ThePotential The potentialfor for Climate climateAuctions auctions a a asas Mechanism mechanism for NDC for NDC Implementation implementation The potential for climate auctions as a mechanism for NDC implementation ThePotential The potentialfor for Climate climateAuctions auctions a a asas Mechanism mechanism for NDC for NDC Implementation implementation ii I vivid economics © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given Attribution—Please cite the work as follows: The World Bank and Vivid Economics. 2018. “The potential for climate auctions as a mechanism for NDC implementation”, by The World Bank, Washington, DC Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org Cover and Interior design: Brad Amburn Creative, LLC THE WORLD BANK I iii Acknowledgements This paper was prepared by Vivid Economics with coordination and peer review provided by the World Bank. We thank the World Bank team for their unequivocal direction through the development of this report. The team included Stephanie Rogers, Rachel Mok, and Tanguy de Bienassis. We also extend our gratitude to Neeraj Prasad for his valuable and undeterred support. Lastly, the report benefitted greatly from the World Bank team of peer reviewers for their valuable input, including Daniel Besley, Stephen Hammer, Klaus Oppermann, Taisei Matsuki, Sandhya Srinivasan, Claudia Barrera, Harikumar Gadde, Eduardo Dopazo, and Keisuke Iyadomi. The Vivid Economics team included John Ward, Thomas Kansy, and Alex Child. iv I vivid economics Contents Executive Summary 1 Section 1 Introduction 4 Section 2 The role of auctions 6 Section 3 The broader policy context 12 Section 4 When are auctions valuable and appropriate? 21 References 26 List of tables and figures Table 1 The three PAF auction results all demonstrate cost effective abatement 9 The suitability of climate auctions depends on the features of the climate outcome Figure 1 opportunity and on the broader regulatory and NDC context (including funding 2 requirements) The suitability of climate auctions depends on the broader regulatory and policy Figure 2 context (including funding requirements) and the features of the climate outcome 13 opportunity The three climate auction modalities help climate policy transition towards increased Figure 3 15 use of market mechanisms in different ways The suitability of climate auctions depends on the features of the climate outcome Figure 4 opportunity and on the broader regulatory and NDC context (including funding 25 requirements) THE WORLD BANK I v ES Executive Su m mary Climate auctions are an innovative public has satisfactorily delivered the climate asset. climate finance mechanism, with high potential As such, climate auctions are a form of results- to support nationally determined contribution based climate finance (RBCF). (NDC) implementation through cost effectively leveraging private investment. The World Bank has The Pilot Auction Facility (PAF), an example developed the concept of climate auctions consisting of a climate auction, has delivered cost- of three essential elements (World Bank, 2017c): effective abatement. The PAF sold tradeable price guarantees, in the form of option contracts, to 1. Products: the sale of price guarantees for support abatement. To date, there have been three climate assets. Climate assets are (tradable) PAF auctions, with the first two focusing on methane units that represent specific climate-outputs or abatement from landfills and the most recent outcomes, such as emission reductions, energy auction focusing on nitrous oxide abatement from efficiency savings or renewable energy. The price nitric acid production. Together, the three auctions guarantee usually takes the form of an option have allocated US$54 million in climate finance to contract that give the owner the right, but not reduce 21 MtCO2e, with bidders paying US$13 million the obligation, to sell the climate asset in the in premiums to acquire the options. To date, the net future at the stated price; cost of the mechanism to the auction funders has been just over US$ 2/tCO2e. Existing studies on the 2. Price formation: the price paid for the PAF suggest there is potential to replicate the climate guarantee is determined by an auction format auctions model in other sectors and across other where multiple bidders compete to own the emissions sources and climate outcomes. contract; and Climate auctions may be an attractive option for 3. Risk sharing: the owner of the option contract supporting cost-effective NDC implementation, is only allowed to make use of the fixed price as part of a transition towards the greater use of guarantee if a third party verifies that the owner market-based instruments. The use of competitive THE WORLD BANK I 1 The potential for climate auctions as a mechanism for NDC implementation Figure The suitability of climate auctions depends on the features of the climate outcome opportunity 01 and on the broader regulatory and NDC context (including funding requirements) Three features of climate outcome opportunity Auctions to set prices > information asymmetry between governments and firms > sufficent number of bidders > funder concern is cost-efficiency Suitable for climate auction Price guarantee Results-based > cost viability gap payments > uncertain future demand > effective MRV > financial capacity > institutional capacity Broader regulatory and NDC context + funding requirements Participants Auctions can facilitate transition 1. Leverage self-select into into wider market-based auctions to receive instruments through three 2. Extend public funds. implementation modalities. 3. Fill gaps bidding and the results-based nature of the auction to price signals to deliver abatement. At the same model helps ensure that public resources are time, the continued use of public funds embedded allocated efficiently and effectively, and allows firms in the model may enhance its political feasibility to become increasingly familiar with responding relative to carbon pricing measures, at least in the 2 I vivid economics short term. Over time, climate auctions can help instruments through three different build MRV capacity and an ecosystem of firms implementation modalities. Climate auctions (project developers, consultants) well versed in can be powerful instruments as they provide cost- understanding where there are climate outcome effective abatement, remove a key commercial opportunities and what the costs may be, which may risk (price volatility) that project developers would allow a transition towards more conventional carbon otherwise face, and participant self-selection pricing instruments. and competition means support flows to the most efficient firms. This report develops three A climate outcome opportunity must satisfy three implementation modalities through which climate overarching conditions to be suitable for climate auctions can support NDC implementation as auctions. To successfully implement a climate countries look to increase their use of market- auction, not only should the broader policy context based instruments: be conducive to auctions, it is also necessary that they are applied in the right technical and economic »» Leveraging: delivers additional climate context. Figure 1 details the three overarching outcomes from existing market-based conditions for climate outcome opportunities to be instruments; or suitable for climate auctions, which are: »» Extending: delivers of climate outcomes from »» they must be suitable for using auctions to set areas not currently covered by market-based prices; instruments but where there is a near-term expectation that this can change; or »» they must be suitable for results-based payments; and »» Gap filling: delivers climate outcome targets »» they must be suitable for providing price identified in NDCs where no market can (yet) guarantees. function, but where auctions might provide foundational experience to set the identified Climate auctions can transition support climate outcome opportunity on the path mechanisms towards market-based towards coverage under a market instrument. THE WORLD BANK I 3 The potential for climate auctions as a mechanism for NDC implementation 01 IN TR ODUCT ION To mitigate climate change and put the world In just 21 emerging nations, on average US$ 1.6 trillion onto a ‘well-below’ 2°C pathway requires needs to be invested annually over 2016-2030 to meet significant global action. Countries are beginning their NDCs (IFC, 2016). To reach a ‘2°C pathway’, around to step up to the challenge of climate change US$ 3.3 trillion needs to be invested in the energy through the process of implementing their NDCs. system each year until 2030; this is around US$700 These are bottom up voluntary commitments billion more investment required than under the BAU which come in a wide variety of forms: including scenario (World Bank; Ecofys; and Vivid Economics, commitments to reduce emissions by an absolute 2017). Annual renewable energy investment alone amount, commitments to reduce the emissions needs to exceed $560 billion (IEA & IRENA, 2017). intensity of economic activity and commitments There are further investment needs in the waste and to reduce emissions relative to a business-as- agriculture sectors and to reduce industrial process usual (BAU) trajectory. Many countries have also emissions. These investment needs are heavily formulated adaptation commitments. However, concentrated in emerging and developing countries. estimates suggest current NDC targets will result in a McCollum et al. (2013) estimates that about two-thirds global mean temperature rise by 2100 of 3.2°C (CAT, of the required low-carbon investment will be needed 2017), significantly in excess of the Paris Agreement’s in the developing world, particularly China, India, and goal of limiting global temperature rise to well below Latin America. 