This Pillar articulates a vision for long-term systemic change and economy-wide decarbonisation, shaping a least cost pathway to net-zero to enable the achievement of sustainable development outcomes, whilst also addressing biodiversity loss and environmental degradation. Pillar 3 provides guidance on “how” fossil fuel developing economies can seize the transformational opportunities associated with the low-carbon transition, by pursuing green industrialisation, valuing natural capital and building low-carbon value chains with more value-added produced locally. Pillar 3 outlines strategies to accelerate decarbonisation of the power, transport, building sectors, leading to no-regrets and delivering benefits for citizens’ well-being. The Pillar also offers guidance on pricing negative externalities of carbon intensive technologies and modes of production through carbon pricing and inefficient fossil fuel subsidy reform as key steps to deliver least cost decarbonisation plans, as well as reforming fiscal systems to maximise revenue generation, while ensuring equitable distributive outcomes.
Equitable Framework and Finance for Extractive-based Countries in Transition (EFFECT)
Pillar 3. Systemic change and economy-wide decarbonisation
Abstract
3.1. Laying down the global foundations for systemic change: Resetting the relationship between importer and producer fossil fuel-based and mineral-rich developing economies
The uneven global response to the COVID-19 pandemic and ongoing climate, environment and biodiversity crises have highlighted the enormous inequality in access to finance, resources and opportunities which separates advanced economies from the rest of the world. Meanwhile, Russia’s invasion of Ukraine is having a profound impact on energy prices and food security, especially in developing countries. Despite having contributed least to climate change and suffering the worst effects from its physical impacts, developing countries have largely been excluded from accessing the climate finance they need to set their economies on a path to sustainable prosperity, while the overwhelming concentration of coronavirus vaccine deployment in high-income countries is indicative of widening inequalities between North and South when it comes to access to healthcare and basic social protection.
These facts have highlighted the limitations of the 20th century social contract, a trade-off between economic growth and productivity on the one hand, and environmental and social protection and labour rights on the other, which has defined the post-Second World War period in the Global North. While citizens in high-income countries have undoubtedly gained from improved workers’ rights and social protection, vast swathes of the rest of the world have been excluded from these safeguards. The interconnected nature of the pandemic and climate and environmental crises have highlighted the 20th century social contract’s inability to respect planetary boundaries, biodiversity and the sustainable use of natural resources (Frey et al., 2021[1]).
In parallel, the divide between the rich and the poor, both nationally and internationally, has grown rapidly, with direct implications for the climate crisis. Today, the emissions of the world’s richest 1% are 30 times higher than per capita levels consistent with a 1.5°C increase in global temperatures (Frey et al., 2021[1]), and per capita emissions in advanced economies dwarf those in developing countries. Emissions from high-income countries therefore exacerbate the worst physical impacts of climate change including pollution, rising temperatures, land degradation and extreme weather events in countries which are most vulnerable, in turn raising the cost of adaptation measures and contributing to poverty.
International finance and global debt architecture compound challenges for developing countries who face greater obstacles than their advanced economy peers in accessing affordable debt and capital. The cost of borrowing for a country in sub-Saharan Africa with a lower than investment grade rating, for instance, will be seven times higher than for an advanced economy, while perceptions of political, regulatory and payment risk mean developing countries have a far worse track record in attracting private capital in low-carbon investments than high-income countries. Meanwhile, the pandemic has led to burgeoning debt levels for many developing countries, with debt service repayments accounting for huge proportions of government revenue. Between 2019 and 2025, debt service payments on external debt will amount to 20% or more of revenues in 18 developing countries (Jensen, 2021[2]).
Box 3.1. The Great Financing Divide
The Inter-agency Task Force on Financing for Development’s Financing for Sustainable Development Report identifies the Great Financing Divide as a defining feature of the difference between advanced and developing economies in responding to the COVID-19 pandemic. Advanced economies during the pandemic were able to borrow huge amounts of money at low interest rates with long maturities, enabling them to invest in recovery and safeguarding the livelihoods of citizens and businesses. In contrast, the capacity of developing countries to respond to the pandemic was severely curtailed by a lack of access to long-term affordable debt, in spite of the fact that economic slowdowns and debt proportions as a percentage of fiscal revenue were far more pronounced in advanced economies.
Key issues for developing countries include the role credit ratings agencies play in assessing debtor risk of default. Almost all of the 61 sovereign ratings downgrades during the COVID-19 pandemic were developing countries, despite advanced economies performing worse in terms of economic slowdowns. Yet, developing countries found it harder to access long-term debt, and have had to borrow at higher rates and with shorter maturities than advanced economies, resulting in more burdensome service payment schedules, which account for a far higher proportion of fiscal revenue than in advanced economies. This has resulted in almost 60% of LDCs and LICs being at risk of debt distress or in debt distress in 2022, up from 30% in 2015. A key issue is the lack of transparency in credit rating agency methodologies, which penalise developing countries based on perceived risks.
Not only does this mean that many developing countries struggle to mobilise the necessary financial resources to invest in low-carbon transition plans, but also that over decades, public investment in essential public services and infrastructure, as well as institutional and capacity strengthening, has gradually been eroded undermining the relationship between the citizens and the state. Even before the COVID-19 pandemic, many developing countries were experiencing low productivity challenges, high vulnerability and inadequate social protection coverage. In many developing countries, an economic model premised on ready access to cheap fossil fuels affords few benefits for most of the population. Today, 785 million people around the world lack access to electricity, while 2.6 billion lack access to clean cooking solutions (IEA, 2021[4]). Meanwhile, several amplifying factors make developing countries particularly vulnerable, including pre-existing limited fiscal space, a growing burden of unsustainable debt, high levels of poverty and inequality, and more fragile health and sanitation systems, as well as widespread economic informality. At the same time, the pandemic has pushed a further 100 million people into energy poverty, while rampant inflation threatens to exclude investments in developing countries on the margins of risk acceptability from accessing finance (SE4All, 2020[5]).
Any discussion on the low-carbon transition in developing countries must recognise these realities, as well as the unequal global system that has contributed to them. A systemic rethink of the economic model is required to break the assumed link between economic growth and societal progress which has led to a resource-intensive development model characterised by inefficiency, waste and overconsumption in advanced economies and unsustainable production in developing countries.
For developing countries who have contributed least to historic emissions and whose per capita emissions are meagre compared to those of their advanced economy peers, the low-carbon transition is a development issue, entailing the simultaneous achievement of environmental, social and economic objectives as reflected in the SDGs, as well as decarbonisation. For governments to articulate compelling arguments encouraging citizens to accept the short-term costs of the transition, meaningful progress on economic, social and environmental development indicators needs to be prioritised, while balancing decarbonisation targets against their historic contributions to climate change and the realities of persistent widespread exclusion from access to affordable energy at a domestic level, as well as debt and finance at an international level.
Figure 3.1. Regional contributions to cumulative global CO2 emissions (1751-2017)
Source: Adapted from Energy for Growth Hub and the Africa Center, 2021.
Enabling a just low-carbon transition in developing countries will require shifting away from a system that perpetuates existing power dynamics and consumption patterns and the reshaping of the resource-driven global governance system. Moving away from GDP and investor credit metrics as the dominant indicators of societal progress will be key to this process. A more holistic set of indicators, incorporating human well-being and natural capital measurement, can facilitate more equitable and affordable access to international finance and debt for developing countries (SYSTEMIQ, The Club of Rome, and the Open Society European Policy Institute, 2022[6]). Global governance systems should shift from a resource-driven system of competition for and cheap access to natural resources to a system based on collaboration, mutual trust and shared benefits to preserve and regenerate natural resources and work for the well-being of people. This will require advanced economies to drastically reduce materials consumption, which at current levels is unsustainable, investing instead in circular and regenerative business models that incentivise land regeneration, as well as re-use and recycling of materials. Circular economy principles can reduce demand for scarce natural resources, while also avoiding the risk that the energy transition’s thirst for critical minerals and scarce resources, often under stress, exacerbates environmental and social injustice, resulting in an unequal sharing of the costs and benefits of mining between advanced and developing economies (Kalt and Tunn, 2022[7]).
In parallel, profound systems change in international relationships are needed to build transformative win-win partnerships (SYSTEMIQ, The Club of Rome, and the Open Society European Policy Institute, 2022[6]). Such partnerships should account for a fair share of the resources to be used to support local and regional development. This means, for example, building green mineral value chains in the countries and regions where those resources are located. Transformative partnerships between producing and importing countries should also address the major stresses to deliver human needs (i.e. water and land use), when considering the potential for generating revenue from new exports, such as green hydrogen.
Global efforts to diversify and increase resilience of critical minerals, hydrogen and renewable power supply chains offers extensive opportunities for long-lasting and mutually beneficial collaboration between developing producers and advanced economies, including through technical assistance on governance, legal and regulatory frameworks, and mitigating social and environmental risks, as well as financial support for geological mapping and technology transfer to facilitate the development of green value chains in new countries.
A global just transition should also consider the impact of climate policy making in advanced economies across borders. For instance, the EU’s Carbon Border Adjustment Mechanism (CBAM) could impose a carbon price on certain imported goods such as iron and steel, cement, fertilisers, electricity and aluminium. Meanwhile, the EU’s Green Deal and European Industrial Strategy emphasise partnerships with mineral rich economies to improve the supply of critical minerals for the transition. To avoid any unintended consequences on developing countries, importer governments will have to step up and accept the responsibility of supporting exporter governments to keep pace with change and decarbonise sectors, subject to CBAM. Without accompanying transition support, mechanisms such as CBAM could render entire industries and sectors in developing countries uncompetitive for export, with dire consequences for jobs, economic growth and poverty.
Just energy transition partnerships can help importing countries meet energy security, while providing long-term revenue certainty to underpin a transition to renewable energy generation and the growth of low-carbon industries in producing countries. This will allow them to avoid high-carbon lock-in, and enable the progressive phase-down/out of fossil sources as renewables are phased in, while also offering off-takers certainty to facilitate renewables development and provide incentives for importer countries to invest in risk mitigation and subordinate finance instruments to de-risk renewables development.
Advanced economies should:
Fulfil and exceed the annual commitment to provide developing economies with USD 100 billion in climate finance under the Paris Agreement, raising the proportion of blended finance through highly concessional loans, grants, subordinate finance, risk mitigation tools and guarantees to unlock private capital in clean investments. These efforts must recognise that USD 100 billion alone will be insufficient to meet global climate objectives and facilitate a transition which progresses at the required pace across the world. The primary goal should be to stimulate increased flows of private climate finance to developing economies.
Move first and fastest to phase-down/out domestic production of fossil fuels and prioritise energy imports from developing country producers, guided by long-term, mutually beneficial partnerships to support the low-carbon transition, through the achievement of all SDGs, including energy access and security, and consistent with an equitable global phase-down/out of fossil fuel production and Paris-aligned emissions reduction pathways (Calverley and Anderson, 2022[8]).
Importer and producer developing economies together should:
Promote the concept of a new global deal for development to underpin the low-carbon transition, based on recognition of the interplay between environmental and social justice, achievement of all SDGs, and the need to ensure developing countries possess the means to invest in effective public services, social protection, sustainable infrastructure, energy access, healthcare and education, particularly in fossil fuel producer regions and communities. Equalising access to affordable finance and debt will be critical to achieving this goal and is a necessary condition for building public acceptance for low-carbon transition policies across the world.
Establish transformative low-carbon win-win partnerships, as well as public-private partnerships for the deployment of low-carbon technology, progressive fossil fuel phase-down/out and renewables phase-in and capacity building.
Explore opportunities for partnerships between IOCs and NOCs, as outlined throughout Pillar 1, which could be based on recognition of the shared responsibility for curbing flaring and venting in producing countries (see Pillar 1, Section 1.2.3). Partnerships could be established to build capacity on measurement, verification and reporting of CO2 and methane emissions, to facilitate the flow of technical and financial support for the deployment of the best available technologies for emissions abatement, and to jointly investigate the potential for a domestic natural gas market in order to monetise any associated gas, if gas is (also) used domestically.
3.1.1. Reshaping the relationship between the state and its citizens: A necessary condition to build broad societal support for the low-carbon transition
The climate crisis and the pandemic highlight the necessity of reshaping the social and environmental contract between the state and its citizens, recognising the intrinsic links between human welfare and ecosystems. This is true everywhere, but especially in developing countries, as the welfare of the poor depends on their access to, and the quantity and quality of terrestrial and marine ecosystems, as well as of other forms of biodiversity. Developing countries are also most vulnerable to the physical impacts of climate change and biodiversity loss, such as the degradation of critical ecosystem services, sea level rise, drought, wildfires, floods and loss of life. Focusing just on economic growth, and greening later, would be much more costly than following a path now to transform to a greener, more resilient and inclusive economy, as this would entail sharper subsequent corrective measures, higher risk of irreversible environmental damage, high-carbon lock-in and stranded assets, exacerbated by adverse distributional impacts. Deploying nature-based solutions, delivering benefits to the environment and communities, as well as setting the right incentives for the preservation and sustainable use of natural resources, will be key to shaping more sustainable patterns of production and consumption. This includes building a shared understanding within society of the goals to be achieved, the steps to be undertaken, and the resources to be deployed to realise such a large-scale and profound transformation, and to obtain broad societal support to navigate through the transition.
France’s Gilets Jaune (Yellow Jacket) movement demonstrates the risks of public opposition to low-carbon policies and its potential to derail progress of the transition if burdens and costs are perceived to fall primarily on poorer citizens. For all countries, distributing the costs and benefits of the low-carbon transition equitably, and ensuring that those most exposed (including women, migrants, informal workers, ethnic, racial and religious minorities, and Indigenous communities) are not disproportionately affected by negative impacts is a necessary condition for building public acceptance of systemic decarbonisation, and overcoming political economy obstacles to correcting misaligned incentives and internalising negative externalities of fossil fuels production and use.
Structuring effective mechanisms for procedural (affected groups included in decision making), distributional (equitable sharing of costs and benefits) and restorative (compensation for environmental and health impacts) justice is key to this process and can play an important role in ensuring citizens shape a low-carbon trajectory that enjoys wide stakeholder buy-in.
Developing countries may face additional challenges in building support for low-carbon transition strategies and policies because of persistent under-investment in public services, infrastructure, healthcare and education, and the associated need for institutional and individual capacity strengthening. This, in many cases, has undermined trust in governments, with citizens less willing to bear short-term transition costs against long-term benefits for household bills and livelihoods. Where natural resource rents are owned and distributed by the state, fossil fuel producer governments are likely to face greater resistance if a record of state capture, corruption and impunity has further deteriorated the relationship between the state and its citizens.
Articulating a compelling vision that places equitable income distribution, promotion of human capital, poverty alleviation, strong public integrity policies, and environmental and social justice through inclusive decision making at the heart of the relationship between the state and its citizens, can help governments build support for low-carbon transition strategies and policies, alongside decarbonisation plans. Open and inclusive policy making, in which governments broaden the sphere of action in which citizens can influence policy choices, will help to build consensus and strengthen government understanding of citizen needs and concerns, while facilitating public acceptance and support for policy reform. Governments can also leverage digital solutions to facilitate open and inclusive dialogue with citizens, as well as multiple platforms to effectively communicate the benefits of low-carbon transition policies and what they are doing to mitigate impact on citizens who will be negatively affected.
Governments should consider prioritising the following actions:
Incorporate equity and justice issues into national development and decarbonisation frameworks, recognising the interlinkages between environmental and social justice, as well as the importance of valuing biodiversity, nature and ecosystems as core components of a sustainable, inclusive and prosperous society. Governments need to integrate this vision into development and decarbonisation frameworks, clearly articulating how the costs of transition policies on poorer households will be mitigated, and building a compelling vision as to what the benefits will be, when they can be realised and what the necessary steps are to achieve them. Moving away from an economy based on cheap access to fossil fuels should lead to a more equitable distribution of income, better access to services and sustainable infrastructure, as well as health and environmental benefits.
Prioritise strong and engaged intermediary structures, including political parties, unions, associations, community and civil society groups, providing avenues and mechanisms for them to meaningfully participate in the vision and policy design process, in line with recommendations relating to planning for a just transition included in Pillar 2.
Invest in educational and information-sharing tools and campaigns which build awareness of the risks of climate change and a continued reliance on fossil fuels, as well as outlining a vision for transformation, including how citizens can be involved.
3.1.2. Using scenario analysis to assess and manage transition risks
Traditional forecasting methods, which rely primarily on identifying trends from historic data, offer little when it comes to identifying and planning for transition risks. Instead, governments should aim to raise their capacity to integrate new techniques, such as scenario analysis, stress testing and horizon scanning, to identify risks and develop strategies to successfully manage them.
Ultimately, navigating the complexity of risks and uncertainties presented by the low-carbon transition, and taking advantage of opportunities, will entail more sophisticated, holistic and flexible policy making. This must enable governments to anticipate and adapt to changing circumstances, and should reflect national socio-economic conditions and development plans.
Scenarios may need to be revisited following unexpected geopolitical developments. For example, Russia’s invasion of Ukraine has spurred volatility in global commodity markets, causing prices for fossil fuels to rise rapidly. Future scenarios for fossil fuel production and demand will need to account for this volatility, while also addressing the weaponisation of energy exports, renewed energy security concerns and rising domestic energy nationalism which undermines international energy and trade cooperation.
Governments should consider prioritising the following actions:
Use global fossil fuel supply and demand scenarios as a common basis for the discussion of national development plans and the role of fossil fuels within them.
Consider the interaction between fossil fuel production, revenues and demand under different climate/energy transition scenarios, factoring in the costs of domestic consumption and debt servicing, and the effects of lower prices on export revenues and tax income. This will support better understanding of carbon linkages (i.e. how carbon risks would flow from the fossil fuel sector to the wider economy).
Consider the implications for the profitability and fiscal stability of the government (where significant sums of public and private finance are invested in the sector), the companies (including NOCs), as well as the sectors and economies that are most exposed to market risks (e.g. devalued or stranded assets).
Develop plans that are robust enough to address the lowest case scenario for fossil fuel investments, market prices and demand.
Consider that established fossil fuel revenues could be used to support the implementation of a green transformation strategy at home while production is exported – instead of following the traditional “fossil fuel-led” development pathways, with emphasis on the linkages between the fossil fuel sector and fossil fuel-based value chains, which would increase risks. In any case, this option is unlikely to be available to new producers, given the timeframe to market and anticipated speed of decline in oil and gas demand and prices under a 1.5°C pathway.
Actions requiring international support in contexts where government capacity is low:
When assessing the opportunity to explore for and develop hydrocarbon reserves, consider the type of oil or gas and its likely export markets, the scale of the resource, and the cost of development and production against best estimates of commercially viable production under the 1.5°C scenario, with due regard given to assumptions related to the choice and deployment of carbon abatement technologies.
Assess the resilience of current plans in the sector to gradual or more disruptive change in international and domestic energy and industrial markets, in particular in the “lowest case” scenario, where revenues are lower than expected and projects are delayed or do not reach a final investment decision.
Build capacity to undertake non-traditional forecasting techniques (which go beyond identification of trends from historic data), risk management such as stress testing and scenario analysis, as well as effective institutional co-ordination processes to facilitate government-wide collaboration on risk management. This will help governments begin to plan for unanticipated events, identify them earlier and minimise negative impacts. Important techniques include scenario development and deep dive analyses, assessing how transition risks will play out in different sectors and communities (Collins, Florin and Sachs, 2021[9]).
Consider incorporating horizon-scanning techniques into planning apparatus. Horizon planning can be used to identify weak signals of coming changes, based on which governments can plan and develop mitigation strategies (Collins, Florin and Sachs, 2021[9]).
Using scenario analysis to assess and manage risks of continuous reliance on fossil fuels
Multi-decade scenario analysis can help simulate risks of continuous reliance on fossil fuels and their impacts on national plans for revenue management and spending, energy and industrial policy. This analysis can also plot the interaction of production, exports and/or domestic consumption, infrastructure development, revenues, associated emissions and well-being indicators under different transition pathways.
This will help inform decision making regarding the fossil fuel sector, in the light of economic and social trade-offs associated with different development pathways as well as alternative options for revenue-generation, access to energy, sustainable infrastructure and sustainable economic growth.
The impact of risks associated with continued reliance on fossil fuels will vary depending on a country’s stage of fossil fuel production, the type and scale of resources, their production cost and low-carbon nature, as well as the planned allocation of production to export and/or domestic markets. These factors should be considered in macroeconomic scenario analyses conducted by central banks, regulators and ministries of finance, in line with the Network for Greening the Financial System.
Box 3.2. Scenarios for fossil fuel production and demand
Future scenarios for fossil fuel production and demand are highly dependent on assumptions about technology development and deployment, and future global climate policy. They also depend heavily on assumptions about the deployment of CC(U)S, carbon removal strategies, and on the competitiveness of “green” hydrogen produced by the electrolysis of water, versus “blue” hydrogen, produced by steam methane reforming of natural gas. Patterns of demand will also be affected by the impacts of climate change itself, which will be more severe and disruptive the less successful efforts are at meeting the Paris Agreement objectives.
Scenarios can be based on climate models or on energy systems models. The first type of model is used to study the climate effects of GHG emissions, whereas the second type considers the energy sector reforms necessary to reach climate targets. Scenarios can also incorporate climate effects and energy supply and demand across different economic sectors.
According to the IPCC’s Sixth Assessment Report, limiting global warming to 1.5°C will require global CO2 emissions to decline by about 48% by 2030 and 80% by 2040, compared to 2019 levels. To limit global warming to below 2°C, CO2 emissions need to decline by about 27% by 2030 and 52% by 2040, compared to 2019 levels. In modelled pathways that limit warming to 1.5°C, the global use of coal, oil and gas in 2050 is projected to decline with median values of about 95%, 60% and 45%, respectively, compared to 2019.
According to UNEP’s 2020 Production Gap Report, global coal, oil and gas production would need to decline annually by 11%, 4% and 3%, respectively, between 2020 and 2030, to be consistent with a 1.5°C pathway. The same report finds that countries are instead planning and projecting an average annual increase of 2%, that would by 2030 generate more than double the emissions consistent with the 1.5°C limit.
The Energy Transitions Commission finds that reaching net zero by 2050 will require electrification of 65-70% of final energy demand, versus 19% today. It will also require an expansion of the role of clean hydrogen to 15-20% of final energy demand, hydrogen-based fuels (ammonia, synthetic fuels), biomass as bioenergy or bio-feedstock for the chemical industry, and natural gas combined with CCS.
The IRENA Transforming Energy Scenario would cut fossil fuel-use by about 75% by 2050. This scenario sees emissions fall at a compound rate of 3.8% per year, to 70% less than today’s level by 2050. The largest consumption declines would take place in coal, reducing by 41% by 2030 and 87% by 2050, and oil by 31% by 2030 and 70% by 2050. Natural gas demand would increase by 3% by 2030, but would decline 41% by 2050. Under this scenario, the share of renewable energy in electricity generation would increase to 65% by 2030 and the share of renewable energy in the global energy mix would increase from 19% in 2019 to 79% by 2050.
The IEA’s Net Zero Roadmap finds that the share of fossil fuels in the global energy supply would need to be reduced from around four-fifths currently to one-fifth by 2050. Coal demand would need to be reduced by 90%, gas demand by half and oil demand by 75% by 2050. By then, electricity will account for around half of total energy consumption, with solar providing 20% of global energy demand. Due to energy efficiency improvements, global energy demand will under this projection be around 8% smaller in 2050 than it is today, although the size of the world economy will double. Clean energy investment will need to triple by 2030, to around USD 5 trillion per year up from around USD 1.4 trillion today.
The rapid drop in oil and natural gas demand in the net-zero scenario means that no fossil fuel exploration and no new oil and natural gas fields are required beyond those that have already been approved for development in 2021. Fossil fuels would still be used for non-energy purposes in sectors where the complete elimination of emissions is particularly challenging (mostly oil to fuel aviation in particular), and in the electricity and industrial sectors requiring USD 650 billion investment in CC(U)S. A small amount of unabated coal and natural gas are used in industry and in the production of energy, resulting in around 1.7 Gt CO2 emissions in 2050, which would be offset by Bio-Energy with Carbon Capture and Storage (BECCS) and Direct Air Carbon Capture and Storage (DACCS). Investment in fossil fuel-based CC(U)S could be avoided if additional investment were mobilised for extra wind, solar and electrolyser capacity, for electricity-based routes in heavy industry, and for expanded electricity networks and storage to support this higher level of deployment, with an additional cumulative investment to reach net-zero emissions in 2050, which would be USD 15 trillion higher than in the Net Zero Emissions by 2050 Scenario.
The IEA’s (2021) report on financing the clean energy transition in emerging and developing economies finds that annual clean energy investment in these economies must increase from less than USD 150 billion in 2020 to over USD 1 trillion annually by 2030 to reach net-zero emissions by 2050. These countries, which are home to two-thirds of the world population, will represent 90% of future emissions growth. However, they only receive 20% of the funding for low-carbon technologies and other green investment.
Meanwhile, the IEA’s Africa Energy Outlook 2022 notes that Africa’s industrialisation will rely in part on expanding its use of natural gas. The report states that 5 000 billion cubic metres of natural gas have been discovered in Africa, but have not yet been approved for development. This resource could provide 90 billion cubic metres of gas per year by 2030, sufficient to drive development of the continent’s fertiliser, steel and cement industries, as well as water desalination. Cumulative CO2 emissions from utilisation of this gas over a 30-year period would amount to 10 Gt, raising the continent’s share of global emissions to just 3.5%. However, the report also notes the importance of Africa leveraging its gas to primarily meet domestic needs, rather than for export, while in parallel preparing for a gradual decline in revenues from fossil fuels.
What can governments do to build capacity to develop scenarios on future fossil fuel production and demand?
Set up a team or identify a technical agency dedicated to modelling and scenario building.
Support the continuity and growth of internal capabilities by regularly updating scenarios and engaging with external stakeholders to ensure quality assurance
Build partnerships with external institutions to enhance capacity and co-develop energy models and scenarios
Disclose assumptions and data used and engage with a broad range of stakeholders, including civil society, to foster well-informed national policy dialogue.
When outsourcing scenario development, ensure that absorptive capacity exists within government to aid understanding and use of scenario results.
What can the fossil fuel industry do to support governments in developing scenarios on future fossil fuels production and demand?
Share fossil fuel production and demand scenarios at project level wherever possible
Fully disclose scenario data and modelling methodologies and help governments understand the underlying data and assumptions as well as the implications for fossil fuel production.
Explain how long-term strategies are tested against different carbon-constrained scenarios.
Explain that in order to remain sustainable and competitive, a leaner and more efficient oil and gas industry is required. This will include shortening investment cycles, developing low-carbon and low‑cost resources, minimising product losses including methane leakage, and increasing recycling and re-use of inputs such as water, as well as infrastructure repurposing, wherever technically and economically feasible.
Help governments improve understanding around the deployment of significant higher levels of artificial intelligence and automation, and remote operation and management.
Publicly disclose how company decarbonisation and sustainability plans will impact specific projects in producer countries. Fossil fuel companies – both private and state-owned – should disclose production, energy transition and responsible exit plans for their projects. They should also engage with stakeholders on the social and economic impacts that project continuation, wind down or transfer would have on host governments and communities (e.g. impacts on payments to government and local employment, timelines and decommissioning plans).
What can development finance institutions do to support governments in developing scenarios on future fossil fuel production and demand?
Provide training and capacity-building support to government technical agencies to develop scenario analysis and the capacity of ministries to understand and use scenario results.
Build partnerships to co-develop energy models and scenarios.
Provide funding to access proprietary tools for scenario development.
3.1.3. Integrating national development and decarbonisation plans
Low-carbon development integrating climate change with development objectives is a process of structural transformation that requires the elaboration of a long-term vision developed through a multi-stakeholder governance process and a coherent strategy, underpinned by a combination of consistent policy direction and careful sequencing of complementary and mutually reinforcing measures to enable an efficient and cost-effective shift to a low-emission and climate resilient economy. Long-term integrated development planning, incorporating interconnected energy, climate, environmental, macro-economic fiscal, labour, skills, industrial, infrastructure and transport policies, will be key for fossil fuel producer developing and emerging economies to align short and mid-term policy choices with long-term objectives, increase policy coherence and support implementation. Setting a long-term direction underpinned by wide stakeholder buy-in will also require articulating the benefits of low-carbon development models, which can outlast election cycles and changes in government administrations. Mainstreaming low-carbon and climate resilience development strategies into national development planning should also integrate effective Measurement, Reporting and Verification (MRV) mechanisms to regularly take stock of progress, and be sufficiently flexible to adapt to changing circumstances and the emergence of new technologies and evolving climate conditions.
This will entail taking co-ordinated and harmonised actions horizontally across multiple departments and vertically across levels of government (national, regional and local, with meaningful stakeholder engagement), all pulling in the same direction, as opposed to an array of isolated policy measures often implemented in an inconsistent manner and leading to suboptimal or even contradictory outcomes.
Just transition plans, Nationally Determined Contributions (NDCs), and national development and economy-wide decarbonisation plans should be integrated into a coherent national development and decarbonisation programme that clearly articulates how social, environmental and economic objectives will be achieved, alongside delivery of the least-cost pathway to decarbonisation. Moreover, the process of building a national development framework, coherent with the NDCs, provides an important way to build public acceptability for the low-carbon transition, if steps are taken to integrate citizens’ voices into the policy making process and the framework is delivered from the bottom up. Developing countries can also integrate conditional components into their NDCs. These are emissions reduction and avoidance initiatives and investments that are achievable contingent on the receipt of international finance, technology and capacity transfer. This is an important mechanism to hold advanced economies to account regarding shared responsibility for decarbonisation, and to clearly delineate the limits of what can be accomplished based on domestic resources alone and what will require international support. Fossil fuel producer developing countries should capitalise on efforts to diversify oil and gas supply to insist on technology and skills transfer and finance to deploy emissions abatement technologies on oil and gas production, processing and transport. This represents a key factor in maintaining market access, as well as longer-term partnerships to support deployment of renewables generation and investment in infrastructure for transmission, distribution and transport, which will be key to sustaining a longer-term move away from a dependence on fossil fuel revenue.
Achieving overall policy coherence between decarbonisation strategies and overarching development plans requires close collaboration and alignment between institutions mandated to lead on each process. In many countries, the environment ministry leads on the NDC, while the finance, economy or planning ministry is normally responsible for overall economic planning and prioritisation of development programmes through the national budgeting process, as well as being the designated recipient of international development assistance and climate finance. Imbalances in administrative capacity, established lines of communication with other government departments and levels of influence between these institutions can make it challenging to integrate NDC initiatives into the national development planning process, particularly where projects are funded through national budget allocations and compete with other spending imperatives.
Shared leadership roles on NDC development, for example, between environment and finance ministries, and clear legal mandates over which entities are responsible for which components of NDC development can help to: 1) better integrate NDC development with the broader economic planning process; 2) ensure initiatives in the NDC are adequately resourced, while aligning NDC and economic planning cycles, and 3) ensure similar stakeholders are consulted across both processes to improve policy coherence.
Clearly defined sectoral goals, based on SMART (Specific, Measurable, Agreed-upon, Realistic and Timebound) design principles bracketing targets and initiatives by sector and GHG type can support implementation, clarifying requirements for agencies responsible for oversight (Bird, Monkhouse and Booth, 2017[18]).
Table 3.1. Suggested interim measurement indicators to track decarbonisation progress by sector
Source: Adapted from (D’Arcangelo et al., 2022[19]).
Governments should consider prioritising the following actions:
Consider how to align NDC and national development planning processes, integrating planning cycles with NDC actions, and interim and long-term targets into budget allocation cycles. This process is key to aligning decarbonisation, social, economic and environmental development objectives, and balancing climate change goals.
Consider how to optimise sequencing of reforms, based on national circumstances and political economy considerations. For example, policies which lead to increased costs for certain segments of the population can be spread over time to avoid creating obstacles, while they can also risk derailing simpler, less contentious reforms which may be more straightforward to introduce.
Establish interim and long-range decarbonisation measurement indicators based on extensive industry and cross-government consultation to ensure they are ambitious yet achievable, as well as consistent with a just and least-cost decarbonisation pathway and complementary to overall development objectives. Basing these targets on SMART design principles will facilitate oversight from implementing agencies (Bird, Monkhouse and Booth, 2017[18]).
Consider how to align and harmonise authorship and ownership of NDC and national development planning, particularly in contexts where the former is led by the environment ministry and the latter is led by the finance or economy ministry, which may carry more weight in cross-governmental administration and engagement processes. Joint ownership between the environment and finance or economy ministry can ensure both institutions pull in the same direction in integrating decarbonisation and development goals. An inter-governmental co-operation agency or commission with a strong mandate can help to facilitate this process, ensuring policy making adheres to high-level climate and development goals.
Clearly delineate which NDC targets are achievable with domestic resources only, and which are conditional and can be achieved upon receipt of technology and skills transfer and financing from international partners. Clearly defined and costed activities, which are accompanied by a clear rationale as to how they will contribute to further emissions reduction beyond what is considered unconditional in the NDC, will facilitate access to international support, and can support discussions with importer governments and development finance institutions to make this support a reality.
Actions requiring international support in contexts where government capacity is low:
Invest in robust MRV systems and build cross-sectorial capacity to monitor, follow-up and report on progress against emissions reduction targets as an important requirement for attracting climate finance and guarding against greenwashing, and to enable timely changes to policy direction when measures are not working or prove to be counterproductive to overall achievement of least-cost transition outcomes.
3.1.4. Mobilising transition finance
The IEA Net Zero report states that “for many developing countries, the pathway to net zero without international assistance is not clear. Technical and financial support is needed to ensure deployment of key technologies and infrastructure. Without greater international co‐operation, global CO2 emissions will not fall to net zero by 2050” (IEA, 2021[20]).
In developing countries, uptake of green finance has been significantly slower than in advanced economies. Less than 20% of USD 1 trillion of green bonds issued globally are from developing countries. Between them, Latin America and Africa combined make up less than 3% of global green bond issuance. For the world to achieve the objectives of the Paris Agreement, international support is needed to enable access to finance for countries with high emissions, including their NOCs and heavy industries. However, high emitters frequently do not qualify for green finance, as they do not meet the required benchmarks or criteria for GHG. The slow uptake of green finance in emerging economies raises the question of whether it is fair to impose the same benchmarks and criteria used in advanced economies on developing economies that are already struggling to provide basic services to their populations. Furthermore, under current criteria, countries that score low on environmental, social and governance (ESG) performance standards, but make genuine efforts to improve would not be able to access green finance.
Box 3.3. What is transition finance?
Transition finance has recently been gaining traction as a complementary approach to existing green finance instruments that, in the area of climate change mitigation, tend to focus on providing and mobilising finance for economic activities and projects that are already low- or zero-carbon. To date, transition finance is a nascent and evolving space and as such does not currently have a commonly agreed definition. However, a 2021 OECD review of related approaches and instruments found that existing approaches tend to view transition finance as being intended to decarbonise economic activities or entities that are currently 1) emissions-intensive, 2) may not yet have a zero-emission alternative economically available or credible in all contexts, 3) but are important for socio-economic development.
