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CLIMATE AUCTIONS A Market-Based Approach to National Climate Action Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized2 | THE WORLD BANK With the Paris Agreement and most of its detailed rulebook now finalized, countries and subnational actors face the challenge of translating climate targets and strategies into action and determining how to finance these actions. There is a particular need for innovative approaches to deliver finance at the scale and pace necessary to limit global temperature rise to well below 2°C. However, evidence is growing that up-front grants and loansthe dominant instruments for allocating limited public concessional funding for climate mitigationare not optimal to support large- scale decarbonization. As the recent special report of the Intergovernmental Panel on Climate Change has highlighted, climate auctions represent one of the most promising new approaches to mobilize finance in support of Nationally Determined Contributions NDCs. 1This policy brief presents ways in which climate auctions can be applied at the national level to cost-effectively support countries in achieving their climate targets. For decades, public funders have relied primarily on grants and loans to allocate public subsidies for climate and development projects internationally. However, these instruments can be costly to administer, deficient at leveraging private investment, and often unsuccessful in delivering intended results. Climate auctionsa 21st-century alternative competitively allocate public funding to commercially developed mitigation projects, ensuring both transparency in selection processes and efficiency in leveraging investment. Climate auctions offer successful project developers and commercial entities a guaranteed price for verified emission reductions, which these entities can then use to raise additional finance. In addition, climate auctions only disburse funding upon delivery of mitigation results, reducing the risk for the taxpayer. At a national level, climate auctions can help countries achieve their NDCs and other climate targets in the short term while supporting carbon pricing and greater climate ambition in the medium to long term. 2 This is not an untested concept. Climate auctions have been piloted successfully at both the international and national levels, and in the era of NDC implementation, they also represent an effective tool to raise climate ambition. While most countries have outlined priority sectors in their NDCs, many are still identifying specific mitigation activities as well as finance needs and strategies. 3Climate auctions can support countries in developing a pipeline of bankable, cost-effective projects for meeting climate targets, while also attracting limited international public funding. For countries seeking to raise their NDC ambition, climate auctions offer a stepping-stone to carbon pricing and regulation. This brief explores why climate auctions are an effective tool for achieving climate outcomes, focusing on how developing country policymakers can utilize auctions to accelerate NDC implementation and raise climate ambition. It then outlines how climate auctions work and where they are most effective in achieving climate outcomes. INTRODUCTIONCLIMATE AUCTIONS | 3 Climate auctions resolve challenges for national policymakers seeking to achieve their climate targets, for international and domestic public funders seeking to effectively allocate limited resources for climate outcomes, and for project developers and commercial entities seeking to invest in clean technologies. NATIONAL POLICYMAKERS Climate auctions can help national policymakers achieve mitigation results in line with their NDCs, while also laying the groundwork for increased climate ambition over time. Specifically, climate auctions provide direct incentives to kick-start mitigation investments in key sectors. As auctions rely on limited public funding, they can also serve as a bridge to implement carbon pricing or other regulations, which can be crucial for unlocking economy-wide climate action. Climate auctions can facilitate NDC implementation in four ways First, by providing direct support to close cost viability gaps and de-risk investments, climate auctions can attract commercial entities to undertake mitigation projects. Leveraging the private sector’s strength in seeking out and structuring bankable and cost- effective projects helps national policymakers build viable project pipelines to implement their NDCs. The pipeline of bankable projects identified through the auction process extends beyond auction winners and can be utilized for further results under subsequent carbon pricing policies. By engaging the private sector, climate auctions also contribute to developing an ecosystem of support for mitigation activities. Second, climate auctions can help build private sector capacity and willingness to engage in carbon pricing schemes. In some sectors, introducing effective carbon pricing or other regulatory policies may be difficult due to industry opposition. In the short term, climate auctions provide a direct incentive to stimulate investments in these difficult sectors. This initial support provides industries the chance to build capacity and make the necessary investments before they are subject to carbon pricing or mandatory abatement policies. In some cases, repeated auctions and greater uptake of mitigation activities will also drive down the cost of the mitigation technology, paving the way for further investments and decreased compliance costs in a future carbon pricing or regulatory scheme. Finally, auctions can also send a price signal to policymakers seeking to design effective carbon pricing or other emissions regulations. Third, climate auctions can leverage and strengthen market infrastructure, where applicable, to catalyze and produce emission reductions for achieving climate targets. Irrespective of the evolution of future emissions trading schemes, using existing government focal points and globally agreed ologies for calculating and verifying emission reductions bypasses the need to design monitoring and uation systems from the ground up. Under the Clean Development Mechanism CDM, 106 developing and emerging economies established national authorities for coordinating, approving, and verifying the results of projects that generate carbon offsets. 