2°C from pre-industrial levels. Moreover, at present, most governments have not introduced sufficient There are large challenges in delivering this policies to reach even their current commitments investment. Total global climate finance (private (CAT, 2017). Substantial further action will be needed and public) in 2016 reached US$ 383 billion, with to reach a 2°C pathway, let alone come below it. total renewable energy investment averaging just under US$ 305 billion in 2015/16 (Buchner et al., For countries to achieve, and go beyond, their 2017) - only just over half of the US$ 560 billion NDC targets requires significant investment, estimated need for renewable energy investment particularly in emerging and developing countries. in a 2°C pathway. A UNDP (2016) survey on NDC 4 I vivid economics implementation barriers suggests that the top need »» Section 2 discusses the World Bank’s PAF model of countries is support for mobilising resources. as an example of the climate auction model, This includes identifying public resources that can illustrating some of its potential and initial be used to meet NDC targets, introducing effective lessons learnt institutional mechanisms to distribute funds, developing capacity to help attract international »» Section 3 illustrates that climate auctions financial support, and finding tools and approaches can support NDC implementation by playing to help with private sector engagement. a transition role, taking account of the role of public resources in the model Climate auctions are an innovative public climate finance mechanism, with high potential »» Section 4 highlights that the climate to support NDC implementation through limited auction model may be most effective in use of public resources to cost effectively delivering climate outcomes when identified leverage increased private investment. This opportunities are suitable for auctions, results- briefing note considers the role of climate auctions based payments, and can benefit from price in more detail: guarantees THE WORLD BANK I 5 The potential for climate auctions as a mechanism for NDC implementation 02 TH E R OLE OF AU C T I ONS Countries have already begun to harness the MWh to US$50/MWh for solar and from US$90/ power of auctions to deliver cost effective MWh to US$45 MWh for wind (IRENA, 2017). South climate outcomes. Auctions can support more Africa’s flagship Renewable Energy Independent cost-effective climate outcomes than command- Power Producers Procurement Programme and-control instruments by providing competition (REIPPPP) used auctions to drive significant private and flexibility as to who undertakes climate sector investment into renewable power projects. outcome opportunities and how: whoever finds an Over 5 bid windows, the REIPPP incentivised the opportunity most attractive will be the most likely connection of over 6 GW of renewable capacity, to win the auction. Auctions can further facilitate through auctioning fixed price power purchase climate investment by auctioning products which agreements (PPAs), and attracted US$ 13.2 billion of make investments into low-carbon technologies private sector investment (Mangondo, 2016).1 more lucrative or less risky (Taschini, Fankhauser, & Hepburn, 2013). Auctions can expand beyond renewable energy to support a wide range of different projects or Auctions in renewable energy generation programmes that help achieve climate policy/ demonstrate these benefits. The rise in auctions NDC targets. The World Bank has developed the that allocate fixed price power purchase agreements concept of climate auctions that consist of three to the lowest bidder have helped facilitate essential elements (World Bank, 2017c): significant falls in the cost of renewable power and, more importantly, ensured that consumers 1. Products: the sale of price guarantees for and taxpayers capture the benefit of these cost climate assets. Climate assets are (tradable) reductions. The number of countries auctioning units representing quantified climate-outputs or renewable energy contracts has increased from 6 outcomes, such as emission reductions, energy in 2005 to 67 in 2016 (World Bank, 2017c). Between efficiency savings or renewable energy. The 2010 and 2016, global average prices for renewable price guarantee usually takes the form of option power procured from auctions fell from US$250/ contracts that give the holder of the option the 6 I vivid economics BOX right, but not the obligation, to sell the climate asset in the future at the stated price; 01 Meanings of key PAF terms »» Put option: a financial contract that gives 2. Price formation: the price paid for the the holder the right but not the obligation to sell assets to the auction funder at an guarantee is determined in an auction format agreed price where multiple bidders compete to own the »» Strike price: the guaranteed price that the contract; and PAF pays per emission reduction 3. Risk sharing: the owner of the option contract »» Put option premium: the price paid by the auction winners to purchase the put option is only allowed to make use of the fixed price guarantee if a third party verifies that the owner »» PAFERN: Pilot Auction Facility Emission Reduction Note, a World Bank issued, zero- has satisfactorily delivered the climate asset. As coupon bond that delivers the put option such, climate auctions are a form of RBCF. »» Redemption: Refers to redemption of the PAFERNs, which involves the payment of the Climate auctions are market-based instruments in strike price by the World Bank as issuer of the sense that agents compete in the auction format the PAFERNs to PAFERN holders presenting to win the price guarantee. This price guarantee eligible emission reductions should then facilitate investment by removing a key »» Maturity: the date on which the PAFERN commercial risk (price volatility) that the firm would holder can redeem the PAFERN otherwise face. As noted above, they are also an »» Descending clock auction: an auction in example of RBCF as the firm holding the guarantee is which the premium is announced, and the only entitled its use when they have delivered, and bidders iteratively bid down the strike price verified the delivery of, the specified climate asset »» Ascending clock auction: an auction in (World Bank; Ecofys; and Vivid Economics, 2017). which the strike price is announced, and the bidders iteratively bid up the put option premium 2.1 The PAF illustrates the benefits, »» Eligibility criteria: requirements for how, when, and where emission reductions occur and challenges, of auctions in order to qualify for redemption The PAF provides insight into the benefits of climate auctions and the potential to extend the model into new sectors. The PAF shows how auctions from the recommendations of a Methane Finance can lead to cost-effective abatement and resource Study Group’s (2013) report on ‘Using Pay-for- mobilisation. Additionally, the lessons learned from Performance Mechanisms to Finance Methane the PAF model suggest that there is potential to extend Abatement’, which an international group of the auctions model into other sectors and sources of experts convened at the request of the G8 to review emissions and other climate outcomes. innovative approaches to methane abatement. The Group recommended the use of an auction The PAF initially used climate auctions to unlock mechanism to sell tradeable put options that methane emission reductions. The PAF emerged guarantee prices for abatement delivered from THE WORLD BANK I 7 The potential for climate auctions as a mechanism for NDC implementation methane projects. This aims to reduce the risk The tradability of the auctioned options is a key for project developers arising from potentially feature of the PAF design. This allowed the winner low future clean development mechanism (CDM) of the auction to transfer the put option to another prices, thereby using public funds to unlock private entity, who could then benefit from the fixed price, investment. Box 1 provides a list of the meanings of subject to the emission reductions of the second key PAF terms (World Bank, 2015). entity meeting eligibility criteria. This meant that, even if a winning bidder’s project failed to realize emission reductions, the price guarantee might still BOX be used by someone else, increasing the probability 02 The key results of the PAF that emission reductions are achieved (Chee & LaCasse, 2017; Ecofys and Climate Focus, 2016). demonstrate the power Tradability reduces the risk of a common problem in and flexibility of auctions renewable power auctions, whereby prices are bid Each of the three auctions differed in too low and bid winners cannot deliver their project design: based on these prices, resulting in the abandonment »» Auction 1 focused on methane emissions of the projects (Foresight, 2017). (CH4) from landfills. The put option premium was fixed, and participants bid There have been three PAF auctions to date, on the strike price, in an multi-round descending clock auction (NERA, 2015). which together have allocated US$ 54 million in climate finance to reduce 21 MtCO2e, with