In this context, transition finance is considered a promising avenue for mainstreaming climate transition considerations in finance and across corporates, especially when supporting energy-intensive and hard-to-abate sectors to decarbonise. Transition finance-related instruments and approaches have, however, been criticised by financial market participants and civil society for creating greenwashing risks and showing a lack of environmental integrity. This is further compounded by the heterogeneity of existing transition finance approaches, which can be difficult to compare across jurisdictions and markets. One of the key risks is creating carbon-intensive lock-in through investments into emissions-intensive assets or infrastructures with a long lifetime. Even if those investments are aimed at efficiency improvements and emission reductions, absolute emissions of the targeted assets and infrastructures may remain too high to be consistent with the temperature goal of the Paris Agreement. A key challenge in transition finance is to balance these risks when ensuring environmental integrity and preventing emission lock-in, while remaining inclusive of sectors and geographies in need of finance for their climate transition.
The OECD Guidance on Transition Finance applies to corporates and posits that to prevent greenwashing and support cross-border co-ordination in the transition finance space, transition finance transactions should be based on credible corporate climate transition plans. This can ensure that there is an entity-wide strategy behind the related financial instrument, including mechanisms to prevent carbon-intensive lock-in for assets and infrastructures at risk. The guidance therefore proposes that transition finance should be understood as “finance deployed or raised by corporates to implement their net-zero transition, in line with the temperature goal of the Paris Agreement and based on credible corporate climate transition plans”. It sets out ten key elements of credible corporate climate transition plans, such as target-setting and reporting on progress, and proposes modifications for small- and medium-sized enterprises as well as certain corporates operating in emerging markets and developing economies, in order to allow for inclusiveness. While the guidance focuses on non-financial corporates, many of its elements can also apply to other entities, including, for example, national and municipal administrations.
Source: Authors based on (OECD, 2022[21]); (Tandon, 2021[22]).
Transition finance complements green finance
Compared to green finance, transition finance often refers to finance that targets progress on climate and environmental parameters, rather than only satisfying certain climate and environmental thresholds or criteria (see Box 3.3 for further background on transition finance). Whereas green budgeting and reporting, green financial instruments and green taxonomies, as well as other green finance-related tools, can be used in a static manner by stakeholders to inform their investment decisions, transition finance aims to be more forward looking and dynamic (Box 3.4 clarifies the difference between green, sustainability-linked and transition financial instruments such as bonds). Transition finance does not necessarily require countries or companies to have achieved certain performance standards today to be eligible for financing, but instead provides finance for countries and companies that set themselves on an ambitious and verifiable path of transition, including performance milestones and targets to be met over a certain period, measured by pre-defined and verifiable KPIs and metrics. For example, under some existing transition finance approaches, equity investments in existing natural gas projects could be linked to progress towards eliminating emissions from natural gas production for hydrogen or from existing natural gas-fired power plants by applying CC(U)S to the flue gases from natural gas-powered plants or to the design of transition ready and future-proof infrastructure (see also Pillar 2, Section 2.3). Without transition finance, emerging and developing economies with energy-intensive and hard-to-abate sectors could be excluded from the financing that they need to transform their energy systems and, more broadly, their economies, while advanced economies continue to decarbonise.
An important challenge for transition finance in emerging and developing economies is to balance environmental credibility with inclusiveness, by creating credible criteria and mechanisms whereby this financing is allocated, including mechanisms for monitoring, verification and reporting of progress on climate and environmental parameters, and to prevent carbon-intensive lock-in.
Box 3.4. Bond instruments to support the climate transition: Green, sustainability-linked and transition bonds
Interest in green and transition finance continues to grow, as an increasing number of companies, financial institutions, and jurisdictions across the world adopt net-zero targets. In this context, fixed-income instruments are gaining traction in green finance more generally, but especially in the transition finance space. To date, most transition finance-related instruments are sustainability-linked bonds and loans, although a new denomination of transition bonds is also starting to emerge. Green bonds are also often included in the transition finance discussion, despite their narrower focus on low- and zero-emission projects, as they are a key building block in an issuer’s overall climate transition. For example, ICMA’s Climate Transition Finance Handbook takes the view that a “transition” denomination should communicate an issuer’s strategy to align with the Paris Agreement goals. This means that a “transition bond” could be either a green, sustainability, sustainability-linked or a transition bond, if it contributes to the issuer’s climate transition strategy.
Green bonds
Green bonds are generally use-of-proceeds instruments whereby the funds raised are used to finance or refinance projects or assets that are deemed eligible through a project categorisation or taxonomy. Funds raised through green bonds are committed to projects that contribute to climate or environmental objectives, such as investment in renewable energy or zero-emission transport. The most prominent standard for green bond issuances, both by private and sovereign issuers, is the International Capital Market Association (ICMA) Green Bond Principles, which are voluntary process guidelines to “promote integrity in the development of the green bond market” by providing clarity on the approach to issuance, transparency and disclosure.
Sustainability-linked bonds
Sustainability-linked bonds are performance-based instruments that allow companies to raise finance for general purposes, while setting out sustainability performance targets that need to be achieved by the issuer. The bond’s finance terms, such as the coupon, are linked to these targets and vary depending on whether the issuer achieved the predetermined target. Targets can generally cover several sustainability-related dimensions, including climate, environmental and social elements, though nearly 60% of issuances in Q1 2022 specifically targeted GHG or carbon emission reductions. For this reason and because sustainability-linked bonds are accessible to issuers from all sectors and geographies, they are considered as a promising financial instrument for transition finance.
Transition bonds
Transition bonds are a very recent market segment, with to date less than 20 issuances explicitly labelled as such and mostly issued by non-financial corporates in Asia, using the ICMA Climate Transition Finance Handbook. The Climate Bonds Initiative (CBI) is currently undertaking work on a dedicated transition label, which would define transition bonds as use-of-proceeds instruments, used to finance specific economic activities and projects that are compliant with CBI’s criteria, in a manner similar to green bonds.
Source: Authors based on (OECD, 2022[21]); (Tandon, 2021[22]); (ICMA, 2020[23]); (ICMA, 2021[24]); (CBI, 2022[25]); (CBI, 2022[25]).
Governments should consider prioritising the following actions:
Establish frameworks that ensure verifiable progress towards commitments under NDCs.
Adopt regulatory requirements for corporate disclosure on environmental risks in line with the Taskforce on Climate-Related Financial Disclosures (TCFD). Monitor progress of the International Sustainability Standards Board (ISSB)’s work on sustainability disclosures, which builds on recommendations of the TCFD, to enhance provision of information on sustainability-related risks and opportunities necessary for investors to assess enterprise value (IFRS, 2022[26]).
Actions requiring international support in contexts where government capacity is low:
Foster standardisation of transition finance guidelines, standards and definitions, on how to measure sustainability performance, including relevant KPIs, as well as mechanisms to guard against risk of greenwashing, to provide investors with the necessary information to assess the credibility of transition plans and monitor implementation.
Consider issuance of domestic currency transition bonds to build a liquid sovereign transition bond market for domestic investors. This will be contingent on development of guidance and standards for sovereign transition bonds, which enable investors to assess the credibility of transition plans, progress against them and guard against greenwashing.
Criteria for issuing sovereign transition bonds could include 1) the allocation of responsibility for verification and reporting of transition bond proceeds, 2) establishing criteria for verification and reporting on bonds; and 3) ring fencing of sovereign transition bonds proceeds from the general budget.
Establish a local corporate transition bond index.
What can financiers do?
Local commercial and investment banks can seek out protocols for transition bond issuance and develop internal processes to identify eligible projects, including by seeking clients with credible climate transition plans. OECD guidance on transition finance can help identify relevant corporates with credible transition strategies.
Banks can provide more efficient foreign exchange hedging to mitigate the risk of currency volatility for foreign investors venturing into local markets.
Local investors (including pension funds) can demonstrate a stronger interest in transition bonds, and in providing new green retail products.
Index providers can create local corporate transition bond indexes when appropriate.
What can government and financiers do together?
Bond issuers (sovereign and corporate) can contribute to long-term market creation by 1) incorporating long-term risks to their economies and business models, 2) building system resiliency, and 3) cultivating a new set of investors and building credibility by establishing a history of issuance for transition bonds.
Provide training on the process and benefits of issuing transition bonds.
What can development finance institutions do?
Provide guarantees tied to transition bonds. Possibilities include a basket of bonds in which development finance institutions take the first-loss (equity) tranche.
3.2. Economic diversification
With some countries expected to see a 51% drop in government oil and gas revenues, as a result of the shift to a low-carbon world over the next two decades, economic diversification, including through economy-wide decarbonisation, is an imperative for fossil fuel-producer emerging and developing countries, to set their economies on a pathway to sustainable growth. This is particularly the case for countries that are dependent on oil and gas for 60% or more of their fiscal revenue, and in some cases above 90% (Coffin, Dalman and Grant, 2021[27]). Economic diversification, in addition to increasing resilience to external shocks through reducing dependence on few sectors or commodities, can help to decouple government spending from price fluctuations, create quality jobs and broaden the tax base, as well as reduce pollution and environmental degradation by moving away from fossil fuel-intensive industries. This strategy can also contribute to strengthening the contract between the state and its citizens, given the positive correlation between broader taxation, citizens holding government to account, improved public spending, and more inclusive and improved policy making. Fossil fuel revenue can provide an important avenue for governments to fund strategic and targeted investments to set the foundations for economic diversification and to stimulate productivity and competitiveness in the private sector. For example, Ghana’s One District, One Factory scheme uses oil revenue to build a factory in each of the country’s 260 districts to promote export competitiveness, while Saudi Arabia’s Public Investment Fund has allocated USD 1.1 billion to support SME development.
Fossil fuel producer emerging and developing economies should adopt strategies to build diversified, value-added economies, characterised by increased productivity of non-fossil fuel private sector firms and diversified export revenue. Ultimately, no single sector or industry will be able to replace revenue from fossil fuels, and the process of diversifying and transforming the economy will be a lengthy and uncertain endeavour, requiring long-term vision, with few guarantees of success.
Governments can play a role in correcting market failures and misaligned incentives to investment, production and consumption that are environmentally harmful and exacerbate fossil fuel path dependency, while at the same time clearing the way for the uptake of cleaner substitutes (see Pillar 3, Section 3.3). However, this can be challenging given the established and widespread availability of cheap carbon-intensive products and infrastructure which benefit dominant, incumbent industries and in which large volumes of capital have been invested. Addressing this imbalance requires raising the competitiveness of new sectors.
Through improved public-private co-ordination, involving public-private dialogue processes and programmes to create and identify opportunities for private sector investment, governments can set an enabling environment through which they can manage the transition away from fossil fuel dependence and scale up low-carbon technologies. This process requires a long-term but flexible vision, as well as an institutional structure enabling the identification of opportunities that align with national development objectives and circumstances upon which government and industry can build together. Rather than trying to pick winning sectors from the outset, governments can pursue a flexible portfolio of potential options emerging from public-private dialogue and identify the most appropriate enabling measures. Effective feedback loops and constant, proactive engagement with industry and business is vital to incorporating lessons learned into adaptive and integrated policy making, with government participation in industry networks and associations feeding back into government plans. A core function of government’s role is to ensure experimental programmes take place to test what technologies work in the local context and how they should be adapted, and that resulting lessons are fed back into government policy making and support for businesses (Alternburg and Assmann, 2017[28]).
Box 3.5. Key transition management elements for developing countries to overcome fossil fuel dependence and phase-in low-carbon technological substitutes
1. Plan proactively as an initial step, including the development of a long-term vision and a clear roadmap with interim goals and steps.
2. Communicate early and clearly with investors and the private sector about the intended vision and roadmap to achieve policy objectives. Involve stakeholders, including manufacturers, business associations and standardisation bodies, as early as possible in the process to identify innovations and opportunities that are best suited to the national context.
3. Carefully select a portfolio of options to provide with government support, ensuring that the selection is reviewed by independent experts to avoid capture by lobby and interest groups.
4. Pursue a sequential approach to providing support to greener technologies, tightening restrictions, applying charges and removing preferential treatment for fossil fuel-intensive businesses.
5. Explicitly include policy learning in the process of phasing in low-carbon technologies, ensuring that policy making builds on lessons learned, and feedback mechanisms are in place to end public support if it is shown not to be working.
6. Leverage multiple available policy options, including mandates, market pull policies, research and development, skills and capacity development, and standards and certification, based on analysis of local context and engagement with consumers and the private sector.
7. Invest in quality control and assessment mechanisms, including technology testing, to build confidence among consumers in new low-carbon technologies.
Source: (Alternburg and Assmann, 2017[28]).
For the most part, countries with limited but high potential domestic technology manufacturing capabilities will be late-comers to the market, and will be catching up with established manufacturers. One way to build domestic manufacturing skills, expertise and know-how would be for governments to support firms to invest in assembly, with future potential for manufacturing in specific low- and medium- tech green products (e.g. solar heaters, solar water pumps, solar driers, drip irrigation systems, rainwater harvesting technologies or LPG, LNG or ethanol cooking stoves), or to promote manufacturing of components for renewables technology or batteries for domestic deployment and exports (e.g. blades for wind turbines, or PV modules, and mirrors). This strategy has notably been employed by China, a late-comer to solar photovoltaic components manufacturing, but now the dominant player, as well as Chinese Taipei in the electronics sector. India’s National Mission on Transformative Mobility and Battery Storage, which aims to develop gigascale manufacturing in five years, also employs this strategy, initially focusing on battery module and battery pack assembly, and at a later stage progressing to battery cell manufacturing as the firms’ capacity improves (Kumar and Shrimali, 2020[29]).
However, pursuing a bottom up or catch-up strategy still requires good choices as to which products are likely to be successful. Governments need to undertake a baseline assessment and build credible and reliable statistics on existing industry capacity, raw materials, energy availability and financing, size of local enterprises, level of participation in value chains, supplier landscape and institutional capacity for skills and small and medium-sized enterprise development to inform strategic planning, required skills upgrading and technical training activities, as well as potential government incentive schemes and support measures. Industry demand analysis is also key to building economies of scale necessary to drive costs down and take advantage of potential export opportunities.
Regional co-ordination has strong potential to create market demand at scale, and avoid overlap between countries in terms of manufacturing capability and co-ordinating roadmap development to foster technology transfer and collaboration on financing. Additionally, joint ventures or strategic partnerships with advanced economies can support technology transfer and financing.
Figure 3.2. Fiscal dependence on oil and gas revenues by country (2015-18 average revenues as a percentage of total government revenues)
Source: (Coffin, Dalman and Grant, 2021[27]), Beyond Petrostates: The burning need to cut oil dependence in the energy transition, Carbon Tracker Initiative, https://carbontracker.org/reports/petrostates-energy-transition-report/.
Many fossil fuel producers are well placed to respond to growth in demand of green products, fuels and services given established energy and trade infrastructure, such as ports, pipelines and storage facilities, a skilled workforce familiar with producing, converting and handling energy fuels and products, and existing energy trading relationships (IRENA, 2022[30]).
In parallel, fossil fuel producer governments should pursue horizontal or non-sector-specific, broad-based policies which aim to build a thriving SME sector as an engine for quality job creation – especially in contexts with rapidly growing young populations who will need jobs – and to drive innovation and competition, with a view to integrating firms into regional and/or global value chains (GVCs). Participation in such value chains represents a central challenge for developing countries, many of whom are distant from manufacturing hubs, and face high transport costs. This is particularly the case for countries in Latin America and sub-Saharan Africa. Participating in higher value-added segments of the value chain, which create skilled jobs and higher income, rather than, for example product assembly, can be difficult to achieve in the face of international competition. Broad-based measures to improve the business environment, including streamlining business registration processes and revising bankruptcy rules, alongside policies to attract foreign direct investment in promising sectors, such as establishment of special economic zones, ideally linked to resource corridors offering improved shared infrastructure for multiple sectors, can help to enhance the quality and efficiency of SMEs, ultimately enabling them to compete with international peers.
Facilitating access to finance for SMEs is one of the most transformative changes governments can introduce. If finance is deployed strategically and targeted towards a company’s development needs, it can enable a firm to invest in the skills, business intelligence, design capacity, processes and equipment it needs to innovate, upgrade its products and build efficiency, to better compete on price and quality with international peers. Access to finance is a central impediment to upgrading firm productivity in developing countries, where the banking sector is often undercapitalised and few financial products are available for SMEs. In fossil fuel-producer countries, fossil fuel revenue flows directly from NOCs to governments without passing through the banking sector, leading to a situation in which the country is income rich, but banks are cash poor. In these circumstances, governments can try to address this balance by targeting SME financing programmes through the local banking sector, or through other financial intermediaries, such as a Strategic Investment Fund (SIF) to raise firm productivity and competitiveness.
Some fossil fuel producers have adopted vertical diversification strategies focused on industries linked to fossil fuels further down the value chain, such as chemicals and plastics manufacturing. Saudi Arabia’s Vision 2030, for instance, aims to expand the country’s existing petrochemicals industry. For a few fossil fuel producers, particularly those with low-cost production and competitive existing downstream industries, this can be an effective way to diversify revenue and monetise existing reserves. However, for the overwhelming majority of fossil fuel producer emerging and developing countries, which lack a comparative advantage and trade relationships in these downstream sectors, and without enabling infrastructure in place, the downside risks of vertical diversification will be too high, particularly given the high cost of abatement when cross-border carbon pricing mechanisms, such as the EU’s CBAM, kick in in the middle of the current decade. These countries are better off adopting broad-based measures to stimulate the competitiveness of non-fossil fuel sectors.
Box 3.6. IEA’s support for producer economies under the Clean Energy Transitions Programme (CETP)
Through its Clean Energy Transitions Programme (CETP), the IEA is working with producer economies to leverage their existing capacities and competitive advantages in traditional energy forms towards clean and low-carbon energy technologies. The aim is to help countries chart a low-carbon pathway for their own growing energy demand, while also exploring export opportunities for emerging low-carbon energy sectors, such as hydrogen.
This is a broad-ranging programme that cuts across the work streams of the IEA. It includes supporting renewable and clean energy deployment through policy reform; navigating the pathways available to countries seeking to implement national hydrogen strategies; and bolstering economic resilience through the promotion of local value chains. The programme functions through high-level dialogue; tailored support for national policy development; and thematic workshops and training. The programme has successfully put on the international agenda the unique challenges faced by this unique subset of countries, hosting with Oman a “Ministerial Dialogue on Clean Energy Transitions and Economic Resilience in the MENA region” in September 2021, while the IEA Executive Director published a joint opinion article with the Deputy Prime Minister of Iraq on the importance of climate action in producers.
The energy transitions in the producer economies programme supports the IEA’s ongoing work by feeding lessons learned and data collected from producer economies back into IEA analysis and publications, such as the World Energy Outlook, Energy Technology Perspectives and Renewables Market Report.
Governments should consider prioritising the following actions:
Consider strategies for economic diversification at the earliest possible opportunity, especially for communities in fossil fuel producer regions, recognising that a broad-based approach which incorporates horizontal, or non-sector specific policies, alongside targeted green industrial policy, will maximise chances of success in a highly competitive and constantly evolving global market place. Governments should recognise that economic diversification is a long-term process, requiring constant adjustments to policy making to ensure overall value for money, and to support projects which bear fruit, while abandoning those that are less successful.
Promote strong SMEs which can innovate, take risks and grow, as this is key to accessing regional and/or GVCs, creating quality jobs and broadening the tax base.
Facilitate access to finance for SMEs, as this is key to help them make the necessary investments in strategy, human resources, processes, equipment and research and development, to become competitive in the international marketplace, and move into higher-value segments of the value chain. Fossil fuel producer governments can look to channel finance to SMEs through financial intermediaries in contexts where the domestic banking sector is under capitalised. Financing should be targeted to the development needs of SMEs, and based on clear strategies to grow and export.
Provide missing inputs and services. Education, human capital, and access to quality and affordable services and infrastructure, including transport, trade-related infrastructure, broadband and reliable electricity are key to setting the foundations for non-fossil fuel private sector growth and encouraging foreign direct investment.
Address non-tariff barriers, such as land permitting, access to electricity and intellectual property rules, as this can incentivise investment, both domestic and international, to boost productivity and participate in regional and/or GVCs.
Prioritise measures which promote upskilling, technology transfer and development of local SMEs through strong linkages between international and domestic firms.
Assess how export revenue from fossil fuels can be deployed to support economic diversification policies and incentives through the long term. Deploying emissions abatement technologies, in line with Pillar 1, will be crucial to maintain market access for fossil fuel exports through the medium term, but revenues should be deployed to support investments in sustainable, low-carbon infrastructure, particularly transport, broadband and energy, as well as to reinforce diversification strategies.
Carefully assess the potential benefits, risks, costs and trade-offs of pursuing a dual-track approach to diversification which incorporates investments in downstream industries related to fossil fuels, for example, abated gas utilisation or chemicals manufacturing. Governments should only consider vertical diversification strategies on the basis of existing competitive advantage and rationale for investment (e.g. existence of proven reserves, enabling infrastructure and a market).
Governments should also consider regional disparities by identifying and encouraging opportunities for economic diversification in fossil fuel producer regions. This requires the establishment of forums to build dialogue with local governments and business associations in order to develop assessments of opportunities. Based on these, roadmaps for regional economic development can be built and play to the strengths of local industries in terms of jobs and support for SME development (OECD, 2020[37]).
Assess the product space and national comparative advantage to determine which green tech products, services and components are best suited for local development. This is likely to be products and components where skills, infrastructure and knowledge requirements are not too distant from existing products and services already under production, and for which there is significant domestic and regional demand to enable firms to build economies of scale in order to drive costs down, which will be key to being competitive in international markets.
Assess market size, or the extent of potential demand, as this will play an important role in establishing which products will achieve economies of scale, an important factor in driving down costs and building firm competitiveness against international peers.
Assess existing manufacturing capabilities for assembly and component manufacturing, as well as potential for technology partnerships. This should be paired with a gap analysis to identify gaps or required investments to develop enabling infrastructure, local skills and manufacturing potential, and to meet global quality standards.
Deepen understanding of low-carbon technology products, value chains and investment flows to base informed decisions on attracting investment.
Raise awareness and share information with commercial banks on green products market potential, encouraging them to develop new financial instruments and products to support firm development.
Encourage investment in enabling trade-related infrastructure and special economic zones to promote export clusters.
Set clear objectives and time-bound metrics for governments to assess the success and failure of incentive schemes and SME financing. These should be regularly reviewed in order to avoid wasteful public spending, while recipients of state support should be under constant evaluation to ensure finance and incentives are directed at firms with the most potential.
Create a level playing field between fossil fuel-intensive products and services and green equivalents. This requires the removal of inefficient fossil fuel subsidies and internalising externalities through incremental carbon pricing or other regulatory measures, such as mandates or bans on certain carbon-intensive products and services, as outlined in Pillar 3, Section 3.3.
Regional memorandums of understanding and co-ordination on roadmap development for specific green industrial clusters can help to expand markets for firms to reach economies of scale, encourage technology transfer and pool financing, while avoiding overlaps in terms of which products and services neighbouring governments choose to support.
For late market entrants, consider a bottom-up or catch-up approach to developing manufacturing know-how, and capacity to compete on quality and price.
Actions requiring international support in contexts where government capacity is low:
Joint venture partnerships with advanced economies can support technological and skills transfer in target sectors.
3.2.1. Producing hydrogen and derivatives
For many fossil fuel-producer emerging and developing countries who have access to abundant, low-cost renewables and water resources, or large volumes of natural gas which can be produced and abated cheaply, production of hydrogen and hydrogen derivatives may offer an attractive means by which to diversify the export base, and a vital source of foreign exchange as fossil fuel exports gradually decline. Abundant solar and wind resources in many fossil fuel-producer developing and emerging countries can enable the conversion to green hydrogen as renewables generation in their power systems is gradually expanded. In fact, a number of developing and emerging economies have a strong track record in electrolysis, the process of producing hydrogen from water, albeit powered by fossil fuels rather than renewable energy. This is the result of efforts to improve food security through production of hydrogen for domestic fertiliser manufacturing: India installed 106 MW of electrolyser capacity in 1958, Zimbabwe 74.8 MW in 1975, and Egypt 115 MW in 1960, indicating the presence of a track record and know-how when it comes to hydrogen on which many countries can build (De Sisternes Jimenez and Paul, 2020[38]).
Many fossil fuel producer countries are well placed to invest in hydrogen development, given existing energy infrastructure, including gas storage, and transport and ports, which can be repurposed to accommodate hydrogen production; a skilled workforce which is used to handling, converting and processing energy fuels; and existing energy trade links (IRENA, 2022[39]).
The global market for hydrogen is expected to grow rapidly over the next 30 years, accounting for up to 12% of final energy consumption by 2050, two-thirds of which will be green hydrogen produced from renewables, with the remaining one-third produced from abated thermal consumption of natural gas, with emissions capture through CC(U)S. Current hydrogen sales stand at USD 174 billion, roughly equivalent to sales of Liquefied Natural Gas (LNG), but according to some estimates, could reach annual volumes of USD 600 billion, with a total investment value of USD 11.7 trillion by 2050. This would require installed electrolyser capacity and the technology to convert water into hydrogen, in order to rise from approximately 0.3 GW to 5 000 GW by 2050, two-thirds of which will be produced from renewable energy. Green hydrogen is expected to compete with blue hydrogen on a cost basis by 2030, with cross-border trading set to scale up through the 2030s (IRENA, 2022[39]).
As renewable energy ramps up, fossil fuel producers with low-cost low-carbon gas, as well as abundant renewable energy potential, have an opportunity to progressively shift away from hydrogen production from abated thermal consumption of natural gas, with strict methane emissions requirements and CO2 emissions captured through CC(U)S, towards green hydrogen. This strategy is currently being pursued by Oman, Saudi Arabia and the United Arab Emirates (IRENA, 2022[39]).
Net-zero targets set by advanced economies are largely unachievable without substantial hydrogen imports, a fact which is enshrined in the EU Green Deal and EU Hydrogen Strategy, which outlines plans to co-operate with the African Union on hydrogen and hydrogen derivatives supply. The European Union’s REPower Plan, which aims to reduce dependence on Russian fossil fuels and fast forward the green transition, has set a target for 10 million tonnes of domestic hydrogen production by 2030, and a further 10 million tonnes of imports by the same year (European Commission, 2022[40]). Win-win partnerships between advanced and developing economies can encourage technology, finance, skills transfer and investments, as well as improve project bankability by providing predictable revenue streams. They can also help meet both the domestic needs and long-term supply requirements of importer economies. In fact, over 30 countries, including a number of emerging and developing economies, have outlined hydrogen development roadmaps, and there are a range of bi-lateral agreements between advanced and developing economies to promote development of the industry with the view to cementing long-term supply agreements.
Box 3.7. Emerging and developing country hydrogen strategies and bi-lateral hydrogen development agreements
A number of developing and emerging countries have developed national hydrogen development strategies, with a growing number of bi-lateral hydrogen development and supply agreements:
In February 2022, South Africa’s Department of Science and Innovation launched its Hydrogen Society Roadmap, which outlines steps to develop 15 GW of electrolyser capacity by 2040.
Morocco’s National Hydrogen Commission published its hydrogen roadmap in 2021. By 2030, the country plans to produce 4 TWH for the local market and 10 TWH for the export market, requiring development of 6 GW of new renewable energy capacity, which could create 15 000 jobs.
Egypt installed a 100 MW electrolyser project in December 2021 and has plans for a new 100 MW electrolyser facility for production of green ammonia. The country aims to launch its USD 40 billion hydrogen strategy in 2022, which includes plans for 1.4 GW of electrolyser capacity by 2030.
Chile launched a green hydrogen strategy in 2020. This aims to establish 5 GW of electrolyser capacity in 2025 and 25 GW by 2030, with plans to produce the world’s cheapest hydrogen by 2030, and to become one of the world’s top three hydrogen exporters by 2040.
Colombia’s National Hydrogen Strategy and Roadmap (2021) outlines plans to facilitate development of a green hydrogen industry, taking advantage of the country’s abundant renewable energy potential, and outlining a plan to deliver cost competitive green hydrogen by 2030. The strategy also considers production of blue hydrogen, using CC(U)S to capture emissions, while Colombia’s Energy Transition Law describes fiscal incentives for production of green and blue hydrogen.
In addition, a number of advanced economies have established inter-governmental hydrogen agreements to encourage technology, skills and finance transfers, and to secure potential future supply agreements. Germany, for example, has established supply agreements with Australia, Chile, Morocco, Namibia, Tunisia and Ukraine.
In addition to diversifying the export base, hydrogen currently offers the only viable way to decarbonise hard-to-abate sectors, such as chemicals, steel, haulage, aviation and shipping. These sectors are key to building the necessary demand at scale to increase the commercial viability of the hydrogen industry, and can create a virtuous cycle between decarbonisation efforts and sustainable industrial development. Developing countries with lots of cheap renewables can position themselves as green industrial hubs for hard-to-abate sectors, such as steel and cement, which will need access to abundant green hydrogen and for which global demand will continue to expand in line with the growing global population, industrialisation and urbanisation. The OECD published a Green Hydrogen Opportunities for Emerging and Developing Economies report which focuses on business models, including for integrated green hydrogen/green steel projects, and provides a checklist to help policy makers build an enabling environment for implementation of a green hydrogen strategy, addressing barriers to investment as well as assessing financial solutions to support deployment of green hydrogen (Cordonnier and Saygin, 2022[44]).
Integrating domestic hydrogen production into energy systems can help to reduce dependence on exports while decreasing attendant price volatility, and provide grid stability by enabling energy storage. This can help quicken the addition of renewables generation to the grid for countries suffering intermittency issues. Meanwhile, regional co-operation on hydrogen infrastructural development, cross-border regulation and free trade agreements can support demand creation to increase the commercial viability of regional hydrogen industries.
For remote areas with no energy access, or which are reliant on electricity generation from diesel, hydrogen could help reduce the cost of electricity to communities and remote industrial facilities, such as mines. This is because cheaply produced hydrogen from renewables can be trucked or piped long distances, as well as stored on site for later use, generating electricity at the end location far more cheaply than can be achieved by connecting these zones to the grid.
Furthermore, countries whose power systems rely heavily on turbine-generated thermal power can consider replacing diesel and gas with hydrogen through power plant repurposing, thereby reducing the upfront CAPEX requirement for new power projects, providing baseload power and utilising carbon intensive assets which could otherwise become stranded. Indonesia, South Africa, and Trinidad and Tobago are experimenting with replacing diesel-fired power generation with methanol and ammonia alternatives for use in telecommunications towers. Lastly, hydrogen can support the decarbonisation and depollution of urban areas through the replacement of conventional fuels in public transport with fuel cell transport. China, Costa Rica and Malaysia have introduced fuel cell buses, while India is considering requiring refineries and fertiliser plants to incorporate some green hydrogen into their feedstock (IRENA, 2022[39]).
Box 3.8. Financing and business models to facilitate green hydrogen development
Scaling up green hydrogen production will require a massive investment effort. Global estimates point to a range between USD 500 billion and USD 1 500 billion between now and 2030 to put the hydrogen sector on a path consistent with global net-zero emissions by 2050, including investment in green hydrogen manufacturing equipment, production sites and infrastructures for the transportation and distribution of hydrogen. Investments will also be needed across the hydrogen value chain in renewable power generation capacity and grid infrastructure as well as to produce new hydrogen-based products from new industrial processes.
Mobilising this amount of capital will require investors to act today. However, technology costs are high, and reducing them implies a learning curve to reduce them, with years ahead before cost competitiveness is reached. Governments therefore need to establish an enabling environment to mitigate investment risks. Moreover, governments and development finance institutions alike will need to mobilise substantial public financing to encourage the commercialisation of green hydrogen, supported by a strong regulatory framework. Establishing a strong network of partners all along the value chain to collaborate in developing and implementing a suite of innovative financing and business models will provide benefits. However, without the implementation of de-risking instruments, green hydrogen will not be attractive to the private sector.
Governments should identify early opportunities that do not rely on subsidies and other support to create initial markets, particularly in regions endowed with abundant and cheap renewable power, where the production of green hydrogen will already be cheaper than hydrogen produced from natural gas. These can be linked with small-scale projects or niche markets that have a business case while offering an opportunity to learn by doing.
For first movers and large-scale projects, green hydrogen and its products must rely on a mature value chain and existing markets. Economies of scale to reduce costs, along with long-term contracts with first-mover customers willing to pay a premium for green hydrogen and its products, will help accelerate hydrogen development. Here, vertically integrated partnerships, for instance between a supplier of green electricity, a green hydrogen producer and off-takers of green hydrogen can play an important role in sharing the risks among several actors. Additionally, besides a cheap and continuous supply of renewable power, access to water, land and infrastructure will be essential, as they will be decisive factors for those who invest to export green hydrogen products like steel, ammonia and clean synthetic fuels. Regulatory approaches such as mandates and blending obligations can also help create market demand, together with ambitious policies and commitments like green public procurement. These will alleviate the risks, and therefore contribute to creating an attractive environment for investors.
Governments of emerging and developing economies have limited budgetary resources and are constrained in the financing of large projects. The size of the investment envelope for large-scale projects will require diversification of financing sources and risk among actors. Developing the green hydrogen market will necessitate designing specific financing solutions, notably through public-private partnerships and blended finance. Although grants or concessional loans can enable them to bridge the gap to economic viability of projects, it will be critical to bring in project developers and unlock private capital mobilisation. Structural reforms, such as the phase-out of inefficient fossil fuel subsidies or carbon pricing mechanisms, can strengthen the rationale to invest in clean fuels technologies such as green hydrogen rather than in fossil fuels.
Source: (Cordonnier and Saygin, 2022[44]).
However, commercial green hydrogen development in emerging and developing countries will require electrolyser and fuel cell technology to achieve further cost reductions, as well as international partnerships to foster technology transfer to prospective producers. While many developing countries have some background in hydrogen production, this is primarily confined to large firms, and substantial skills and knowledge development will be required to build a competent and skilled labour base, particularly in regard to the deployment of innovative green hydrogen solutions in remote locations.
The power needs for hydrogen production are also enormous – 21 000 TWh by 2050, according to IRENA, equivalent to total power demand today. The water requirements are also very substantial, amounting to 7-9 billion cubic metres under a 1.5°C scenario, equivalent to 0.25% of total freshwater consumption today (IRENA, 2022[39]). Developing countries facing significant energy poverty, as well as those that are water stressed, will need to consider whether investing in hydrogen production is the best use of scarce resources, given parallel social, economic and environmental development objectives.
