Carbon Pricing in the Power Sector: Role and design for transitioning toward net-zero carbon development

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Table of Contents

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• Foreword 3
• Acronym list 8
• Acknowledgments 9
• Executive summary 11
• Lessons and recommendations 18
• Three main questions to guide the choice and the design of cpis for the power sector in lics and mics 21
• 1. Introduction 25
• 1.1 Impetus for this report 25
• 1.2 Scope of report and theory of change 28
• 1.2.1 Energy policy objectives for power sectors in low- and middle-income countries 28
• 1.2.2 The need for new policy instruments to achieve the new decarbonization goals in the power sector 32
• 1.2.3 Development outcomes from effective power decarbonization 34
• 1.3 Methodology 34
• 1.3.1 Literature review 34
• 1.3.2 Case studies 35
• 2. Electric power and decarbonization in LICs and MICs 39
• 2.1 Power sector characteristics, value chain, and stakeholders 40
• 2.1.1 The power sector value chain and stakeholders 40
• 2.1.2 Power sector structures 42
• 2.1.3 Dispatch procedures 49
• 2.2 Key challenges in LICs’ and MICs’ power sector decarbonization 49
• 2.2.1 Challenges regarding generation and storage 50
• 2.2.2 Challenges regarding dispatch, markets, and transmission 52
• 2.2.3 Challenges regarding distribution and retail 54
• 2.2.4 Challenges regarding consumption 54
• 2.2.5 Challenges regarding economics and governance 56
• 2.3 Policy instruments for decarbonizing power sector 57
• 2.4 An infographic visualizing the introduction of a CPI in the power sector in LICs and MICs 63
• 3. Roles of carbon pricing in the power sector 65
• 3.1 Key elements of CPI design in the power sector 65
• 3.1.1 Design elements relevant to both a carbon tax and an ETS when applied to the power sector 67
• 3.1.2 Design elements of a carbon tax when applied to the power sector 68
• 3.1.3 Design elements of an ETS when applied to the power sector 70
• 3.1.4 Use of dual carbon pricing mechanisms in the power sector 74
• 3.2 Regulation points of CPI in the power sector 74
• 3.2.1 Upstream fuel distributors 76
• 3.2.2 Generation stage 77
• 3.2.3 Dispatch/transmission stage 78
• 3.2.4 Distribution stage 80
• 3.2.5 Consumption stage 80
• 3.3 The potential role of carbon pricing in the power sector 81
• 3.3.1 A shift toward lower-carbon generation mixes 82
• 3.3.2 Influencing dispatch and wholesale purchases in favor of lower-carbon plants 88
• 3.3.3 A shift in consumption patterns 91
• 3.3.4 An intake of new government revenues 94
• 4. Assessing the potential impacts of pricing carbon in different LICs’ and MICs’ power sector contexts 101
• 4.1 The potential for a shift toward lower-carbon generation mixes 102
• 4.1.1 Insufficiently high carbon price to shift investment decisions 102
• 4.1.3 The influence of power sector structure on investment and retirement decisions 105
• 4.2 The potential influence on dispatch and wholesale purchases in favor of lower-carbon plants in LICs and MICs 106
• 4.2.1 Capacity, energy, or grid constraints 107
• 4.2.2 The influence of power sector structure on how carbon pricing affects dispatch decisions 109
• 4.2.3 Failures at the dispatch point 110
• 4.2.4 The influence of power sector structure and regulation on how carbon pricing affects wholesale purchase decisions 111
• 4.3 Potential shift in consumption patterns in LICs and MICs 112
• 4.3.1 Insufficient pass-through of carbon costs to retail tariffs 112
• 4.3.2 Time-of-use tariffs and smart metering 114
• 4.3.3 Auto-generation and the risk of grid defection 115
• 4.3.4 The distributional effects of carbon pricing’s impact on retail tariffs 116
• 4.4 Potential intake of new government revenues in LICs and MICs 118
• 4.5 Matrices to track CPI impacts and assess cpis in different power sector structures 119
• 5. Lessons learned and recommendations 135
• 5.1 The role of CPIs in the broader context of decarbonizing the power sector in LICs and MICs 135
• 5.2 Different CPIs for different power sector structures 137
• 5.3 Designing CPIs to ensure effectiveness, minimize undesired impacts, and maximize co-benefits 139
• 5.4 Political economy challenges and learning curve 143
• 6. Conclusion 147
• 7. Bibliography 153
• Figure ES1 14
• Degrees of market liberalization and unbundling of power sector 14
• Figure ES2 15
• Regulation points along the value chain 15
• Figure ES3 16
• Overview Matrix - Simplified assessment of CPIs options in three power sector models: fully liberalized market, single-buyer model and vertically integrated monopoly 16
• Figure ES4 19
• Main lessons and recommendations 19
• Figure 1.1 29
• Theory of change on the role of carbon pricing in the power sector in low- and middle-income countries 29
• Figure 1.2 32
• Number of countries that have announced commitments to net-zero / carbon neutrality 32
• Figure 2.1 41
• Paradigm change in the power sector 41
• Figure 2.2 42
• Simplified electric power sector value chain and stakeholders 42
• Figure 2.3 43
• Degrees of market liberalization and unbundling of power sector 43
• Figure 2.4 50
• Schematic overview of key issues in LICs’ and MICs’ power sector structures for decarbonization 50
• Figure 2.5 63
• Infographic synthesizing the introduction of CPIs in the power sector in LICs and MICs 63
• Figure 3.1 66
• Map of carbon taxes and emissions trading schemes implemented or scheduled for implementation around the world 66
• Figure 3.2 77
• Regulation points along the power sector value chain 77
• Figure 3.3 90
• Illustration of change in merit order with addition of carbon prices (CPs) 90
• Figure 3.4 95
• Potential uses of carbon pricing revenue 95
• Figure 3.5 96
• Carbon revenues by revenue use and jurisdiction, 2022–2023 96
• Box 3.9 98
• Use of revenues from the EU ETS 98
• Box 4.1 103
• The impact of Kazakhstan’s ETS on investment and retirement decisions 103
• Box 4.2 104
• Issues with incentivizing lower-emission generation in Kazakhstan 104
• Box 4.3 107
• Security of supply in South Africa 107
• Box 4.4 108
• The impact of Colombia’s carbon tax on dispatch decisions 108