bidders »» Auction 2 also focused on CH4 from landfills but with a different auction design. The paying US$ 13 million in premiums to acquire the strike price and number of put options were options. The auctions trialed two different auctions fixed, but participants progressively bid a designs, and targeted two different pollutants (World higher put option premium (NERA, 2016a). Bank, 2017c). The PAF demonstrated that the climate »» Auction 3 focused on nitrous oxide auctions model could ensure fast disbursement, with emissions (N2O) from nitric acid production. As with round 1, bids were made on the the first auction taking place in July 2015 and the strike price using a descending clock first redemption round occurring in November 2016 auction. Auction 3 was also partly designed (World Bank, 2017d). Box 2 provides more details on to try and induce new investment. The auction was divided into a new segment, each auction round. purely for new projects,2 and an open segment without this restriction. The new The results suggest that climate auctions can segment auction took place first, and unspent budget from this auction was to deliver low-cost abatement while providing supplement the open segment auction a benefit to project developers. The PAF put budget (NERA, 2016b). However, demand options redeem annually until 2020. The first was insufficient to clear the market in the new segment auction, even at the highest redemption occurred in November 2016, when four (reserve) strike price of US$ 6/tCO2e (NERA, projects delivered 1.3 million eligible CERs and 2016b). No put options were purchased were paid US$ 3.1 million in price guarantees (World in the new segment and all of the budget transferred to the open segment (World Bank, 2017c). The second redemption took place Bank, 2017a). in November 2017 when project owners received US$ 9.6 million from the sale of 3.4 million eligible 8 I vivid economics table 01 The three PAF auction results all demonstrate cost effective abatement Auction 3— — Auction 3­ Variable Auction 1 Auction 2 new segment open segment Date July 2015 May 2016 January 2017 January 2017 Emission reductions CH4 CH4 N2O N2O targeted Strike price (price guarantee) 2.4 3.5 - 2.1 (US$/tCO2e) Premium price 0.3 1.41 - 0.3 (US$/ tCO2e) Net benefit 2.1 2.09 - 1.8 Volume of put options sold 8.7 5.7 0 6.2 (MtCO2e) Auction budget 13 less spending in 25 20 New segment: 6 (US$ million) new segment Number of 28 21 0 13 bidders Number of 17 12 0 9 countries CERs.3 Around 95% of the options expiring in 2017 The different designs of the three PAF auctions were redeemed; this high redemption rate may provide lessons in terms of price discovery, have been enabled by the tradability of options bidders attracted and budget allocation ensuring that the options ended up being owned efficiency. Some of the key design lessons learned by the project developers that valued them most from the PAF include: (Hernandez & Arango, 2017). The abatement from the first redemption had a net cost to the funders »» The format used in all three auctions provided of US$ 2.08/tCO2e, falling to US$ 2.02/tCO2e in the participants with information from the previous second round. The benefit to project developers is rounds, which facilitated price discovery as also clear as, in the absence of the PAF, they would bidders could incorporate historic information probably have had to sell any emissions reductions into their bidding strategy. The almost identical at around US$ 0.5/tCO2e. At the same time, the low net benefits yielded between auction 1 and prices were partly driven by the facility focused 2 is suggestive of efficient price discovery on reviving abatement from dormant projects, (Chee & LaCasse, 2017). Furthermore, bidding rather than stimulating new project abatement. rules entailed that bidders could only make The explicit effort to encourage new investment in bids less than or equal to the volume of their round 3 was unsuccessful. bid in the previous round, which incentivised THE WORLD BANK I 9 The potential for climate auctions as a mechanism for NDC implementation truthful bidding and avoided the challenge of (CfD) model whereby renewable power producers participants only placing serious bids at the bid for the price needed to make renewable power last moment (so-called bid sniping) (Ausubel, investments profitable (bound by a price ceiling) Cramton, Aperjis, & Hauser, 2014). and the funder agrees to pay the variable ‘top-up’ difference between the auctioned price and the »» The model in auction 2 of fixing the strike price prevailing electricity price.4 The CfD successfully and bidding up the option premium (ascending incentivised new investment, with the latest auction clock design) deterred the entry of less in September 2017 procuring 11 new energy projects capitalized bidders, possibly due to the higher worth close to US$ 230 million (UK Department upfront premium payment acting as a barrier to for Business Energy & Industrial Strategy, 2017). entry (Chee & LaCasse, 2017). Comparing the two models, Bodnar et al. (2017) suggest that the CfD model incentivised investment »» On the other hand, the design of auction 1 because it allowed a sufficiently long timescale for (descending clock) implied a greater risk of project and bid development, provided revenue underspending the total auction budget, as certainty over an extended period of time, and the number of put options for sale increased backed the auction with a large budget (US$780m after each auction round as the strike price compared to US$53m).5 decreased. This risk is limited in an ascending clock auction where the number of put options 2.2 for sale and their strike price remains constant Moving forward in all rounds (Chee & LaCasse, 2017). This may have contributed to the different budget Earlier studies suggest there is potential to efficiencies observed in auctions 1 and 2 with replicate the climate auctions model in other an undersell in auction 1 of around US$ 4 sectors and across other emissions sources and million compared to virtually no underspend climate outcomes. Ecofys and Climate Focus (2016) in auction 2. However, auction 3 also used a assess the suitability for the PAF model for extension descending clock auction with virtually no into six non-methane emitting sectors using a range budget underspend. of criteria.6 They find that CO2 abatement projects in the energy and industry sectors are particularly The PAF experience indicates a need to consider well-suited to the climate auctions model, scoring how to best incentivise new investment using highly on all assessment criteria. Other industrial gas climate auctions. As noted above, the attempt to projects and agriculture, forestry, and other land use incentivise new investment in auction 3 was not (AFOLU) projects, especially forestry, are also found successful. There are a number of idiosyncratic to be suitable, although the authors note potential factors related to the design of the PAF which may concerns regarding the sustainable development help to explain this, including a short marketing impacts of some industrial gas projects, and the period and a relatively small auction budget. By challenge of effective monitoring, reporting and contrast, other auction models have successfully verification (MRV) for climate outcomes in some incentivised new investment. For instance, the UK AFOLU projects. By contrast, the study viewed has developed a so-called Contract for Differences transport and buildings sector projects as generally 10 I vivid economics less suitable for the model due to low price There are also important questions about responsiveness, low applicability or high cost of how climate auctions can be applied by current MRV processes, the wide dispersion of small countries addressing the challenges of NDC emissions sources, and owner-operator differences. implementation. The PAF model supported the However, there may be an important exception delivery of emission reductions from projects initially for new energy efficiency options in the building registered under the CDM, with the additional sector, through exploiting alternative performance resources being provided through international metrics with simpler MRV implications, such as climate finance. While helping to prove the climate the certified green building area or the number of auction concept, different questions arise when efficient appliances (Ecofys and Climate Focus, 2016). considering adapting the model to the context of Similarly, a quantitative analysis of the potential domestic NDC implementation. This includes where for using climate auctions in India’s building sector resources might come from, recognising that many suggests that creative thinking around auction countries face constrained public resources, and design, especially bid product, eligibility criteria and that domestic (and any international complementary performance metrics, could widen the role of the resources) may find it difficult to accommodate the auctions model leading to emissions reductions and uncertain levels of disbursement implied by the water, energy, and financial savings (Carbon Trust, model. There are also further questions around how 2018). auctions can best work alongside other policies focused on NDC implementation. Some elements of the climate auction model remain untested. The PAF version of the climate To help address these remaining questions, the auction model has been successful at reviving remainder