Lastly, though hydrogen represents an attractive way to diversify exports, it will not be as lucrative as oil and gas, entailing higher levels of competition and lower profits, given that there are fewer limitations on where hydrogen can be produced. This has benefits in terms of global security of supply and price stability, though this may be impacted by disruptions to the supply of critical minerals required for electrolyser and fuel cell production (e.g. platinum group metals and nickel, but also rare earths), and may also mean that countries are less likely to become as dependent on hydrogen exports through the longer term as some have become on oil and gas. Hence, governments should consider hydrogen industry development only as one part of a broader, holistic strategy to diversify away from fossil fuel revenue dependence, and should consider also whether hydrogen is better off being deployed to support decentralised energy provision to alleviate energy poverty, rather than exported.
Governments should consider prioritising the following actions:
Assess how the hydrogen industry fits into overall economic, social and environmental strategy, given competing challenges such as energy poverty and water scarcity, as well as the high upfront costs of investing in hydrogen (Beswick, Oliveira and Yushan, 2021[45]).
Assess existing infrastructure, skills and energy trade relationships in determining the feasibility of hydrogen investments. This should be complemented with a gap analysis to understand the investments and technology transfer that would be required to build a competitive hydrogen industry.
Recognise that hydrogen produced from natural gas with strict methane emissions requirements and CC(U)S should only be considered if the enabling gas infrastructure is already in place. If it is not, governments risk investing substantial capital in investments which could become stranded, unless also used to supply the domestic market.
Set clear milestones for a gradual transition to green hydrogen as costs come down below the production of hydrogen from abated natural gas. Assess plans for long-term infrastructure against the risks of stranded assets, ensuring any new infrastructure is hydrogen ready and future-proof, for instance ensuring pipeline conversion to hydrogen and biomethane is feasible – accounting for technology requirements and costs from the outset to ensure conversion is possible when costs come down (see also Pillar 2, Section 2.3).
Recognise that the energy intensiveness of hydrogen production means it needs to be deployed to decarbonise hard-to-abate sectors, such as aluminium, cement, fertiliser, and iron and steel, or to power rural and remote areas first, where there is no alternative.
Consider the capital-intensive nature of the hydrogen industry, weighing investments against other competing priorities, such as investing in storage for the grid, utility scale projects, and transmission and distribution infrastructure.
Establish strong private sector dialogue mechanisms to build the right regulatory framework for the hydrogen industry.
Consider demonstration projects as an effective means to reduce perceptions of risk for the private sector, build domestic skills and knowledge, and drive down costs.
Consider how regional integration and sharing resources can support the development of a hydrogen industry (power pools, electricity interconnections, demand creation).
Actions requiring international support in contexts where government capacity is low:
Develop strategies to build long-term technical competency for conversion, handling, and transport of hydrogen and hydrogen derivatives.
Develop a roadmap with clear signals for demand creation, such as mandates on the industrial use of hydrogen fuel and hydrogen derivatives, and public procurement and certification schemes to provide revenue predictability for hydrogen projects, pulling investment through with demand-side policies to make projects bankable. This may also include investing in equipment to enable the transition from gas to hydrogen, developing business strategies to take advantage of new opportunities and recruiting staff with the right expertise, as well as reinforcing investor confidence in the existence of a market place for low-carbon hydrogen and supporting co-operation between government and industry.
Producer and importer economies together should:
Establish long-term international partnerships to create a hydrogen development roadmap based on long-term supply agreements, and to foster knowledge, finance and skills transfer. This will allow hydrogen exporters to benefit from revenue smoothing and will ensure capital can be raised affordably, which is essential given that predictable revenue streams are key to project bankability.
Development finance institutions should:
Provide fossil fuel producer governments with technical support to assess the economic, social and environmental costs, technology transfer requirements, and feasibility of integrating hydrogen development into overarching sustainable development and decarbonisation strategies.
Support the development of credible rules and standards governing hydrogen production and trading, which transcend national boundaries, and guard against green-washing.
3.2.2. Developing lithium-ion battery value chains
Lithium-ion batteries are set to play an important role in global decarbonisation, enabling a 30% emission reduction in the transport and power sectors, creating significant economic value and quality jobs, and facilitating the roll out of electricity access to unserved areas through combining renewable energy and electricity storage technologies with mini and decentralised grids. Battery demand is set to grow 25% year-on-year, equivalent to a 19-fold increase to reach 2 600 GW in 2030, according to the World Economic Forum’s base case scenario. This will be driven mainly by lithium-ion battery use in electric vehicles, which will account for 60% of demand in 2030, when 34 million electric vehicles are expected to be sold worldwide, 45% of which will be in China, as well as its role in facilitating uptake of renewable energy in the power sector through enhancing grid absorption capacity. Between 2015 and 2018, energy storage demand grew between 60% and 70%, with 220 GWh expected to be installed by 2030 (WEF, 2019[46]).
Meeting this anticipated scale-up in demand for battery storage will entail enormous investments across the battery value chain, including mining, refining and beneficiation, cell manufacturing, battery pack assembly and recycling. Of up to USD 440 billion by 2030, some USD 100 billion will be invested in the mining sector and USD 200 billion in cell manufacturing. Demand for cobalt is expected to grow by 4 times, lithium by 6 times and class one nickel by 24 (WEF, 2019[46]). Substantial investments and actions to ensure good governance in the mining sector, as well as comprehensive measures to mitigate negative social and environmental impacts, and to realise tangible local benefits, are crucial (see Pillar 3, Section 3.2.3).
Meanwhile, significant progress will also be required to decrease the carbon footprint of battery manufacturing, reduce the critical minerals requirements in battery technology, and to increase recycling, re-use and refurbishments of batteries and critical minerals to reduce overall demand for new materials and pressure on mine sites. This will necessitate decarbonisation of battery cell manufacturing through the progressive addition of renewables technologies to the grid. In parallel, investment in recycling facilities and innovation in battery design to enable disassembly, which can facilitate recycling and re-use, will be key to the sustainability of battery value chains and enabling their end of life treatment (WEF, 2019[46]).
Developing and emerging economies can position themselves to participate in battery value chains, where possible, collaborating regionally to leverage economies of scale, optimise resource use, build market demand, and eventually upgrade products and service to participate in GVCs. For many developing country minerals producers this could facilitate their transformation from exporter of raw materials to becoming more productive components of the value chain, through beneficiation and manufacturing. For example, batteries represent between 40% and 50% of the value of electric vehicles, with battery cells accounting for 70% of the battery pack. Raw materials represent 50% of the value of cell production, with manufacturing accounting for the remainder (TIPS, 2021[47]).
Box 3.9. Leveraging regional value chains for sustainable transformative development in Africa and Latin America
Increased collaboration to build and strengthen regional value chains can offer emerging and developing countries an opportunity to pool resources, build market demand for new products and services, and to strengthen regional knowledge and expertise, which can encourage innovation and adaptation of products and technologies to local contexts. Through leveraging economies of scale, regional value chain development can also support firms in developing and emerging markets to build competitive advantage, attract investment, and ultimately participate in GVCs through upgrading products and services.
Regional collaboration which leverages natural resource endowments could offer the opportunity to build demand for green products and technologies, such as lithium-ion batteries or alternative low-carbon fuels, so long as environmental and social aspects are effectively integrated into mineral development planning. In sub-Saharan Africa, for instance, the availability of different minerals resources required for lithium-ion battery manufacturing could provide the foundation for collaboration on the development of regional lithium-ion battery value chains. This may include, for example, working towards the development of battery precursor plants and two, three wheelers regional hubs, supported by centres for excellence for advanced battery research to develop the required competencies and skills. Bauxite, for example, is available in Guinea; copper in the Democratic Republic of Congo (DRC) and Zambia; cobalt in DRC, Madagascar and South Africa; manganese in Gabon and South Africa; nickel in Botswana, South Africa, and Zimbabwe; phosphate in Algeria, Egypt, Morocco and South Africa; and lithium in Zimbabwe. To fully realise these opportunities, African developing countries need to put in place an enabling environment to unlock private investment, enhance mineral exploration, attract technology partners and mobilise private capital. At the same time, abundant renewable energy potential in Africa could offer the opportunity to build regional demand for green hydrogen as an alternative to fossil fuels, with countries leveraging electricity interconnections to optimise resource use in hydrogen production for both domestic needs and export.
Despite this potential, however, many regions across the Global South are yet to capitalise on the transformative potential of regional value chains. Intra-governmental trade, for example, in sub-Saharan Africa stands at just 15% of the continent’s total trade. The African Continental Free Trade Area (AfCFTA), which came into force in January 2021, can foster the development of regional value chains, including through addressing non-tariff barriers, creating of improved intra-regional infrastructure and transport networks, and supporting firms to work across borders and attract investment by providing them with access to greater markets.
Likewise, many countries in Latin America that have substantial reserves of critical minerals will be well-placed to take advantage of growing global demand. There is potential for the creation of lithium battery and electric vehicle hubs in the region, incorporating a life cycle approach to critical minerals, good governance in the mining sector, and the development of sustainable and responsible value chains. Enhanced co-operation between mining and manufacturing companies across the region will be necessary to pull together the technology, qualified human resources and materials (40 different elements) needed to produce lithium batteries and electric vehicles (EVs), which can all be found in the region in the necessary quantities and qualities. Forging alliances with global battery and EV manufacturers will be key to deploying best available technologies and encouraging knowledge transfer.
Source: (AUC/OECD, 2022[48]); (BloombergNEF, 2021[49]) and authors.
Cell manufacturing is currently dominated by a few firms in a few economies, mainly limited to China, Japan, South Korea and the US. Developing and emerging economies are unlikely to be able to compete in terms of research and development and innovation, or on skills and knowledge, yet there are opportunities for them to participate elsewhere in the battery value chain.
South Africa, for example, in 2011 launched its Energy Storage Research, Development and Innovation Programme, consisting of several universities, to identify opportunities for the country to participate in global battery value chains. Initially focusing on research and development and innovation, the programme shifted focus to leveraging South African comparative advantage in minerals processing and beneficiation, as well as battery pack assembly, on the basis that, initially at least, South African firms would struggle to compete with global technology leaders without substantial investments in knowledge and skills (TIPS, 2021[47]).
The consortium has identified regional collaboration on resources, including lithium, cobalt, manganese, nickel, graphite, bauxite, copper, iron, phosphate and titanium, all of which are available on the African continent, as an opportunity to underpin battery value chain development, as well as domestic comparative advantage in minerals beneficiation as key opportunities for scale-up. In South Africa, beneficiation to battery standards currently does exist for manganese and aluminium, but not other metals. The Manganese Metal Company currently refines manganese ore into manganese metal, including for use in lithium-ion batteries, and is the only supplier of electrolytic manganese metal not in China, while Hulamin, an aluminium semi-fabricator, is an existing producer of a number of lithium-ion battery-related products. Additionally, some South African firms are able to undertake battery assembly using imported cells. From August 2021, South Africa will ban hazardous e-waste, including lithium-ion batteries, in landfills, while planned investments in waste management, including a pilot recycling facility, will improve the country’s capability to undertake end-of-life treatment (TIPS, 2021[47]).
Governments should consider prioritising the following actions:
Consider establishing a cross-disciplinary body, including industry, educational institutions and government bodies, to assess assembly and potential future manufacturing capacity in the lithium-ion battery value chain, based on existing industries and resource endowments.
Review the policy and regulatory framework to encourage growth and innovation in selected segments of the lithium-ion battery value chain (i.e. assembly, manufacturing of pre-battery precursors, repair, refurbishing and recycling). Government policy should aim to cut red tape, lower barriers to market entry, facilitate access to information on market potential and improve access to finance for firms, where necessary. Tax subsidies on research and development can also encourage firm innovation, but should be combined with regular ex-post evaluation of support provided to ensure effective use of available resources and redirect support when it proves not to be working.
Consider the potential for regional collaboration, including investment in trade related infrastructure, commitment to free trade, regional integration, removal of non-tariff barriers, pooling of resources and collaboration on skills and knowledge development, to help build a market for lithium-ion battery parts and collaborate on manufacturing and research and development. Public procurement, particularly on a regional basis, given its scale and capacity to provide market signals, could also be used to create regional and national demand.
3.2.3. Developing a responsible mining sector and sustainable critical minerals value chains
Growing demand for critical minerals, metals and rare earth elements can offer mineral-rich developing and emerging economies an opportunity to invest in the mining sector as an engine for sustainable growth, economic diversification and localised development. Twenty-three critical minerals are vital to the deployment of solar panels, wind turbines, electric vehicles, battery storage, hydrogen electrolysers and fuel cells, and demand for them is forecast to grow rapidly through to 2050. For instance, the World Bank estimates that demand for minerals required for solar, including copper, iron, lead, molybdenum, nickel and zinc, could increase by 300% in 2050 under a 2°C aligned scenario (Hund et al., 2020[50]). Furthermore, the production of graphite, lithium, and cobalt will need to increase by more than 450% by 2050 to meet demand from energy storage technologies (Hund et al., 2020[50]), with over USD 1 trillion in global mining investments required by 2035 (Wood Mackenzie, 2020[51]). In fact, if advanced economies in Europe and the United States were to maintain the same levels of consumption, currently known resources or planned mines could supply only about 50% of the lithium and 80% of the copper required for electric mobility and renewable energy generation globally (FT, 2022[52]).
Much of this rapid increase in mining activities will occur in developing countries. For the global low carbon transition to succeed, advanced economies will need to form partnerships with developing countries to support cleaner, better-governed mining extraction activities for the next several decades (The Hill, 2022[53]).
For fossil fuel-based emerging and developing economies with substantial reserves of critical minerals and metals, and whose labour force could relatively easily transfer from fossil fuels jobs to mining jobs with limited reskilling required, mining development represents an attractive opportunity, particularly given US and EU efforts to diversify and build more resilient and sustainable global supply chains to minimise the risk of supply disruption.
Latin America, with Chile, Brazil, Peru, Argentina and Bolivia is well placed to meet the demand for critical minerals for the low-carbon transition, while in Asia, Indonesia, Philippines and Malaysia have significant reserves of bauxite and nickel, and India is a major producer of iron, steel and titanium (Arrobas et al., 2017[54]). Africa is also well placed to meet supply of critical minerals, and holds substantial reserves of bauxite, chromium, cobalt, copper, gold, iron, lithium, manganese, platinum and uranium. The DRC, South Africa, Zambia, and Zimbabwe are home to substantial reserves of copper and cobalt. Platinum can be found in South Africa and Zimbabwe; uranium in Namibia, Niger and South Africa; gold in Ghana, South Africa and Sudan; iron in South Africa; manganese in Gabon, Ghana and South Africa; bauxite in Guinea and lithium in Zimbabwe (EIU, 2022[55]). However, many of the locations in which there are substantial reserves of the 23 most relevant minerals and metals and rare earth elements to the transition are also hotspots for fragility and conflict, with many of these concentrated in Latin America, Southeast Asia and sub-Saharan Africa. For example, human rights abuses, child labour and pollution are well documented in eastern DRC, an area which produces 63% of the world’s cobalt, a key material for electric vehicle manufacturing, and where 20% of mining takes place through artisanal and small-scale mining (ASM); while extraction of nickel in Guatemala, an important metal in solar panels and energy storage, has been linked to violence and forced displacement (Church and Crawford, 2018[56]).
Good governance of the mining sector
Ensuring that mining contributes to sustainable development requires robust regulation, laws and policies for the mining sector, as well as equitable revenue generation, distribution and use, underpinned by institutions in charge of effective implementation and enforcement (Church and Crawford, 2018[57]).
Governments in mineral-rich developing countries should develop a holistic and integrated governance framework that covers the entire value chain of the extractive sector, from geological mapping, mineral exploration, mine development, mining, mineral processing and refining, ore transportation, manufacturing of end-use products, to recycling and mine closure (IRP, 2020[58]). The success of a sustainable mining sector should be measured based on the strength of its economic outcomes but equally on the existence of sound environmental management, respect for the rights and interests of affected stakeholders, and observance of the highest governance and transparency standards (IRP, 2020[58]).
Box 3.10. The Sustainable Development License to Operate: Moving toward an integrated and inclusive mining governance framework
The International Resource Panel in its report Mineral Resource Governance in the 21st Century: Gearing Extractive Industries Towards Sustainable Development, calls for moving beyond the established paradigm of the “Social License to Operate”, towards a new governance reference point that enables public, private and other relevant actors in the extractive sector to make decisions compatible with the 2030 Agenda’s vision of sustainable development.
The new governance framework is referred to as the “Sustainable Development License to Operate”, and extends the Social License to Operate in several important ways. It addresses a broader subject matter integrating all pillars – people, planet, prosperity, peace and partnership – of sustainable development, and sets out principles, policy options and good practices for enhancing the extractive sector’s contribution to achieving the SDGs.
The Sustainable Development License to Operate is designed to improve the net societal benefits of mining, and is not necessarily meant to function as a licence in the compulsory or regulatory sense. It addresses a broader subject matter covering the nexus of all environmental, social and economic concerns that fall within the remit of the SDGs and related targets. The concept is relevant to all actors in the extractive sector across the public, private and civil society sectors; its implementation is a shared responsibility across nations and different actors along the minerals value chain; and it sets out not only minimum standards of practice, but also a set of internally consistent principles, policy options and good practices for enhancing the extractive sector’s contribution to achieving the SDGs.
Source: (IRP, 2020[58]).
While price fluctuations and commodity cycles are standard attributes of the minerals sector, these can be further exacerbated by the specific characteristics of the energy transition, including technological breakthroughs, mineral substitution and improved recycling rates. Governments in mineral-rich developing countries should recognise that natural resource revenues are volatile as restrictive trade policies, sanctions and regional and global conflicts can also create supply shortages and influence pricing. This volatility has implications for revenue management and spending, as it is difficult for governments to anticipate future revenues flows and use those revenues effectively.
To manage the counter-cyclical nature of resource revenue flows and ensure the availability of a consistent level of resources for spending, governments should establish a clear and consistent fiscal policy framework coupled with a commitment to sound macroeconomic management of natural resource revenues. For example, stabilisation funds can help protect the economy when commodity markets collapse and revenues from natural resources decline by ensuring long-term fiscal sustainability that supports long-term development objectives. Stabilisation funds should be integrated into the budget through clear rules regarding the deposit of natural resource revenues, and the withdrawal of money for use in government spending and investment (OECD, 2019[59]).
The projected expansion of mining for critical minerals could increase the risk of corruption. For mineral-rich countries, corruption poses a major threat to sustainable development. The increasing global competition for access to natural resources, high rents generated by resource exploitation and the “gate-keeping” function performed by governments, combined with discretionary powers, and limited competition among key economic players are among the factors that increase the exposure of the mining sector to corruption. Consequently, governments in mineral-rich developing countries should ensure that corruption risks are mapped at each stage of the value chain, and that their legal and institutional framework is equipped to eliminate or mitigate these risks to the greatest extent possible across a broad spectrum of inter-connected policy areas, including licensing, procurement, tax issues and public financial management (OECD, 2016[60]).
In particular, governments in mineral-rich developing countries should set out a robust regulatory regime for the granting of mining exploration and production rights. It is recognised that a robust legal framework with comprehensive laws and regulations, setting out conditions of general application for extractive operations and limiting the scope for project-specific negotiated terms, provides a stronger foundation upon which a country can manage its extractive industries according to national priorities (OECD, 2020[61]).
Governments should ensure that beneficial ownership information is required and assessed. This can help reduce corruption by identifying whether mining contracts have been awarded to entities that involve politically exposed persons. The public disclosure of signed mining contracts can also add an important dimension of accountability to the licensing process by identifying any deviation from standard terms and conditions, any company receiving undue favourable treatment, or any instances where decision makers have granted contracts to companies where there is a conflict of interest. Contractual transparency is increasing globally, and since January 2021, all countries implementing the EITI Standard are required to publish new and amended contracts, licenses and agreements concluded with extractive companies (EITI, 2019[62]).
Rapid increases in demand for lithium, cobalt, copper and rare earth elements pose the greatest risks from an environmental and social standpoint. Cobalt, aside from human rights abuses, is often associated with air and water pollution, and soil contamination, as well as health impacts for miners and surrounding communities, particularly given much of the mining is non-mechanised and takes place in dangerous conditions. Lithium and nickel can contaminate water, while rare earth processing entails the use of hazardous chemicals and substantial production of waste materials (Dominish, Florin and Teske, 2019[63]).
The scaling up of due diligence and certification schemes will be key to enhancing supply chain transparency, enforcing social and environmental safeguards and putting pressure on upstream and processing companies to implement better practices. Building on existing international standards, legislation and due diligence schemes for responsible sourcing of minerals from conflict-affected and high-risk areas, new forms of international cooperation and upgraded standards need to be developed to cater to the green critical minerals sector, as well as the recycling and waste management industries, while strong and concerted government action on both the supply and demand side is necessary to tackle waste, pollution and environmental damage, and human rights abuses.
Box 3.11. Aligning with the global benchmark: OECD standards on responsible business conduct (RBC)
Businesses, especially those engaged in supporting the low-carbon transition, can make a positive contribution to sustainable development, provided they address the potential adverse impacts linked to their activities or supply chains. The OECD Guidelines for Multinational Enterprises are the only multilaterally agreed and comprehensive code of responsible business conduct that governments have committed to promoting. In order to foster implementation of the Guidelines, the OECD has developed several government-backed standards on supply chain due diligence, including in the extractives sector. Importantly, these standards address potential adverse impacts along the whole value chain, including along transport, trading and processing.
A burgeoning architecture of regulatory and market expectations has taken shape around OECD standards on RBC, particularly in the minerals value chain. Legislation and industry norms incorporating RBC standards and concepts have been adopted in OECD countries like Colombia, France, Germany, the UK and the US as well as by the EU and non-OECD countries that play critical roles in mineral supply chains including China, the DRC, Rwanda and the United Arab Emirates. Premier exchanges and trading hubs including the Dubai Multi-Commodities Centre, the London Bullion Market Exchange, the London Metal Exchange and the New York Mercantile Exchange have incorporated OECD standards into their sourcing requirements.
The OECD carries out Alignment Assessments against OECD due diligence standards of industry schemes and multi-stakeholder initiatives set up partly to help companies comply with such requirements. Anchoring policies to support the development of a responsible mining sector in these global benchmarks will promote coherence and help avoid fragmentation in certification systems.
The OECD Guidelines for Multinational Enterprises (MNE Guidelines) provide principles and standards for responsible business conduct in a global context consistent with applicable laws and internationally recognised standards.
The OECD Due Diligence Guidance for Responsible Business Conduct provides plain-language explanations of the MNE Guidelines’ due diligence recommendations to help enterprises avoid and address adverse impacts related to workers, human rights, the environment, bribery, consumers and corporate governance that may be associated with their operations, supply chains and other business relationships.
The OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas provides detailed recommendations to help companies respect human rights, prevent corruption and financial crime and avoid contributing to conflict through their mineral purchasing decisions and practices.
The OECD Due Diligence Guidance for Meaningful Stakeholder Engagement in the Extractive Sector provides practical guidance to mining, oil and gas enterprises in addressing the challenges related to stakeholder engagement related to social, economic and environmental impacts.
The handbook Frequently Asked Questions: How to address bribery and corruption risks in mineral supply chains provides practical answers to frequently asked questions on how companies can identify, prevent, mitigate and report on risks of contributing to bribery and corruption through their mineral sourcing.
As perceptions around the economic value of critical minerals are heightened, this may lead to calls for greater state participation in the mining sector, where the involvement of SOEs could increase risks related to revenue mismanagement, corruption, and environmental and social impacts (EITI, 2022[69]). This may involve SOEs securing larger stakes in mining projects or having more stringent requirements related to domestic processing and local content. Governments may also consider investing in certain critical minerals up to the pre-feasibility level, as this would allow the state to use its share of the minerals as feedstock for vertically integrated operations. For example, the DRC plans to build a 10 000 metric-tonne cathode precursor plant to leverage its abundant cobalt resources and hydroelectric power, and to become a low-cost and low-emissions producer of lithium-ion battery cathode precursor materials (BloombergNEF, 2021[49]).
Without adequate safeguards, state participation can exacerbate many governance challenges. In particular, the sale of publicly owned minerals can have a significant impact on the development trajectory of resource-rich developing and emerging economies due to the large volume of commodities sold and the amount of money involved. Governments of mineral-rich developing countries should ensure that their SOEs are mandated and resourced to carry out transparent and competitive buyer selection procedures that reduce discretion and close opportunities for corruption (OECD, 2020[70]).
Box 3.12. National mining companies: A driver or a barrier to the development of a responsible mining sector?
Although not as prevalent as NOCs, national mining companies (NMCs) play a significant role in many mineral-producing countries, including in Botswana, Chile, Eritrea, Guinea, Kenya, Mongolia, Morocco, Myanmar, Namibia, South Africa, Zambia and Zimbabwe.
Many NMCs were privatised during the 1980s and 1990s due to pressure from international financial institutions in response to low prices, high financing costs, and low productivity due to mismanagement of the NMCs themselves. However, there is now a trend towards greater state control in the mining sector – driven through growth in state-controlled mining and smelting in China and in response to the expected demand for critical minerals.
The success of NMCs has been mixed. In some case, they have been effective vehicles for the development and implementation of government policies. For example, in Chile, Codelco, which emerged from the nationalisation of foreign-owned companies in 1971, now produces 10% of the world’s refined copper, has contributed USD 102 billion to the Chilean state, and sells its own production, both cathodes and copper concentrate, to international buyers including BMW, Nexans and Mitsui. Codelco uses transparent pricing formulas and determines the price of copper based on market prices set by the London Metals Exchange (LME). It has implemented standards to regulate various aspects of the company’s activities (including commercial relations, conflicts of interest and business with politically exposed persons) based on international best practice. In Morocco, OCP is a world leader in phosphate production and is well placed in the Resource Governance Index (75/100). In Botswana, Debswana and Okavango Diamond Company have been recognised for their governance and positive contributions to development.
In other cases, NMCs have fostered inefficiency, revenue shortfalls and corruption. For example, the 2017 Resource Governance Index found that 72% of NMCs do not disclose sufficient quality, timely information about their activities and finances to enable proper external assessments to be carried out. NMCs are also less transparent on average than NOCs. For example, in the DRC, decades of corruption, underinvestment and lack of maintenance led to a general decay of mining infrastructure, and an investigation into Gécamines found a systematic undervaluation of assets that were sold on average at one-sixth their commercial market value, costing the state at least USD 1.36 billion from 2010 to 2012. Despite these developments, Gécamines retains de facto power to select private partners for the projects in its portfolio, and contracts are awarded without due process, leading to cases of suboptimal selection of partners, corruption, and further losses to the state.
Collaboration between governments, the private sector, local communities and civil society organisations is crucial in order to leverage the extractives sector to catalyse long-term, competitive, diversified and, sustainable development. Communities can benefit through equitable revenue distribution and spending. In the past, taxes and royalties from mining operations were collected by the central government and local communities saw little direct benefits from those revenues. However, over the last decade several countries have introduced regulations to share those mining proceeds between central government, regional/local authorities, and communities. For example, in Ghana, the Mineral Development Fund collects all royalties on behalf of the government and then distributes them to local authorities, central governments and communities. Governments should recognise that it may not always be possible to fully maximise financial, economic, social and environmental benefits in the same timeframe, but all benefits should be incorporated into the objectives of the project over its life cycle (OECD, 2020[61]).
Through integrated planning, mining projects can serve as an anchor for power generation, local procurement of goods and services, and shared use of infrastructure. Governments should set out a framework to foster direct and local entrepreneurship through the local provision of goods and services, and enable the development of other sectors or segments of production that can support the creation of a diversified economy. Governments should first seek to understand the mining industry, its production and market structure, and consider how the country can position itself well along regional and global value chains. Subsequently, they should aim to support local firms to comply with international standards and industry requirements, in order to generate in-country shared value opportunities (OECD, 2016[74]).
Another area where local communities can benefit is through skills development and employment. Mining can contribute to building human capital through direct training and education of the workforce by the private sector. Governments should note however, that with increasing technological developments, mines are likely to be more mechanised and require less employees. Governments may consider encouraging the establishment of local employee ownership schemes where local employees and/or communities are given an ownership stake in the mining projects through shares in the mining company or joint venture.
Mining projects are often located in remote or underdeveloped areas and mining companies will need to construct a significant amount of infrastructure to support the mine. This may include roads, airstrips, water, electricity and sanitation systems, as well as health and accommodation facilities. Governments should encourage the shared use of infrastructure so that local communities can also benefit. In addition, infrastructure requirements should be integrated into local and national planning as well as set out in the mining licence/contract.
Governments may require or encourage the use of benefit sharing agreements between mining companies and local communities, including Indigenous Peoples, to establish a clear process for engagement. Benefits may include payments, profit sharing, local hiring, skills development, education, cultural support, and environmental protection and remediation (Raderschall, Krawchenko and Leblanc, 2020[75]).
Governments in mineral-rich developing countries should also consider the role that renewable energy can play in a sustainable mining sector as there are opportunities to integrate off-grid electricity generation solutions into mining operations, which often represent a significant share of resource-rich countries’ final energy consumption (IEA, 2017[76]). As an example, in 2014, the mining and quarrying sector accounted for 38% of total electricity consumption in Chile. Due to the increasing competitiveness of renewable energy technology, solar and wind power solutions have become increasingly attractive to the mining industry, with Latin America, particularly Chile and Mexico, leading the way in the integration of utility-scale renewable energy projects for mines (Alova, 2018[77]).
A sustainable mining governance framework should also consider the end of life of the mine – including environmental remediation, and any future industrial use of the site. For example, solar arrays and wind turbines can be installed at closed mining sites, where mines are located in close proximity to power lines, enabling grid connection. The conversion of mining sites to renewable energy can offer local communities and businesses an opportunity for revenue, employment and continued economic growth, while also contributing to the low carbon transition (Church and Kuehl, 2022[78]).
Mineral-rich developing countries can draw from a number of mining governance initiatives and standards when developing their legal frameworks (see Box 3.13). A mapping of mining governance initiatives and standards by the International Resource Panel in 2020 identified over 80 initiatives – ranging from comprehensive policy frameworks to platforms for dialogue; from legally binding initiatives backed by United Nations sanctions and national laws to voluntary initiatives; and from single stakeholder-led to multi-stakeholder platforms that bring together many types of stakeholders (IRP, 2020[58]).
Box 3.13. Selected key mining governance initiatives
Africa Mining Vision
The Africa Mining Vision (AMV) sets out a comprehensive governance framework that extends beyond the mining sector. The AMV seeks to integrate mining into industrial and trade policy and to extricate Africa from its historical role as an exporter of raw materials to become a manufacturer and supplier of knowledge-based goods and services.
It sets out a developmental approach meant to break mining enclaves by fostering economic and social linkages between the extractive sector and other sectors of the local economy, promoting resource-based industrialisation and economic diversification, developing socio-economic infrastructure for broader use and accelerating regional integration.
EITI Standard
The Extractive Industries Transparency Initiative (EITI) Standard provides a framework and a process for promoting greater transparency and accountability in the oil, gas, and mining sectors. The EITI Standard requires the disclosure of information along the extractive industry value chain, from how extraction rights are awarded, to how revenues are managed and allocated by government.
By so doing, the EITI seeks to foster multi‑stakeholder collaboration, promoting a healthier and more accountable sector that can play a positive role in development.
Model Mine Development Agreement
The Model Mine Development Agreement is an output of the Mining Law Committee of the International Bar Association. It sets out a collection of examples from existing mine development agreements and other materials to help negotiators and drafters reflect on some of the difficult issues of legality, fairness and balance presented by large foreign natural resource investment, particularly in developing countries.
The final product is web-based and publicly accessible. It is not “prescriptive” in the sense of setting out one standard form; rather, it seeks to provide an agenda for negotiations based on a sustainable development objective that is common to all parties.
Mining Policy Framework
The Mining Policy Framework is an output of the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF), and sets out concrete objectives and processes to achieve good governance in the mining sector, and to effectively advance sustainable economic development and reduce poverty. As a non-binding policy guidance tool, the MPF lays out international best practice across six key pillars of mining law and policy.
Natural Resource Charter
The Natural Resource Charter is an output of the Natural Resource Governance Institute (NRGI), and offers policy options and practical advice for governments, societies and the international community on how best to manage resource wealth.
To help governments make decisions, the charter contains 12 precepts. The first 10 precepts elaborate guidance on how a country and its government might manage natural resources. The last two precepts speak to international actors – extractive companies and those responsible for international governance.
Governments should consider prioritising the following actions:
Develop a holistic and integrated governance framework that covers the entire value chain of the extractive sector. This should encompass accountability and transparency, licensing and permitting, taxation, local impacts, revenue distribution, government spending and environmental safeguarding (NRGI, 2014[82]); (IRP, 2020[58]).
Ensure that they have the core institutions needed to promote and regulate the minerals and metals industry. This may include a Geological Survey, a Mining Directorate and an Environmental Directorate/Agency. In the case of developing countries, governments should assess the possibility of sharing some key resources/expertise at the regional level with the support of regional institutions (IRP, 2020[58]).
Undertake geological mapping and/or invest in the acquisition of geological data to understand the extent of endowments of critical minerals and rare earth elements and present geoscience data in an accessible way to attract private sector investment.
Assess the potential role of mining as part of a broader development strategy. National mineral policies and strategies should be aligned with the SDGs, and should consider the risk of environmental degradation and human rights abuses, and the cost of investing in enabling infrastructure (IRP, 2020[58]).
Consider the full life cycle of natural resource developments and their value chains when identifying in-country shared value opportunities (OECD, 2016[74]).
Set up mechanisms to ensure the benefits of the mining industry are shared in a way that is equitable, fair and visible at the local level (Church and Crawford, 2018[57]). The OECD’s Toolkit for Mining Regions Well-being provides a tool to help identify the main strengths and challenges on well-being in mining regions, assessing economic, social and environmental dimensions (OECD, 2021[83]).
Ensure that non-revenue generation benefits (taxes and royalties) are fully considered and explored. Mining projects can serve as an anchor for renewable energy and power generation, local procurement of goods and services and shared use of infrastructure.
Set out a framework for the mining sector to foster direct employment and local entrepreneurship through the provision of goods and services, to encourage the shared use of infrastructure and innovation, and enable the development of other sectors or segments of production that can support the creation of a diversified economy (OECD, 2016[74]).
Support local firms to comply with international standards and industry global requirements for quality and price, including through the adoption of, and compliance with certification standards (OECD, 2016[74]).
Explore opportunities for the mining sector to provide electricity off-take in remote areas not covered by the grid, where feasible, supporting roll out of energy access to surrounding communities as a core component of the national development strategy.
Integrate supply chain due diligence requirements into mining sector regulation and legislation for transition critical minerals, in line with the recommendations set forth in the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (OECD, 2013[66]).
Clarify specific avenues and/or further institutionalise regulatory approaches that promote LSM-ASM co-operation on industrial concessions in order to ensure consistency for production sharing or supply agreements, reduce uncertainty around the business environment and make it more attractive to LSM operators to work with artisanal miners on a commercial basis (OECD, 2019[84]).
