A version of this memo was published in the SAIS Perspectives here.
Executive Summary
Developing countries and cities account for more than 60% of global GHG emissions[1] but represent less than 25% of carbon pricing systems globally[2],[3]. The Green Climate Fund (GCF) can strategically leverage climate finance to incentivize carbon pricing in developing countries by conditioning mitigation and adaptation aid on instituting a minimum price for emissions.
The GCF should provide more aid and compensation for developing countries with higher carbon prices. There are two benefits to this approach. First, it provides an incentive for countries to pursue increasingly ambitious carbon prices – thus increasing trust and coordination in the global climate regime as developed countries know their donations are driving higher emission reductions. Second, the domestic revenues from carbon pricing schemes will help developing countries finance investments associated with the costs of mitigation and enable a just transition to a low-carbon economy.
By establishing carbon pricing systems in developing countries, GCF can help establish international carbon markets that open additional revenue streams. Getting involved in carbon pricing efforts gives GCF an opportunity to shape Article 6 negotiations for global carbon markets where a portion of the sale of carbon credits and emission reductions are required to go to developing countries, thus channeling additional revenue for global mitigation and adaptation efforts.
Why Focus on Carbon Pricing?
Carbon pricing is a uniquely powerful mitigation solution due to its ability to influence energy use and investment decisions across all sectors of the economy as well as being tied to emission targets which guarantee that they are met. A well-designed carbon tax or cap-and-trade system will create incentives for cost effective emission reductions in the short run and cost reducing innovation in the long run[4]. One analysis found that on its own carbon pricing could deliver almost a third of the emission reductions necessary to avoid a rise of 2°C[5]. Unfortunately, GCF has no official policy or involvement in driving this vital policy mechanism while the developing countries it supports are on pace to account for ~70% of global energy demand in the next 20 years[6].
Carbon pricing has several advantages for developing nations:
- Economy-wide Impacts: It’s a technology neutral way to incentivize economy-wide decarbonization by making it more expensive to pollute than to find lower carbon alternatives.
- Revenue Generation: It generates revenue through tax collection or permit auctions that can be used by governments to support an equitable clean energy transition through R&D, job re-training, and investment in the poorest, most polluted areas. The revenue could also be used to support U.N. Sustainable Development Goals (SDGs) or directly compensate populations affected by the shuttering of energy intensive industries.
- International Cooperation: It can serve as a focal point for international carbon pricing coordination resulting in additional revenues through the sale of carbon credits and emissions reduction that can go towards adaptation and mitigation costs.
How Climate Finance Can Spur Carbon Pricing In Developing Countries
International climate cooperation requires mutual commitments and stable incentive structures – coordinating national carbon prices is an efficient solution to achieve this. A major gap in the current Paris regime is that nations are only held to voluntary commitments which are not legally binding. If one country perceives that their decarbonization efforts are not being complemented by similar efforts in other countries, then the ambition and political will to ratchet up mitigation efforts will weaken. This dynamic has the potential to play out between developed and developing countries as the global share of emissions from developed nations continues to decrease[7]. National carbon prices are transparent and easily comparable, thus setting a floor for international cooperation and negotiations.
Conditioning climate finance aid to developing countries based on establishing a carbon price would incentivize adoption of carbon pricing systems globally. Developing countries lack the capacity and expertise to introduce carbon pricing systems and are disincentivized due to the high costs of mitigation. Indeed, even small changes to the prices of basic commodities because of a carbon price can have a significant impact on underprivileged groups. However, if they are compensated by richer countries then developing nations would be more willing to set carbon prices. The GCF should leverage its transfer payments for adaptation and mitigation on the condition that countries set a minimum carbon price. GCF can use existing funds to help establish tax collection or permit auctioning and allocation infrastructure.
Climate aid should be allocated to go more to countries who increase their carbon price over time, thus increasing ambition and trust in the climate regime. As countries start with different minimum carbon prices the hope is that they will rise and converge over time. However, GCF can accelerate this process by allocating increasing amounts of aid to those countries who increase their carbon price. In this way, developing nations continually pursue more ambitious carbon prices and developed nations will have increased trust and confidence that their transfer payments are achieving higher emission reductions.