of this paper focuses on two critical dormant investments rather than generating new issues: investment. This reflects a more general concern that climate auctions, and other RBCF measures, may »» What is the broader domestic policy context in need to be paired with traditional upfront financial which countries should consider using climate instruments, such as grants, to deliver transformative auctions? investments (World Bank, 2017d). Additionally, expanding into sectors where MRV practices are less »» What are the conditions under which climate well developed has yet to be fully tested. auctions are valuable and appropriate? THE WORLD BANK I 11 The potential for climate auctions as a mechanism for NDC implementation 03 Th e br oader p ol i cy c ont ex t This section assesses the policy context in which outcomes. From a political economy perspective, climate auctions might support the activities the former is relatively easy to introduce, with clear embedded within any country’s NDC . It explores 7 beneficiaries and costs that are diffuse across a wide when the broader policy and regulatory context, tax base. Exploiting these characteristics, subsidies and its expected future trajectory, may be well- can play a useful role in building familiarity with suited to climate auctions. It suggests that, within technologies and bringing down costs (World Bank, a broader policy transition towards the greater use Ecofys, & Vivid Economics, 2016). Subsidies can also and coverage of market-based instruments, climate act as useful support policies in some countries, auctions may be particularly helpful in leveraging the while they gradually begin implementing and power of price signals in currently covered sectors, enforcing stronger, market-based policies. However, extending the reach of price signals to sectors on the subsidies are less efficient at reducing emissions verge of market inclusion, or gap filling to achieve than carbon pricing, as they do not encourage a discrete non-market policy objectives. The broader 8 demand-side response by end consumers, and policy context also needs to be one where there are there are often concerns about their long-term sufficient public resources to use the auction model. sustainability and scalability because their take up Section 4 then explores the particular (economic) is often voluntary and they rely on limited public characteristics of activities within a country are the resources (Fischer, Newell, & Preonas, 2014). best candidates for using the climate auction model. Figure 2 summarises the structure of both sections. From this perspective, climate auctions can be thought of as a policy instrument that ensures Climate policies in many countries involve a the efficient and effective use of public resources gradual transition from domestic public funding and incentivises self-selection:9 to market based instruments. This entails a move from using public subsidies to support the »» Like ‘standard’ subsidies, auctions involve delivery of climate assets to leveraging private funds the continued use of public funds to support by internalising the costs or benefits of climate climate outcomes (through the publicly backed 12 I vivid economics Figure The suitability of climate auctions depends on the broader regulatory and policy context 02 (including funding requirements) and the features of the climate outcome opportunity Climate auctions act as transitionary climate policies through three modalities: LEVERAGE Auctions to set prices > information asymmetry between additional climate governments and firms outcomes from existing > sufficent number of bidders market instruments > funder concern is cost-efficiency EXTEND the reach of existing market instruments into new areas Suitable for climate auction FILL GAPS Price guarantee Results-based to target discrete > cost viability gap payments > uncertain future demand > effective MRV climate outcomes > financial capacity outside the scope > institutional capacity of markets Broader regulatory and NDC context + funding requirements price guarantee). However, the competitive This implies that climate auctions may have allocation mechanism of the subsidy, and its a particular role to play in supporting the results-based nature, helps ensure the efficient progression towards a comprehensive suite of use of these public resources market-based instruments and climate markets within a country. The number of countries with »» Like a carbon price instrument, auctions can carbon pricing mechanisms has grown rapidly facilitate the delivery of climate assets where it is in recent years. As of 2017, 42 countries are cheapest, as it will be those who have access to implementing or planning to implement some the cheapest/most efficient processes who are form of domestic carbon pricing mechanism, an most likely to win the auction, so long as they almost threefold increase in three years (World choose to participate. Similarly, as with a carbon 10 Bank; Ecofys; and Vivid Economics, 2017; World Bank, price, firms receive the financial benefits of the 2014). However, this is far smaller than the number policy once they have successfully delivered the of countries that have identified interest in using climate outcome (emission reduction or other). domestic carbon pricing mechanisms. The World THE WORLD BANK I 13 The potential for climate auctions as a mechanism for NDC implementation Bank’s Partnership for Market Readiness (PMR) and become covered under existing market the International Carbon Action Partnership (ICAP) instruments; or identify at least a further 23 additional countries that have made public announcements of considering »» Gap filling delivers climate outcome targets carbon pricing mechanisms (ICAP, 2016; PMR, 2016). identified in NDCs where no market can (yet) There are, however, a number of well-known political function, but where auctions might provide economy difficulties associated with moving from foundational experience to set the identified considering carbon pricing to committing to its climate outcome opportunity on a potential implementation (Victor et al., 2015). Climate auctions path towards coverage under a market may be able to play a valuable role in overcoming instrument. these barriers while helping demonstrate the cost effectiveness of market-based instruments. At the The following sections describe the three same time, they can help build MRV capacity, and modalities. While much of the economics of the build an ecosystem of firms (project developers, use of the model is consistent across the three consultants) well-versed in understanding where options, they represent quite different roles for there are climate outcome opportunities and what climate auctions from a policymaker perspective. the costs may be. For project developers, both the Leverage and Extend aim to prepare project developers for There are three main ways in which climate inclusion under future, or more stringent, markets. auctions can act as transition tools to support The Gap model, by contrast, aims to develop a NDC implementation. Figure 3 illustrates that the fledgling ecosystem of project developers and three climate auction modalities differ in terms of achieve climate outcome targets independently. how they help transition current market instruments. The analysis also draws on two case studies, from They y-axis represents a binary threshold of whether India and South Africa, to illustrate the potential climate opportunities are covered under a current application of the different climate auctions market mechanism or not. The arrows reflect the modalities. These case studies were selected on the different modalities’ impact on transitioning climate basis of the interest of key stakeholders in the two outcome opportunities into markets: countries and focus on sectors identified as being particularly well-suited for the climate auction »» Leveraging delivers additional climate model. outcomes from existing market-based instruments, increasing the depth of current 3.1 market instruments (reflected by the blue arrow Leveraging additional becoming wider); or climate outcomes »» Extending delivers of climate outcomes from Climate auctions can leverage existing market- areas not currently covered by market-based based instruments to unlock additional climate instruments but where there is a near-term outcomes in sectors already covered by that expectation that this can change, such that instrument. Policymakers may wish to achieve auction covered climate outcomes eventually additional climate outcomes whose cost is above 14 I vivid economics Figure The three climate auction modalities help climate policy transition towards increased use of 03 market mechanisms in different ways Current Leverage market Extend Not in current market Gap filling Time the price in the existing market, for example to summarises how climate auctions, applied in the correct for additional market failures such as context of India’s Perform, Achieve, Trade (PAT) learning-by-doing effects that could reduce future scheme, could leverage additional energy savings costs. Climate auctions can target these specific from thermal power producers. opportunities and deliver additional climate Under the leverage model of climate auctions, outcomes without increasing the ambition of the there are important design features policymakers entire market-based instrument. need to consider, including:11 »» stipulated pricing rules; and In these cases, climate auctions