El mensaje de año nuevo de Karsten Neuhoff y su visión de la política climática para 2020

 De mi buzón de correo:

Happy new year from the Climate Policy Department at DIW Berlin!

Allow me to share some of our analysis that may be relevant for the 2020 policy discussion based on the following three developments in 2019.

•        Carbon neutrality is widely seen to be necessary, technologically feasible, macro-economically viable and can help to achieve multiple sustainable development goals.
•        Carbon neutrality provides clarity for the political discourse on the future of electricity, transport, industry and housing. It thus allows mainstream political parties to debate tangible, long-term transition strategies.
•        Improving governance structures for climate policy and sustainable finance enhances the ability of governments to implement effective policy frameworks and for firms to invest.
With a clearly defined and easy to understand climate neutrality objective, with stronger anchoring in our societies, and with a good governance framework in place, in Germany and Europe much of 2020 will be dedicated to improving policy implementation. The focus on carbon neutrality can also help to clarify pathways and emission targets for 2025 and 2030 in the run-up to the COP 26 in Glasgow.

Let me illustrate this based on some of our analysis for the (i) industrial sector (ii) power sector (iii) governance structures for climate policy and sustainable finance.

(i) The Industry Sector

The production of basic materials like steel, cement or plastics is responsible for a quarter of global greenhouse gas emissions. Climate neutrality can be reached with a combination of new climate friendly production processes and materials and significantly more resource efficiency and recycling. So what policies can unlock these mitigation opportunities?

Carbon pricing is obviously an important element. Economists have long argued for the internalization of externalities, but usually focused on incentives for efficiency improvement of production. However, this is insufficient, as we show in a review of empirical evidence and economic theory with Robert Ritz. Due to international trade of products and free allocation of emission allowances, carbon cost pass-through is limited. The industry and construction sectors do therefore not internalize carbon costs in their choices on resource efficiency and material substitution. With limited carbon cost pass-through, material producers also struggle to see a business case for break-through technologies with incremental costs and hesitate to invest.

Full carbon cost internalization should be an essential objective of a policy package. As part of the European Green Deal, the EU Commission is considering a carbon border-adjustment mechanism to strengthen the carbon price incentive while avoiding carbon leakage risks. To create relevant incentives for investors, such a mechanism needs to be robust for the long-term, e.g. also beyond the tenure of the current US government. Proposals purely focusing on the production site face a dilemma. Design elements that make a mechanism robust to WTO challenges, e.g. limiting coverage to imports, reduce the effectiveness in creating incentives towards carbon neutrality.

The dilemma can be resolved by complementing the EU ETS with a climate contribution, e.g. a charge on the final sale of basic materials like steel, cement-clinker or plastic. It is set at the same benchmark used for free allowances allocation and thus reinstates the full carbon cost internalization. With the introduction, free allowance allocation is reformed as well and directly linked to production volumes. This avoids windfall profits and enhances carbon leakage protection. We have complemented analysis on legal, micro-economic, and administrative aspects with a model-based assessment of the positive macro-economic implications. Governments and basic material producers in several EU member states are now discussing the climate contribution as a pragmatic option to achieve the policy objectives of the carbon border-adjustment mechanism.
Obviously, also the carbon price level and uncertainty matter for investment incentives. Jörn Richstein has analyzed how national governments can offer Carbon Contracts for Difference for innovative low-carbon production processes and materials. They can create incentives exceeding current carbon price levels, and hedge companies against market and regulatory risk. As a result, financing costs and the need for innovation funding decline. Discussions at member state and EU level are ongoing, and involve also funding through the climate contribution as well as opportunities for EU guidance documents to facilitate early harmonization.

Large-scale material efficiency and substitution to low-carbon alternatives can require a lot of coordination. It extends from the definition of product requirements, design and material choices to qualification and certification of participating firms. Olga Chiappinelli analyses the scale of public purchasing activities, and reviews the experience of national and local governments using green public procurement. Considering green criteria can reduce public authorities’ carbon footprints and create lead markets for climate-friendly product design, material choice and usage patterns.

