO2 by 2030 and USD 125-140/tCO2 by 2040 in a scenario consistent with meeting Paris Agreement goals. These are levels far above most current domestic carbon prices.

In power generation and industry, a robust carbon price tends to drive deployment of low-carbon fuels, increased efficiency, carbon capture and storage (CCS) and early retirement of high-emission assets.

For example, high carbon prices in China would have a significant effect in reducing coal-fired power generation without CCS, particularly after 2025.

In contrast, in sectors that are shaped by consumer choice carbon pricing plays a more supportive role.

For example in transport, carbon pricing can be crucial to offset the effects of lower oil prices in a decarbonized world. However further policies such as standards, mandates and subsidies are needed to unlock more substantial technology shifts, such as electrification, advanced biofuels development and other large-scale investments for transport infrastructure, which are not driven by price alone.

Therefore in the absence of such high carbon prices, complementary energy policies are needed to fill the gaps, creating even more complex policy mixes.

These real-world policy packages will be shaped by both domestic energy transition objectives (such as economic development, climate goals, air quality, public health, energy security and access), and constraints (such as limited resources, barriers to raising energy prices, and existence of high-carbon infrastructure).

This is particularly true in power and industry. In power, regulations may be needed to actively encourage the retirement of coal-fired generation that is not CCS-equipped, something we have already seen in the UK and Canada.

In both power and industry, measures would be needed to drive deployment of technologies such as CCS and for integration of variable renewables. In transport, even further strengthening of fuel standards and subsidies for alternative vehicles could be needed to offset the lack of carbon price incentive that would otherwise have moderated transport demand from conventional vehicles.

Beyond clarifying the role of carbon pricing within a country’s policy mix, it is crucial to understand how a suite of policies interact – either positively or negatively – and seek ways to enhance coherence and alignment of the whole policy package over time. The more complex the policy mix, the more difficult this challenge becomes.

The next phase of our IEA work programme will be to tackle these questions in the context of China’s national emissions trading system as it relates to ongoing power sector reform and a myriad of other low-carbon policies on energy conservation, renewable energy, and control of coal supply and consumption.

But there will be a need by many countries around the world to further strengthen thoughtful, real-world packages of complementary energy policies to keep their sustainable energy transitions on track. The IEA will continue to contribute with our insights and analysis.

Anita Hafner, Peter Janoska and Caroline Lee are members of the IEA’s Environment and Climate Change Unit.