4In addition, the CDM and other international carbon market offset systems, including the Verified Carbon Standard VCS, Gold Standard GS, and Climate Action Reserve CAR, have generated ologies for measuring mitigation results across a range of sectors, offering ready-made systems for monitoring, reporting, and verifying results under a climate auction scheme. Climate auctions can also strengthen carbon market infrastructure e.g., by utilizing verification agents that confirm reductions have occurred, further laying the necessary groundwork for introducing more economy-wide carbon pricing policies. Fourth, while retaining the strengths of a market- based mechanism, climate auctions can align with and channel support for national development. For example, countries can choose to hold an auction covering specific subsectors or technologies, WHY CLIMATE AUCTIONS 4 | THE WORLD BANK WHY CLIMATE AUCTIONS thus directing commercial investment into areas prioritized for economic development. The projects supported through climate auctions can also result in other development outcomes, like local enterprise development, job creation, or health benefits. PUBLIC FUNDERS INTERNATIONAL AND DOMESTIC Public funders play a critical role in de-risking climate investments and supporting projects that may not yet be commercially viable. iHowever, public funders also face the challenge of determining how best to use their limited resources to help countries achieve their NDCs and other climate goals. To maximize impact, public funders must 1 reduce the time and cost of “picking winners” or selecting funding recipients; 2 determine the level of funding needed to generate mitigation results without crowding out private investment; 3 leverage private investment, thus avoiding overreliance on public resources; and 4 ensure that projects receiving funding deliver lasting results. While public funders aim to minimize resources needed to pick winners, the process of eliciting and reviewing funding proposals can be time consuming, opaque, and costly. Funders have to choose which projects to support based on often-competing selection criteria, leading to politically fraught and lengthy selection processes. Climate auctions resolve this challenge using competitive tendering to transparently allocate funding to the projects that can reduce emissions at the lowest price. As with renewable energy auctions, these auctions can be designed to take place online over the course of hours as opposed to the weeks, months, and sometimes years required to allocate funding in the current system. Having selected recipients, public funders must also determine the right level of subsidy to achieve climate or development results without crowding out private investment. 5To do so, public funders typically make a case-by-case determination of the level of support needed to make projects commercially attractive while minimizing public outlays. Setting the public subsidy at an appropriate level is resource intensive, and funders looking across a portfolio of grants they provided for climate mitigation would have difficulty assessing whether they truly delivered the best value for their money. Climate auctions, through competitive tendering, transparently reveal the minimum amount of finance required to make a mitigation project commercially viable. Finally, climate mitigation finance can be denominated in the key unit of interest tons of emissions reduced. Rapid progress toward achieving NDCs requires that limited public funding must unlock large volumes of private investment. Public climate finance has failed to leverage significant private investment according to the Organisation for Economic Co- operation and Development, the US81.4 billion of public climate finance flowing from developed to developing countries in 2013 and 2014 mobilized only US29.5 billion in private capital and can even act as a deterrent to innovation. 6Instead, climate auctions employ results-based payments, providing a steady stream of revenues, thus allowing developers to attract additional lower-cost commercial finance. This not only lowers the required outlay of public finance but can also significantly lower the abatement cost of capital-intensive projects by reducing overall costs of capital. Additionally, competitive tendering can incentivize private sector innovations and cost reductions, further reducing the required public funding needed to make a project bankable. iPublic funders include both international funders such as bilateral development agencies and multilateral climate funds, as well as domestic sources such as climate and environment funds.CLIMATE AUCTIONS | 5 WHY CLIMATE AUCTIONS Finally, public funders must ensure that projects deliver lasting results. Funders want projects to be successful, but the prevailing international climate finance model is for donor countries acting via bilateral agencies or multilateral climate funds to disburse funds based on complex grant applications with no guarantee that the intended climate results will materialize. When funders allocate grants prior to project completion, they must conduct due diligence to understand and mitigate risks that projects won’t deliver intended results. 7Funders also want projects to become commercially viable and outgrow reliance on public funding. In up-front grant-based systems, public funders often find themselves in the position of providing continued funding if they wish to see continued mitigation. Climate auctions, by providing results-based payments, address this challenge. 8Auction winners cannot redeem their price guarantees until their project’s successful results are verified, which reduces delivery risk for funders. Auctions also help build carbon market infrastructure, both by developing a pipeline of projects and a stable demand signal over time. As these markets are established, with sufficiently high and stable carbon pricing, public funders can phase out their support and instead allow the market to take over the role of incentivizing low- carbon investment. PROJECT DEVELOPERS AND COMMERCIAL ENTITIES Project developers and commercial entities assessing mitigation opportunities must realize a favorable risk- return profile before deciding to invest. 9Particularly in developing economies, climate projects often face barriers to investment due to their high perceived risk, uncertain returns, or capital intensity that entails long payback periods. 10While up-front grants lower the capital cost of projects, they often stop short of addressing the revenue risk that makes many projects unviable. At a minimum, climate auctions’ results-based payments provide the revenue certainty commercial developers need to make projects bankable. A commercial developer holding a price guarantee from a public fund see next section for mechanics can take this to a bank as collateral to secure up-front financing, just as it does with power purchase agreements in the case of renewable energy projects. The procedure for securing public subsidy via a climate auction can also be far more transparent and less bureaucratic than up-front grant and concessional loan processes. Commercial project developers have a simple, clear set of requirements to receive their perance-based payment upon project completion. In addition, where a competitive market for emission reductions exists, climate auctions offer potentially higher returns by providing the option to sell to the market. 6 | THE WORLD BANK EXHIBIT 1 How Climate Auctions Resolve Policy, Funding, and Investment Challenges NATIONAL POLICYMAKERS PUBLIC FUNDERS PROJECT DEVELOPERS AND COMMERCIAL ENTITIES Objective Challenges of Current System Climate Auctions Solution Achieve mitigation results Complex process for developing and implementing project pipelines in line with NDCs Auctions develop a pipeline of bankable projects Auctions utilize existing market infrastructure to rapidly achieve results Ratchet up climate ambition through effective carbon pricing Difficulty introducing carbon pricing Auctions provide direct support for mitigation to ease transition to regulation Auctions offer the learning opportunity to strengthen carbon market infrastructure Minimize resources needed to pick winners Reliance on time-intensive, costly processes for selecting projects Transparent and competitive auctions award funding to projects that deliver emission reduct
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