While these policies are essential to build up new technologies, practices and business models, I am not certain that on their own they will be strong enough to phase out carbon-intensive production processes. Hence, together with Alice Pirlot, Manuel Haussner and Timo Gerres we assess administrative and WTO review experience and find that any government can implement product carbon requirements which effectively ban the sale of carbon-intensive materials in their territory for all products. Obviously, product carbon requirements are only feasible once a sufficient share of climate friendly materials are available post 2030. However, their anticipation is already relevant for today’s corporate strategy. Climate-friendly production processes and materials are no longer “nice to have” but essential to secure the “license to operate”.
We have developed this policy package with the Climate Friendly Materials (CFM) Platform in cooperation with IDDRI (France), WiseEuropa (Poland), IVL( Sweden), IIT Comillas (Spain), as well as Radboud University Nijmegen (Netherlands), REKK (Hungary), Vrije Universiteit Brüssel (Belgium) and published it as "Building blocks for a climate-neutral European industrial sector" to inform the debate on the EU’s European Green Deal with scientific input and EU member state perspectives. These policies are good for an inclusive transformation that allows all countries to take part and also offer much needed clarity welcomed by industry.

(ii) The power sector

Carbon neutrality does require further increases of the deployment of wind and solar power. To enhance public acceptance for onshore wind power, the federal German government argued for generic requirements on the minimum distances of wind turbines to nearby residential areas. Evaluating state-level experience, Jan Stede and Nils May show that the resulting reduced land that is available translates into a drastic reduction of the deployment of wind power. Moreover, there is no evidence that stricter minimum distance regulation significantly increases public acceptance of wind power. One reason is that regulation protecting residents from the site-specific noise and shadow emissions of wind turbines is already in place in Germany. Luckily, after a heated debate the German government refrained from implementing general minimum distance regulations for the time being. 2020 will show if policy makers will advance more promising alternative approaches. National and international experience shows that mandatory payments from project developers to the respective municipalities can facilitate this and increase acceptance.

The need of renewable power for carbon-neutral industrial production processes starts to focus the attention of industry and hence also policy makers on ensuring large-scale availability of wind and solar projects at low financing costs. While private power purchasing agreements (PPAs) have gained much public attention in 2019, our analysis with Nils May suggests that they can increase levelized cost of electricity from wind and solar projects by up to 30% due to regulatory uncertainty and incomplete markets. Publicly-backed contracts for difference for renewables avoid such cost increases, enable competition between sites and can render climate neutrality viable.

To use wind and solar power effectively, flexibility across the power sector will be essential. It requires more storage, stronger grids, and especially unlocking of demand side flexibility. Jörn Richstein, Jan Stede and Saeed Hosseinioun analyzed how to unlock demand side flexibility in basic materials processes like cement production via suitable regulatory frameworks and the role of aggregation in enabling demand response. Multi-part bids in intraday auctions could for example lead to a better integration of demand response. Together with the European research, industry and policy partners in the Future Power Markets Platform, we furthermore explored potential developments of forward markets to support the changing generation mix and investments in particular in demand side flexibility. These are just two steps in the gradual improvement of German and EU power market designs towards further efficiency improvements and EU integration.

(iii) Governance structure for policy and sustainable finance

Reflecting on the last decade, it is fascinating to see for how long we have tried in Germany to implement climate policy without breaking down targets and responsibilities to ministries responsible for transport, buildings, industry, agriculture or energy. Can you imagine what would have happened with a similar approach in the private sector? What would have been the fate of a private firm that tells each employee to maximize overall shareholder value without offering further guidance? Obviously, at least annual indicators and targets are defined for every business unit and team.

A lack of clearly defined and allocated responsibilities may well be the reason that Jan Stede and Puja Singhal find “a lost decade” for the buildings sector. Temperature-adjusted heating energy demand in German multi-family homes has consistently increased since 2015. In 2018, it was higher than in 2010. For the buildings analyzed in the Heat Monitor, retrofit activity was low: Less than 1% of the buildings surface is typically retrofitted per year. This is only a fraction of the retrofit rate that was achieved in the 1990s in East Germany.
Given this experience, the biggest progress on German Climate Policy in 2019 was probably the Climate Change Law defining emission pathways for sectors, allocating the responsibility for these targets to line ministries, improving reporting, and establishing an annual climate change cabinet meeting to align objectives across sectors. It was great to see these elements implemented. In our analysis, we had identified two further components that deserve attention in 2020.

First, policies may only show real emission impact with delays of several years, for example after the realization of infrastructure projects. Therefore, not only timely reporting of realized emissions, but even more important, emission projection reports by an independent institution are important. They can allow the public to assess measures implemented by the current government and therefore praise ministers that implement effective climate policies. It is therefore important to measure and define progress along key indicators for the transformation to climate neutrality – e.g. based on the share of climate friendly material production, the depth of thermal retrofit, or the scale of electricity storage capacity realized.