can help realise »» the type of price guarantee offered. additional climate outcomes, until the time when the existing market instrument can take over. This The main auction pricing rule to consider is is the model of the first three PAF auctions, which whether to use a uniform price auction or not. unlocked methane and nitrous oxide abatement A uniform price auction offers the same price to that were not incentivised by prevailing low CER all successful bidders while a discriminatory price prices. This model entails that climate auctions auction would offer different price floors according support the delivery of the additional climate to what firms reveal they need through the auction. outcomes temporarily, while technology costs The practical implications of which design leads to fall or prices for the climate outcome rise. Box 3 better financial outcomes for the auction funder THE WORLD BANK I 15 The potential for climate auctions as a mechanism for NDC implementation is an empirical question which depends on the to sell climate outcomes at the agreed strike price particular context of the auction—for example, to the funder, who then removes purchased climate market uncertainty, number of participants, demand outcomes from the market. Under the top-up price for the auction product (Monostori, 2014). With guarantee, bid winners are required to sell climate auctioning tradable products, however, uniform price outcomes into the market, but the auction funder auctions maximise environmental effectiveness commits to paying the difference between the compared to price discrimination auctions. 12 agreed strike price and the prevailing market price. A project developer receives the same incentives Policymakers also need to decide whether to under both types of price guarantee, however there provide a price floor through put options (as in PAF are differences in terms of costs to the auction funder model) or instead commit to paying a ‘top-up’ on and general market impact, specifically: the prevailing market price. Under the put option, bid winners receive the right, but not the obligation, »» Top-ups may be cheaper for the auction funder BOX 03 Climate auctions in India could leverage the impact of the Performa, Achieve, Trade (PAT) scheme to deliver additional energy efficiency improvements from thermal power producers »» The Perform, Achieve, Trade (PAT) scheme is a market-based instrument designed to achieve energy efficiency improvements in energy intensive large industries and facilities. The scheme develops energy consumption reduction targets for facilities. Facilities that consume more than their targets purchase energy savings certificates (EsCerts) from facilities who consume less than their target (or otherwise pay a penalty). »» Climate auctions can help leverage additional energy efficiency from thermal power producers (TPPs) and deliver prioritised support based to projects delivering greater local air quality co benefits. TPPs are the focus of PAT, yet they were the only sector not to surpass physical energy consumption reduction targets in the first cycle of PAT and the sector was a net purchaser of EsCerts. Using auctions in PAT to provide price guarantees for energy efficiency improvements would stimulate long-term energy efficiency investment by reducing project risk reflected in potential low future EsCert prices. As increasing the efficiency of TPPs may result in both lower GHG and other local air pollutant emissions, this would have significant local health co-benefits. »» A segmented auction design with set-asides for projects with greater co-benefit values, would maximise the public benefit of climate auctions. The local health co-benefits of energy efficiency improvements in TPPs closer to population-dense regions are greater than for TPPs in remote regions. As such, there exist differences in total project values from the perspective of the auction funder. Providing set-asides for these high-impact thermal power plants could provide prioritised support to more socially valuable energy efficiency improvements »» Initial analysis suggests that there exists numerous potential sources of auction finance, and domestic institutions capable of implementing auctions. India has a number of Funds which could potentially finance a climate auction, such as the Power System Development Fund (PSDF), the National Clean Energy Fund (NCEF), State Energy Conservation Fund (SECF) scheme, and the Partial Risk Guarantee Fund (PRGF). International development climate finance might also be sourced. Domestic institutions would likely play a significant role in implementing climate auctions: the Central Electricity Regulatory Commission (CERC), the Bureau of Energy Efficiency (BEE), the India Energy Exchange (IEX), and the Central Electricity Authority (CEA). 16 I vivid economics as they only pay the gap between the market (within the targeted sector) (World Bank & Frankfurt price and the auctioned strike price. This helps School of Finance and Management, 2017). Over time, maximise the use of auction funds as they only this may pave the way to integrate such climate pay as much as is needed for climate markets outcome opportunities into the existing market- to engage. However, the provision of a subsidy based instrument.15 For example, Box 4 describes to climate assets that were previously too costly a case study exploring how the climate auctions threatens to crowd out other climate assets and model could extend the reach of South Africa’s lead to a lower market price. carbon tax.16 Here, climate auctions in the waste sector could help stimulate abatement opportunities »» The put option avoids the risk of crowding out as, while the sector functions as an offset mechanism, if the option is used, funders fully purchase the and help prepare the sector for full inclusion under climate outcome. It may also be easier to ensure 13 the tax in subsequent phases. tradability through a put option model. 14 The key challenges and design considerations 3.2 for the extend climate auction model are Extending the reach of similar to those for the leverage model. Similar market-based instruments to the Leverage model, policymakers still need to decide whether to offer a uniform price or price Climate auctions can also support NDC discriminate, and must decide whether to offer implementation through helping extend existing price guarantees as a top-up or some form of put market-based instruments into new sectors. option. One additional consideration in this model Climate outcome opportunities can be excluded from surrounds the appropriate amount of information market-based instruments for a range of reasons to provide to potential participants considering including concerns about the costs of delivering the extend model supports sectors without market outcomes in that sector (similar to high-cost market experience. Distributing information before the segments under the Leverage model); difficulty auction, and revealing maximum information in monitoring, reporting and verification (MRV) between auction rounds, can help increase of climate assets in these sectors; or because of the symmetry of information between auction political economy challenges. In these cases, climate participants which makes it more likely that the auctions can help extend the reach of the market- auction will be won by the participant who values based instrument. the auctioned product most highly. This model helps extend market-based 3.3 instruments by facilitating early stage learning Filling a policy gap to deliver opportunities and preparing other sectors for discrete climate outcomes market inclusion. The auctioned subsidies can help overcome early stage investment cost challenges; Climate auctions can also fill a policy gap by while self-selection and the RBCF characteristics providing results-based incentives to encourage of the model can help develop capacities for MRV the efficient delivery of climate outcomes practices and propagate this to other opportunities where there is no immediate expectation of THE WORLD BANK I 17 The potential for climate auctions as a mechanism for NDC implementation BOX 04 Climate auctions in South Africa could help extend the reach of the carbon tax to deliver additional mitigation from the waste sector »» The upcoming carbon tax in South Africa plans to exclude the waste sector from direct coverage, until after the initial implementation phase. This exclusion is because of administrative challenges faced by undertaking sector-wide MRV in these sectors (Republic of South Africa National Treasury, 2014). Instead, emission reductions from the waste sector will be targeted by allowing abatement from this sector to be sold to tax-liable entities as offsets. However, from 2022 onwards, the government plans to cover the waste by the tax (Republic of South Africa, 2017b).17 »» Climate auctions can help prepare the waste sector for inclusion under the carbon tax by alleviating the initial cost-viability gap, supporting early stage investment, and providing capacity building opportunities. Due to the design of various tax allowances, the effective tax rate is likely to be below the marginal abatement cost of any waste sector mitigation measure, limiting the sector’s attractiveness as a source of offsets. Auctioned price guarantees for abatement from landfill gas (LFG) waste sector projects could help support a fledgling industry by mitigating investor risks and build local capacity through