Create economically viable artisanal exploitation zones. This may include the demarcation of land plots suitable for ASM activities. Viable artisanal exploitation zones also require regulatory approaches that attract investors, partners and customers to help carry out overburden removal and mine planning (OECD, 2019[84]).
Set out a clear and consistent fiscal policy framework coupled with a commitment to sound macroeconomic management of natural resource revenues with properly sized stabilisation funds. This can help to insulate the economy from price, production or other external shocks and ensure medium- and long-term fiscal sustainability that supports long-term development objectives (OECD, 2019[59]).
Set out a robust regulatory regime for the awarding of mining exploration and production rights, and use bid rounds where relevant (OECD, 2020[61]); (IRP, 2020[58]).
Undertake a mapping of corruption risks at each stage of the value chain and ensure that the legal and institutional framework is equipped to eliminate or mitigate these risks to the greatest extent possible across a broad spectrum of inter-connected policy areas, including licensing, procurement, tax issues and public financial management (OECD, 2016[60]).
Ensure that SOEs are mandated and resourced to carry out the buyer selection process without suffering public revenue losses through sub-optimal allocation and corruption (OECD, 2020[70]).
Actions requiring international support in contexts where government capacity is low:
Develop scenario and sensitivity analysis capacity to understand future demand and prices, and what this means for the economics of a proposed mine. This effort requires both commodity-specific expertise and modelling expertise, which may not always be available in-house. The resulting analysis should include related economic spillovers: local employment, local inputs of goods and services, shared use of infrastructure, social development benefits of a project, etc. (Toledano et al., 2020[85]).
Establish stabilisation funds to provide a financial buffer when commodity markets collapse and revenues from natural resources decline. These funds should be integrated into the budget through clear rules regarding the deposit of natural resource revenues, and the withdrawal of money for use in government spending and investment (OECD, 2019[59]).
Identify changing trends in global consumption and production patterns (progressive ore grades decline and increasing labour, transport, energy, processing, capital/ equipment costs), changes to end uses for minerals (innovation in final products), and carbon emissions trading (OECD, 2016[74]).
Development finance institutions should:
Form partnerships with developing countries to ensure cleaner, better-governed mining extraction activities to support the global low carbon transition during the next several decades.
Provide technical support to governments to improve mining sector governance throughout the mining life cycle.
Government and the mining industry together should:
Expand existing supply chain regulations to apply to green transition minerals. Priority should be given to cobalt, lithium and rare earths, due to projected rapid increases in their demand and their importance to the low-carbon transition (Church and Crawford, 2018[57]).
Engage proactively and constructively with ASM to address risks of conflict and improve access rights and security conditions. Potential options include assigning land in LSM concessions to ASM; developing and implementing training programmes and technical assistance to improve safety, extraction and processing techniques; promoting health and safety; and providing mining equipment to improve health and safety and extraction and processing techniques to improve efficiency and limit waste (OECD, 2019[84]).
Engage with local multi-stakeholder groups to reach a consensus on how to integrate ASM into the formal mining sector, including addressing informal fees, generating payments for regulatory services and formalising the role of ASM cooperatives (OECD, 2019[84]).
Collaborate to leverage the extractives sector to catalyse long-term, competitive, diversified and, sustainable development, including by ensuring that local communities impacted by mining are also beneficiaries, determining which types of infrastructure and power projects need to be built to support mining operations, ensuring the sustainable use of water and creating opportunities to roll out power access based on mining (OECD, 2016[74]).
The mining industry should:
Identify areas for pre-competitive collaboration with industry peers and stakeholders, including major contractors and suppliers to catalyse the mining sector for sustainable development (e.g. collective identification of skills requirements and solutions to common environmental challenges) (OECD, 2016[74]).
Evaluate the potential to unbundle contracts for services and supplies, to support the creation of enhanced opportunities for local businesses, in particular SMEs (OECD, 2016[74]).
Evaluate the potential to make advance purchase orders and forward purchase agreements or implement other mechanisms that could help facilitate the integration of local suppliers in extractives sector value chains (OECD, 2016[74]).
Publicly report on environmental and social risks in the value chain and how these are being addressed (OECD, 2013[66]).
Renewable energy technology manufacturers and electricity vehicle manufacturers should engage with upstream mining and processing companies to improve social and environmental practices through improvements to transparency, reporting on supply chain risks and response plans.
Engage communities in a meaningful way across the mineral life cycle. Incorporate the views of stakeholders and local communities using best practice tools, for example, IFC Performance Standards on Assessment and Management of Environmental and Social Risks and Impacts.
Adopt international best practice on tailings management through adherence to the Global Industry Standard on Tailings Management (Global Industry Standard on Tailings Management, 2020[86]).
Undertake risk-based due diligence in line with the OECD Due Diligence for Responsible Supply Chains of Minerals to identify, prevent and mitigate risks of corruption deeper in the supply chain, potentially outside the scope of criminal liability, but nonetheless directly linked to company operations. Industry should then publicly report on those risks, regardless of the requirements of home country legislation (OECD, 2021[68])
Consider the future industrial use of the site at the post-mining stage. The conversion of mining sites to renewable energy can offer local communities and businesses with an opportunity for revenue, employment and continued economic growth, while also contributing to the low carbon transition (Church and Kuehl, 2022[78]).
Circular economy approach
A transition to a circular economy can play a key role in reducing demand for minerals and metals, which, in turn, can mitigate and reduce the harmful environmental and social impacts often associated with resource extraction. A circular economy approach is grounded in energy efficiency, re-use and recycling of material inputs to reduce pressure on mineral extraction, with a view to building a more resilient global economy and reducing vulnerabilities (FT, 2022[52]). Alongside, advanced economies, several developing countries have adopted initiatives incorporating circular economy principles. For example, in 2017 Nigeria, Rwanda and South Africa launched the African Circular Economy Alliance, to share best practices for the design and implementation of regulatory frameworks that promote the circular economy (UNEP and IRP, 2020[87]).
However, mineral-rich developing countries should consider carefully the implications of the implementation of circular economy principles in advanced economies – especially in terms of reduced demand for minerals and metals and the corresponding loss of export earnings. In its Circular Economy Action Plan, the EU has set a goal to double the use rate of circular material by 2030. Many new mines are scheduled to come into production during this timeframe, and their economic viability could be significantly impacted if the EU reaches its target and reduces its demand for primarily extracted materials from the developing world (Toledano et al., 2020[85])For example, a study assessing the impact of an EU-wide transition to a circular economy on the region’s raw material trading partners found that 24 developing countries rely on raw material exports to the EU for between 1% and 8% of their GDP (UNEP and IRP, 2020[87]). In order to mitigate the risk of lost export earnings, mineral-rich developing countries should adopt policies to capture a greater share of value by adding value to the extractive products before they are exported, as well as diversifying their economies including into emerging sectors such as recycling and renewables (UNEP and IRP, 2020[87]).
The scaling up of recycling and re-use can offer a viable job creating industry in its own right. A key part of the circular economy is the recycling and re-use of electronic waste (e-waste).
Global e-waste is projected to reach 120 million metric tonnes per year by 2050, and with less than a 20% formal recycle rate, the annual value of global e-waste is over USD 62.5 billion. Consequently, the circular economy can provide potential opportunities for developing countries to reuse their own mineral consumption through the re-use and recycling of e-waste. For example, the Nigerian government, along with the Global Environment Facility and the UNEP have initiated a project to build a formal e-waste recycling industry in Nigeria (Toledano et al., 2020[85]).
However, the processing of e-waste carries significant health and environmental risks for developing countries, as e-waste may contain several hazardous materials, such as lead, mercury, cadmium and arsenic. Many developing countries lack effective policies and robust infrastructure for the processing and management of e-waste, which can cause hazardous materials to leach into the land or atmosphere if proper processing techniques are not followed (Bazilian, 2020[88]); (Parajuly et al., 2019[89]).
Furthermore, developing countries are often used as a dumping sites for unwanted e-waste from advanced economies. In recent years, some advanced economies have taken steps to reduce this trade. The European Union adopted a directive on e-waste in 2012 (Directive 2012/19/EU on waste electrical and electronic equipment, WEEE), that forbids exports of hazardous e-waste to countries that are not members of the EU or the OECD. Furthermore, since 2019, the export of e-waste from advanced economies to developing countries is also prohibited by international law (Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal, Annex VII.) (European Court of Auditors, 2021[90]).
However, despite the existence of EU and international regulations, this trade continues. Illegal e-waste shipments are often misclassified as “used equipment” rather than waste in order to escape legal requirements, as there are economic incentives for the trade and a low risk of getting caught (IISD, 2021[91]). A 2017 experiment by the NGO Basel Action Network tracked 314 items of e-waste in ten EU Member States. Eleven items ended up in seven different non-OECD countries and territories including Ghana; Hong-Kong, China; Nigeria; Pakistan; Tanzania; Thailand and Ukraine. In another example in 2020, Spanish police dismantled an organised criminal group responsible for illegally shipping over 750 tonnes of hazardous e-waste from the Canary Islands to Africa (European Court of Auditors, 2021[90]).
Governments should consider prioritising the following actions:
Adopt policies to capture a greater share of value by adding value to the extractive products before they are exported to account for the reduced demand for minerals and metals and the corresponding loss of export earnings (UNEP and IRP, 2020[87]).
Invest in the critical minerals recycling and re-use industry as a component of an economic diversification strategy. The circular economy can provide potential opportunities for developing countries to re-use their own mineral consumption through the reuse and recycling of e-waste (Toledano et al., 2020[85]).
Actions requiring international support in contexts where government capacity is low:
Develop a robust regulatory framework for the protection of the environment and human health, through the sustainable management of e-waste (Perry et al., 2019[92]).
Ensure that e-waste legislation is aligned with internationally recognised conventions, such as the Basel Convention, and internationally recognised recycling standards (Perry et al., 2019[92]).
Development finance institutions should:
Integrate support for circularity initiatives into development assistance, such as Aid for Trade. This could be harnessed to help countries transition to resource-efficient, more circular economies as well as adjust to the risks and opportunities posed by circular economy policies in the economies of major trading partners (UNEP and IRP, 2020[87]).
Consult and share information with developing country governments about new circularity measures. Ensure that reasonable time is given to enable stakeholders to adjust, and that adequate assistance is provided to developing countries to support their adaptation (UNEP and IRP, 2020[87]).
Enhance international dialogue and co-operation in an effort to better understand and respond to the distributional impacts of circular economy policies (UNEP and IRP, 2020[87]).
Advanced economies should:
Develop regulations to stop the export of e-waste to developing countries and strengthen compliance monitoring mechanisms for companies.
3.2.4. Developing sustainable agricultural supply chains
With the world’s population expected to grow to almost 10 million people by 2050, meeting global food security needs while avoiding catastrophic climate change and limiting biodiversity loss will be an acute challenge. Agriculture, forestry and other land use globally currently accounts for about 23% of GHG emissions and about 50% of the world’s vegetated land (IPCC, 2020[93]). Food insecurity, caused by rapid population growth and the physical impacts of climate change, has been exacerbated by the Russia’s war in Ukraine, given these two countries account for about 29% of global wheat exports and 19% of maize exports. Meanwhile, spiralling gas prices have led to rising fertiliser costs which could potentially result in global agricultural output to fall by millions of tonnes (Hanson et al., 2022[94]). Already since the start of the COVID-19 pandemic, the number of food insecure people around the world has doubled, from 135 million to 276 million, while 750 000 people are facing famine, including acute starvation and malnutrition in Afghanistan, Ethiopia, Somalia, South Sudan and Yemen (United Nations, 2022[95]) (OECD/FAO, 2021[96]).
Rising global food demand risks exacerbating deforestation and conversion of grassland to cropland, destroying ecosystems and biodiversity. If oil and gas prices are high, governments could be incentivised to pursue policies which encourage unsustainable biofuels production to offset high fuel prices, which in turn could lead to the destruction of natural ecosystems that provide substantial carbon storage (Hanson et al., 2022[94]). A large proportion of the expansion of agricultural land is expected to take place in developing countries. Sub-Saharan Africa, for example, has seen 53 million hectares converted to crops in the last 20 years, equivalent to a 34% increase, 79% of which replaced natural ecosystems. Latin America has seen 34 million hectares converted to crops, 39% of which was previously natural ecosystems (Hanson et al., 2022[97]).
Abiding by Paris Agreement objectives and feeding future populations will require the agriculture sector to become more efficient, increasing crop and livestock yields per unit of land used. For developing countries, improving agricultural performance, particularly through investment in processing and value addition to upgrade participation in regional and global value chains, offers an opportunity to boost economic growth and create jobs. Poorly developed logistics and transport infrastructure in rural areas, low levels of sustainable fertiliser use, and a lack of energy availability necessary for agrifood processing limits opportunities for value addition and increases costs. Sub-Saharan African countries, for example, mainly export raw agricultural commodities for production and processing overseas. Facilitating the development of regional agrifood value chains in downstream segments, such as processing, marketing, transport and retail, could create additional skilled jobs, which is especially relevant in Africa where half of the labour force is employed in agriculture, which functions as a dominant source of employment in rural areas (AfDB, 2022[98]).
The physical impacts of climate change are already damaging agricultural yields in developing countries, with more regular extreme weather events such as droughts, floods and wildfires destroying livelihoods or making traditional farming practices unviable. The need for investment in adaptation, including land irrigation and adoption of climate-resilient farming techniques, seeds and crops, is therefore critical to address food insecurity and build the resilience of rural communities. Small-scale farmers in developing countries are the most vulnerable, given a lack of access to affordable finance, technology and mechanisation, information, training and education to enable them to adapt to changing conditions.
In parallel to raising yields, global GHG emissions from agriculture will need to reduce to remain consistent with the Paris Agreement. In terms of origin, livestock accounts for 45% of global agricultural emissions, energy use for 22%, rice methane for 16% and soil fertilisation for 13%. However, land use change, or conversion of natural ecosystems, primarily forests and grasslands into cropland, also has a very significant impact on emissions, as these practices remove carbon storage which will require years or even decades of regrowth to replace (Locke, 2021[99]).
Decarbonisation of the agriculture sector, particularly large-scale farms, can be especially challenging because emissions are hard to measure and are influenced considerably by environmental and local conditions, as well as farming techniques. However, a range of approaches are available to decarbonise farming methods, including reducing the carbon content of fertiliser and making its use more targeted, diet modification to reduce methane emissions from livestock, raising yields and reducing flooding times of rice paddies, and switching to localised renewable energy generation solutions rather than using fossil fuels (Locke, 2021[99]).
Government support to agriculture, particularly in developed countries, distorts markets, stifles innovation and harms the environment, while also disincentivising increased agricultural output in developing countries. Between 2017 and 2019, 54 OECD and EU countries, plus 12 emerging economies, spent on average USD 536 billion per year on direct support to farmers, half of which came from policies to maintain domestic prices above international levels. At the same time, these countries spent comparatively little on measures to underpin long-term sector performance, including research and development, infrastructure, biosecurity and other enabling measures, amounting to USD 106 billion on average per year. Reforming public support to agriculture would improve agricultural output and efficiency in both developed and developing economies, reduce waste and increase competitiveness of the food industry (OECD, 2022[100]).
In addition, public support to farming can offer governments an effective and powerful tool to improve environmental practices and incentivise farms to adopt low-carbon practices and clean technologies (OECD, 2020[101]). For example, Brazil, under the country’s National Plan for Low Carbon Emissions in Agriculture, has offered lines of credit to farmers who adopt less emissions-intensive practices, while making finance available to encourage research and development on climate resilient crops (Russell and Parsons, 2014[102]). Yet, public support for farming can be hard to reform, given entrenched interests from influential groups, while smaller-scale farmers who are most in need of access to affordable finance receive little support.
Improving access to agricultural services, especially training and information services relating to productivity and adaptation to changing climate conditions, such as adopting climate resilient seeds and crops, or diversification of products, for example blending crops, livestock and forestry, can build resilience by diversifying revenue streams. Technology can also play an important role in adaptation, providing information on changing weather patterns to support adaptation of planting timing and harvesting, as well as improving communication to ensure farmers are aware of subsidies and support for which they are eligible. In Malawi, for example, information on weather patterns and accompanying agriculture advice is provided to small-scale farmers by the inter-ministerial National Agriculture Content Committee via radio programmes and mobile messaging, enabling farmers to make informed decisions based on climatic conditions (Ferdinand, Rumbaitis del Rio and Fara, 2021[103]).
Eliminating food waste, which currently accounts for one-third of all food produced before it gets to the table, will also be vital. In addition, governments should take steps to protect remaining ecosystems to avoid further biodiversity loss and destruction of carbon storage, as well as to rehabilitate land unsuitable for agricultural production to regenerate ecosystems.
Governments should consider prioritising the following actions:
Consider reforming public support for agriculture, offering incentives to encourage farming practices which reduce GHG emissions, resilience and improve productivity. Public support for agriculture should be based on an assessment of national context, including production and consumption, split between arable and livestock, types and size of producers, ensuring an equitable sharing of public support with smaller-scale farmers.
Develop plans to extend affordable and micro-finance to small-scale farmers to boost productivity, assess risks associated with the physical impacts of climate change and build resilience.
Enhance provision of agricultural services, particularly information sharing and communications on changing weather patterns, as well as warning systems, through a variety of accessible formats, to help small-scale farmers understand the risks presented by climate change and respond to changes, for example, by adopting more resilient seeds and crops, adjusting planting and harvesting schedules, and diversify revenue streams to build resilience.
Take steps to protect remaining natural ecosystems and rehabilitate land that is unsuitable for agriculture, which can enhance carbon storage.
Set national targets for reducing food waste, and establish actionable roadmaps to achieve goals, for example, through investment in agrifood processing, cold storage, enhancing supply chain co-ordination and public education programmes.
Increase funding to research and development, including through partnerships with the private sector focused on adapting traditional farming practices to boost productivity and encourage adaptation and resilience to climate change, but not at the expense of environmental degradation.
Consider how to strengthen linkages between enterprises, agricultural co-operatives and farmers to enhance participation in value chains, and to facilitate access to technology and knowledge transfer. Cooperation between farmers can serve to boost productivity and increase yields, as well as facilitate connections to markets.
Support the development of climate change-related insurance schemes for small-scale farmers.
Strengthen commitments to decarbonisation of the agriculture sector in NDC, and strengthen MRV systems.
Incentivise the use of renewable energy solutions and decentralised grids in the agriculture sector, rather than thermal power generation.
Invest in rural infrastructure, including cold storage, transport, energy, flood protection and irrigation infrastructure, to encourage strengthening of regional agricultural value chains.
Advanced and developing economies together should:
Invest in development and expansion of climate and disaster risk finance and insurance products to protect communities in developing countries, especially those reliant on agriculture from existential impacts of increasingly frequent extreme weather events.
3.2.5. Valuing natural capital to advance the low carbon transition
Alongside deposits of oil, gas and minerals, developing countries are also endowed with significant amounts of natural capital – which can be valued and used to advance the low-carbon transition. Natural capital refers to the approach of attributing economic value to natural assets – including forests, rivers, agricultural land, coral reef systems, and the range of ecosystem goods and services that flow from them (carbon sequestration, clean water, pollination). Placing an economic value on the goods and services provided by nature creates incentives for actors to invest in and conserve them (Bresnihan, 2017[104]). In fact, as natural capital become more stressed and increasingly scarce in the future, it is expected that its value will increase. If irreversible thresholds are passed for irreplaceable ecosystem services, their value may increase exponentially. However, because natural capital and ecosystem services are often not properly valued by the market or adequately quantified in order to be compared with economic services and manufactured capital, they are often not given sufficient weight in policy decisions (Costanza, 1997[105]).
Considerations around natural capital valuation and use are especially relevant for developing and emerging economies, as the consequences of ecosystem degradation and biodiversity loss are experienced more severely in those countries.
A 2020 World Economic Forum study estimated that ecosystem restoration and avoided land and ocean use expansion could deliver 11 million more jobs by 2030 through opportunities such as ecotourism, sustainable forestry management and nature-based solutions for mitigating climate change (Dasgupta, 2021[106]). Developing countries can take advantage of these opportunities by preserving their stocks of natural capital, and then using them sustainably to advance transformational, low-carbon development. In equatorial countries, this often involves the preservation and reforestation of rainforests, which can then be used to sustain responsible forestry and eco-tourism. For example, Gabon has put in place a number of policies to develop a sustainable forestry sector. In 2002, 13 national parks were created covering 11% of Gabon’s territory where logging was restricted. For areas were logging is permitted, Gabon’s forestry law stipulates that companies must log sustainably by harvesting trees on a 25-year rotating basis. In 2010, the export of unprocessed logs was banned in order to capture additional value from turning a raw log into sawn sections, plywood or furniture – which can increase its value several fold (FT, 2021[107]).
The development of a responsible eco-tourism sector underpinned by the preservation of natural capital has the potential to deliver substantial economic growth and revenue for developing countries. In 2019, global travel and tourism generated some USD 8.8 trillion, representing over 10% of global GDP. Eco‑tourism is only a small proportion of that total but a study found that globally natural protected areas received 8 billion visitors a year (Dasgupta, 2021[106]; WTTC, 2019[108]). In recent decades, Costa Rica has demonstrated that substantive economic growth can be achieved by valuing natural capital and investing in nature conservation. The country was able to triple the size of its economy while doubling the size of its forests and moving to almost 100% renewable energy production. Forests that had shrunk to cover just 21% of Costa Rica’s territory in 1987 had increased to 52.4% by 2013, due to a policy of active reforestation, which was funded in part through a carbon tax and by the fiscal space created by earlier policies (e.g. disbanding of the army in 1948). In 1997, a 3.5% carbon tax on gasoline was introduced and the revenues were used to launch a system of payment for environmental services (PES), as well as the expansion of protected areas. In 2018, the carbon tax generated 11% of all government revenue and has funded a PES system for 300 000 hectares of forest. The resulting preserved and reinvigorated natural capital (rain forests, river canyons, waterfalls and coral reefs) is now sustaining an eco-tourism sector that generates tax revenues for the central government while also creating economic opportunities and employment in those regions (Dwyer, 2019[109]).
High-value eco-tourism industries are also expanding in Africa. For example, both Rwanda and Uganda have used their unique biodiversity to develop an eco-tourism sector based around gorillas despite having less than 1 000 mountain gorillas between them. By charging tourists for viewing permits, Rwanda earns USD 300 million a year from gorilla tourism. Since these high-value eco-tourism industries began, gorilla numbers in the area have recovered, demonstrating that valuing natural capital can positively impact preservation (FT, 2021[107]).
Box 3.14. Grande Mayumba project: Using nature-based solutions to generate economic value
The Grande Mayumba project in Gabon is intended to derive economic value from natural capital through the development of sustainable timber, agriculture and ecotourism businesses, supported by regional infrastructure, in accordance with Gabon’s Sustainable Development Law.
Over the next few years, more than USD 200 million will be invested in commercial activities and infrastructure at Grande Mayumba, generating around 4 000 new jobs in the coming decade, and providing much-needed socio-economic benefits. Over 25 years, the project is expected to avoid 200 million tonnes of carbon emissions in the area, preventing unplanned development, deforestation and degradation of the ecosystem while delivering sustained commercial value. A sustainable timber business will provide local income and jobs, while a sustainable agriculture business will raise 20 000 cattle, buffalo and other wildlife and improve degraded soil quality, increasing carbon sequestration.
One-third of the project area will be designated for conservation, covering estuarine, montane and savannah ecosystems to ensure that critical biodiversity is protected.
Source: (FT, 2021[107]); (ACDG, 2022[110]).
In some cases, the conservation of natural capital itself can bring financial benefits. For example, 85% of the territory of Gabon is covered by carbon-absorbing rainforest, making the country one of the few net sequesters of carbon globally. In 2019, Gabon entered into an innovative emissions reduction scheme with the Central African Forest Initiative, a Norwegian-backed fund that issues payments in exchange for reducing emissions from deforestation and forest degradation. The agreement provides for results-based payments of USD 150 million over a ten-year period. The first payment was made in 2021 after independent experts verified Gabon’s results from reduced deforestation and forest degradation (mainly from forestry activities) in 2016 and 2017 (FT, 2021[107]).
Box 3.15. How can governments use natural capital to generate revenue?
Governments can implement a number of policy instruments to generate revenue from the conservation and the enhancement of their natural capital and ecosystems. Some of these are specifically aimed at revenue generation, whereas others seek to provide incentives for businesses to behave in more environmentally sustainable ways.
Environmental taxes – refer to taxes placed on environmentally harmful activities (for example, pollution, or the use of natural resources), and are based on the polluter pays principle.
Fees and charges – include entrance fees to national parks, fees on hunting licenses, charges on land-based sewage discharge, charges for groundwater abstraction, etc.
Tradable permit schemes/cap-and-trade programmes – include individual transferable quotas (ITQs) for fisheries, tradable development rights, tradable hunting rights and emissions trading schemes. These instruments set a limit on the total amount of a natural resource that can be exploited, and then allocate individual permits to users that they can trade. If the initial permit is auctioned rather than allocated, tradable permit schemes can raise revenue.
Biodiversity offsets –refer to conservation actions intended to compensate for the residual, unavoidable impacts of development projects, after prevention and mitigation measures have taken place, and are based on the polluter pays principle. Depending on their design, biodiversity offsets could also generate revenue for governments.
Payments for ecosystem services – refer to voluntary transactions between service users and service providers that are conditional on agreed rules of natural resource management for generating offsite services. PES are based on the user- or beneficiary-pays approach and can be used to raise revenues through government interventions.
Fines for environmental damage – generate revenue from environmental infractions that can be used to support projects to restore nature.
Source: Adapted from (OECD, 2021[111]).
Valuing natural capital
In order to contribute to sustainable growth, natural capital first needs to be properly valued. Natural capital valuations can help in calculating the true cost of capital and therefore identifying which projects governments should pursue and which are likely to be unsustainable. If natural capital costs are taken into account alongside existing considerations of capital, labour and technology costs, the market can be incentivised to select inputs where production places far less demands on natural ecosystems (Hodgson and Tarditi, 2021[112]).
Box 3.16. Valuing natural capital in Costa Rica
In 2012, the Central Bank of Costa Rica and the World Bank began a joint project to try to place a value on Costa Rica’s natural assets. With cross-government participation (Ministry of Planning, Ministry of the Environment and the Ministry of Finance), the programme intended to enable better measurement and management of the country’s environmental policies by establishing monetary values for its forests, water resources and natural energy sources.
Stocks and flows of natural resources (forests, waterways, fisheries, etc.) are presented in physical and monetary terms with a market value ascribed to them. For example, forests are valued by the price the timber would fetch if sold to the market. Valuation of assets and flows that do not have a market value are not included, but future versions of this methodology may include the value of ecosystems and therefore be able to provide value for carbon sequestered by the forests.
Source: (Dwyer, 2019[109]).
One approach to valuing natural capital involves the beneficiaries of ecosystem services paying the providers. This is known as “payment for ecosystem services” (PES). In other terms, PES provides incentives for owners of natural resources, such as farmers and forest owners, to preserve and manage resources in order to provide ecological services. The most common PES schemes relate to payments for the protection of landscapes, the maintenance of habitats for endangered species, and the preservation of hydrological functions related to the quality and quantity of freshwater flows from upstream areas to downstream users. In order to be effective, PES systems must target a well-defined ecosystem service and ensure that payments add to the value of the ecosystem service that would be provided under a business-as-usual scenario. Furthermore, they must be able to monitor the provision of the ecosystem service. PES schemes are not easy to design and implement and require a substantial amount of initial effort. For instance, baselines for ecosystem services must be established in order to determine if PES will provide additional value.
The PES approach was first devised in 1997 by Costa Rica to reverse the severe deforestation that had taken place across the country. The National Forestry Fund made payments to landowners for maintaining their forests due to the external benefits that those forests provided. The PES approach has since been taken up on a global scale by the United Nations in order to reduce GHG emission by paying for forest conservation in developing and emerging economies. The Reducing Emissions from Deforestation and Forest Degradation in Developing Countries (REDD+) scheme has been part of climate-change negotiations since 2007 (Bresnihan, 2017[104]). It was adopted at the 19th UNFCCC Conference of the Parties (COP19) in 2013 and provides complete methodological and financing guidance for implementation activities in the forest sector that reduce emissions from deforestation and forest degradation, as well as the sustainable management of forests and the conservation and enhancement of forest carbon stocks in developing countries. Thanks to the implementation of REDD+ projects, many developing countries have significantly enhanced forest monitoring and management capacities, which are essential to achieving forest protection over the long term.
Box 3.17. Payments for Environmental Services in practice: the Case of Mexico
Mexico was one of the first countries in Latin America to implement a national Payment for Environmental Services (PES) scheme, which was initiated in response to high deforestation rates and degradation of watershed ecosystem services. Between 1993 and 2 000 crops and pastures grew significantly at the expense of forests and jungles, which were subject to extensive deforestation. Mexico is home to over 60 million hectares of forests and tropical jungles, approximately 60% which are owned by communities and ejidos, or organised groups of peasants in an institutional arrangement that involves both individual plots of land and common property areas.
Under the PES scheme, a contractual relationship is formed between the forest owner and the government’s forestry department (CONAFOR), whereby the owner receives a payment at the end of each year if the forest is conserved. The payment seeks to cover the opportunity cost for land owners of preserving the forest. The PES scheme is financed through revenues from water fees that are ear-marked and managed in a trust fund. This funding mechanism creates an indirect link between users and providers of the environmental service and also protects the programme from budgetary problems that could arise if the PES programme were financed through the general budget.
The PES scheme was launched in 2003, and by 2013, 4.27 million hectares were enrolled in the programme, benefiting 7 350 private or communal landholdings and representing an investment of USD 651 million. In the years between 2003 and 2007, the PES scheme successfully prevented 18 000 hectares from being deforested. In addition, the PES scheme has encouraged local stakeholders, international agencies, and central and regional government to establish frameworks that account for ecosystem services in a way that includes market alternatives. For example, in Mexico, both city and state governments have recognised that the water they consume depends on upper watershed conditions, which in turns has motivated those entities to take the initiative and pay for such environmental services.
Overall, the success of a PES scheme will depend on the existence of a robust legal framework, financial mechanisms that allow for multi-year projects, transparency and accountable contractual relationships between the government and owners of forested land, dedicated funding sources, and platforms dedicated to increasing local stakeholder participation.
The role of accounting mechanisms in the valuation of natural capital
There are a number of accounting mechanisms that developing countries can use to value their natural capital assets. Natural capital accounting (NCA) refers to the use of an accounting framework to measure and report on stocks and flows of natural capital. NCA covers accounting for individual environmental assets or resources, both biotic and abiotic (e.g. water, minerals, energy, timber, fish), as well as accounting for ecosystem assets (e.g. forests, wetlands), biodiversity and ecosystem services (UN, 2014[116]). The accepted international standard for natural capital accounting is the United Nations’ System of Environmental Economic Accounting (SEEA), which provides a framework that brings together economic and environmental information in an internationally agreed set of standard concepts, definitions, classifications, accounting rules and tables to produce internationally comparable data.
To facilitate informed decision making, the SEEA Central Framework brings together information on water, minerals, energy, timber, fish, soil, land and ecosystems, pollution and waste, production, consumption and accumulation. Each of these elements is assigned specific and detailed measurements enabling patterns of consumption and production and their effect on the environment to be clearly understood. The SEEA can be used as a guidance tool for both policy development and evaluation as well as decision‑making processes. Raw data (in the form of aggregates and indicators) can be applied to areas of the environment that are the focus of decision makers. In addition, detailed information, covering some of the key drivers of environmental change can be used to provide a richer understanding of the policy issues and trade-offs. Lastly, SEEA data can be used in models and scenarios to assess the national economic and environmental effects of different policy scenarios in country.
Box 3.18. Policy use of natural capital accounting mechanisms
The European Union’s INCA project was launched in 2015 to produce a pilot for an integrated system of ecosystem accounting for the EU, based on the UN SEEA Framework.
The INCA project assessed the EU’s ecosystem extent, initial ecosystem condition accounts and produced the first monetary estimate of gross ecosystem product for the EU. The results of this ecosystem assessment have subsequently informed several concrete policy initiatives of the European Commission:
The Framework to Facilitate Sustainable Investment aims to help create the world’s first ever “green list”, a classification system for sustainable economic activities. This will establish a common language that investors and businesses can use when investing in projects and economic activities that have a substantial positive impact on the climate and the environment.
The EU Pollinators Initiative aims to improve scientific knowledge about insect pollinator decline, tackle its main known causes and strengthen collaboration between the actors concerned. The assessment identified that 50% of demand for pollination services is not met. This means that about 50% of areas where pollinator-dependent crops are grown in the EU (e.g. fruit trees) do not provide suitable condition for pollinators (e.g. nesting sites).
The EU nature restoration plan (part of the EU Biodiversity Strategy for 2030) is supported by the assessment of the INCA project. Under the plan, ecosystem accounts can be used to guide large-scale restoration efforts by mapping where ecosystems are degraded, monitoring the condition of ecosystems following restoration and assessing the benefits of ecosystem restoration through ecosystem services.
Source: (Vysna et al., 2021[117]).
In 2014, the World Bank set up a global partnership to promote sustainable development by ensuring that natural resources are mainstreamed in development planning and national economic accounts. Entitled Wealth Accounting and the Valuation of Ecosystem Services (WAVES), the partnership aims to implement NCA at the national and subnational levels based on the SEEA, and to incorporate NCA into policy analysis and development planning. As a result, several developing countries have used NCA mechanisms in their policy-making process. For example, Rwanda’s land accounts are informing its national land management system, allowing policy makers to study trends in land use and changes over time. In the Philippines, NCA mechanisms have provided inputs into tools such as environmental impact assessments and cost-benefit analysis of existing policies, which, in one case, helped institutions make decisions such as setting priority areas for mangrove protection and restoration in South Palawan. In a review of the WAVES programme, the World Bank noted the importance of NCA mechanisms reaching not only environment ministries, but also ministries in charge of economic growth and planning in order to integrate environmental considerations into economic policy (World Bank, 2021[118]).
Governments should consider prioritising the following actions:
Consider mechanisms that provide incentives to preserve natural capital and global common goods, like forests, rather than just paying for reducing emissions.
Introduce natural capital into national accounting systems. Increased investment in physical accounts and valuation would improve the quality of natural capital accounts (Dasgupta, 2021[106]).
Join the World Bank’s global partnership, Wealth Accounting and the Valuation of Ecosystem Services (WAVES), in order to incorporate NCA into policy analysis and development planning (World Bank, 2021[118]).
Communicate the economic benefits of preserving natural capital and natural infrastructure (rivers, forests, etc.). These benefits include the potential to increase resilience to climate change through ecosystem-based adaptation approaches (Burke, Ranganathan and Winterbottom, 2015[119]).