Second, the finance sector can accelerate the low-carbon transition by monitoring the exposure of the real economy to so-called transition risk. This is the risk for a project or firm, if governments suddenly strengthen climate policies. It can involve write-offs of assets values (e.g. of coal power stations), losses of market shares and profitability (e.g. for cars with combustion engines), or risk the entire operation of a company for example if it cannot secure clean input factors to serve markets that implement product carbon requirements (e.g. through green public procurement). Following Carney’s call for attention, countries like the UK, France and the Netherlands had already therefore improved climate-reporting for listed companies and investors.

The outgoing EU commission had therefore prioritized sustainable finance. In particular the proposed taxonomy for sustainable investments to guide the reporting by firms was heavily discussed. It is based not only on aggregated emissions of firms, but also looks at the emission performance of major activities like steel production. To enhance the input from the scientific side to the national and EU process, together with Frankfurt School of Finance and the Universities of Augsburg, Kassel and Hamburg we set up the German Sustainable Finance Research Platform. With platform partners, Franziska Schütze coordinated a critical review of the taxonomy outlining improvement perspectives and Ingmar Jürgens co-authored with our partners a policy brief synthesizing the evidence base on mandatory corporate emission reporting. It shows that mandatory reporting creates incentives for companies to reduce emissions. The adoption of the taxonomy at the end if 2019 is only a first step, review provisions and a standing committee create opportunities for further improvements.

In 2019, the German Government declared the ambition to become one of the leading sustainable finance market places, and established a sustainable finance advisory group with its first full report planned for 2020. While not the first such group, its distinctive feature is the participation of real-economy firms. I think it will be particularly interesting to explore how the new clarity on carbon neutrality will be reflected in reporting structures to inform investors in achieving a positive climate impact and financial institutions and regulators in testing for financial stability. As Sustainable Finance Research Platform, we are contributing to all working groups of the advisory board.

From a global perspective, 2019 ended without an agreement on the rulebook of the COP in Madrid, which illustrates the discrepancy between the top-down vision of the Kyoto Protocol and the bottom-up vision of the Paris Agreement. The Kyoto vision is based on an agreement of emission (reduction) targets for countries. Countries can trade allowances to balance surplus and shortage, and have incentives to achieve targets to reduce costs of buying allowances. The COP in Copenhagen, however, showed that this framework does not motivate countries to commit to ambitious emission reduction targets. Why would countries commit to ambitious targets, if they subsequently have to pay large sums to buy surplus emissions from countries with less ambitious commitments?

Hence, the Paris Agreement vision of climate cooperation focuses on national commitments towards a low-carbon transition, which are iteratively strengthened. In article 9, richer countries commit 100 billion per year to support climate action in poorer countries. In principle, the Paris vision does not comprise international trading. In political practice, several actors wanted to retain trading opportunities and hence the Paris agreement also comprises an article on international trading. The debates at the Madrid COP were all about the precise rules for this article 6. Discussions will now continue on what rules for international carbon trading could secure environmental integrity? Will the potential benefits of such trading justify the additional complexity it creates for national international climate action?

What is probably just as important is a more precise characterization and broader understanding of Article 9. How can USD 100 billion of climate finance support domestic policy makers in the further development and implementation of nationally determined contributions (NDC)? How can this help to achieve a just and Paris compatible transition? How to structure the funding to help developing countries to manage the transition risks and leapfrog directly to advanced climate neutral technologies? We just started a four-year project as part of the German international climate initiative together with Teri in India, UCT in South Africa, FGV in Brazil, the CCCITB in Indonesia, as well as New Climate Institute, Vivid economics and IKEM, to contribute to the evidence base on these questions and feed it back to the political discourse.

Let me conclude with thanking the funding our department received from German Ministries for Economic Affairs and Energy (BMWI), Environment, Nature Conservation and Nuclear Safety (BMU) and Education and Research (BMBF), the EU Commission, the OECD and the foundations Mercator, Mistra, and ECF. But most of all, I would like to thank all of you for inspiring conversations and constructive cooperation. Let’s continue to work together in 2020 to accompany the implementation of an effective climate policy framework.

In this spirit – best wishes for 2020 on behalf of the entire department,

Karsten Neuhoff