learning-by-doing. »» Several auction design amendments, relative to the PAF model, would help ensure the model takes account of sector characteristics. Some of the potential changes to the original PAF model could include: »» a flexible auction budget to reduce the impact of potential low participation; »» the distribution of a project cost prospectus study to reduce information asymmetries between participants; and »» longer timeframes and larger budgets to incentivise new investment projects. »» Local funds and institutions could both finance and administer the auctions. The South African Green Fund or municipal infrastructure grants may be potential sources of auction funding, possibly paired with development finance institution or development bank funds. Two institutions would likely be capable of administering auctions with minimal capacity building requirements. The Independent Power Producers Procurement Programme (IPPPP) Office has experience in renewable auctions, while the Department of Environmental Affairs set up the South African Green Fund and has a national responsibility for waste and emission reductions. using markets. Some NDC policy objectives relate future price purchase contracts between bidders to climate outcomes where there is no short-run and the auction funder, upon the delivery of the prospect that they will be supported through the outcome. This can help support the efficient delivery use of market-based instruments. For example, of certain climate outcomes, although some non- a country’s NDC may have policy goals around market outcomes may be inherently more difficult to afforestation, or improved climate resilience where accurately measure.18 there may be little domestic experience in using market based instruments. In these cases, climate In this case, auctions act as a transformational auctions can ensure the efficient delivery of these tool. Previous World Bank analysis shows how RBCF outcomes by using a competitive bidding process can help to build a broader network of agents with among participants to identify the lowest cost the capacities to manage the risks associated with providers. The auction would provide guaranteed ex post remuneration of climate outcomes, develop 18 I vivid economics MRV processes, and trial experimental market assets. This requires public money. In the PAF designs (World Bank; Ecofys; and Vivid Economics, application of the climate auction model, developed 2017). These apply equally to this version of the country governments, specifically Germany, Sweden, climate auction model; indeed, it is effectively an Switzerland, and the United States, provided theses example of results-based climate finance where the resources, with US$ 54 million in contributions over quantum paid per result is determined through an the first three auctions. Provided the availability auction rather than policymaker decree. of sufficient public resources, the climate auctions model is capable of allocating these revenues The design options under this climate auction efficiently so as to leverage additional private model exclude top-up contracts, and the model resources. implies different design complexities. The funder would always have to pay the full cost of The sustainability of climate outcomes the climate price guaranteed climate outcome, as supported by auctions relies on the government there is no other underlying market. Funders can explicitly announcing the transitional intention still decide whether to offer the same uniform of auctions. To help ensure the sustainability price for all assets or to price discriminate. Due to of supported outcomes and avoid the pitfalls of the novelty of a market approach for opportunities projects reliant on public funds, governments can under this model, there may be significant bidder make clear the finite timelines of support delivered uncertainty regarding cost trajectories to deliver through auctions and the intended transitional climate outcomes. This necessitates that funders pathway into market instruments. This will help closely consider the type and amount of information ensure that project developers understand the revealed after each bidding round, the time elapsed intended direction of future regulation. Transparency between rounds, and the time between auctioning such as this could provide long-term signals that the asset and delivery of the climate asset. One could both increase early participation in auctions, option to ensure similar information levels is to through highlighting first mover advantages, and undertake a comprehensive cost study and make it clearly illustrate government’s commitment to public available to all potential bidders. fiduciary responsibility. 3.4 However, greater domestic public resources Climate auctions require are being allocated to climate change. Ambition additional public resources towards domestic climate action is growing around the world after the Paris Agreement. 197 countries A key component of the broader policy context have submitted NDCs, of which at least 87 countries, is the initial availability of sufficient public representing 65% of 2014 global GHG emissions,19 resources which the auction model can then indicate some form of unconditional climate action, distribute efficiently to crowd-in private largely implementable without foreign financial financing. In contrast to market based instruments assistance (Strand, 2017; WRI, 2016).20 In 2013,21 like emission trading systems and carbon taxes, the estimates of domestic public climate finance rose to climate auction model relies on public resources to at least US$ 60 billion a year,22 a significant increase underwrite price guarantees for delivered climate from estimates of US$ 21 billion in 2011 (Buchner THE WORLD BANK I 19 The potential for climate auctions as a mechanism for NDC implementation BOX 05 A wider range of countries are using public resources to support NDC implementation »» One model of raising public climate finance involves capturing the proceeds from existing market based instruments. For example, Costa Rica uses the revenues from a fuel tax and a water surcharge imposed on landowners to finance its National Forest Financing Fund (FONAFIFO) (Faerron, 2016). FONAFIFO implements a Payments for Ecosystem Services (PPSA) programme, where landowners are compensated for planting and protecting trees, and is vital for the implementation of the country’s REDD+ strategy (Bosquet, 2012). Similarly, India currently uses a portion of the Rs 400/tonne cess on coal to finance its National Clean Energy Fund (NCEF) which provides funding to research and innovative projects in clean energy technology. India also has several energy efficiency market-based instruments, from which some of the proceeds go into creating fiscal instruments (such as risk-sharing arrangements or seed capital) to leverage private investment (Jha, 2014). The design of South Africa’s (upcoming) carbon tax includes a revenue recycling component, which may support certain climate projects (such as low carbon public transport and a solar water heater programme) (Hemraj, 2016). »» Other countries have capitalized climate change funds using hypothecated portions of the general government budget. For example, the Vietnam Environment Protection Fund (VEPF) receives an annual budget from the central government budget of US$ 24 million (Priambodo, Streiferdt, Tänzler, & Semmling, 2013).23 The Indonesia Climate Change Trust Fund (ICCTF) is resourced by a combination of bilateral and multilateral donors and domestic public financing (Bird & Tilley, 2012) with the Government of Indonesia provided US$ 142 million to the ICCTF in 2016 (ICCTF, 2016b).24 Annual ICCTF project financing in 2016 was US$ 34 million, with 62% going to seven land-based mitigation projects, 30% going to seven adaptation projects, and 8% going to three energy projects (ICCTF, 2016a). Mexico’s Climate Change Fund, created in 2012, delivers finance to projects contributing to climate change mitigation and adaptation and is resourced from a range of sources, including federal grants, domestic or foreign donations, foreign government contributions, and contributions from international organisations (SEMARNAT, 2015). et al., 2014; Buchner et al., 2011). Public domestic public resources as efficiently as possible to help resources to address climate change tend to come implement NDCs. Given the cost-effectiveness of from either the general government budget or abatement delivered by the PAF climate auction hypothecated proceeds from other market-based model, and considering the analysis of how climate instruments. Box 5 provides just a few examples of auctions can be best applied in the broader current domestic public climate funds. policy context, there are likely to be numerous opportunities to move forward with the climate As countries continue to increase committed auction model using domestic resources. Where domestic public resources to climate change, necessary, international mechanisms and resources there is increasing potential for the application can provide support, including risk mitigation of the climate auctions model to use these instruments, to enhance credibility. 