Actions requiring international support in contexts where government capacity is low:
Launch an ambitious system of payment for global environmental services (PES) where the beneficiaries of global ecosystem services pay the providers in order to conserve existing natural capital.
Encourage the development of a wider set of indicators of social, economic and environmental well-being. These additional indicators can provide invaluable insights into whether current trajectories of ecosystem condition and resource use undermine future economic development or support a transition to an economy that reduces environmental risks and supports sustainable development (Burke, Ranganathan and Winterbottom, 2015[119]).
Standardise data and modelling approaches to make it easier to embed natural capital accounting in national economic accounts, and to improve decision making at scale around the world (Dasgupta, 2021[106]).
Encourage natural capital valuation assessments for public infrastructure projects. Since natural capital valuation includes the costs incurred by nature to produce a public good, these costs must be added to the total costs estimated for executing public infrastructure projects (Modak, Mathur and Vaidyanathan, 2019[120]).
Encourage the inclusion of natural capital valuation assessments in financial sector reporting. Since natural capital valuation includes the costs incurred by nature to produce a commercial good or service, this information must be transparent and easily available to all stakeholders – regulators, investors and the general public. Companies must be encouraged to file information on their natural capital valuation assessment with the regulators (Modak, Mathur and Vaidyanathan, 2019[120]).
Development finance institutions and bilateral development agencies should:
Consider providing payments for forest conservation to developing and emerging economies in order to incentivise forest stewardship and sustainable use.
Provide technical support to developing country governments to make it easier to embed natural capital accounting in national economic accounts.
Provide access to satellite-imagery that enables the real-time usage of natural resources (Modak, Mathur and Vaidyanathan, 2019[120]).
3.3. Restructuring fiscal frameworks and reforming energy pricing to optimise domestic resource mobilisation, build redistributive taxation systems and correct misaligned incentives
Fossil fuel-producer developing and emerging economies typically have narrower tax bases than diversified economies. This increases the impacts of commodity price volatility on government spending and weakens the social contract between citizen and state, because citizens are less likely to demand adequate and reliable public services from government in return for tax payments. The low-carbon transition presents governments with an opportunity to strengthen fiscal frameworks through progressive reforms that limit impacts on poorer citizens, broaden the tax base to increase domestic resource mobilisation, reduce reliance on few commodities and attract private investment in priority green sectors, such as renewable energy, storage and hydrogen.
In addition, phasing out inefficient fossil fuel subsidies and pricing carbon, either through a carbon tax or an emissions trading scheme (ETS), can be powerful tools to encourage low-carbon technological innovation, deployment and scale-up, as they provide long-term price signals to encourage deployment of renewables, and to incentivise firms and individual consumers to make lower carbon business and lifestyle choices. Without internalising negative externalities of high-emitting fuels, which impose unaccounted for environmental and social costs on society, diffusion of low-carbon substitutes will be all the more challenging. In fact, subsidies and unpriced externalities act as a negative tax on low-carbon products and technologies, distorting price incentives and rendering them uncompetitive against subsidised carbon intensive alternatives, which benefit from energy inputs below market price (Sen, Nepal and Jamasb, 2020[121]). As part of a coherent strategy, removal of inefficient fossil fuel subsidies and introduction of carbon pricing can enable fossil fuel-producer emerging and developing economies to correct misaligned incentives, free up substantial revenue for investment in more productive areas of the economy, and provide a means by which to propel their economies towards low-carbon sustainability, resilience and prosperity.
3.3.1. Addressing misaligned incentives through fossil fuel subsidy reform and carbon pricing
A fundamental driver of fossil fuel path dependency is that incentives which influence the way in which people and businesses invest, produce and consume do not account for environmental, climate and social costs. The most powerful tools to address misaligned incentives and to level the playing field between carbon intensive technologies and greener substitutes are inefficient fossil fuel subsidy reform and pricing carbon to account for negative environmental, climate and social costs. Applied coherently, policies which remove preferential treatment of fossil fuels, for example through consumer or producer subsidies, tax or permitting exemptions, and those which place a price on carbon (through carbon taxes, fuel taxes, environmental taxes, excise taxes or an ETS) on the production or use of polluting products, can gradually help to influence path-dependent consumer behaviour, and accelerate phase-out of fossil fuel use, and scale-up of cleaner substitutes (Alternburg and Assmann, 2017[28]).
However, fossil fuel subsidy reform and carbon pricing may be challenging for many developing country governments from a political economy and administrative perspective. They can also result in negative distributional impacts if poorer households are unable to cope with price increases. Governments should therefore plan to address fossil fuel subsidy reform and carbon pricing in an incremental manner, in line with careful assessment of national circumstances, and paired with progressive expansion of social protection provisions and investment in public services and infrastructure particularly efficient and affordable public transport. Ensuring citizens have affordable and greener alternatives to turn to when prices for established polluting technologies rise, and alleviating the negative impacts on poorer households, will be critical to implementing of reform packages and mitigating the potential risk of public backlash.
Reforming fossil fuel subsidies
Across the world, fossil fuel subsidies remain pervasive. OECD data suggest that fossil fuel subsidies to consumers and producers across G20 economies increased to USD 190 billion in 2021, from USD 147 billion in 2020, given the rebound in global economic activity after the COVID-19 pandemic and rising fossil fuel prices. Support to producers, at USD 64 billion in 2021, was the highest since OECD tracking began, at a 50% year-on-year increase, and up 19% on 2019 levels, while consumer subsidies reached USD 115 billion up from USD 93 billion in 2020 (OECD, 2022[122]).
Developing country governments often find it particularly challenging to implement fossil fuel subsidy reform. Their citizen’s inability to absorb higher prices, given a much higher share of household expenditure tends to be spent on energy, can create political economy constraints and negative distributional impacts. Lower middle-income households, which may be struggling to make ends meet, make up a far higher proportion of the population in these contexts than in advanced economies. Increases in energy expenditure caused by fossil fuel subsidy reform could push large swathes of the population into poverty (Finon, 2019[123]).
Fossil fuel subsidies, therefore, are often justified on the basis that they insulate poorer households from unaffordable energy costs, thereby providing them with some form of social protection. Yet the evidence does not support this argument. Research by the Inter-American Development Bank (IDB), for instance, suggests that for every USD 1 delivered to the poorest 20% of the population through petrol subsidies in Ecuador, the government paid USD 20 – mainly because wealthier households use far more gasoline – with this figure falling to USD 10 for electricity, USD 9 for diesel and USD 5 for LPG. This highlights the fact that in some contexts, it may be possible to free up significant budgetary resources, while at the same time improving the livelihoods of poorer households at a fraction of the overall cost of subsidies (Schaffitzel et al., 2019[124]).
The civil unrest which has accompanied attempts to reform fossil fuel subsidies in some countries provides evidence of how contentious it can be if poorly implemented and without adequate social safeguards. This was the case when the Nigerian government attempted to completely remove the subsidy on petroleum products in 2012, and in Ecuador in 2019 when the government announced the removal of subsidies for gasoline and diesel, but was subsequently forced to reverse the policy in the face of protests (Beaton et al., 2016[125]; IISD, 2019[126]). In early 2022, the Government of Kazakhstan’s attempt to remove the fuel price cap on butane and propane led to widespread civil unrest, forcing it to reverse the policy.
Box 3.19. The Extractive Industries Transparency Initiative’s typology of fossil fuel subsidies
Government support for fossil fuels can take a variety of forms, including direct or indirect support to fossil fuel companies, which offset the costs of oil, gas and coal production, as well as reducing the prices consumers pay for fossil fuel products. This makes accounting for the full cost of a government’s subsidy regime difficult to fully assess, particularly given that some subsidies can be funded directly by governments through budget allocations, while in other cases they are funded through state-owned enterprises directly or through other policy mechanisms.
Producer subsidies either take the form of direct payments to fossil fuel producers, or tax exemptions, incentives or breaks for companies which result in governments forgoing revenue they would otherwise receive. This might include direct financial support for producers, credit support, insurance indemnification, no or low charges for mineral leases on government land, preferential treatment in government procurement, tax breaks or special taxes.
Pre-tax consumer subsidies consist of subsidised petroleum products, such as diesel, petrol or LPG, to domestic markets or to power plants. They could include direct financial support for consumers, regulated prices below international rates, and the use of government goods and services below market rates.
EITI Standard 6.2 requires governments to report on quasi-fiscal expenditures, or subsidies provided by state-owned enterprises outside of the budgeting process and where no compensation is provided by government.
Source: (EITI, 2021[127]).
How to approach fossil fuel subsidy reform
The OECD provides a four-step sequential approach for governments to approach fossil fuel subsidy reform in its Companion to the Inventory of Support Measures for Fossil Fuels 2021. This provides guidance to governments to identify priority areas for reform based on national circumstances and development objectives, and makes available a range of analytical tools to help governments assess the extent of fossil fuel subsidies and define their own fossil fuel subsidy reform process. The OECD sequential approach is modular, enabling government to pursue reform programmes in parallel to building capacity, while identifying and closing evidence gaps over time (OECD, 2021[128]) The sequential approach is summarised in Table 3.2.
Table 3.2. OECD sequential approach to reforming fossil fuel subsidies with analytical tools
Governments should consider prioritising the following actions:
As a first step, work to build a full picture of the extent and nature of fossil fuel subsidies, combining price gap and inventory approaches. This process should be iterative, working initially from the most significant government support to incorporate smaller subsidies over time. The process will require substantial resources and expertise. Subsidy tracking must be an ongoing process with new data and information included as and when it becomes available, as subsidy tracking teams move into new areas of analysis, or prices change. This requires a strong policy mandate and good co-operation across government departments, given that government support for fossil fuels can originate from a variety of public agencies.
Recognise that dedicated studies may be needed to calculate accurate reference prices adjusted for local conditions across different fuel types.
In compiling subsidy inventories and quantifying support, prioritise data consistency, use of consistent reference periods and making sources available to build the credibility of subsidy estimates with different stakeholders.
A critical success factor in building the political feasibility of a fossil fuel subsidy reform programme, and leveraging it to improve the livelihoods of poorer households, is understanding distributional impacts and building a comprehensive package of reforms which avoid regressive effects and can be easily implemented.
Assess the impact of different fossil fuel removal options on different income groups, including through an assessment of regional impacts and the effects of price changes on different fuel types and electricity. This should be done using Computable General Equilibrium (CGE) modelling, and combined with household surveys and interviews to build a granular understanding of local impacts as well as impacts across different geographies.
Consider the potential unintended consequences of fossil fuel subsidy reform. For example, in the absence of viable alternatives, removal of LPG subsidies will mean people simply turn to wood for cooking fuels, with impacts including deforestation and health. Increasing prices when no alternatives are available may simply push vulnerable households further into poverty.
Assess options to support poorer households, recognising that the most successful support schemes build on existing administrative infrastructure ideally, social protection mechanisms.
Development finance institutions and bilateral development agencies should:
Provide technical and financial support to assist governments in tracking and calculating fossil fuel subsidies, and to model and simulate the impacts, benefits and disadvantages of competing reform scenarios across different timeframes.
Enhance the availability for governments of comparable data on subsidies across developing and emerging economies to enable comparisons in a centrally accessible database, showing methodologies used.
Assist governments to utilise available best practice methodologies to identify, quantify and prioritise for reform government support for fossil fuels, for example, the OECD Inventory approach.
Provide technical support to governments to model the distributive impacts of fossil fuel subsidy reform and build targeted support packages to mitigate regressive and negative distributional impacts.
Managing the distributional and political economy implications of fossil fuel subsidy reform
Support measures should integrate political economy considerations in order to try to address the likelihood that price increases will precipitate protests by certain income or interest groups. Discontent is not necessarily concentrated among the poorest groups in society, and often society’s very poorest have limited political capital to protest and limited expectations that their circumstances will change, whereas relatively wealthier citizens who have more to lose or more to gain may be more likely to take to the streets (OECD, 2021[131]).
A comprehensive approach to subsidy reform will therefore have to understand the likely behaviours and perspectives of other groups – particularly lower middle-income groups who have relatively higher energy expenditure and may also be struggling to make ends meet, and who will also be significantly impacted by price rises. In Nigeria, for example, some of the biggest protests accompanying government subsidy reform efforts in 2012 took place in Lagos and Abuja, rather than in the poorer north. Households in Lagos and Abuja, relatively speaking, are wealthier, but were set to see a more dramatic change in expenditure levels because their overall energy expenditure was far higher than households in the north (Beaton et al., 2016[125]).
In addition, support measures targeting special interest groups who have strong capacity to mobilise collectively, for example fuel vouchers for taxi drivers, can also provide relatively inexpensive means to address political economy constraints and smooth the passage of fossil fuel subsidy reform (Schaffitzel et al., 2019[124]). Meanwhile, governments can also use demand-side measures to ease fossil fuel subsidy reform. For instance, the Government of Ecuador’s Efficient Cooking Programme subsidises electricity and provides clean electric stoves to households. Residential demand in Ecuador accounts for 92% of LPG use, and the programme aims to gradually shift consumption to alternatives over time, after which, raising prices on LPG will face less public opposition and have fewer distributive impacts (Rentschler and Bazilian, 2017[132]).
Box 3.20. Fossil fuel subsidy reform: Lessons from Indonesia
Fossil fuel subsidies were originally introduced in Indonesia in 1977, and with the country’s transition to becoming a net importer of oil and gas in 2012, represented a growing burden on government fiscal resources and balance of trade, and acted as a disincentive to investment in renewable energy. The financial burden from fossil fuels peaked in 2014, and up to this point, budget allocations to fossil fuels were larger than allocations to other priority spending areas, including health and infrastructure. Through gradual reform of fossil fuel subsidies, Indonesia has been able to bring the budget allocation for fossil fuel subsidies down to about 5% since 2015, with savings reinvested in infrastructure spending, which has seen a significant increase since 2015.
Key success factors in Indonesia’s experience with fossil fuel subsidy reform include widespread communication as to the benefits of reform, paired with mitigation measures including an unconditional cash transfer programme to alleviate negative distributional impacts on poorer households. Indonesia’s Conversion Programme from Kerosene to LPG provided every household with a stove “starter pack”, and a 3 kg cylinder of LPG to try to discourage use of kerosene in cooking which is more polluting. The programme resulted in a five-fold increase in LPG use, and a 92% decrease in kerosene between 2007 and 2015. While prices for both kerosene and LPG have remained the same, subsidies for LPG are lower than for kerosene, providing the same amount of cooking energy at lower cost for the government, as well as less pollution and GHG emissions.
Governments also need to consider the impacts on firm competitiveness of higher energy prices, based on enterprise surveys, interviews and consultations, to develop support packages, where necessary, to support them in adapting to change. Support packages can include compensation to help firms accommodate higher prices and offset losses in the short term, giving companies time to adapt to change. Longer-term grants and subsidies and awareness raising about low-carbon technology and energy efficiency investments can support fuel switching as well (Rentschler, Kornejew and Bazilian, 2017[135]).
Lastly, the way in which governments communicate fossil fuel subsidy reforms and energy price changes is important, and has implications for the ease of reversing such changes. Incorporating reform policy into legislation, for example, will require parliament to change the law to reverse the policy, while including it in regulation will require a ministerial sign off for reversal, which again will be harder to reverse than a simple press statement. Governments should also announce price changes via a government website, rather than relying on press reporting, and ensure announcements are made even if there is no change in energy price. Regular price changes, even if small, can also help acceptance when prices go up, while more irregular changes often lead to very substantial price increases down the line, which will be harder for consumers to absorb, and may generate more opposition. Meanwhile, adopting an automatic pricing mechanism in legislation can help to depoliticise reforms. Governments can also publish transparent formula for setting prices, which can also help convey the extent of the price gap to stakeholders (UN, 2021[136]).
Governments should consider prioritising the following actions:
Consider the need for interim or bridging financing to give time for inefficient fossil fuel subsidy reform to generate savings for support measures, which need to be in place before reforms come in.
Build public acceptance through a comprehensive communications strategy, applying multiple platforms and approaches to explain the scale and impact of the existing subsidy regime, and building consensus around the existence of more economically efficient ways to support poorer households. Explain how revenue will be recycled for the public good.
Consider that lowest income groups may not be the ones to protest and that large segments of the population may be pushed into hardship by fossil fuel subsidy reform because they spend such a high proportion of their income on energy. Assess the political feasibility of reform and the necessity of introducing targeted measures for groups who are likely to mobilise or protest against reform.
Assess the impacts on private sector/industry through firm surveys, interviews and consultations. Develop a response plan, including compensation payments to help absorb short-term costs as well as financial support for firms to switch fuels and invest in low-carbon equipment and energy efficiency measures.
Give consumers and firms time to adapt, taking an incremental and phased approach to inefficient subsidy removal.
Consider financing demand-side initiatives with money saved from subsidy reform, to extend reforms to other areas where reform will have a big impact on prices.
Accounting for negative externalities through carbon pricing
Putting a price on carbon, either through an explicit tax on carbon, taxing carbon intensive products, such as fuel, or establishing an ETS, can form a central pillar of a government’s least-cost decarbonisation pathways, nudging firms and consumers to switch to lower cost and less polluting products and practices. ETS tend to be the most effective mechanisms to reduce emissions, especially in industrialised economies, as they ensure environmental effectiveness, and incentivise use of the most efficient technologies and those that cost least. On the other hand, carbon taxation is better suited to the earlier phase of carbon price implementation, when capacity is weaker, institutional frameworks less developed and sectors characterised by distributed emissions sources.
However, as is the case with fossil fuel subsidy reform, pricing carbon can be challenging to implement because of the impact of price increases on poorer citizens, and because it threatens vested interests which benefit from the status quo. It follows that at least initially, governments should consider setting an explicit carbon price at a very low level, far lower than the USD 50 to USD 100 per tonne of CO2 by 2030 estimated to be required across the world to be consistent with a 1.5 C increase in global temperatures, as recommended by the Paris Agreement High-Level Commission on Carbon Prices (OECD, 2021[137]). Moreover, given that developing countries currently account for a very small proportion of global emissions, as outlined in Figure 3.1, the urgency to introduce a carbon price is felt less, though this will change as these economies grow and urbanise (Alemayehou et al., 2021[138]).
Yet, despite these challenges, carbon pricing should still be considered by fossil fuel producer developing and emerging economies as an integral component of a coherent overall strategy to build least-cost pathways to decarbonisation and systemic transformation. Internalising negative externalities through carbon pricing can help tackle local pollution and support domestic revenue mobilisation to finance vital government services. At the same time, it can reduce the risk of stranded assets, help to future proof investments and set the economy on a more sustainable footing which will enable better integration in the world economy as global decarbonisation gathers pace. However, design and implementation will need to be more gradual and incremental than in advanced economies, carefully attuned to national socio-economic circumstances, and complemented with investments in public services and infrastructure that reinforce and support the case for energy price reform.
Through an incremental approach, which is tailored to country circumstances and incorporates policies designed to offset distributional impacts, governments can gradually begin to price carbon. A core concept is the Effective Carbon Rate (ECR), or the sum of any tradeable emission permit prices, carbon taxes, and fuel excise taxes, minus any fossil fuel subsidies that affect pre-tax prices, which produce an overall price for emissions. Egypt, for instance, in 2018 had net negative energy tax revenue, but has since made substantial progress in closing this gap through fossil fuel subsidy reform and introducing new taxes on petroleum products. Egypt is now close to eliminating subsidies on fossil fuels completely. If Egypt were to raise its ECR to EUR 30 per tonne of CO2, a common low-end benchmark for OECD and G20 countries, it could free up public funds equivalent to 1.5% of GDP, as well as effectively incentivise low-carbon investments and consumers and businesses to switch to low-carbon alternatives (OECD, 2021[137]).
Yet, progressively transforming the ECR from net negative to net positive will be contingent on governments providing ongoing targeted support to consumers and businesses to offset negative distributive and competitiveness impacts and build public acceptability of carbon pricing measures. At the same time, consumers and businesses must be afforded viable greener alternatives in order for price signals to accelerate the transition. This will require complementary and sustained investments in infrastructure, particularly transformation of public transport and urban spaces to improve accessibility to amenities and services, as well as integrated technology transfer and innovation policy which can encourage diffusion of low-carbon appliances, equipment and technology.
Administratively straightforward carbon pricing via fuel taxes
Initially, governments may choose to tax carbon implicitly through increasing existing taxes on fuels, particularly given that the most polluting fuels, such as coal and diesel, are often the lowest taxed. Most countries already raise revenue through taxes on fuels in some form, normally through an excise tax which has a similar impact to carbon taxes on consumer behaviour.
This can help to incrementally increase the ECR and has the advantage of building on existing tax administration systems, as well as limiting the need to develop sophisticated MRV systems, given a proxy for CO2 emitted per unit of fuel by type can be used to assess emission reduction gains instead. The process of improving net positive gains on the country’s ECR should be incremental, with governments investing in parallel in infrastructure and public transport to provide citizens with real viable alternative choices once a carbon price is applied, which in turn will enable increases over time.
Building more sophisticated carbon pricing mechanisms and linking carbon markets
As part of a long-term strategy, fossil fuel-producer emerging and developing economies may eventually turn to explicit carbon pricing beyond incremental increases to taxes on fuels, through introduction of a carbon market mechanisms such as an ETS. This could eventually create opportunities to mobilise climate finance. For example, the Clean Development Mechanism (CDM) under the Kyoto Protocol allowed a country with an emissions reduction commitment to implement a mitigation project in a developing country. This allowed it to obtain UN-issued Carbon Emissions Reductions (CERs), or carbon credits, which could be used to contribute to its emissions reduction commitments or sold.
Given emissions abatement opportunities across industries relating to oil, gas and coal, fossil fuel producer emerging and developing economies are particularly well-placed to generate climate finance through carbon markets. Relevant projects might include technologies to reduce carbon intensity of coal mining, oil and gas producers providing carbon storage units for CO2, gas utilisation projects to reduce flaring or energy efficiency projects.
On the basis of the model established by the CDM, a number of regional economic groupings and in some cases provincial governments, have set up their own ETS. As of 2021, there are 33 ETS schemes in operation around the world (one supranational, eight country level, 18 provinces and states, and six cities). These cover 16% of global GHG emissions and jurisdictions making up 54% of global GDP (ICAP, 2021[139]). Key ETS schemes include the EU ETS (cap and trade, introduced in 2005) and China’s ETS (cap and trade, introduced in 2001), which is now the world’s largest carbon market (World Bank, 2021[140]).
Box 3.21. Cap and Trade versus Baseline and Credit ETS
ETS can be grouped into two categories: Cap and Trade schemes and Baseline and Credit schemes. In Cap and Trade schemes, a government establishes a threshold for emissions during a predefined time period, and emissions quotas are allocated to industry. In Baseline and Credit systems, an emissions baseline is established for regulated entities and any emissions above the baseline have to be accounted for through credits. Entities which reduce their emissions below the baseline receive credits for these emissions cuts and can sell them to higher emitters.
Source: (Price, 2020[141]).
A rulebook for Article-6 of the Paris Agreement governing the functioning of an international carbon market, which could eventually serve as a replacement for the CDM, was agreed at COP26 in Glasgow in November 2021. The new rulebook establishes a mechanism for carbon trading between governments, and also between companies and governments, as well as a 5% levy to fund adaptation projects. However, while agreement on Article-6 does raise the prospect that increased financial flows will accrue to emerging and developing countries, the extent to which this will take place is not clear at this stage. Sixty-one countries, including major fossil fuels producer countries such as Egypt, Kazakhstan and Nigeria, have signalled their intention to utilise carbon markets to meet their NDC commitments (GDI, 2021[142]).
Key principles to ensure the integrity of ETS include making sure emissions mitigation is real, measureable, verifiable and permanent, which requires effective MRV systems, and environmental integrity is guaranteed (crediting does not result in an overall increase in emissions). Avoidance of double counting (no two entities can use the same emissions reductions or avoidance to contribute to their NDCs) is also key (World Bank Group & Carbon Partnership Facility, 2021[143]). Projects should also be able to demonstrate conclusively that in the absence of carbon market support, carbon abatement technologies would not have been deployed.
Box 3.22. Kazakhstan’s ETS
Working alongside the World Bank’s Partnership for Market Readiness (PMR) programme, Kazakhstan in 2013 launched an ETS to drive development of low-carbon technology, energy efficiency and investment in renewable energy. Kazakhstan’s ETS now regulates 40% of emissions, covering 225 entities with emissions exceeding 20 000 tonnes of CO2 per year. For Kazakhstan, which is the world’s 21st biggest emitter, with 85% of its emissions emanating from its coal intensive energy sector, the ETS represents a first step on the pathway towards net zero, though more needs to be done to achieve this goal by 2060, a target to which it committed in 2020.
Source: (Marteau, 2021[144]).
Governments should consider prioritising the following actions:
Calculate the national ECR by sector and fuel type and establish long-term plans to transform it to net positive, and improve revenue gains via gradual elimination of fossil fuel subsidies and incremental reforms of existing fuel taxes, for instance, excise taxes. The OECD already publishes the ECR for many developing and emerging countries as part of its Taxing Energy Use project, in which data from 71 economies are analysed (OECD, 2021[137]).For some fossil fuel producer developing and emerging economies, national socio-economic conditions may affect the feasibility of an explicit carbon price in the short term.
As part of a short- to medium-term strategy, prioritise incremental increases in the national ECR through progressive reform of inefficient fossil fuel subsidies and a rise in existing taxes on fuels, incorporating measures to offset political economy challenges and negative distributional impacts. This will enable governments to leverage existing tax administration systems, thus avoiding the establishment of 1) sophisticated MRV systems, as a proxy can be used to calculate impact on emissions reduction; and 2) an explicit carbon price, which may not be feasible from a political economy perspective.
Prioritise raising fuel taxes on the most polluting fuels, noting that coal and diesel tend to be the least taxed in emerging and developing countries.
Communicate effectively to the public the rationale for carbon pricing, explaining the scale and opportunity costs that subsidies and unaccounted for externalities entail, and offering more efficient ways to support vulnerable households and to use revenue in a more productive way.
Consider that firms and households need time and support to adapt to rising prices. Consider the role of non-price measures, including alternative fuel mandates, performance standards, subsidies and grants, in facilitating improvements in the ECR over time. This can provide an effective means to nudge firms and households towards behavioural change in contexts where there are strong political economy barriers, because costs of compliance are not felt uniformly across income and interest groups.
As part of a long-term strategy, plan to raise the ECR stating the objective to introduce carbon pricing down the line through an ETS or explicit carbon tax, and outlining the criteria at which point introduction of such systems will be feasible as citizens and firms have access to viable alternatives.
In parallel, build institutional capacity and expertise to design more sophisticated carbon pricing systems.
Consider that trial periods can support implementation, giving firms and consumers time to adapt to changes. Political opposition tends to be greatest prior to implementation, and trial periods can help mitigate this risk.
Establish a habit of making regular adjustments to energy prices, and communicate them regularly, according to a set day of the week or month via a government website. If an announcement is scheduled, but no actual price change takes place, this should still be communicated. This will sensitise consumers to changes and facilitate the process of adaptation. In addition, regular energy price changes mean that changes are likely to be smaller, whereas changes after a long period of time mean that price increases are likely to be much higher, which are more likely to result in civil opposition or have more profound impacts on households and firms.
Consider the impact of CBAM when additional fees on imports are introduced by the EU on market access and firm competitiveness in trade exposed sectors. Also, consider introducing a limited emissions at source tax, with taxes rising over time. In general, exemptions should be avoided, with revenue from the tax instead recycled back to taxed firms to incentivise fuel switching and investment in energy efficiency and emissions abatement measures to incentivise decarbonisation of industrial production.
Targeted measures to offset impacts on interest groups who have strong capacity to mobilise can help overcome political economy obstacles.
Consider where taxes are collected. Fewer taxpayers result in a more administratively straightforward process for tax collection, but taxpayers must be able to pass costs on to consumers for the system to be effective at changing behaviours.
Consider a range of options for introducing new taxes, for example, fuel taxes, a direct emissions approach, carbon added tax, and a climate damage tax. A decision as to which approach is best suited to the national context should be based on a range of factors, including climate and economic objectives and capacity of the tax administration system. A blended approach of different mechanisms is also an option. Undertake extensive consultations when designing an approach, including with civil society and industry groups.
Development finance institutions and bilateral development agencies should:
Provide technical support to governments to set energy prices and develop pricing formulas.
Provide communications and stakeholder support to governments to help build public acceptance of energy price reform and support the development of effective and targeted assistance measures.
Provide technical assistance to governments considering the establishment of ETS.
Provide technical assistance to governments in strengthening MRV systems.
Actions where international support would be required where government capacity is low:
Consider introducing automatic pricing mechanisms in legislation which will trigger a set price increase when certain conditions are met. This can help depoliticise energy price reform. Incorporating energy price reform in legislation can also make it harder to reverse policy because this will require parliamentary approval. Including price reform in regulations, or as a simple announcement will be easier to reverse, requiring a ministerial signature in most contexts, or limited approvals to change policy respectively.
Publish a transparent price formula which allows consumers to understand the price gap, and presents a clear picture of the incremental increases required over time to bring local prices into line with adjusted reference prices. A publicly available and simple-to-use formula can also be an effective communications tool, enabling government to transparently explain to citizens and firms the scale of subsidies and build a rationale for reform.
Review and improve existing MRV systems. Carbon crediting relies on establishing credible emissions baselines, and measurement and verification of emissions reduction. Mobilisation of finance at scale requires sophisticated techniques to ensure accurate establishment of baselines, and aggregation of emissions reductions across a large number of entities. Establishment of effective MRV systems is therefore key, in particular using ISO 14064-1 and ISO 14064-2, ISO 14067 standards for carbon management.
Develop a domestic policy and regulatory framework in line with the agreed rules under Article-6.
Consider opportunities to collaborate with other governments in obtaining carbon credits. This can make achieving targets more feasible. If one country falls short of its targets, its partner country may have the potential to make up the difference.
Assess risk of emissions being inflated before crediting mechanisms are introduced to make reductions in emissions easier.
Review institutional strengthening and capacity building needs if considering the introduction of ETS. Carbon markets are complex to design, including, for example, requirements to establish credible baselines or emissions caps, as well as stabilisation mechanisms to limit price volatility, and require strong institutional capacity to be successfully implemented.
Revenue recycling from fossil fuel subsidy reform and carbon pricing
As revenue or savings from fossil fuel subsidy reform and carbon pricing begin to grow, revenue recycling offers an opportunity to double up on GHG emissions disincentives by reinvesting revenue in a range of areas, including those related to the low-carbon transition. Revenue recycling options include reinvesting revenue in R&D to promote technological innovation, investing in renewable energy and energy efficiency measures, and more general developmental and human capital objectives, such as education, healthcare and infrastructure, or paying off public debt. Some governments choose to ring-fence spending for specific sectors or objectives, a process which can be complex to implement given the requirement to involve a large number of agencies, but one which can tell a convincing story as to how revenue from carbon taxes is being reinvested for the public good.
Ultimately, many countries introducing carbon or environmental taxes choose to recycle revenue across a range of areas. As part of a comprehensive energy sector reform programme following the Fukushima disaster in 2011, Japan introduced a carbon tax in 2012, putting a price on coal and petroleum, which is reinvested in R&D and low-carbon projects. Colombia introduced a carbon tax in 2016 and uses revenue to support the peace process as well as environmental projects (PMR, 2019[145]).
Governments should consider prioritising the following actions:
Prioritise complementary investments in infrastructure, particularly public transport, and policies to encourage technology transfer and firm innovation as part of a comprehensive, integrated strategy to promote the diffusion of contextually adapted and affordable low-carbon technology and appliances to provide consumers with low-carbon alternatives to switch to when higher prices from carbon pricing eventually kick in. Without viable and affordable alternatives, energy price reform will have limited impacts on firm and household behavioural change and could lead to unintended consequences, such as pushing lower income households into poverty, or incentivising the use of more polluting biomass as cooking fuels.
Recognise that a stronger social contract between citizen and state will enable the process of energy price reform, and, accordingly, prioritise strengthening trust in government institutions in line with recommendations under Pillar 3, Section 3.1., as well as targeted transfers to vulnerable groups. Governments should understand that energy price reform is often undermined by a lack of public confidence that resources saved will indeed be recycled for the public benefit.
Carefully consider the range of revenue recycling options, including removing distortionary taxes, investment in low-carbon transition plans, development and human capital objectives, and debt reduction. This should be based on rigorous assessment of country circumstances, as well as on consultations with relevant interest groups.
Consider establishing a dedicated fund to manage revenue from carbon taxes. This can improve accountability and transparency of reinvestment plans.
3.3.2. Raising revenue collection by addressing tax compliance and restructuring fiscal frameworks
Domestic revenue mobilisation significantly underperforms in many developing and emerging economies, where untapped revenue streams could represent an important tool for governments to manage the impacts of declining revenue from fossil fuels. On average, developing countries mobilise less than 20% of GDP in taxes, with approximately half of low-income countries and lower middle-income countries raising less than 15%, compared with between 30% and 45% in OECD countries (European Commission, 2015[146]).
Domestic revenue mobilisation is more challenging in contexts where informal or subsistence workers make up a larger proportion of the workforce, which is often the case in developing countries where informal labour can account for as much as 80% of the labour market. Governments can take steps to collect more tax by improving tax compliance including by reducing tax evasion, and tax avoidance and cracking down on illicit financial flows, as well as closing the policy gap through mobilisation of untapped revenue streams to diversify the tax base. This might include property taxes, VAT, carbon taxes, or environmentally related taxes more broadly, such as vehicle taxes and excise taxes not aligned with carbon content.
Closing the compliance gap entails bringing taxes actually collected into line with the theoretical amount of tax which could potentially be collected. This will require governments to: 1) build more efficient and effective tax systems, raising human resource capacity and systems efficiency to eliminate loopholes which are often created by complex taxation regimes; 2) fight tax evasion; and 3) enhance regional and international co-operation to limit tax evasion and profit shifting. Developing and emerging economies tend to be more affected by corporate tax evasion than advanced economies, because corporate income tax on average makes up a higher proportion of government revenue, at 16% and 8% respectively (European Commission, 2015[146]). Tax incentives and exemptions deployed to attract foreign direct investment tend to be costly and inefficient, failing to achieve the objectives for which they are designed.
Governments can also review tax policy arrangements to identify additional tax instruments that can help to broaden the tax base and increase revenue collection. The introduction of value added taxes over the last decade in fossil fuel producers, for instance in Bahrain, Egypt and Oman, has presented an effective tool for governments to mobilise revenue (Coplin and Nwafor, 2019[147]).
Taxes that target citizens who are better able to pay, both through progressive personal income taxation or property tax, are underused in many developing and emerging country contexts and can help to make a taxation system more equitable. Property taxes and capital gains taxes in particular tend to be lower as a proportion of government revenue in developing countries, and may present an effective means through which to broaden the tax base in a progressive manner (Coplin and Nwafor, 2019[147]).