Supporting Global Carbon Markets Offers New Revenue Streams for Mitigation and Adaptation
Establishing carbon pricing systems globally can facilitate the rules for international carbon markets under Article 6 of the Paris Agreement. Nearly half of the initial Nationally Determined Contributions (NDCS) include the use of international cooperation through carbon markets[8]. Enabling countries to effectively trade emission reductions and carbon credits across borders will be critical to the overall effort of global decarbonization. By helping establish carbon pricing systems, GCF will earn a seat at the table to ensure that carbon market rules are structured appropriately to benefit developing countries and to mitigate against the risks of double counting.
Successful international carbon markets will catalyze additional revenue streams for GCF to funnel to global mitigation and adaptation efforts. Under the Kyoto protocol a fee was levied on international emission trading and carbon credit purchases through the Clean Development Mechanism which funded nearly 30% of the U.N. Adaptation Fund[9]. Article 6.4 of the Paris Agreement would effectively replace the Kyoto Standard by ensuring that this “share of the proceeds” shall “assist developing country parties that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation” in addition to “covering administration expenses”[10]. By involving itself in Article 6 negotiations, GCF has an opportunity to open a large pool of public and private climate finance contributions to further scale its mission.
[1] Center for Global Development, “Developing Countries Are Responsible for 63 Percent of Current Carbon Emissions,” August 18th, 2015, https://www.cgdev.org/media/developing-countries-are-responsible-63-percent-current-carbon-emissions.
[2] United Nations Development Programme, “Human Development Reports – Developing Regions,” 2020, http://hdr.undp.org/en/content/developing-regions.
[3] World Bank Group, “State and Trends of Carbon Pricing 2021,” May 2021, https://openknowledge.worldbank.org/handle/10986/35620
[4] James Boyce, “Carbon Pricing: Effectiveness and Equity,” 2018, https://www.sciencedirect.com/science/article/abs/pii/S092180091731580X.
[5] Harvey, et. al, “Designing Climate Solutions,” 2018, pg. 253, https://islandpress.org/books/designing-climate-solutions.
[6] Stephen Eule, “A Look at IEA’s New Global Energy Forecast,” Global Energy Institute, November 29th, 2018, https://www.globalenergyinstitute.org/look-ieas-new-global-energy-forecast.
[7] UNFCC, “Most Developed Countries on Track to Meet their 2020 Emission Reduction Targets, but More Ambition Needed by Some,” November 23rd, 2020, https://unfccc.int/news/most-developed-countries-on-track-to-meet-their-2020-emission-reduction-targets-but-more-ambition.
[8] Kelley Kizzier, Kelly Levin and Mandy Rambharos, “What You Need to Know About Article 6 of the Paris Agreement,” December 2nd, 2019, https://www.wri.org/insights/what-you-need-know-about-article-6-paris-agreement.
[9] Carbon Brief, “In-depth Q&A: How ‘Article 6’ carbon markets could ‘make or break’ the Paris Agreement,” November 29th, 2019, https://www.carbonbrief.org/in-depth-q-and-a-how-article-6-carbon-markets-could-make-or-break-the-paris-agreement.
[10] Carbon Brief, “In-depth Q&A: How ‘Article 6’ carbon markets could ‘make or break’ the Paris Agreement,” November 29th, 2019, https://www.carbonbrief.org/in-depth-q-and-a-how-article-6-carbon-markets-could-make-or-break-the-paris-agreement.
About The Author
Chetan Hebbale is currently a graduate student at the Johns Hopkins School of Advanced International Studies (SAIS) in Washington, D.C. focused on international economics, climate change, and sustainability.
Prior to this, he spent over 4 years at Deloitte Consulting working on technology and strategy projects at the CDC and U.S. Treasury Department.
He is a native of Atlanta, GA and attended the University of Georgia.
Chetan Hebbale 