20 I vivid economics 04 wh en ar e au c t i ons val u abl e an d appr opr i at e? This section defines the conditions under which 4.1 the use of each individual element of the climate Suitable for using auction model is appropriate, to identify where auctions to set prices climate auctions may be valuable. In order to successfully implement a climate auction, it is There are three conditions under which auctions not sufficient that the broader policy context is can be used and provide value: conducive to auctions, it is also necessary that the specific technical and economic characteristics of the 1. Auctions are valuable when there is activities associated with the creation of the climate significant difference in the amount of asset are well-suited to auctions. To explore this, we information on the costs and/or the consider the characteristics of opportunities that are performance of technologies. If the well suited to each of the individual elements of the prospective funders had a good understanding climate auction model; opportunities that have all of the costs of the relevant technologies or many of these of these characteristics are strong they could set the price by decree; if they candidates for using the auction model. knew which firms would be able to provide the climate assets, they could also select the Three key features define the climate auction participants. However, when neither of these model: conditions are satisfied then there is merit in using the competitive auction mechanism to 1. The price of the product sold is determined identify the firm best able to provide the asset through an auction mechanism and the price at which they are willing to do 2. The product sold is a price guarantee, backed, if this. As the renewables experience shows, the necessary, by public funds competition engendered by an auction can 3. The price guarantee is results-based: it can often result in significantly lower prices than only be used by a party that has successfully expected,25 increasing value for money for delivered the climate assets funders. THE WORLD BANK I 21 The potential for climate auctions as a mechanism for NDC implementation At the same time, auctions are more likely to However, non-compliance is somewhat be successful when the information between mitigated in the climate auction model in cases firms is relatively similar and certain; if where the price guarantee is tradable.29 there are large discrepancies firms may be reluctant to participate in the auction or 3. The third condition is that the funder of the be less aggressive in their bidding strategy, auction is primarily concerned about the reducing the auction’s effectiveness. The cost of delivering outcomes. The fundamental climate auction product (typically a futures benefit of the climate auctions model is contract) is only valuable if the strike price (or the ability to facilitate competition between the price that it is agreed the funder will top participants on the price needed to deliver the up to) exceeds the future market price at the outcome, and so to deliver climate outcomes relevant point in time. This means that bidders’ at low cost. While multi-factors auctions expectations about this future market price are can be designed to encourage competition an essential factor in determining their bidding across multiple variables (not just cost but strategy. There is a risk that the highest bidder also, potentially, co-benefits such as local air will only win because they underestimate the quality outcomes or jobs created) these types future market price the most, resulting in the of auctions are significantly more complex and ‘winner’s curse’. Taking this into account, 26 less common.30 A more pragmatic way to target rational bidders reduce their own bid, and multiple climate outcomes may be to hold collectively the market-clearing price that the separate auctions for each different outcome. auction can realize, downward (Krishna, 2009). 27 This effect will be smaller when all bidders Even if the conditions for the use of auctions are know that they have broadly the same amount satisfied, auctions need to be designed sensitive of information as all other bidders and that to their context. There is a wealth of literature of the possibility of suffering a winner’s curse is how to carry out auctions, both the format (e.g. correspondingly lower. sealed or open, ascending or descending clock) and infrastructure (physical versus online or other 2. The second condition is a sufficient number forms). Crucially, this literature demonstrates that of well-informed and well-resourced auction design needs to be sensitive to the number participants, who can absorb the transaction and capacity of participants, their information about cost of bidding, such that the auction is the market, and the type of climate outcome. competitive. A sufficient number of participants reduces the risk of collusion. There is often 4.2 some trade-off between attracting sufficient Suitable for results-based payments bidders for competitiveness and avoiding collusion, and the risk of non-compliance, The second key feature of the climate auction i.e. not delivering the climate asset, as the model is that it provides a results-based increased number of participants increases payment. Rather than the winner of the auction the probability that the winner of the auction immediately receiving a product, they are only is unable to then deliver the climate asset. 28 entitled to benefit from the product if they 22 I vivid economics successfully deliver the agreed climate asset. This simplify measurement, for example standardised places more risk on the auction winner than if, for energy saving certifications might be translated instance, it was competing for a grant to support the to an estimated CO2e savings without requiring financing of a climate outcome project. direct emissions MRV. Placing greater risks on a climate asset project 2. Participants can absorb the delay between developer has both an advantage and a acting and receiving the results-based disadvantage. The advantage is that they face a product. This can be ensured in one of three stronger incentive to deliver the result (climate ways, or through a combination of them. First, if asset). This may increase the quantity or quality of there is a relatively short time period between that which can be delivered with a given amount the action needed to deliver the climate action of resources. The disadvantage is that it places and the receipt of the results-based payment additional risk on the owner of the options contract, then the additional risk faced by the bidders who will require a higher reward (a higher minimum will be less. Second, if delivery of the climate strike price) as compensation. This may reduce the asset requires relatively little up-front financing amount of climate assets achieved with a given cost, then bidders will find it easier to manage amount of funding. Consequently, the auction the delay. Finally, it will be easier for substantial funders need to balance the possibility that the up-front financing costs to be absorbed if the model increases the probability of achieving a set bidders are able to access capital markets easily, of results against the likelihood that the delivery of or if the results-based mechanism targets larger, these results may be more expensive. well-capitalized participants. To balance this trade-off, there are three fundamental conditions that need to be satisfied 3. Third, both funder and participants need to use a results-based payment: to have sufficient institutional capacity to set up and respond to an RBF incentive 1. Effective measurement of the result. To make (ESMAP, 2013). For the funder, this relates to the a payment against a result, it is essential that ability to develop and monitor the instrument it is easy and non-controversial to establish and ensure quick disbursement of resources whether the result has been delivered. In the when bidders deliver the agreed results. For climate auction context, this means that there bidders, this relates to the planning tools and are well-established, robust MRV processes managerial ability to map out the expected associated with the delivery of the climate asset. cash flows from an RBF instrument, and to This process may rule out certain projects that react to the new incentive structure. have non measurable or non-verifiable benefits. MRV costs are likely to be more manageable in 4.3 cases where there are relatively fewer actors Suitable for providing involved, e.g. emission reduction from industry price guarantees rather than emission reductions from individual households. Robust MRV proxies can also The final feature of the climate auction model THE WORLD BANK I 23 The potential for climate auctions as a mechanism for NDC implementation is that the product received by the bid winner, make it difficult to incentivise energy efficiency if they successfully deliver the agreed climate improvements. In these cases, a price guarantee outcome, is a price guarantee. The provision is unlikely to be effective, or could be expensive, of this product, rather than for instance a lump- and policymakers should first address these sum payment, helps to further identify where a other barriers before implementing climate climate auction model can be used. Two factors are auctions. particularly important: 2. Price guarantees are most useful when 1. Price guarantees are most useful where bidders face uncertain future demand for the there is a possible cost viability gap. The climate outcome. By contrast, previous research price guarantee gives confidence to the auction suggests that if bidders face uncertainty related winner that a possible incremental cost gap to the future trajectory of costs required to will be filled. This is often the biggest barrier deliver the climate outcomes, price guarantees to delivering climate assets. However, in other may not provide the revenue/profit stability that cases, the barriers to delivering climate assets supports investment (Vivid Economics, 2010). may be non-financial, such as informational, behavioral, bureaucratic, or transactional Figure 4 summarises the conditions under which barriers, or split incentives that, for instance, climate auctions are most appropriate. 