Lastly, raising existing excise taxes on polluting energy products, or in some cases introducing environmental or carbon taxes, while reducing taxes on low or zero carbon products, can be an effective means through which to broaden the tax base, raise revenue and internalise negative externalities. However, governments should be conscious of public acceptability issues, as well as the risk of unintended consequences that could push poorer citizens into poverty if no viable and affordable alternatives are available when prices increase.
The Tax Administration Diagnostic Tool (TADAT)1 is a key instrument that governments can use to assess the health of their tax administration system, and identify strengths and weaknesses, as well as priority reforms to increase revenue mobilisation, improve tax compliance and broaden the tax base. Meanwhile, the Revenue Administration Gap Analysis Programme (RA-GAP), created by the IMF, provides a methodology for governments to estimate the gap between theoretical taxes which could be collected and actual tax collection (European Commission, 2015[146]).
Governments should consider prioritising the following actions:
Review national taxation systems and performance to assess policy and compliance gaps, and identify reforms to improve compliance, identify untapped tax instruments to diversify the revenue base and increase tax collection. The TADAT and RA-GAP offer important tools to help governments achieve these objectives.
Consider consolidating all tax incentives for investment under one authority or government body. This can facilitate better management of the net cost of such measures, which should be calculated regularly, alongside more regular monitoring and periodic assessment of performance against objectives.
Review tax exemption expenditure to assess efficiency against clearly defined objectives. Eliminate exemptions where they are not achieving their targets. This will improve perceptions of fairness and generate revenue.
Establish a mechanism to regularly review tax expenditure (Mullins, Gupta and Liu, 2020[148]).
Consider the equity implications of adjusting fiscal arrangements, particularly if introducing consumption taxes, such as VAT, given these measures can disproportionately impact the poorest. If consumption taxes are introduced or increased, they should be paired with spending policies, such as cash transfers, to ensure costs are born principally by wealthier citizens. This needs to be taken into account during assessment of existing tax policy and spending (Coplin and Nwafor, 2019[147]).
Develop a strategy to effectively communicate the introduction of new taxes or adjustments to fiscal arrangements. This should clearly explain when changes will be taking place, outline why changes are necessary, and point citizens and businesses towards information resources that can support compliance or ensure they are aware of specific exemptions or support which apply to them. The ultimate goal should be to raise customer awareness and achieve structural changes in their behaviours, thus supporting the just transition.
Strengthen the tax collection capacity of sub-national government. This can significantly increase tax revenue and revenue generation. Strengthening subnational government revenue will ultimately improve the provision of locally administered public services (Coplin and Nwafor, 2019[147]).
Development finance institutions should:
Provide technical support to governments to assess the compliance gap and develop strategies to raise compliance and collection over time. Donors can support governments to undertake strategic reviews via TADAT and RA-GAP tools.
3.3.3. Spending better through more efficient and redistributive fiscal frameworks
In addition to policies designed to collect more revenue and broaden the tax base, governments should adopt measures to improve the efficiency and fairness of fiscal systems through enhanced spending on expansion of social protection programmes, and improving the strategic allocation of resources. Incremental tax reforms in Latin America, for example, alongside gradual increases in investment in social protection schemes, including via cash transfers to vulnerable households, has had some success in reducing household inequality and tackling poverty (Bargain et al., 2021[149]).
Governments should consider the net fiscal incidence of taxation systems, which is the combined overall economic impact of government taxation and non-tax revenues (i.e. transfers to government from NOCs) against public spending. Government policy should seek to establish a system in which the net fiscal incidence redistributes towards low-income groups. This might include, for instance, expanding social protection provision, education or healthcare services, particularly in rural areas. While VAT might be regressive in isolation, a good fiscal system would be able to harness the revenue generating power of VAT, whilst compensating poorer households through increased and better targeted spending. Overall, the net effect would be a positive one.
Establishing effective redistributive tax systems relies on governments having a good understanding of the spatial distribution of poverty across a country, both by region and also at a very local level, which can help governments identify groups who will be affected by fossil fuel closure. This requires investment in systems to collect granular level data, such as household data, and a better understanding of informal labour (see Pillar 2, Section 2.2.2).
Effective redistributive fiscal systems are also important for delivering a just and equitable low-carbon transition. In developing countries in which overall levels of poverty can be high, it is important to provide support to communities who are negatively affected by the low-carbon transition, for example, through loss of employment, or higher transport costs owing to subsidy removal. At the same time, this could lead to resentment among other sections of the population, many of whom are also poor, which could be difficult for governments to manage. This is why it is necessary to build an effective pro-poor fiscal system so that all low-income groups receive assistance, while at the same time providing additional targeted assistance to those especially affected by the low-carbon transition.
Lastly, governments should strive to improve the efficiency of public spending, eliminating waste and building mechanisms to improve project and programme prioritisation. The Public Expenditure Financial Accountability (PEFA) programme offers a diagnostic tool for governments to review revenues, public expenditure, procurement and financial accountability mechanisms, with a view to identifying necessary reforms and capacity-building requirements. Key objectives of the PEFA process include aligning government spending with available resources, and improving the strategic allocation of resources via improved budget planning and allocation processes in line with national development priorities in such a way as maximises the public good (European Commission, 2015[146]).
Governments should consider prioritising the following actions:
Progressively invest in the expansion of social protection systems and coverage in line with incremental increases in tax collected, and broadening of the tax base, in line with recommendations in Pillar 2, Section 2.2.4.
Review public financial management and budget allocation frameworks to eliminate inefficient spending, and enhance the strategic allocation of public resources. This should include measures to improve data collection on public spending and building capacity to monitor and evaluate results. The PEFA process can support governments in identifying priority reforms and improving budget prioritisation and allocation processes, in line with national strategic goals, available resources and macroeconomic and fiscal policies.
Development finance institutions should:
Support governments to implement public financial management reforms and the PEFA process.
Assist developing country governments in analysing the tax gap, leveraging existing systems and experience in calculating and determining both tax compliance and policy gaps.
3.4. Addressing energy poverty and decarbonising electricity systems
With 785 million people worldwide with no electricity access and 2.6 billion without access to clean cooking solutions, the challenge of decarbonising electricity systems and rolling out affordable, reliable and sustainable access lies at the heart of the development challenge for fossil fuel producer emerging and developing economies. It also highlights the global inequalities that are the crux of the low-carbon development challenge for advanced and developing economies alike (IEA, 2021[150]). Despite the recent rising cost of capital driven by inflationary pressure, huge cost improvements over the last ten years in renewable energy and storage technologies mean that these are now cost competitive with fossil fuels, if not cheaper, in most parts of the world, offering affordable and decentralised energy solutions to address energy poverty. They can also play a catalytic role in decarbonising industrial production and other areas of the economy across developing countries and emerging markets.
Yet, developing and emerging economies are lagging behind advanced economies when it comes to building decarbonised, resilient, modern energy systems. Decades of underinvestment in generation, transmission and distribution infrastructure has created a legacy of technological deficiency, resulting in grid absorption issues, financially weak state utilities and perceptions that power projects are too risky for private investment if they are not backed by payment guarantees.
Emerging and developing economies account for just one-third of energy investments, falling to 20% when it comes to clean energy (IEA, 2021[150]). Moreover, clean energy investment in emerging and developing economies is currently declining, contracting by 8% to less than USD 150 billion in 2020, before a modest recovery in 2021 (IEA, 2021[16]).
Failure to ensure that citizens of emerging and developing economies have access to secure, affordable, reliable and sustainable electricity on an equal footing with their peers in advanced economies risks undermining social acceptance of transition policies across developing countries. Emerging and developing economies account for two-thirds of the world’s population, and almost all population growth in the next two decades. Per capita emissions are almost one-quarter of what they are in advanced economies, but as they grow and industrialise, the emissions trajectory is set to grow by 5 Gt over 20 years (excluding the Middle East and Eastern Europe), while advanced economies’ emissions will fall by 2 Gt and China’s will stabilise. This means that failure to address electricity system decarbonisation in emerging and developing economies will cause the world to massively overshoot its climate targets (IEA, 2021[150]).
Reversing this trend will require significant mobilisation of capital, with much of the investment needing to be front loaded, as well as unprecedented technology and skills transfer. The IEA estimates that investment in the energy transition in developing and emerging economies will need to increase by seven times to USD 1 trillion per year by the end of the decade to reach net zero. Meanwhile, the African Union’s 2063 Agenda to achieve full electricity access in urban areas, and one-third in rural areas by 2030, equivalent to about 60 million people per year, will require an annual investment of USD 35 billion. About half of this will need to be achieved through off-grid solutions. Meanwhile, providing everyone with clean cooking solutions by 2030 will require an investment of USD 6 billion per year (IEA, 2021[16]).
Failure to address electricity systems decarbonisation and energy poverty could result in a two-track transition, where fossil fuel-based economies continue to produce emissions-intensive products for domestic use and export to other developing countries, while advanced economies decarbonise and invest in frontier low-carbon technologies. A possible option for emerging and developing country producers with cheap and abundant gas is to monetise reserves with production of hydrogen from abated gas while in parallel scaling up investments in renewable energy and storage to produce green hydrogen and establish themselves as green industrial hubs for hard-to-abate sectors such as steel and cement as part of their long-term strategy, as outlined in Pillar 3, Section 3.2.1.
Box 3.23. Considerations for investing in gas-fired power to deal with variability and intermittency
Many developing countries face significant challenges in terms of energy access, with 600 million people in Africa currently lacking access to grid-based electricity. Moreover, financially weak utilities, fuel subsidies and grid absorption capacity issues tend to act as a deterrent to private finance investment in renewables: 90% of investment in renewables in Africa comes from public or multilateral development bank sources. For many developing countries, adding substantial volumes of new renewable energy capacity over a short period of time can cause grid intermittency instability issues given the variable nature of renewables generation technologies. For example, Kenya has experienced severe voltage instability at only about 15% capacity from wind and solar.
Investments in gas-fired-power generation need to be based on a nuanced analysis of country demand and projections under different options, and the cost of gas and related efficiency and abatement technologies, including a balanced assessment of costs versus other technology options. More gas-fired-power generation appears logical for countries such as Iraq and Nigeria, where high flaring rates mean a lot of available gas is currently wasted. In these contexts, investments in abated or highly efficient fossil gas-fired power generation can bolster energy access rates, and can also accelerate the transition towards a renewables-based energy system, acting as a dependable back up when generation from renewables is not possible. This will also enable the deployment of more renewable generation technology to the grid without resulting in intermittency.
Efficient fossil gas-fired power generation can complement wind and solar technology well, given that certain gas turbine and combustion engine technologies can ramp up and stop quickly, accommodating weather variability, at a relatively low fixed cost compared with other fuel types. Owing to their relatively low investment costs and in many regions moderate variable costs, combined-cycle gas turbines (CCGT) can present a financially attractive alternative even if providing power only as a back-up solution.
However, without abatement technologies which will add to the cost of power produced, such infrastructure can also lock in emissions, including local pollution costs, and require long-term fuel inputs. It is therefore critical to fully assess all available alternative opportunities, also taking into account the feasibility and cost of gas abatement. In some regions (e.g. Australia, California, Jordan), it is already becoming apparent that overshoot on thermal capacity can increase either public costs or stranded asset risks or inhibit renewable power investment, given take or pay contracts. A focus on financing thermal power (including with government grants and cheap credit) may also detract from much needed investment in the grid, storage and transformation of the business model to prepare for a lower cost, lower emissions system. Where new gas-fired power plants are developed, they should be designed with increased flexibility in mind, enabling them to transition to back-up power generation when increasing volumes of renewables capacity are added to the grid (IRENA, 2019[151]).
Moreover, given the nature of project financing for power, investment in gas-to-power will leave countries with 40 years or more of gas-fired-power generation. This can appear attractive because gas-fired power is a tried and tested technology that fits current supply-focused energy models. However, building out fossil gas power could potentially lock countries into expensive carbon intensive development pathways for decades, while the cost of more efficient infrastructure, renewables generation and storage are expected to fall, with prices driven down by sustained investment in innovation and energy efficiency improvements. In addition, with time it is likely that technological developments will make electricity storage an affordable alternative, removing the need for baseload power provided by gas-to-power generation. Hydrogen (in particular green hydrogen) offers opportunities for grid balancing and new production and export potentials for existing fossil gas exporters.
Gas-fired power generation could provide governments with an effective means to bolster investment in renewables, quickly decarbonise, lower the trajectory of power generation emissions over diesel or coal-fired power and expand electricity access. However, there are trade-offs, and governments need to assess available information on national demand trajectories, integrated energy infrastructure and cost options (including health and environmental costs), pricing, levelised cost of electricity (LCOE), risks and future financing landscape, in order to be able to make an informed decision. It is critical that governments also consider the opportunity cost of gas-to-power investments in relation to alternative solutions and to understand how well producing and burning gas for electricity generation serve national domestic energy sector goals.
In many developing countries energy access issues are primarily rural problems, so adding substantial amounts of gas to the grid may not provide an access solution in and of itself. Rather, it may be preferable to encourage off-grid solutions in remote areas given the prohibitive costs of infrastructure development. A mix of efficiency, demand-side management, and strengthened and interconnected local grids, which can accommodate increases in renewables, can help avoid incurring high-cost gas, and storage solutions and may offer far cheaper accompaniment to renewable energy. For example, setting tariffs to encourage matching demand, including by compensating customers for reducing loads when necessary to balance the system, is an effective way to deal with variability. This is usually more economic than building new generation and can be initiated through special tariffs for on-grid industry.
Source: (Thurber and Moss, 2021[152]); (IEA, 2020[153]) .
Advanced economies, development finance institutions and bilateral development agencies should:
Massively scale up blended and subordinate finance, concessional loans and grants, in line with recommendations in Pillar 2 to de-risk and unlock private investment in the power sector, alongside reinvigorated efforts to establish new, innovative and transformative partnerships for enabling skills and technology transfer, recognising the joint responsibility of importer and producer countries to achieve global decarbonisation. This should be commensurate with emerging and developing country needs for the energy transition, and recognition of existing and future import demand of advanced economies, particularly for renewable energy and hydrogen.
Recognise the importance of universal access to affordable, secure, sustainable and reliable energy, in line with SDG-7, for generating societal support for transition measures in developing and emerging economies as necessary conditions for achieving global climate targets.
Recognise the pace of the transition will be different between countries, requiring trade-offs, for example in terms of use of renewable energy for hydrogen production or for raising energy access and storage for grid balancing. For African countries, for example, a globally just transition must recognise the necessity for some countries to monetise their gas resources and deploy abatement technologies, as part of a least-cost and realistic pathway to net zero, commensurate with historic emissions contributions and ability to address the climate crisis, as noted in the AfDB’s 2022 African Economic Outlook Supporting Climate Resilience and a Just Energy Transition in Africa (AfDB, 2022[154]).
Ensure investment in power sector fundamentals, including grid stability and robustness, distribution infrastructure and payment collection mechanisms. Transmission and distribution grids are key to enable the deployment of renewable energy and to manage increased demand for electricity. However, transmission and distribution infrastructure is often considered too late in the process or not prioritised for effective renewable energy deployment. This can delay or inhibit the addition of renewables capacity to the grid and add more risk for the private sector, making capital more expensive. Regulatory frameworks should also clarify who is responsible for connecting renewable projects to the grid and make provisions to compensate investors in the event of a delay. Meanwhile, investing in payment collection infrastructure and enforcement can improve the financial health of the state power utility, ultimately making it a more reliable off-taker for electricity from renewable energy projects.
Assess information on pricing and LCOE alongside attendant system costs, wider public health and environmental costs, risks, changing energy generation and distribution as well as the future financing landscape to understand if investment in highly efficient or abated gas-to-power represents a cost-effective solution to deal with variability, intermittency and expanded electricity access. Governments should be clear as to the trade-offs involved, given that they may be locked into carbon-intensive generation pathways when low renewables costs and technological advances in electricity storage may mean cheaper and more sustainable options are available. They should also explore economic options for managing variability, such as tariffs, to encourage matching demand profiles and, where there is hydro, potentially pumped water storage.
3.4.1. Managing power sector planning for least-cost decarbonisation and expansion
Robust power sector planning, capable of identifying the optimum balance of generation and storage technologies as well as of on-grid and off-grid provision of electricity, and translating plans into timely and effective procurement, is of central importance to maintaining and expanding grid flexibility, facilitating scale up of variable renewable energy technologies, de-risking investments for the private sector, and realising least-cost pathways to power sector decarbonisation and expansion. Good sector planning blends dynamic analysis of demand, with identification of required generation, transmission and distribution investments. Through advanced modelling, planners can identify the optimum blend of renewable energy and storage technologies to achieve a balanced system. Additionally, Demand Side Management (DSM) initiatives can enhance grid flexibility, facilitating grid expansion.
Often, however, power sector planning is poorly implemented, and not updated or reviewed regularly enough, with incorrect projections and assumptions leading to the wrong generation capacity being procured, and transmission connections failing to keep pace with generation investments – sometimes resulting in substantial costs for government – or areas with strong renewables resources being overloaded, resulting in procurement delays and raising the cost of connecting to the grid. For instance, the commissioning of the 310 MW Lake Turkana Wind IPP in Kenya, which required development of a 438 km transmission line to connect it to the grid, was delayed by 15 months owing to delays in completing the transmission line. This resulted in the Kenyan government paying the developers EUR 46 million in compensation for the delay. Similarly, South Africa’s renewable energy auction process initially required developers to identify locations that would enable them to minimise tariffs under a PPA, but the resulting concentration of projects in the sunniest or windiest areas led to delays and an increase in connection costs, requiring the government to adapt the system (Sachs, Toledano and Brauch, 2021[155]).
The most comprehensive planning tools are Least Cost Power Development Plans (LCPDP) or Integrated Resource Plans (IRP), which over a period of 15 to 20 years, blend transmission and distribution planning, and define the least-cost supply and demand-side investments needed to fulfil power demand, while reducing overall system costs. System planning should also incorporate broader policy objectives, including energy poverty eradication (Eberhard et al., 2016[156]).
Box 3.24. Best practice guidance for developing an Integrated Resource Plan (IRP)
Building a coherent IRP is a complex process, with long project lead times and large investment requirements, plus multiple uncertainties relating to demand forecasts and evolution of the technological landscape, making planning highly challenging, given the risks of over and under investment and the necessity that grid connections keep pace with generation procurement to avoid expensive delays. Scenario modelling and a dynamic approach to planning ensures ongoing performance monitoring against the plan, updates to reflect changing conditions and technological development, plus extensive engagement with a broad array of stakeholders. Government and industry involvement is key to ensuring the process incorporates as broad a range of perspectives as possible, as well as defining contextually appropriate solutions to specific national circumstances. Given the differences in economic and electricity sector circumstances across countries, there can be no one size-fits-all approach to IRP development. The advantage of using such a tool is that planning can be tailored to meet specific national challenges, including energy access and renewable energy penetration, and updated as circumstances change.
Institutional arrangements
The agency responsible for IRP development, often the state power utility, will normally be named in national legislation. It may be helpful for governments to establish an IRP Consultative Committee or Steering Committee with clear terms of reference and clearly defined roles and responsibilities between participants – including who has ultimate decision-making authority over the plan – and a regular schedule of meetings and programme to develop the IRP. Aside from the utility, key institutions who can be involved in such a body include the regulator, given its role in sector oversight, the energy ministry, who sets the policy framework to enable achievement of IRP goals, as well as the economy or finance ministry, which plays a central role in IRP affordability.
Where government capacity to develop an IRP is lacking, there is often a tendency to use external consultants. Relying on third parties exclusively to develop an IRP is not advisable, given the importance of government ownership when it comes to implementation, as well as the need to ensure an IRP can be updated across its full lifetime, in some cases up to 30 years. Where external consultants are used, their terms of reference should incorporate capacity transfer requirements to strengthen government capacity to design and implement a workable IRP.
Key steps in the IRP development process
1. Objective setting. Establish the main goals the IRP will aim to achieve, as well as how these will be measured through interim and long-term quantitative and qualitative indicators. Objectives should include national social, economic, environmental development and emissions reduction objectives, and might include targets such as raised energy access, increasing security through reducing use of external resources such as imported fuels, scaling up renewables penetration, and improving utility cost recovery and least cost pathways to decarbonisation and power sector expansion. An IRP needs to be integrated into national development and economic diversification plans and a country’s NDC.
2. Build demand forecasts. Understanding future energy use and how this will evolve in line with demographic and technological developments across the country is key to understanding how much generation capacity and what type needs to be procured where and when, as well as the transmission infrastructure requirements to enable grid connections and transportation of power to different demand centres. Good data relating to historic electricity sales by location and consumer class, and how the load curve evolves throughout the day, as well as economic and demographic data, can support informed forecasts as to future demand growth. End-use data relating to household use of appliances, and energy intensity data (kWh/year), disaggregated by household, industrial and institutional consumers, are also key to this process. While sometimes available in national census data and utility surveys, these data can be hard to obtain in some cases, and development financing institution support may be needed to improve data availability in some contexts.
Trend forecasting assumes past trends will continue, but lacks the ability to build detailed and nuanced demand forecasts that accommodate future demographic, economic and technological developments. End-use forecasting, supported by econometric analysis, can paint a more nuanced picture of future demand, and can also be updated and adjusted when new information and data become available. Given demand forecasting is inherently uncertain, multiple forecast scenarios are advisable, for example, a high demand forecast, medium demand and low demand.
3. Understanding electricity supply options. Governments should build alternative candidate plans for electricity supply, incorporating a full review of available options, including storage options, and outlining promising technologies which warrant more in-depth assessments, including utility scale, centralised, local and decentralised mini-grid options, as well as requiring a blend of baseload and peak load generation alternatives, alongside incorporation of enabling transmission and distribution options. Preferred supply options can be allocated a score against a range of factors, for example, cost/MWh, fuel use per kW and, emissions per kWh, as well as based on suitability of available sites. This process enables planners to eliminate options which are obviously unsuitable and shortlist others which can then be subject to more detailed analysis such as comparison of life cycle generation costs (cost of capital, finance, operations and maintenance against electricity output), dispatchable power and so on.
4. Understanding Demand Side Management (DSM) options. Governments need to understand the suitability of DSM alternatives using information awareness campaigns, variable pricing schedules (higher tariffs for peak times), energy efficiency measures (e.g. housing insulation and more efficient appliances) and fuel switching (moving from gas to solar for heating, for instance), comparing data on feasibility, costs and affordability. As with supply, DSM options can be allocated scores, a key criteria being the lifetime cost of DSM measure per unit of energy saved, versus cost of generating energy which would otherwise be saved, as well as the likelihood of customer acceptance of proposed measures.
5. Preparation and assessment of candidate supply and DSM plans. Based on supply and DSM analysis, governments can prepare candidate supply and DSM plans for assessment against different demand scenarios, aiming to shortlist several for final consideration. Key considerations should include which configurations provide least-cost decarbonisation and expansion options, how much spare generation capacity will be needed to keep the system reliable – this is effectively a trade-off between cost of additional capacity and acceptable risk of interruptions – loss of load probability, or the probability that system load will exceed supply in terms of number of days per year, and availability and cost of establishing an interconnection with a neighbouring country to balance the grid where necessary.
Scenarios can be adapted to model uncertainty, including through stress testing, which can assist in facilitating understanding of what would happen if assumptions are incorrect (e.g. if demand is low in reality when the IRP forecasts high demand). Probabilistic assessments can help assess which scenarios are most likely. Software Tools, including PLEXOS, SDDP and WASP, can facilitate this comparison process, but ultimately personnel involved in the planning process will be key to arriving at an optimum configuration of supply and DSM solutions.
The preferred IRP should be outlined in detail, including supporting studies and contingency plans, in a detailed document.
6. Implementation, evaluation, monitoring and iteration. Adoption of the IRP is just the start of the process and the IRP should be considered as a live reference document by which to judge performance against power sector plans. The IRP should be regularly updated based on a range of evolving factors, such as evolving technology costs, new data on demand, updates to an NDC, performance on generation procurement and transmission development.
Institutional location and capacity is a critical factor in planning effectiveness, as well as in implementation of plans. Often, planning is undertaken by whichever state agency is responsible for transmission infrastructure usually the power utility or dedicated entity responsible for transmission, in many developing countries, depending on the extent to which the sector is unbundled. In theory, this should facilitate coherence between necessary generation and transmission investments. However, in many countries, the financial conditions of the utility mean that it is not in a position to finance investments in transmission infrastructure, which gets left behind, undermining system integrity, limiting the capacity to absorb variable renewables generation and raising risks for private developers.
Government power sector planning functions are often insufficiently resourced in terms of personnel, expertise, software or indeed contracted out to external consultants, often leading to a disconnect in terms of implementation. Resolving these capacity constraints and establishing a clear link with procurement plans, as well as the ability to incorporate views of industry, other government agencies and communities, is a core requirement in expanding and decarbonising the power sector, with significant investments in planning expertise or transfer of planning responsibilities to another agency (e.g. an independent regulator or dedicated planning function).
Box 3.25. Enhancing grid flexibility through electricity interconnections
Electricity interconnections and power pools can support grid flexibility, least-cost pathways to decarbonisation and optimisation of resource use by expanding the complementary blend of power available to the grid at any one time, bearing in mind, sun often shines when the wind is not blowing, and low water levels in terms of hydro may be compensated for by high water levels in neighbouring countries. This can provide the necessary flexibility for the grid to absorb more variable power generation.
The Southern Africa Power Pool estimates that savings in Southern Africa once fully interconnected could amount to USD 1.6 billion per year, while the West African Power Pool estimates potential savings of between USD 5 billion and USD 8 billion. However, fully functioning and efficient interconnections and power pools can be challenging to establish, requiring a commitment to free trade of electricity between countries, regional regulations or a regional regulator that can enforce requirements across borders, and adequate interconnection infrastructure, as well as resolving differences in transmission fees between countries.
In Africa, the African Continental Free Trade Area (AfCFTA), which entered into force in January 2021, can support enhanced electricity co-operation and connectivity between countries, facilitating the alignment of regulations, co-operation between utilities and power pools, and cross-border remuneration frameworks, to enhance energy trading. This can enable some countries which expect to have a surplus of electricity from renewable sources – Egypt, for example, is expected to have a surplus of 74 GW by 2035 – to more easily supply surrounding countries with clean power, as well as aggregating demand from industrial clusters to incentivise investments in power projects which can sell across borders.
Identifying prospective locations for renewables generation and integration with transmission planning can support least-cost systems development, particularly in contexts where the integration of variable renewables generation into a fossil fuel-based system for the first time will have localised impacts. South Africa’s Council for Scientific and Industrial Research (CSIR) has identified eight Renewable Energy Development Zones (REDZs), enabling government to plan for least-cost connections to load centres, and providing reassurance for the private sector that necessary transmission infrastructure will indeed be in place (IRENA, 2018[159]). In identifying such locations, governments should consider overall power sector costs, rather than just for a particular power project, entailing a potential trade-off between areas with the best renewables resources and the cost of connecting to the grid. Meanwhile, power system planners will need to consider the implications of the physical impacts of climate change, which could lead to disruptions in supply or increase demand, and build resilience into infrastructure planning (Jin et al., 2021[160]).
In addition to robust investment in transmission infrastructure, which can aggregate distant resources to improve electricity sector functioning at peak times, investments in grid digitisation and storage options can also enhance grid flexibility and facilitate its ability to accommodate more variable energy generation over time. This process will become increasingly challenging and complex as more renewable energy projects are added to the grid, given that many grids in developing countries are already close to voltage capacity. Through predictive modelling, grid digitisation can assist in identifying probable systems failures, enabling investments in equipment to be targeted strategically, which minimises costs, and to reduce overall transmission and distribution losses, one of the primary reasons for power utility financial problems. Moreover, individual smart meters can help utilities better understand customer demand profiles, enabling tariffs to be better tailored to consumer paying power, particularly medium to large consumers. This can assist with cost recovery and ultimately serve to improve overall service for customers (Sachs, Toledano and Brauch, 2021[155]).
As an electricity system becomes more sophisticated, incorporating larger volumes of variable renewable energy generation, it will need additional measures to enhance flexibility and accommodate periods of peak demand when power generation from renewables is low and vice versa. Power sector planning can incorporate storage options and adaptation to thermal generation facilities, as well as DSM techniques, to address these issues. Retrofitting existing thermal dispatchable power generation stock can enable existing gas or diesel power generation facilities to ramp up and ramp down quickly depending on power generation from renewables at a given time, as discussed in Box 3.26.
Meanwhile, electricity storage, either through pumped hydro or batteries, offers options to reduce dependence on fossil fuel generation and deploy clean power effectively to the grid when there is little wind and sun. Batteries offer a preferable alternative to pumped hydro, especially for remote areas, because the latter can take a long time to build, and variable water levels, which are likely to become more pronounced as the physical impacts of climate change worsen, mean sufficient water volumes may not always be available at peak times.
The cost of lithium-ion batteries has fallen 85% on costs in 2010, and is expected to drop a further 50% by 2040 (SE4All, 2020[5]). Government-sponsored demonstration projects, as well as hybrid renewable energy and storage auctions, and suitable regulatory and incentive frameworks are still necessary to encourage investments in battery storage in many developing countries, as costs remain high. For emerging and developing countries whose power sectors run primarily on thermal generation from fossil fuels, incentivising storage investments will be more difficult early on, given that substantial baseload generation will be capable of accommodating small variability from limited renewables generation. How storage is remunerated is therefore crucial to encouraging investment. Viet Nam has identified specific hydro and battery storage sites in its National Electricity Development Plan (2021 to 2030), which includes 2.7 GW of hydro, with 900 MW of pumped hydro storage and 1.2 GW of lithium-ion battery storage (IEA, 2021[150]).
Box 3.26. Energy storage ownership and remuneration options
Energy storage, particularly in developing country contexts where grids may be weak, and transmission infrastructure underdeveloped, with rapid additions in variable renewable energy capacity resulting in high frequency and voltage variations, can provide cost-effective solutions to delivering electricity system flexibility. Storage options, including the variety of technologies available, like battery storage and pumped hydro, should be considered alongside alternative options, such as additional generation capacity and Demand Side Management (DSM) in establishing overall system balance. A key consideration for power system planners is to understand the potential value addition storage can bring to an electricity system based on the different functions it can fulfil, and to design incentive options and remuneration for developers accordingly. This can be more complex for energy storage projects because of the diverse functions they can fulfil in an energy system, including frequency and voltage control and enabling ramping up and down of variable renewable energy capacity.
Power sector planning should consider the range of storage applications for grid stability, comparing costs against alternative measures, and incorporating these considerations into design of a least-cost IRP. This can be assessed by calculating the levelised cost of storage (LCOS), assessing total costs, including CAPEX and operational costs across the lifetime of a storage project. This process can be complicated by the need to understand the various potential applications of storage in a system, given that this can lead to storage projects obtaining a number of revenue streams from different sources. This can improve project economics but make it more challenging to understand the implications on value to the system.
For developing countries, where at least some aspects of the power utility remain vertically integrated and there is just one transmission system operator, two primary options exist for storage project remuneration. A non-market model entails the system operator, for example, the mandated transmission company or utility responsible for grid management, investing in a storage facility and obtaining a return from customers through electricity sales. A market approach entails multiple project developers competing on cost and buying and selling power to the transmission company or utility. This can make defining contractual arrangements for storage projects complicated, given that storage facilities will buy power at times of low demand when it is cheaper, and sell it back to the grid when prices are high.
To facilitate the development of storage projects, key considerations for governments include assessing ownership rules, clarifying what kinds of entities can own and operate storage and what kinds of services they can provide. Similarly, permitting and grid codes may also need to be adapted to accommodate storage projects. Governments should also consider how levies, surcharges and taxes are applied to storage projects, given the fact they both buy and generate electricity, which can pose a risk of double charging.
Source: (World Bank, 2020[161]).
Alongside storage solutions, DSM can assist governments in shaping demand to match system capabilities, as well as reducing overall system costs by matching lowest-cost generation technologies with demand as often as possible. This is best accomplished by incentivising consumers to use electricity at different times to reduce peak demand through peak pricing and time of use tariffs. Extensive customer engagement will help to encourage behavioural change, although governments should be aware that some consumers, both individual and industry, may be unable to adjust demand.
Governments should consider prioritising the following actions:
Well-resourced planning functions in terms of expertise, people, modelling tools, software and ability to engage with stakeholders, are key to designing LCPDP and IRP which integrates generation, DSM, transmission and distribution infrastructure investments to build least-cost, dynamic power sector investment plans. Consider moving the planning function to an independent regulator, or dedicated planning agency, and ensure that the power utility or dedicated transmission company invests in plans, as well as ensuring plans are regularly updated.
Establish strong links between power sector planning and procurement of new generation facilities, including decisions on technology based on least-cost solutions, and determine where, when, and who is best placed to invest between public investment and the private sector.
Identify renewable energy zones, based on connection costs, as well as power generation potential based on solar and wind and other solutions, and the investments required to get electricity to demand centres. Factor this into auction and permitting plans, and consider tariffs which reflect this trade off, for example, higher tariffs for developers in areas with slightly lower generation potential. Planning must recognise that it is the overall system costs which count, not the individual generation cost at one particular point in the system.
Progressively incorporate storage options as renewable energy is added to the grid, while considering the need for demonstration projects to bring costs down to commercial levels. Include also incentive mechanisms, hybrid auctions with renewable energy, retrofitting and repurposing, as outlined in Pillar 2, Section 2.3, and concessional finance to facilitate investments in storage.
Consider how to shape demand through DSM, reducing demand at peak times by incentivising electricity usage where possible at non-peak hours when power will be cheaper. Recognise that this will require engagement with industry and consumers to achieve, as well as clear messaging.
Actions requiring international support in contexts where government capacity is low:
Prioritise transmission and distribution investments based on least-cost planning (IRP or LCPDP), noting that utilities are unlikely to be able to invest in this alone. Significant investments in core trunk infrastructure and grid digitisation may need to be financed via development finance institutions in order to ensure scale-up of renewable energy and that storage is feasible.
Prioritise grid digitisation (seeking development finance institution assistance where investments cannot be covered by the utility), which can optimise investments in equipment, smart metering and predictive failure modelling. This can help minimise transmission and distribution losses, enhancing sector integrity and power utility financial health, as well as providing a more nuanced picture of customer usage profiles, including potential to pay (based on medium-sized or large-sized customers). Ultimately, this approach can assist governments to in revising tariffs to improve cost-reflectiveness to ensure that customers with higher paying power are asked to pay more, and higher costs are not paid by poorer households who lack the ability to do so.
Explore opportunities to retrofit thermal generation to ramp up and ramp down quickly, for use when there is no renewable energy generation. Factor this into planning, alongside the need to ensure incentives for operators, or compensation because over time they will generate far less power. This requires careful co-ordination of scaling up of renewables generation and storage over time, phasing out plants which are at the end of their lives, so as to minimise stranded assets.
Development finance institutions and bilateral development agencies should:
Where data relating to demand and energy end-use are lacking, help the utility obtain data through household-level and firm surveying.
Provide technical assistance to the power sector planning function in order to build institutional capacity to undertake and maintain comprehensive electricity sector development plans.
Where applicable, consider providing technical assistance to support the establishment of an independent regulator.
Provide technical assistance for governments to conduct analytical assessments of transmission and distribution networks and to assess power generation and storage options. Governments should avoid outsourcing technical studies and planning to consultants, given the importance of government ownership in updating, maintaining and evaluating plans.
Provide technical support for governments to identify business models and remuneration options to encourage private investment in electricity storage.
3.4.2. Attracting private sector participation through reform of the power sector
For fossil fuel-producer emerging and developing economies, and particularly for those whose credit rating is below investment grade, attracting private investment in clean energy, or independent power projects (IPPs), is one of the greatest challenges in achieving systemic decarbonisation and expansion of the electricity sector.
State-owned power utilities have played a dominant role in investing in generation and transmission infrastructure for the last 50 years. Many of these companies are financially weak and debt laden, on account of considerable transmission and distribution losses, lack of cost-reflective tariffs and poor management, and as a result have chronically underinvested in power infrastructure over the past four decades, a fact which has further contributed to their financial difficulties, and undermined consumer confidence and customer payment discipline.
Box 3.27. Utility financial health and de-risking projects for the private sector
Project finance for IPPs is normally based on a long-term power purchase agreement (PPA), and requires revenue predictability. The creditworthiness of the off-taker, normally the state utility or dedicated transmission company, is therefore key, and in many developing and emerging country contexts, a project will be unable to reach financial close because of perceived payment risk without a development finance institution or state guarantee.
Key reasons why state power utilities are financially weak include high transmission and distribution losses and low payment collection rates, which together account for over half of turnover deficits in 21 utilities, and three-quarters in 13 utilities in Africa. For example, transmission and distribution losses average 23% in sub-Saharan Africa, compared with 10% in advanced economies; while average payment collection rates are 88.4% in sub-Saharan Africa, against 100% in advanced economies. The fact that tariffs are not cost-reflective, because governments are unwilling to agree to sufficiently high and regular increases for fear of impacting consumers who would struggle to pay, alongside inflated public wage bills, also plays a big role in utility financial weakness. Many public power utilities are also poor technical and operational performers, as well as being hamstrung by unsustainable debt, all of which contributes to decades of underinvestment in transmission and distribution infrastructure needed to build a balanced and reliable grid which can accommodate the addition of new variable renewable energy generation capacity as well as roll-out of the grid to unserved areas. For many public power utilities, financial challenges are self-perpetuating because poor customer service affects payment discipline, and the longer the system goes without repair or upgrades, the more expensive such investments become.
PPAs which adequately balance risks between private and public sectors, development finance institutions and sovereign payment risk guarantees, can help to mitigate risks for developers. However, in reality, few such mechanisms are ever used. As part of a longer-term strategy to boost the integrity of the power sector, governments can look to improve utility financial health through improvements in technical and operational performance to reduce transmission and distribution losses, accompanied by initiatives to improve cost recovery, including gradually raising tariffs, especially for medium and large customers who can afford to pay more, and raising payment collection rates. Debt restructuring, which normally requires the involvement of a development finance institution, can help to alleviate the burden of very high debt service payments, while corporate governance reforms, including managerial incentives, board autonomy and makeup, and fiduciary accountability can improve overall performance.
The solution to this issue for many governments, encouraged by guidance from international development organisations such as the World Bank, has been the unbundling of vertically integrated power utilities, separating out generation, transmission and distribution functions, encouraging improved financial management and facilitating private sector participation. Unbundling can eventually lead to a situation in which government oversees a competitive power market capable of crowding in private capital. In many emerging and developing countries, particularly in Latin America, the process of unbundling, combined with the development and implementation of a long-term vision for transmission and distribution infrastructure expansion, proved successful, leading to substantial private sector participation and power sector expansion (Eberhard et al., 2016[156]). Elsewhere, however, and especially in Africa, unbundling has been only partially completed. Just 10 out of 54 countries have vertically unbundled utilities, and these have a far worse track record of planning for and investing in transmission and distribution infrastructure for the long term (Sachs, Toledano and Brauch, 2021[155]).
Box 3.28. Achieving utility cost recovery through a combination of tariff increases and efficiency improvements
Enhancing cost recovery for utilities is an important factor in strengthening the integrity of the power sector, facilitating investment in transmission and distribution expansion, and attracting private capital to generation projects. Improving cost recovery of tariffs over time, particularly for larger and industrial customers who can afford to pay more, is key to cost recovery, while cross-sectoral subsidies can be used to make electricity more affordable for less well-off customers, a strategy which also helps to insulate policy makers from political resistance to tariff increases.
Achievement of cost recovery requires more than simply increasing tariffs. It also necessitates greater attention to reducing transmission and distribution losses and raising bill collection. However, costs for utilities are not static, and change based on currency fluctuations, fuel prices and debt service costs. This means that while a utility may achieve, or come close to achieving cost recovery in one year, this may not last as conditions evolve. Colombia, for example, was able to achieve cost recovery between 2011 and 2016, but failed to do so in 2010 because low rainfall impacted hydropower availability.
Progressive tariff setting can help to alleviate the financial situation of utilities. Pakistan’s approach to tariff setting, for instance, incorporates an allowance for transmission and distribution losses, while Ugandan electricity distribution company UMEME updates its tariffs annually, making a quarterly adjustment for inflation. This has enabled it to finance expansions in distribution infrastructure, as well as raising efficiency levels and abiding by its debt service payment commitments. Moving towards better cost recovery requires utilities to adopt a constantly evolving and holistic approach, adapting to changing conditions, raising tariffs sufficiently regularly, constantly driving to improve efficiency, reducing transmission and distribution losses, and improving payment collection, planning for least-cost generation solutions and connections to the grid, while striving to improve service provision and employing a hedging strategy which utilises cheaper electricity imports to use least-cost generation solutions to deliver cost-effective generation.
Source: (Foster and Rana, 2020[162]).
In many African countries, the public utility competes with the private sector in power generation projects, while also being responsible for sector planning and investment in transmission and distribution infrastructure, and in some cases also being the power off-taker. In this context, the financial challenges of many utilities create a number of problems. Long-term underinvestment in transmission and distribution infrastructure adds a layer of risk for private developers and makes it more challenging to add renewable energy resources to the grid. Because they are considered non-creditworthy or risky power off-takers, IPPs find it hard to reach financial close without payment guarantees. These factors add complexity to the challenge of scaling up private investments, and for the most part, arranging project finance for IPPs, which relies on long-term revenue predictability, will be difficult to organise without payment guarantees and a robust power purchase agreement (PPA), which requires strong government legal capacity to negotiate.
Box 3.29. The role of Power Purchase Agreements in allocating costs and risks between public and private entities
A power purchase agreement (PPA) is a contract normally signed between a public off-taker, such as a utility or mandated transmission company, and a private developer or IPP. A PPA aims to balance risks and costs between public and private partners, enabling project developers to raise project finance based on predictable revenue streams. It is considered a key component of achieving project bankability, while providing the off-taker with the certainty to obtain a pre-agreed amount of power to meet demand and provide grid stability.
A PPA normally contains two pricing components:
An availability or capacity charge, payable by the off taker for the developer making electricity available, even if it is not purchased. The capacity charge normally provides a revenue stream for recouping CAPEX investment on a project.
An output charge is paid for electricity provided.
A PPA can also include clauses which cover sales to third parties. This can enhance project bankability, as well as provide a safeguard that the PPA will not get in the way of energy trading if the sector is liberalised during the project lifetime.
PPAs typically include provisions detailing penalties for poor or non-performance by the developer, such as too little electricity produced or failure to complete construction on time. Key areas of contention in PPAs are often what constitute force majeure, for instance, if project operations are disrupted by events which are beyond the control of the developer. A PPA should also cover penalties for government, for example, if delays to completion of transmission connections mean the project cannot begin delivering power at a certain date as planned, as well as what will happen in the event that mechanisms to set tariffs are changed. PPAs should also detail allocated time frames for maintenance when the project will not be producing electricity, as well as details of the testing regime to assess project capacity and performance.
Source: (World Bank, 2021[163]).
Additionally, an independent, well-resourced and professional electricity sector regulator can help provide the private sector with the assurance that disputes will be dealt with fairly and predictably, which will lower perceptions of risk. Over time, as governments are able to bring more IPPs online, perceptions of risk will lessen, to the point where fewer, or no guarantees will be necessary. However, this will also be contingent on there being sufficient and carefully planned investments in transmission and distribution to facilitate an expansion in renewable energy generation.
Governments have a range of options to incentivise private sector participation and to assess bids and proposals for renewable energy project development. Governments across the world have used feed-in-tariffs as an effective way to provide revenue predictability to private investors and bring costs down over time. However, setting tariffs at the right level can be challenging for governments with low capacity, leading to windfall profits for companies if too high, or deterring investor interest if set too low. Regulators should also scrutinise any private investment in the transmission and distribution network given it is essential infrastructure.
An alternative approach is renewable energy auctions, as a mechanism to drive prices down and procure the necessary generation facilities across a range of technologies on the basis of an Integrated Resource Plan (IRPs) or Least Cost Power Development Plans (LCPDP). Renewable energy auctions have the advantage of delivering least-cost power and can also be used to signify intent to procure more renewables generation to the private sector, helping to build a rationale for private companies to invest time and resources based on the potential of there being further projects down the line. Aside from delivering lowest-cost procurement, auctions can also help to take renewable energy technologies over the risk curve, eventually removing the need for guarantees, and can be paired with initiatives to bring battery storage technology to commercial levels. South Africa’s Renewable Energy Independent Power Producer Programme (REIPP) is a good example of a government using an auction process and reforming the regulatory framework to provide clear signals to the market, which creates competition and increases investor confidence in the sector. Ultimately, REIPP has driven down electricity prices and put South Africa in a strong position to attract the required private investments in renewables to gradually replace its coal generation capacity.
Box 3.30. Design considerations for procurement of renewable energy generation capacity through Feed-in tariffs (FITs), auctions and unsolicited proposals
Feed-in tariffs
Feed-in tariffs (FiTs) provide developers with long-term price predictability, offering an off-take agreement based on a given price for electricity per kWh. They can be effective in facilitating the rapid scale-up of renewable energy generation capacity because developers can raise finance based on a predictable revenue stream from electricity generation, while also obtaining an acceptable profit.
Two pricing structures are common: A fixed FiT price offers the same price for the duration of a contract, while a premium price FiT combines the market price with a premium payment which can be fixed for the duration of the contract, often between 15 and 20 years, or can decline over time.
For governments, and especially those with limited capacity, setting a FiT at the right level is the biggest challenge. If too low, it can deter investment, while if too high it can result in inflated profits for developers and poor value for money for consumers, not least because auctions can offer a more effective means to procure least-cost power, and provide better safeguards against corruption risks (see below). A FiT needs to be adapted to technology type and project size, with the most typical approach to setting payment levels based on assessments of levelised cost of renewable electricity, or a per kWh cost which incorporates project capital, cost of finance, and operational and maintenance costs against projected sales of power. Tariffs should also be aligned with resource quality, with higher tariffs potentially required for sites with lower resource quality in terms of wind and solar, but where governments want to incentivise development, for example, because of existing transmission infrastructure.
Additional design considerations include the need to reduce tariffs over time, in line with declines in technology costs. This is a key factor in ensuring consumers do not pay over the market price for power as well as overall least-cost pathways to power sector decarbonisation and expansion. However, this must be achieved transparently and predictably, and in such a way that investor confidence is maintained. Pre-determined annual adjustments, plus more substantial assessments and revisions every three to five years, based on detailed appraisals of technology markets and prices, can be helpful in this respect.
Governments must also consider overall FiT costs. They can do this by setting a limit for FiT deployment, for example, when a pre-specified volume of generation capacity has been procured or funding for the FiT has run out, cognisant also of the need to honour electricity purchase agreements already signed.
Renewable energy auctions
As an alternative to FiTs, renewable energy auctions offer an effective means through which to procure least-cost power, as well as achieving additional objectives, in line with national development goals. They also have the advantage of real price discovery, given a competitive process can drive down prices and reduce the asymmetry in information between government and the private sector.
At a basic level, governments invite developers to submit bids to develop renewable energy projects with a commitment to provide electricity at a certain price per kWh. Bids are assessed on price and other predetermined criteria – potentially including the requirement to provide electricity storage. Then governments, in emerging and developing economies, often the power utility – sign a PPA with the winning bidder.
Renewable energy auctions can be technology and location neutral, which can often result in the lowest electricity prices, as developers can select locations with the best generation conditions and also choose which technology offers least-cost solutions. Governments can also specify technology requirements as well as specific sites for development if they want to scale up deployment of certain technologies or deploy projects at points on the grid where connection costs will be lowest or transmission infrastructure is already in place.
Governments have a choice as to how much generation capacity to procure at one time, although this is also contingent on the absorption capacity of the transmission infrastructure. Countries with significant power deficits or facing power crises may be tempted to procure large amounts of capacity all at once to meet growing demand. However, the steep learning curve for renewable auction first rounds should be taken into account. This normally means later auctions will benefit from significantly more competition, leading to lower prices as well as other improvements on initial iterations. Trying to procure too much power in a first auction can result in higher prices, leaving consumers paying more for power than they need, and failing ultimately to benefit from cost reductions in later rounds. For example, South Africa’s first renewable energy auction round in 2011 failed to generate sufficient competition, but subsequent rounds, based on improved learnings from the first and through generating progressively more competition, have succeeded in consistently driving down prices. Governments can also consider setting a maximum threshold in terms of price per kWh above which bids will not be considered to ensure value for money.
At the end of 2021, a total of 131 countries implemented renewable energy auctions. This is higher than the total number of countries that still rely on some level of direct support through feed-in tariffs (92 countries), and is twice the number of countries that have used renewable energy auctions in 2015.
Using auctions has brought notable benefits since the underlying principle for any bidder to win a project is generally cost. The objective of achieving least-cost projects has helped to accelerate innovation, further improving technologies and corresponding efficiency levels. A consequence of technological maturity and experience accumulated about investing in bankable projects is that financiers now provide loans with much better conditions. Data from the IRENA show record prices for utility-scale solar PV projects at an average price of USD 0.04 cents per kilowatt-hour. The same data highlight that this is 27% less than the average price for coal-fired power plants.
The design of effective renewable energy auctions is key to their success and to real price discovery. Well-designed auction volume and clear criteria for entry of bidders, supported by clearly stated commitments of project stakeholders and a transparent procurement process, all contribute to high levels of competition. These help to ensure that implementation of the projects, once won, fulfil the project requirements. Investors and financiers also benefit from a predictable and certain investment environment with clear signals on prices and quantities of future auctions. In general, the greater the competition, the more competitive the prices, which gives governments an incentive to lower barriers to entry. Yet, lowering them too far can mean firms that lack the requisite technical, legal and financial capacity to realise the projects may win, or bid with unrealistically low prices, often resulting in significant under procurement. To an extent, this risk can be mitigated through a two-stage process that includes an initial round to qualify bidders based on project experience, and technical and financial capacity to limit participation to developers who in reality will be able to deliver on commitments.
Additional design considerations include compliance rules such as bid bonds and delay penalties, which fine winners if they do not adhere to agreed development schedules or if the resulting project underperforms. Allocating responsibility for transmission connections is also key, something which is normally the responsibility of the utility, and developers need to be entitled to financial compensation in the event of a delay to transmission connection. Bid bonds or completion deposits can also reduce the risk that the winning bidder fails to deliver on commitments, given that a PPA will not introduce legally binding commitments until after the auction has been completed, and can also reduce the risk of under procurement of generation capacity.
IRENA’s Renewable Energy Auctions: A Guide to Design provides useful guidance on this topic.
Unsolicited proposals
Countries with significant power deficits or power crises are likely to be approached with unsolicited bids by developers who see an opportunity to make a decent return. In general, governments should try to avoid direct negotiations and unsolicited bids for power projects, because they rarely result in lowest-cost power and can fuel perceptions of undue influence. When a government does decide to engage in direct negotiations, rigorous and independent assessment criteria should be applied. Kenya Power, for example, used to employ a system to assess unsolicited bids which required an open book assessment, where developers were expected to outline expected returns on debt and equity against a pre-specified capital structure. This approach helped avoid overly inflated profits, and enabled comparison of prices offered to benchmarks such as a FiT or auction prices, where available. It is also imperative for an independent and competent regulator to conduct its own assessment to determine value for money.
Governments should consider prioritising the following actions:
Set up an independent regulator, or if there is one, ensure it is strong, independent, professional, and well resourced, with a clear mandate that frees it from undue influence from the power utility or energy ministry. The regulator needs to be capable of making fair, predictable decisions and enforcing competition, especially around auctions. This is vital for investor and private sector confidence.
Identify investment opportunities for the private sector based on renewables potential and connection costs, and translate these into procurement plans.
Assess the merits of encouraging private investment through a feed-in-tariff or a renewables auction, or a combination of both, noting that these options will require specialist government skills and competencies to design. Auctions are better at delivering lowest-cost electricity, but require sufficient competition in the market to be successful. Feed-in-tariffs may present a preferable option for countries with initially limited renewables penetration in the grid.
Deploy sovereign risk guarantees strategically, recognising they are treated as contingent liabilities on the government balance sheet and are therefore limited in availability. Consider that large-scale renewables demonstration projects which are successful can serve to de-risk the sector overall, reducing the need for guarantees through the long term.
Avoid unsolicited bids for renewables projects because they are likely to result in higher electricity costs and risk perceptions of undue influence or malfeasance. Where a government does accept to negotiate with a private developer, rigorous proposal assessment criteria should be applied to assess the bid, which should also be reviewed by an independent and professional regulator.
Clarify which entity a PPA will be signed with. This entity is normally the utility or dedicated transmission operator. The nominated entity should also be responsible for grid management and therefore connection of projects to transmission infrastructure.
Actions requiring international support in contexts where government capacity is low:
In partnership with industry, work to develop a standardised PPA for different types of renewable energy generation projects. This will help to clarify off-take requirements for private investors, cut deal times and mitigate corruption risks.
Invest in government and public utility or distribution company legal capacity to negotiate PPA terms with private developers. This is often a key weakness in getting IPPs off the ground in developing countries.
Review the status of sector unbundling, recognising that the power sector reform can be a politically contentious process. Ultimately, a long-term and carefully developed programme for transmission and distribution infrastructure expansion, plus an independent, professional regulator are the key ingredients for encouraging private sector participation and adding renewables generation to the grid.
Recognise the importance of strengthening utility and transmission company financial health, and in partnership with development finance institution partners, pursue multiple avenues to improve performance. A holistic strategy to achieve this would include addressing transmission and distribution losses, raising payment collection rates, grid digitisation, making tariffs cost-reflective, debt restructuring, corporate governance reforms, and revising managerial incentives to enhance operational and technical performance and improve fiduciary management.
3.4.3. Tackling energy poverty through decentralised energy access
Governments need to integrate considerations around the optimum balance of on-grid and off-grid power solutions into the development of least-cost energy sector development plans. They also need to consider trade-offs between investing in industries such as hydrogen with substantial power demand, and investing in improved energy access.
Advancement in technologies for mini-grids have played an important role in facilitating access for rural communities, with 5 544 mini-grids in operation in sub-Saharan Africa, Southeast Asia, Small Island Developing States (SIDS) and Latin America (SE4All, 2020[5]).
Box 3.31. Leveraging mining projects as anchor off-takers
Forecast growth in the mining sector in developing and emerging economies on account of demand caused by the low-carbon transition raises the potential for mines, as well as other industrial centres in remote locations, to provide anchor off-take agreements for renewables projects, as part of efforts to increase the commercial viability of connecting remote communities. In fact, it is important for governments to consider how mines and industrial centres can be incentivised to use renewable energy generation, in order to avoid power demand at these sites massively contributing to national emissions, while other cuts are made elsewhere in the economy. Governments should ensure that energy, mining, and economy and planning ministries co-operate closely to identify where mining can play a role in electrifying local communities via renewables, and that these requirements are integrated into mining permitting requirements accordingly.
However, achieving SDG-7 by 2030 will require the connection of a further 238 million households across sub-Saharan Africa, Southeast Asia and SIDS, equivalent to 60 million people per year. Though some of these people will be connected through expansion of the grid, some 111 million households will need to be connected through off-grid solutions, owing to their remote or low-density location (SE4All, 2020[5]).
One of the core challenges in connecting these communities is their limited power demand, accompanied by often low and unpredictable incomes, which limits their ability to pay for electricity. This can make mini-grids and remote connection projects unviable as commercial endeavours. For the most part, most rural connection projects are based on development finance institution or foundation funding, rather than representing viable investments for the private sector.
Some initiatives have sought to raise local demand through financing roll out of appliances, while others have identified innovative business models that are able to accommodate longer pay-back periods. Mining projects, or industrial centres, have also been used as anchor off-takers, providing a commercial basis to roll out electricity to surrounding communities and households.
Whereas mini-grids until relatively recently tended to be based on diesel generation, the substantial drop in cost of solar PV and battery storage, and the potential of green hydrogen to transport electricity from renewables over long distances, mean that decentralised, low-carbon technology solutions now offer the lowest-cost pathway to rural electrification.
Governments should consider prioritising the following actions:
Assess the regulatory framework to facilitate private investments in mini-grid and rural connection projects. Key issues include regulations to compensate mini-grid operators if the main grid is extended to areas in which they operate, and if they are not allowed to sell to the grid. Enable flexibility in mini-grid tariffs to support developers to set tariffs in a manner consistent with local payment power and commercial requirements.
Consider the deployment of subsidies to incentivise private sector investment in mini-grids. The most typical mini-grid subsidies are either up-front CAPEX subsidies to support grid development, or results-based payments, disbursed based on verification of an electricity connection.
Actions requiring international support in contexts where government capacity is low:
Consider establishing an energy access fund, capitalised with development finance, institution finance and fossil fuel export revenue, to roll out energy access programmes via mini-grids.
Development finance institutions and bilateral development agencies should:
Accelerate provision of concessional finance and grants for governments to roll out energy access projects through mini-grid initiatives consistent with achievement of SDG-7.
3.5. Encouraging low-carbon technology transfer, innovation and diffusion through science, technology and innovation policy
Integrated science, technology and innovation policy making is key to encouraging diffusion and innovation in low-carbon technology, processes and products, as well as their deployment at scale. To build achievable low-carbon transition pathways which enable them to take advantage of opportunities presented by the transition, fossil fuel producer emerging and developing economies will need to set the enabling conditions and establish incentive structures to encourage technology transfer and innovation, as well as emissions reduction, across a range of sectors and industries.
At a global level, there have been significant advances in driving down the cost of low-carbon technologies and scaling up their deployment, especially in high-emitting sectors such as energy, transport and buildings. To limit global temperature increases to 1.5°C by 2050, most of the global reductions in CO2 emissions between now and 2030 must come from technologies which are readily available today. However, almost half the low-carbon technologies needed to achieve required CO2 reductions in line with net zero pathways by 2050, such as advanced batteries, electrolysers for hydrogen and direct air capture and storage, are still at the demonstration or prototype phase (IEA, 2021[20]).
In addition, many lower middle-income countries and developing economies, particularly those whose development models rely on revenue from or cheap access to fossil fuels, are highly constrained in terms of access to low-carbon technologies, including technologies which can already be readily commercially deployed elsewhere, for instance, renewables technologies, low-carbon materials and buildings, electric public transport and trains. Low-income countries, for example, accounted for just 0.01% of low-carbon technology exports and 0.3% of imports between 2015 and 2016. Lower-middle-income economies accounted for 1.9% of low-carbon technology exports and 6.2% of low-carbon technology imports during the same period, while figures for upper middle-income economies stood at 25.2% and 31.6%, respectively. High-income economies accounted for 73% of low-carbon technology exports between 2015 and 2016, and 61.9% of low-carbon technology imports during these years, highlighting global inequities in access to technology required for the low-carbon transition (Pigato et al., 2020[165]).
Fossil fuel producer emerging and developing economies which lack a strong non-fossil fuel private sector capable of absorbing skills and know-how as part of the process of technology transfer, followed by innovation, will rely, at least initially on low-carbon technology transfer through foreign direct investment or imports from advanced economies or emerging economy technological innovators such as India and China. Based on this, domestic firms can then reproduce, adapt and improve imported technology to reflect local circumstances, and at a later stage move towards innovating themselves and exporting through integration into GVCs.
This process can support the development of affordable contextually appropriate technology which can be deployed at scale, further driving down costs and supporting the gradual transition towards a net-positive Effective Carbon Rate (ECR), as firms and consumers are presented with lower carbon lifestyle and business choices.
Successful low-carbon technology transfer, however, requires a more integrated approach than simply importing the technology itself. For example, it necessitates that countries build the necessary human capital through investments in education and training programmes to enable domestic firms and workers to understand, use, and then improve and adapt imported technologies. It also relies on the existence of enabling infrastructure, and regulatory incentives to accelerate low-carbon technology deployment and incentives at scale and to encourage foreign direct investment in the first place. Governments also need to ensure low-carbon technology and products can compete with incumbent fossil fuel-based industries through the introduction of and incremental improvements to the ECR. The OECD Recommendation on FDI Qualities and the related Policy Toolkit can provide guidance on implementing such measures to attract sustainable investment that supports low-carbon technology transfer (OECD, 2022[166]).
Firms and the labour force in fossil fuel producer emerging and developing economies, and especially those with heavily subsidised fossil fuels, may lack the incentives, technical competencies and capacity to innovate. For these countries, addressing the low-carbon technology gap requires investment in education and training, as well as supporting firms to build competencies to absorb and adapt low-carbon technology through subsidies and grants to research and development. Foreign direct investment also provides an effective way to support this process, as it can require skills intensive partnerships which can be effective at facilitating transfer of technologies and know-how. Governments should also prioritise long-term investment in sustainable infrastructure which maximises the positive impacts on sustainable development, increases economic efficiency through the life cycle of the project, integrates environmental considerations, builds resilience against natural disasters and integrates social considerations. Reliable and available electricity, broadband coverage and low-carbon public transport, both to encourage foreign direct investment and also to progressively offer firms and consumers lower carbon and green alternatives, are particularly important in this regard. Meanwhile, employment of risk mitigation measures – for example, sovereign guarantees, political risk insurance, subordinate finance from both governments and development finance institutions, in line with recommendations in Pillar 2, Section 2.4 will be central to encourage investment and facilitate knowledge spillover.
In parallel, governments should adopt a coherent set of demand and supply-side measures to incentivise firms to innovate and adapt low-carbon technology to national circumstances, over time nudging firms towards lower carbon choices. Standards and regulations, including energy efficiency standards for buildings and transport, green certification, fuel and technology use mandates, and bans on the highest emitting technologies, introduced in a gradual and well-signalled manner, can support the incremental process of phasing out carbon-intensive and high-emitting technologies. In parallel, governments can deploy measures to incentivise firms to innovate and adapt technologies to meet changing market demand through grants, loans and subsidies. Grants and subsidies to both firms and individual consumers can offset costs accrued as they transition to lower carbon alternatives, as well as to build demand to further incentivise firms to develop low-carbon products and services. Incentivising firm and consumer behavioural change through mandates, grants, loans and subsidies will only have a limited impact if the negative externalities of burning fossil fuels are not incorporated into energy pricing. Governments will need to determine what kind of incremental approach to carbon pricing is feasible and warranted based on affordability and the availability of viable alternative choices, and to eventually complete the process of redirecting incentives fully away from fossil fuels.
Governments should consider prioritising the following actions:
Adopt integrated innovation policy making, leveraging an optimum combination of measures, including long-term price signals, regulatory requirements and standards (e.g. emissions and building standards) subsidised loans and grants, green public procurement and fiscal instruments.
Prioritise investments in education and training, as well as partnerships between the private sector and educational institutions to build human and firm capacity to absorb technology transfer and adapt and improve technologies to local conditions. This will require long-term vision and programming to support the gradual diffusion and scale-up of least-cost technologies for decarbonisation.
Deploy risk mitigation instruments strategically to de-risk and encourage foreign direct investment in priority areas to take low-carbon technologies over the risk curve to the point where they are self-sustaining and to build economies of scale (refer to Pillar 2, Section 2.4.2 for further guidance).
Consider revising import rules. Tariff barriers on low-carbon technologies can raise project costs, potentially deterring foreign direct investment, while non-tariff barriers to doing business can also have a detrimental impact on investment.
Consider establishing publicly funded technology and innovation incubators and accelerators which can bring together industry and educational institutions and promote research and development in priority areas.
Introduce parallel non-price measures, such as grants, subsidies and loans for low-carbon technologies and research and development, alongside the progressive introduction of performance standards, fuel mandates and bans on high-emitting technologies, to complement incremental increases in the ECR. This can provide incentives and support for domestic firms to innovate and produce affordable low-carbon technologies, products and materials, because it will gradually create a market for these goods, and firms will direct research and development spending to meet this demand.
Consider establishing or mandating a dedicated government agency to undertake strategy development, to conduct targeted and bespoke studies into technological development and innovation and domestic opportunities in target sectors, and to play a role in tracking domestic innovation and technology transfer, as well as looking at international technological trends and how they relate to the domestic market.
Actions requiring international support in contexts where government capacity is low:
Consider reviewing and revising intellectual property legislation, noting that if it is too stringent it may prevent domestic firms from replicating and improving imported low-carbon technologies, while if it is too weak, it may deter foreign investment because of the risk of leading to replicated products.
Leverage international agreements and trade deals to include technology transfer components in priority sectors, for example between importer and producer countries to encourage skills, knowledge and technological development in the hydrogen industry.
3.6. Enhancing low-carbon mobility and decarbonising transport
Fossil fuel-producer emerging and developing countries facing rapid population growth and urbanisation have an opportunity to leapfrog systems design, delivering benefits to citizens at scale, particularly in fast-growing small- to medium-sized cities where large segments of the population lack access to mobility and energy. A systems approach to decarbonising the transport sector, alongside strategies to enhance access to mobility and proximity to amenities and services, which integrate energy, transport and urban planning, would enable governments to achieve substantial emissions reduction goals, alongside enhancing citizens’ well-being.
Key tools in this regard include geographic information systems (GIS) that can map mobility demand and facilitate planning, avoiding gridlock and congestion. Such tools can assist the design of cities with sustainability in mind, situating amenities and services closer to demand. This would result in citizens travelling shorter distances and taking more sustainable transport options to do so.
A central weakness of current thinking on transport decarbonisation is its focus on decarbonisation of individual components of the transport system, particularly cars, and replacement with electric vehicles (EVs), as opposed to a more holistic approach which reduces the overall need for individual vehicles through better designed cities and improved public transport. This approach negates the transformational potential of systems thinking, which can provide a far more efficient way to achieve simultaneous decarbonisation and achievement of socio-economic development goals in developing and emerging economies. Global transport development policy to date has to a large extent equated well-being with access to mobility, ignoring the importance of proximity to well-being at the same time. Well-being is not about being able to travel long distances to access services; rather, it is reinforced by access to necessary services and amenities via relatively short trips (OECD, 2021[167]).
Urban renewal policies, which seek to spread out amenity and service hubs across cities, rather than concentrating them in central areas, and which connect them with efficient, quality and affordable public transport, can support improved citizen well-being and decarbonisation in existing large and mega-cities. However, overwhelmingly, the opportunity to decarbonise and build more balanced urban spaces with citizens’ well-being in mind, lie in developing and emerging economies. This is particularly the case in intermediary cities, small and medium-sized agglomerates which act as bridges between rural and urban areas which tend to expand quicker than mega-cities but are characterised by low-quality infrastructure, along with poor planning and weak governance structures. It is also the case in fast-growing smaller cities of between 300 000 and 1 million people (OECD, 2021[167]; SE4All, 2021[168]).
More than two-thirds of the world’s population will live in urban areas by 2050, when 58% of global emissions are expected to come from cities. Moreover, of all the infrastructure expected to be built by 2050, almost 75% will be in cities that have yet to be built (OECD and Harman, 2021[169]). Most of this growth will be in emerging and developing countries. Nigeria, for instance, is expected to be the world’s third most populous country by 2050. Half of Nigerians are under the age of 18, and between 2010 and 2030, 77 people will move to Lagos every hour (Dunne, 2020[170]).
Many fossil fuel-producer emerging and developing economies, therefore, have an opportunity to leapfrog systems design, avoiding cities that are trapped in high car demand scenarios, with sprawled and congested systems, that lock in carbon-intensive development pathways and undermine citizens’ well-being and access to services.
To take advantage of this opportunity, governments can steer urban, energy and transport planning towards a systems approach to urban development. This can break down the silos between energy, transport and planning ministries, and municipal and urban authorities’, to enable and incentivise them to undertake joint systems planning for better, more sustainable urban development, and to upgrade citizens’ access to decent services, amenities, employment opportunities, and sports and cultural facilities. This approach can limit and even reverse the spread of urban sprawl, and avoid new cities being organised around dense central urban areas, largely inaccessible to surrounding residential areas except via car access (OECD, 2021[167]).
An “Avoid, Shift, Improve” approach to integrated urban planning and sustainable mobility seeks to avoid unnecessary journeys, including through the promotion of walking, cycling and electrified two- and three- wheeler transport options. Shift policies meanwhile aim to encourage users to move towards more efficient modes of transport from car use. The greatest decarbonisation gains for emerging and developing countries are likely to lie in a combination of these measures. Meanwhile, improve policies aim to reduce the carbon intensity of existing modes of transport and fuels, eventually replacing them with low-carbon alternatives (OECD, 2021[167]; SE4All, 2021[168]).
Shift policies can be enabled by effective municipal urban and public transport planning, optimising public transport routes to build convenience and provide better options than taking a car. Public transport systems in many developing and emerging economies tend to be chronically underfunded, run on old and polluting diesel bus fleets, and are in need of route optimisation. This creates a vicious cycle in which consumers turn to individual cars, as a more reliable and convenient transport option – a trend exacerbated by the COVID-19 pandemic – undermining public transport operators’ ability to recover costs and invest in fleet renewal or an improved service. Substantial investments in fleets, as well as operator and municipal capacity to put public transport on a sound financial footing, can encourage investments which will improve services and attract customers. Gradual tariff rises are key to enabling improved cost recovery over time.
Investments in urban light rail, metro and tram systems can provide viable long-term solutions to public transport performance in densely populated areas. However, CAPEX requirements can be prohibitively high and project economics can be challenging given uncertain passenger demand in some developing and emerging country contexts, the dominance of cars and the inability of some passengers to afford higher fares necessary to raise finance.
Instead, Bus Rapid Transit (BRT) schemes, which tend to be between 1.5 and 2.6 times cheaper per kilometre than light rail, may present a more affordable and realistic option for some governments facing rapid population growth and urbanisation. BRT systems use right–of-way systems and bus corridors to improve the efficiency of bus routes, thereby giving buses an advantage over other traffic, and can help to ensure public transport is a preferable option over car travel (IRENA, 2021[171]).