24 I vivid economics Figure The suitability of climate auctions depends on the features of the climate outcome opportunity 04 and on the broader regulatory and NDC context (including funding requirements) Three features of climate outcome opportunity Auctions to set prices > information asymmetry between governments and firms > sufficent number of bidders > funder concern is cost-efficiency Suitable for climate auction Price guarantee Results-based > cost viability gap payments > uncertain future demand > effective MRV > financial capacity > institutional capacity Broader regulatory and NDC context + funding requirements Participants Auctions can facilitate transition 1. 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(2017a). 13 Private Companies Compete in $13 Million World Bank Climate Auction. Retrieved November 8, 2017, from http://www.worldbank.org/en/news/feature/2017/01/11/13-private-companies-compete-in-13- million-world-bank-climate-auction World Bank. (2017b). Pilot Auction Facility: Auctions. Retrieved November 8, 2017, from http://www.pilotauctionfacility. org/content/auctions-0 World Bank. (2017c). Pilot Auction Facility for Methane and Climate Change Mitigation. In New York Climate Week Rountable. New York: World Bank Group. World Bank. (2017d). Results-Based Climate Finance in Practice: delivering climate finance for low-carbon development. Washington D.C. World Bank, Ecofys, & Vivid Economics. (2016). State and Trends of Carbon Pricing 2016. Washington, DC. World Bank, & Frankfurt School of Finance and Management. (2017). Results-Based Climate Finance in Practice: Delivering Climate Finance for Low-Carbon Development. WRI. (2016). CAIT Climate Data Explorer. World Resources Institute. Retrieved from http://cait.wri.org 28 I vivid economics Endnotes 1. R194 billion, converted to US dollars using annual 2016 exchange rate of 14.7 ZAR/US (OANDA, 2017). 2. Projects having not purchased abatement technology before the date of the auction (Ausubel, Cramton, Hauser, & Aperjis, 2014; Chee & LaCasse, 2017). 3. Redemptions from auction 1 delivered 1.7 million metric tons of CO2e from CDM methane abatement projects in exchange for a payment of over US$ 3.9 million. Redemptions from Auction 2 delivered 1.4 million metric tons of CO2e from CDM, VCS, and GS methane abatement projects in exchange for a payment over US$ 4.9 million. Redemptions from Auction 3 delivered 290,000 metric tons of CO2e from a CDM nitrous oxide abatement project in exchange for a payment of US$ 609,000. 4. Under the CfD, if the market electricity price increases to above the predetermined auction price guarantee, then generators must pay the increment above the price guarantee back to the public funder. 5. The CfD budget is converted to US Dollars using the average annual exchange rate for 2017 (OANDA, 2017). 6. This analysis used seven assessment criteria: (i) price responsiveness of the targeted sector to a price guarantee; (ii) the availability of monitoring, reporting and verification (MRV) standards; (iii) sectoral abatement potential; (iv) abatement costs; (v) availability of existing projects; (vi) regulatory considerations; and (vii) sustainable development impacts (Ecofys and Climate Focus, 2016) 7. However, the rules and procedures developed in the wake of the Paris Agreement could affect the nature of using climate auctions and therefore the final versions (set for adoption in late 2018) should be considered before progressing any implementation of climate auctions towards NDC goals (Bodansky, O’Connor, & Rajamani, 2018). 8. Climate auctions are also capable of supporting the implementation of other policies such as feed-in-tariffs 9. While the leverage and extend modalities, developed below, are more immediate transitional mechanisms, the transition under the gap fill modality is more long-term and uncertain. 10. However, the voluntary nature of the auction-based model may serve to reduce cost-effectiveness if there are behavioral reasons why a firm that could financially benefit nonetheless choose not to participate. 11. These design considerations also apply to the extend model, discussed in Section 3.2 and, in part, to the gap model of Section 3.3. 12. This is because under price discrimination auctions, no one might trade with the lowest-value bid winner (highest premium or lowest strike price) should they fail to deliver. 13. Unless policymakers then choose to sell the climate asset. 14. While there is no theoretical reason for top-up price guarantees not to be tradeable, no previous climate auction has yet used tradeable top-up price guarantees (Bodnar et al., 2017) 15. There is a legitimate concern that providing subsidies for the delivery of climate assets may, rather than easing the transition to other market-based policies like carbon prices, make that transition more difficult, as participants resist gradual withdrawal of the subsidy. This risk can be diminished by clear pre-announcements of the intended transition and steadily reducing the resources provided through auctions over time. At the same time, the example of China illustrates how such a transition can be achieved (albeit not from an auction model): the Chinese industrial sector’s experience with the CDM market had a significant influence on the Chinese government’s decision to establish the seven regional pilot ETSs and contributed to the creation of the Chinese Certified Emissions Reductions (CCER) offset programme (Swartz, 2016). THE WORLD BANK I 29 The potential for climate auctions as a mechanism for NDC implementation Endnotes 16. In this example, climate auctions act as a leveraging model in the offset market, but an extending model in the carbon tax, as it prepares the waste sector for inclusion under the tax (similar to the influence of the CDM on the Chinese ETS). 17. Waste sites included will be those receiving 5 tonnes per day or a total capacity of 25,000 tonnes (Republic of South Africa, 2017a). 18. For example, there are a number of inter-related challenges to monitoring and evaluating adaptation outcomes, such as a lack of standardised methodologies, metrics and indicators; difficulty of identifying baselines; long timeframes; difficulty of attributing outcomes to specific interventions (Christiansen, Schaer, Larsen, & Naswa, 2016). 19. Excluding land-use change and forestry. 20. However, not all parties agree that achieving unconditional targets do not require foreign assistance. 21. Buchner et al. (2017) do not provide more recent estimates for global domestic public climate finance due to data limitations. 22. Based on a small number of countries 23. The VEPF also receives a portion of its financing from a charge on the sale of Certified Emissions Reductions (CERs) under the CDM programme which it manages, and from other environmental protection fees paid by firms for compliance. 24. Indonesian rupiah (IDR) converted to US dollars using annual 2016 exchange rate of 105.5 IDR/US$ (OANDA, 2017). 25. For example, UK prices for offshore wind procured through CfD auctions decreased by 47% over 2015-2017, yielding prices cheaper than nuclear power and natural gas power procurement (RenewableUK, 2017). 26. The resource curse is a form of adverse selection bias whereby, a bid winner is systematically more likely to win due to overestimating, rather than underestimating, a bid product’s value (Milgrom, 2004). 27. To illustrate this with a real-world example, Hong & Shum (2002) show that the winner’s curse significantly impaired government revenues from procurement auctions for highway- and bridge repair contracts in New Jersey. 28. This is highlighted by the experience in early Federal Communication Commission (FCC) spectrum auctions. The FCC offered lower down payments and attractive financing options for small firms (defined by low asset ownership and sales), and further allowed some licenses to be bought only by small firms. After winning, some small firms defaulted on their loans, leaving their part of the spectrum unused and resulting in loss for the FCC and consumers (Milgrom, 2004). 29. To nevertheless mitigate the risk of non-compliance, certain design choices can maximize expected compliance. As is standard in many procurements, the auction can specify a set of criteria that participating firms need to meet. PAF climate auctions, for example, specified a list of environmental, health and safety criteria (World Bank, 2015). These could be amended by other firm qualifiers, insofar as government bodies are able to identify compliance- relevant characteristics which are also likely to differ by country. 30. They also entail higher MRV costs as multiple outcomes must be monitored. Additionally some outcomes could possibly be difficult to accurately measure and verify, such as jobs created which, unless very specifically defined, can be ambiguous and open to gaming. 30 I vivid economics 1818 H Street, NW, Washington, DC 20433 USA www.worldbank.org/climatechange THE WORLD BANK I 31