Lastly, fee-charging congestion zones, and additional traffic circulation fees for car users linked to vehicle performance standards or age, as well as tighter parking restrictions and enforcement in densely populated areas, can help nudge car users towards public transport, walking and cycling, as car use becomes less affordable in comparison. Complementary increases in petrol and diesel prices, in line with longer-term plans to raise the national effective carbon rate (ECR), as outlined in Pillar 3, Section 3.3.1, can also enable these shift policies.
Improve policies represent the least effective means to decarbonise urban mobility, and are likely to be less feasible in developing and emerging country contexts where lower citizen purchasing power means that the roll-out of electric vehicles, at least initially, will be slower. Lack of demand makes the economics of investing in extensive charging infrastructure challenging, and where the penetration of renewables in the energy mix is relatively low, a mass transition to electric vehicle use may result in limited emissions reduction gains.
Box 3.32. Electrification of two and three wheelers can bypass the high costs of electric vehicle charging infrastructure and address affordability constraints
While rapid expansion of electric car markets in many developing countries may be unrealistic in the medium term given the high cost of rolling out charging infrastructure and affordability barriers, which create challenges in building market demand, the electrification of two and three wheelers can offer an affordable alternative for consumers, with substantial decarbonisation impacts, particularly in urban areas. Unlike electric cars, charging for electric two and three wheelers can be done relatively quickly through a household plug connection, rather than requiring expensive national charging infrastructure. Moreover, though currently more costly than two or three wheelers running on internal combustion engines, electric two and three wheelers are far more affordable than electric cars, with costs expected to come down further as the market grows.
Moreover, in many developing countries, two and three wheelers are already a dominant form of transport in many cities. Two and three wheelers, according to the World Bank, account for three out of four vehicles in Ouagadougou and two out of three in Bamako, accounting for 50% of CO2 emissions from vehicles and 60-75% of pollution in these cities. The transition to electric two and three wheelers could contribute to a 30% reduction in the life cycle emissions of a motorcycle and 50% for a scooter. However, if 70% of the current two- and three- wheeler fleet were to switch to electric today, they would account for 19.5% of the total electricity production of Mali and 82% in Burkina Faso, demonstrating the importance of integrated transport and power sector planning, and the vital role electricity sector decarbonisation can play in rolling out decarbonisation of other sectors. Of course, the higher the penetration of renewables in the grid, the greater the decarbonisation gains of switching to electric two and three wheelers.
Source: (World Bank, 2022[172]).
Yet, policies to electrify public transport, particularly municipal buses and mini-buses, which make up the bulk of public transport in many developing and emerging country contexts, can have a profound impact, especially in tandem to the avoid and shift policy options outlined earlier in this section. In the absence of established charging infrastructure, however, innovative charging approaches will need to be identified.
For emerging and developing economies, the predominance of mini-buses in public transport offers a major opportunity to transition a substantial part of the public transport fleet to run on electricity (IRENA, 2021[171]). However, in most contexts, this is complicated by the dominance of informal firms in this area. These may be resistant to change and in any event are more likely to lack the substantial volumes of capital required to make the investments in fleet renewal or adaptation.
Biofuel blending mandates and biomethane in public and municipal fleets can also support improve policies, initially at relatively low cost, given that 20% blends can normally be accommodated without engine modifications, but raising the proportion of biofuel in the mix will eventually require more investment. In this context, it will be critical to ensure the sustainability of the biofuel production supply chain. As with shift policies, gradual improvements in fuel performance standards, alternative clean fuel use mandates, and incremental increases in fuel prices can also support the implementation of “Improve” policies. Some emerging and developing economies may want to consider import restrictions based on the age and emissions intensity of vehicles, given that they are often prime targets for exports of high-emitting and old second-hand cars. Governments, however, should also consider the risk of unintended consequences, as this approach could remove access to mobility for many citizens who have no alternative.
Box 3.33. Use of sustainable biofuels offers low hanging fruit to decarbonise transport sector
The use of sustainable biofuels in vehicle engines offers low hanging fruits to decarbonise the transport sector and offers some potential to decarbonise transport systems at limited cost, while also providing benefits in terms of reduced air pollution in cities. Biofuels can normally be blended with fossil fuels at 10% or sometimes higher such as in Brazil which has a blend mandate of 27% ethanol in gasoline. Over 70 countries worldwide have introduced some kind of national mandate for fuel blending, though just seven have biofuel levels of more than 10%. Though higher levels of biofuel content blending in fuel mixes inevitably have greater decarbonisation impacts, blending above 10% may require engine modification, which may create affordability barriers. At the same time, “flex fuel” technology, allowing for any mix up to 100% biofuel use, is readily available and widely used in countries like Brazil, confirming the viability of its use as a transition to low carbon automotive transportation that tends to be less costly than the electrification of the fleet.
Blending mandates can serve as an effective means to decarbonise transport systems, especially if paired with complementary Avoid and Shift measures which aim to reduce journey frequency and distances, and utilise more efficient modes of transport such as public transport, walking, cycling, and electric two and three wheelers. Particularly in municipal public transport, investment in engines able to run entirely on biofuels can support decarbonisation in cities. For example, the Brazilian city of Curitiba, through its Biocidade programme, implements a 100% biodiesel mandate for its municipal bus fleet.
Replacement of fossil fuels with biofuels produced either from crops or waste products can be not only a valuable source of cleaner energy, but also of income and employment, particularly in rural areas. In considering biofuels production and bioenergy use as part of an integrated and just low-carbon transition strategy, governments must also consider the social and environmental risks such as biodiversity loss and elimination of natural carbon storage, if forests and grasslands are cleared for crop production or production of biofuels displaces food production from arable land, particularly at a time of global food shortages. At the same time, if adequately managed, the combination of biofuels and food production may provide for greater economic sustainability over the long term and be mutually reinforcing.
Biofuel production currently accounts for around 4% of arable land worldwide, corresponding to 22% of world sugar production, 12% of corn and 15% of vegetable oils. According to the IEA, global demand for biofuels will grow by 41 billion litres, equivalent to 28% between 2021 and 2026. This growth must be managed sustainably, reducing competition for land use with food production, avoiding biodiversity and natural carbon storage loss and an overall net increase in emissions. The IEA’s Net Zero Scenario envisages a rapid increase in the use of biofuels to replace fossil fuels by 2050, with deployment increasing 10% per year by 2030. However, this scenario involves no expansion of cropland for bioenergy nor conversion of existing forested land into bioenergy crop production, with 60% of bioenergy supply coming from waste and residues which do not require land use.
Raising the proportion of biofuels produced from waste and residue, including cooking oils, animal fat waste and agricultural waste, as well as from dedicated crops that are complementary with food production, can help achieve this balance.
Carbon content of biofuels throughout the value chain also varies significantly, depending on production technologies, and whether crop growth eliminates ecosystems whose vegetation would otherwise provide carbon storage if it were left in place. In some cases, the production of biofuels can therefore result in a net negative impact on climate change.
The production of conventional biofuels from crops is achieved through well-established technologies and processes, while the production of biofuels from waste and residues for the most part is in the research and development stage, and faces scalability challenges given that feedstock is more limited. Technological innovation will be required to enable commercial production. Currently, for instance, cellulosic ethanol and biomass to liquids technologies based on non-food feedstock cost double or triple their fossil fuel equivalents.
Thus, in implementing policies to support biofuels production or importation, governments should:
Consider the sustainability implications of producing biofuels from arable land, integrating social and environmental considerations into biofuels production and bioenergy policies. In line with the IEA’s Net Zero recommendations, biofuel production should avoid expansion of arable land or conversion of existing forests for crop production, as well as avoiding a net increase in emissions through elimination of natural carbon storage.
Consider adopting policies and tax regimes to maximise the collection and valorisation of organic waste, residues and used oils to create circular value chains for the production of sustainable biofuels.
Promote the integration of electricity co-generation from waste in biofuel producing units.
Sustain the development of smart agriculture techniques that include low-Indirect Land Use Change (ILUC) crops to generate vegetable oils, thus avoiding competition with food chains and making use of poor quality land not suitable for food production.
Finance studies assessing the potential for production of biofuels from food and agricultural waste, as well as from land which is unsuitable for food production.
Introduce certification for biofuels produced sustainably.
Governments should consider prioritising the following actions:
Consider establishing a ministerial co-ordination agency or function to better integrate urban, energy and transport planning, and establish linkages with relevant urban and municipal planning authorities, to facilitate joint systems planning and leapfrogging urban design.
Identify new, growing and intermediary urban areas which can benefit from an integrated approach to urban development. In tandem, identify areas of existing large and mega systems in which services and amenities can be brought closer to densely populated areas in parallel with policies that promote the renewal and revival of affordable, efficient and quality public transport, walking and cycling as preferable alternatives to car use.
Invest in government and municipal planning capacity and ability to collect and interpret data to map the spatial dimensions of demand growth.
Recognise that well-being and equality are best served by a combination of mobility and proximity of demand centres to necessary services, amenities and job markets, and build a national vision for urban development on this basis.
Adopt an “Avoid, Shift, Improve approach” to urban mobility decarbonisation and urban planning, recognising that policies which avoid the need for journeys will have the most transformational impacts on decarbonisation and well-being, implemented in parallel with shift policies that enable the transition to public transport alongside improvement to quality and reliability of services.
Consider population purchasing power in assessing electrification of transport options. In many emerging and developing country contexts, a lack of affordability and high investment costs to install the extensive charging infrastructure required means a mass switch to electric vehicles may not initially be feasible, and may not have the desired decarbonisation impact if there is limited renewables penetration in the grid. As an initial step, electrification of buses and investment in Bus Rapid Transport (BRT) systems can provide a more cost-effective alternative which, if combined with policies to increase proximity of demand and services, can encourage user uptake and result in substantial emissions reduction gains.
Integrate electrified two- and three- wheeler options, walking and cycling into systemic mobility planning. These can provide effective means to reduce car use as avoid policies to bring consumers closer to demand bear fruit, but will require substantial investments in pavements and dedicated cycle lanes in many emerging and developing countries to avoid safety risks. Policies which build market demand for electric two- and three-wheelers can also support domestic manufacturing (see Pillar 3, Section 3.2) (SE4All, 2021[168]).
Consider options for pricing car use in densely populated areas and explore how this can support an increase in the use of public transport and uptake in alternatives, such as walking and cycling. Options include incremental increases in fuel prices, in line with the recommendations in Pillar 3, Section 3.3.1, congestion zone fees, fees for high-emitting vehicles within certain zones, peak charges and vehicle performance standards.
Consider incremental increases in requirements to incentivise fuel switching to hybrid, low-carbon fuels or blended fuels, alongside vehicle performance standards, congestion pricing and tighter parking restrictions in densely populated areas to encourage low-carbon fuel take up and use of alternatives. However, these tools need to be gradually built up in parallel to the proliferation of alternative options, such as cycle lanes and expanded public transport choices and efficiency. Import restrictions on older, more polluting vehicles can also help developing countries divest themselves of their role as major destinations for second-hand car exports, though this approach risks removing mobility options from some citizens if alternatives are not available.
Actions requiring international support in contexts where government capacity is low:
Build investment strategies for municipal public bus transport, over time, seeking to modernise and decarbonise fleets, optimise routes and bring them to a point where tariffs can be cost-reflective. These measures will be key to encouraging use of public transport and generating revenue which can be further invested in improvements. This will also facilitate a reduction in car usage and congestion, and help shift public bus transport away from the low-cost, low-revenue, low quality trap in many developing and emerging economies (OECD, 2021[167]).
Build long-term strategies for investment in light rail, trams and metro systems.
Development finance institutions and bilateral development agencies should:
Invest in and support investments in light urban rail, metro systems and BRT through feasibility studies, as well as risk mitigation instruments; finance high upfront costs; and grant support to municipalities and transport providers to build more effective plans and strategies.
3.6.1. Decarbonising freight transport
Modernising freight systems is a key part of transport system decarbonisation. Globally, international freight accounts for 9% of all transport emissions, with road freight, comprised of both short- and long-distance haulage, making up 15% of total freight, but comprising 44% of freight emissions (IRENA, 2021[177]; ITF, 2021[178]). For many developing and emerging economies which lack established rail freight infrastructure or large-scale internal waterways for movement of goods, and where the proliferation of smaller and sometimes informal freight companies means the use of more, older and smaller trucks, the share of road freight and its emissions tends to be far higher.
Long-distance road freight is challenging for developing and emerging economies to decarbonise because long distances and heavier loads mean low-carbon and electric alternatives are not yet available as commercial replacements to engines running on petrol and diesel, though this is likely to change as costs for hydrogen production gradually fall. Moreover, smaller firms, which make up a large bulk of haulage companies in developing countries, are less likely to be able to make the significant investments required to upgrade fleets to low-carbon alternatives.
Decarbonisation of freight, therefore, for fossil fuel-producer developing and emerging economies, will require a combination of measures. These may include sustained and long-term investment in rail freight and inland waterway routes to facilitate a shift to lower carbon freight modes through long-term subsidies and grants, progressive implementation of fuel economy and emissions standards, and gradual rises in fuel pricing.
In parallel, governments can look to incentivise freight companies to implement short-term measures to improve efficiency and reduce emissions, supporting investments and introducing performance standards for aerodynamic retrofits, reduced rolling resistance of tyres, measures to reduce vehicle weight and partial inclusion of biofuels where feasible. Meanwhile, collaboration incentives and digital platforms to encourage collaboration on freight between firms can optimise vehicle use and minimise emissions (Transport Decarbonisation Alliance, 2019[179]).
Governments and urban planning authorities, however, should also incorporate strategies to decarbonise urban freight into urban planning systems, particularly for urban developments which are yet to be built. Urban freight accounts for a relatively small proportion of overall freight volumes, but disproportionately high emissions given the high number of short journeys by multiple smaller vehicles. This means urban freight and carriers may be more receptive to incentives to switch fuels, or adopt hybrid vehicles, given the costs of doing so are lower, and technologies are already commercially available. Zero emissions zones for freight in urban areas can also incentivise uptake of low-carbon fuels and vehicle models, though this must be implemented gradually to give firms time to adapt their fleets. This can be carried out in parallel to grants and subsidies to offset the costs of switching, while increasing collection points and route optimisation, and implementing fuel pricing rises (see Pillar 3, Section 3.3.1).
Governments should consider prioritising the following actions:
Carry out a stakeholder mapping of freight firms across the value chain and develop effective stakeholder engagement strategies to design workable policies and a realistic timeframe for implementation, while determining what kind of support firms will need to invest in low-carbon alternatives.
Consider establishing a zero emissions zone for freight building targets, implementation timeframes, regulations and support measures in concert with urban freight companies. Pilot implementation can help to improve policies and build acceptance, as well as giving firms time to adapt.
Municipal authorities should review their powers to restrict traffic and may need to collaborate with other regional or other local authorities to this end, particularly in establishing zero emissions zones for freight.
Invest in the expansion of rail and inland waterways to displace road freight where possible.
Consider the potential of low hanging fruit of aerodynamic retrofits, reduced rolling resistance of tyres, measures to reduce vehicle weight and partial inclusion of biofuels through performance standards and grants.
Raise regulatory and performance standards and fuel switching and blending requirements, in parallel to progressive rises in fuel prices to incentivise decarbonisation.
3.7. Decarbonising the buildings and residential sector through energy efficiency and renewable installations
Representing almost one-third of total global final energy demand and about 15% of direct CO2 emissions, decarbonising buildings and construction represents an area of enormous emissions reduction potential, as well as an opportunity to reduce air pollution and improve citizen well-being (IEA, 2021[180]). Despite significant advances in building and materials efficiency, however, emissions from this sector continues to rise, and according to the IEA, the rate of building energy intensity reduction needs to five-fold as quickly over the next ten years to be on track to achieve net zero by 2050 (IEA, 2021[181]).
The challenge is particularly acute in many emerging and developing countries, which will experience rapid population growth and urbanisation over the next two decades, with enormous volumes of building construction to meet rising demand. In many developing countries, much of the building stock is old, dilapidated and in need of repair, and for the most part built prior to the introduction of building efficiency standards. Moreover, lower average purchasing power and fewer available affordable energy efficiency options in developing and emerging economies mean that dwelling owners, businesses and indeed governments can less afford to make the upfront investments required in energy efficiency or renewable energy installations than in advanced economies.
Moreover, given emerging and developing economies will be hardest hit by the physical impacts of climate change, particularly by rising temperatures and more frequent heatwaves, energy demand from cooling appliances, particularly air conditioning, is set to expand rapidly over the next two decades. As more and more households invest in air conditioning in line with rising temperatures and population growth, this is likely to compound the buildings sector decarbonisation challenge in countries experiencing rising temperatures and more frequent heatwaves. Just 15% of households in Southeast Asia have an air conditioning system, for example. Yet, electricity demand for cooling in the region has grown seven-fold since 1990, to 8 TWh in 2020. The IEA estimates that without mitigating actions to encourage efficiency improvements, energy demand from cooling could rise to 300 TWh by 2040, equivalent to the combined total electricity consumption of Singapore and Indonesia today (IEA, 2022[182]).
Despite these challenges, decarbonisation of the residential, building and construction sectors can also be an opportunity for emerging and developing economies. The scale of expansion in building stock required to meet the needs of growing and urbanising populations in emerging and developing economies means that the policy focus is more likely to be geared towards efficiency in new buildings, rather than retrofitting older stock, though of course it is important that this issue is not neglected.
Developing and emerging economies, therefore, are likely to make the greatest decarbonisation gains in setting performance standards for new buildings, incentivising on-site and cluster-based renewable energy solutions, as well as innovation in low-carbon materials production and construction techniques. Given 37% of a building’s carbon footprint is typically embodied carbon, or emissions from extraction and manufacturing of building materials, the construction process and demolition, focusing on these segments of the value chain could result in the greatest emissions reduction gains. This will also help to build a substantial domestic market for low-carbon materials production and construction techniques, which can create quality jobs and boost economic growth (IEA, 2021[181]).
Indeed, given the majority of the remaining energy consumptions from buildings tends to be from electricity consumption – though many buildings also use gas – decarbonisation of the national power system is a major component of buildings and residential sector decarbonisation. For countries with high renewable energy penetration, therefore, there will be an even greater benefit from focusing on materials and construction processes, given that embodied emissions will represent a far greater proportion of overall emissions from buildings stock.
As a priority first step, policy making should seek to require greater energy efficiency in buildings before considering renewable energy solutions, on the basis that this will provide the least-cost pathway to decarbonisation, as well as alleviate pressure on the national electricity system as a whole. Once efficiency improvements have been exhausted, policy making should look to incentivise on-site renewable energy solutions, either for individual buildings or clusters of buildings, given that this will add to overall renewable energy installed capacity, rather than place an extra burden on the national grid. Lastly, where on-site cluster-based solutions are not considered feasible, connecting buildings to the grid via a PPA can be considered (Becque et al., 2019[183]).
For new buildings, design innovations and building energy codes are the primary tools to incentivise and require improved operational energy efficiency. Fossil fuel-producer emerging and developing economies have an opportunity to leapfrog buildings design, borrowing from techniques which optimise use of space and provide passive solutions to cooling, heating and lighting, such as use of shade, reflective surfaces and optimisation of air flow, to reduce demand for high-emitting cooling and heating appliances. Governments can set minimum energy efficiency and thermal performance standards, ensuring they cover all new buildings, including both residential and non-residential, in building energy codes. These should get incrementally stronger in line with progress towards net zero and as competencies in low-carbon building design and installation of domestic architecture and construction firms gradually improve in response to market demand.
Policy making to improve the operational efficiency of existing buildings will be more challenging for emerging and developing country governments because absence of data as to the condition and needs of existing buildings makes identification of the least-cost approach to retrofits challenging. In addition, a lack of domestic experience in deep energy retrofits, at least initially, may make improvements at scale difficult to achieve. In many instances, building owners may also be unwilling or unable to invest the significant sums required to improve energy efficiency, meaning that governments will need to provide subsidies and incentives to encourage investment, which may not be affordable.
Decarbonisation objectives asides, refurbishing and retrofitting existing building stock, including improving sanitary conditions, will be an important component of livelihood improvements, while measures to increase the energy efficiency of buildings, such as envelope renovation (windows, roof and walls) and service systems improvements (cooling, heating and ventilation) can be pursued in parallel.
Governments can support municipal authorities to undertake studies of existing buildings stock, using it to identify key challenges and needs to address. The results of these studies should also inform the development of a strategy which combines a range of elements to incentivise and require improvements to existing stock. This could include information-sharing and education campaigns as to the benefits of energy efficiency, and research and development grants and subsidies to construction and architecture firms to develop new products and services. Additionally, training and education to enable companies to move into this space, and financial incentives such as tax rebates, low interest loans and grants to assist buildings owners pay for retrofits and improvements, can support gradual energy efficiency improvements of buildings stock. The introduction of certification standards, in line with building energy codes for new buildings can also support consumers to make more informed choices about buying or renting buildings, particularly if they are able to access information on the impact on energy bills (IEA, 2021[181]).
Raising the energy efficiency of appliances (e.g. air conditioning and fans, lighting and cooking appliances), particularly in the context of rising population and urbanisation, should represent a core element of efforts to decarbonise the buildings and residential sector, in addition to improved design, building energy codes and retrofitting the buildings themselves. Additionally, systems innovations and improvements which can optimise overall energy use in a building, for example, switching lighting off when a room is not in use, can also help to improve energy efficiency and reduce bills for consumers. Progressive improvements to appliance and systems efficiency also benefit from the advantage that replacements and updates are required over much shorter timeframes than a buildings own life’ cycle, therefore presenting more regular, short-term opportunities to decarbonise and improve energy efficiency in the sector, through progressively more ambitious policy making and technological advances.
For energy consuming appliances, particularly those which account for a high share of energy consumption, such as air conditioning, governments can introduce mandatory minimum energy performance standards (MEPS), to eliminate the worst performing products and appliances from the market. Efficiency labelling and consumer awareness campaigns can enable customers to make more informed choices to reduce their energy bills. As outlined above, such approaches need to be complemented with policies to incentivise firms to produce improved, low-cost appliances for the domestic market. This might include subsidised research and development to focus on energy efficiency improvements, alongside “pull” incentives, such as scrappage schemes for old appliances which include zero-interest or low interest loans or on-wage or on-bill finance to assist consumers in replacing them with more modern and efficient alternatives. This can help create a market for appliances with high energy efficiency ratings and further encourage firms to invest in improvements.
In some contexts, governments will also need to consider citizens and households who lack the means to switch to more efficient appliances, where introduction of MEPS or outright bans on higher emitting products could push them towards higher emitting alternatives.
Additionally, systems improvements, particularly for larger buildings can entail substantial efficiency improvements and emissions reductions. For larger, higher-emitting new buildings, for instance, BECs can require automated lighting or cooling systems to improve efficiency, or the employment of buildings efficiency managers. Establishing a legislative and enabling environment conducive to the development of an Energy Service Company (ESCO) market can also support energy efficiency improvements.
Box 3.34. Facilitating energy efficiency and renewable energy solutions through Energy Service Companies (ESCOs)
Energy Service Companies (ESCOs) offer energy efficiency and renewable energy solutions, normally to non-residential buildings or industry, via Energy Performance Contracts (EPCs). Savings are generated for the energy user, and remuneration for the ESCO is based on performance and paid for based on savings delivered and reductions in energy bills.
Development of a thriving ESCO sector can overcome a range of market failings and make it easier for businesses lacking expertise and knowledge in energy efficiency and renewable energy to reduce their energy demand and bills at the same time. ESCOs can overcome an absence of upfront capital and facilitate financing for retrofits, energy efficiency measures and renewable energy solutions, either through providing the required capital themselves, or through established links with lenders, who recoup capital through energy savings. They can also overcome a lack of expertise in energy efficiency design among businesses or awareness of options to reduce demand by providing easily understandable products for businesses who can outsource the design and implementation of energy efficiency services.
In advanced economies and China, the market for ESCOs has grown rapidly, mainly thanks to an enabling environment which allowed ESCOs to thrive by strengthening energy efficiency targets and environmental targets in the country’s 13th Five Year Plan (2016-2020). However, in developing and emerging economies, the model has been less successful. This is mainly because ESCO firms lack strong balance sheets or domestic financiers do not offer appropriate financial products, as well as a lack of firm expertise and accreditation to support and encourage consumers to make informed choices. Governments can work to incentivise and strengthen the ESCO market, by setting enabling policies and legislation, as well as encouraging domestic banks to offer new financing products for firms. They can also take a lead in use of ESCOs to encourage energy efficiency in public buildings, leveraging public procurement power to build a thriving local ESCO market, and encouraging domestic firms to diversify and strengthen their product offerings which can then be deployed in the private sector.
Source: (World Bank, 2016[184]); (IEA, 2021[185]).
Governments should consider prioritising the following actions:
Strengthen collaboration between national government policy makers, who normally set energy efficiency policies such as building efficiency codes (BECs) and the regulatory framework for renewables installations, and municipal and local authorities, who play a central role in enforcing and administering national policies at a city and building level. Feedback from municipal authorities can also support improvements to national-level policy making and identify areas where local government requires national-level support for effective implementation, for example, guidelines on buildings inspections, and communication of changes in building efficiency standards with dwelling and business owners.
Consider national circumstances, particularly the extent of existing renewable energy penetration in the electricity system, and the scale and timing of future building stock expansion in the light of population growth and urbanisation. The financial willingness and capacity of business and dwelling owners to make investments in energy efficiency and renewable solutions retrofits (for existing stock), and the existing capacity of domestic architecture and construction firms to respond to new energy efficiency requirements will also be key to designing financial incentives to encourage energy efficiency measures and sustainable building design.
Countries with a high proportion of renewables penetration already may find that embodied emissions from buildings occupy a far greater share of overall emissions from the sector, and may therefore be better off focusing on policies to incentivise efficiency and the decarbonisation of materials extraction, and manufacturing and construction methods, and setting protocols for demolition to encourage recycling, reuse and repurposing. Where countries are fiscally constrained and savings are low, yet face rapid population growth and urbanisation leading to substantial construction of new buildings stock, it may be preferable to focus on introducing BECs which become incrementally stricter, and incentivising new firms to produce more efficient designs and construction techniques.
Support municipal authorities to undertake detailed studies of the residential and buildings sector to establish baseline data for energy consumption and GHG emissions, and to identify barriers and potential incentives for energy efficiency improvements. This can be a planning tool to assist municipal and national authorities to gather insights in to how they can deploy limited financial resources and build workable strategies for buildings decarbonisation which conform to realities on the ground.
Adopt mandatory and incrementally strengthening BECs for all new buildings. These should include minimum energy and carbon performance standards. In some instances, BECs can also integrate design components, such as reflective surfaces and optimisation of air flow, which provide passive solutions to cooling and lighting and limit demand for energy use. Governments should also provide clear guidance and training on BEC implementation and enforcement to municipal authorities.
Alongside BECs, consider introducing building labelling standards which provide information to prospective buyers and tenants as to a building’s energy efficiency and the associated impact on their bills. This will support greener choices and help build the market for retrofits and new buildings designed with sustainability in mind.
Prioritise policies which incentivise building, appliance and systems energy efficiency over renewables installation as a first step, on the basis that this will provide the least-cost pathway to buildings and residential sector decarbonisation, and will also alleviate overall pressure on the electricity system. Renewables installations should be considered once energy efficiency options are exhausted (Becque et al., 2019[183]).
Recognise the importance of scaling up the use of energy efficient appliances, phasing out high emitting alternatives, and the ways in which this can support progressive decarbonisation alongside changes to building stock given their shorter life cycles. To incentivise diffusion of more energy efficiency appliances, consider the introduction of mandatory and incrementally strengthening Minimum Energy Performance Standards (MEPS), combining this with a labelling programme and information sharing with consumers to raise awareness of how adopting such appliances can have a positive impact on their energy bills. In parallel, scrapping schemes, which subsidise consumer purchases of less energy-intensive appliances can help build market demand and facilitate a mass switch to low-demand alternatives, incentivising firms to produce more efficient, improved products for the domestic market. In parallel, highly subsidised or free replacement of appliances may be necessary for the most vulnerable households, and policy makers should be aware of the risk of unintended consequences if poorer consumers are pushed towards more polluting appliances or those which damage health as a consequence of government policy, for example, users of LPG for cooking switching to charcoal owing to rising costs (IEA, 2022[182]).
To support innovation in appliance manufacturing, governments can provide innovation grants to firms, enabling them to invest in staff, training, new equipment and design. Continuous strengthening of appliance MEPS will require constant communication with suppliers and manufacturers to ensure they understand and can respond to new changes to MEPS, and to provide an opportunity for feedback and requests for support to meet new standards (IEA, 2022[182]).
Public procurement can also drive market innovation given its scale. Approved equipment lists, for example, for air conditioning and lighting, which conform to MEPS, can have significant signalling power, encouraging firms to invest in product improvement and innovation.
Where renewable energy solutions are required, incentivise on-site or new off-site solutions, rather than connections to existing electricity made available through the grid. This will increase overall installed capacity from renewables and build increased energy security and resilience for both cities and buildings (Becque et al., 2019[183]).
Consider subsidies, low-interest and interest-free loans, grants and tax rebates to incentivise building owners to invest in energy efficiency retrofits which conform to BEC standards. For both appliances and retrofits for buildings, support may need to offset high initial investment costs for consumers. This can be done through on-bill or on-wage, low-interest financing programmes, or through incentivising use of ESCOs which can bear the upfront costs.
National and municipal governments can lead by example, retrofitting existing buildings for energy efficiency and where necessary adding renewables. This can provide an important signal to domestic construction and architecture firms to incentivise them to invest in low-carbon design and construction capacity which other building owners can then benefit from.
Consider reducing any remaining electricity subsidies, in line with the recommendations in Pillar 3, Section 3.3, given that subsidised electricity will reduce incentives to invest in energy efficiency measures to reduce bills.
Invest in communications and information-sharing campaigns to highlight and make citizens aware of the impact of energy efficiency on bills, as well as to raise awareness about government schemes and support that can offset the cost of efficiency and renewable investments.
3.7.1. Incentivising renewable energy auto-generation for buildings
As a complementary set of measures, renewable energy deployment can be considered once all options to encourage energy efficiency through building design, retrofit improvements, and appliance and systems efficiency improvements have been exhausted, enabling buildings owners to capitalise on the highly competitive costs of renewables against other generation fuels. Policy making should aim to incentivise on-site renewable energy generation (e.g. solar thermal systems, air-sourced heat pumps or distributed solar PV). If a suitable location for a renewable energy installation is not available on site, off-site renewables installations (e.g. as renewables solutions for entire districts) can be considered, as they may be more suitable for buildings clusters, rather than a connection to the grid. This approach can also enhance energy security in buildings and urban areas during a period in which electricity system stability may be fragile, as new renewables capacity is added during the process of energy sector decarbonisation (see Pillar 3, Section 3.4).
Governments can take steps to incentivise smaller-scale renewable energy solutions for buildings or clusters of buildings, for example, by offering tax exemptions for buildings which install renewables, streamlining the permitting process for smaller projects, and offering a stable FiT to sell excess power to the grid. BECs and building standards can also incorporate requirements to ensure new buildings, where possible, are renewables ready. Examples include structural integrity requirements consistent with solar, or rooftop facilities organised to maximise the available space for solar installations. In Singapore, for example, all rooftops over 400 m2 should be solar ready (IEA, 2022[186]). Lastly, to overcome upfront financing costs and limited renewables knowledge among businesses and consumers, governments can encourage and set a legislative environment for ESCOs.
Governments should consider prioritising the following actions:
Ensure energy sector regulation and policies enable and incentivise buildings or sets of buildings to set up renewable energy solutions. Potential policy options are available in Pillar 3, Section 3.4 and might include stable FiTs, self-generation licences, enabling groups of buildings to aggregate demand and sign a PPA, and streamlining the permitting process.
Consider what kind of incentives can encourage on-site renewables solutions, for example, tax rebates for building owners where renewables are installed, or enabling building owners to sell excess electricity back to the grid at a fixed price. Buildings and business owners must be aware of these incentives, which they should be able to take advantage of in a straightforward manner. Consider provisions within BECs that will ensure new buildings are designed with possible renewable energy installations in mind, for example, maximising roof space and structural integrity requirements.
3.7.2. Addressing embodied carbon emissions in buildings
Reducing embodied emissions from extraction and manufacturing of materials, construction and demolition of buildings, will be key for developing and emerging economies to decarbonise the residential and buildings sector, particularly in countries with an already high penetration of renewable energy in the grid and where embodied carbon represents a much higher overall proportion of the sector’s carbon footprint.
Cement and steel are some of the hardest materials to decarbonise, at least in the short term and will remain so until hydrogen and CC(U)S are available at commercial costs to decarbonise these and other hard-to-abate sectors. Government strategy, therefore, can focus on encouraging a life cycle approach in these sectors over the short to medium terms. Measures may include efforts to encourage greater recycling, collection and use of scrap steel, through the promotion of re-use and remanufacturing options, and incentivising repurposing of buildings. Efforts should also begin to design policies that will help meet the longer-term needs of these sectors, such as ensuring the availability of low-carbon resources for steel and cement production, enabling access to funding for the transition to low-carbon production in these sectors, and ensuring robust markets for low-carbon materials. In parallel, governments can provide research and development financial support to firms to lower the carbon intensity of manufacturing and construction processes, as well as to develop alternative low-carbon products and materials, and efficiency processes, and support collaboration and partnerships between educational institutions and industry. This can be an important factor in building capacity and competencies in the construction sector to respond to low-carbon requirements of new building codes.
In parallel, long-term strategies to decarbonise hard-to-abate sectors via hydrogen and CC(U)S, as well as power sector decarbonisation, will be required to provide future steel and cement in the buildings sector.
Governments should consider prioritising the following actions:
Introduce demolition protocols which ensure alternatives such as repurposing have been considered, as well as mandatory re-use and re-cycling requirements at the end of a building’s life. This will require governments to also invest in recycling facilities to support the re-use of materials such as steel whose production has high carbon contents.
Consider developing materials efficiency standards and labelling.
Invest in training and education programmes, as well as partnerships between educational institutions and industry, to encourage the development of low-carbon design and materials manufacturing competencies in the market place. This will build the capacity of firms to respond to changing needs and to innovate to produce greener materials and products.
Consider publishing efficiency guidelines for new buildings, materials manufacturing and demolition, including how to design and build new structures which limit the use of carbon-intensive materials such as cement and steel.
Incentivise firms to invest in research and development to innovate and design new products which are bio-based and can replace where possible the use of cement and steel, in parallel to encouraging re-use and re-cycling.
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Note
← 1. The TADAT was set up as a collaborative project between the IMF, the World Bank, and the governments of France, Germany, Japan, the Netherlands, Norway, Switzerland and the UK.