Social Price of Carbon in the Evaluation of Public Investment Projects in Latin America

Summary

Through the Paris Agreement, the international community committed to working to keep the global temperature increase below 2ºC. In this context, countries submitted their greenhouse gas (GHG) emission reduction targets to the United Nations Framework Convention on Climate Change through their Nationally Determined Contributions (NDCs). The countries of Latin America and the Caribbean have joined this commitment and, therefore, like the countries of the rest of the world, need to move towards structural change with production and consumption patterns that are more sustainable and compatible with the climate goal, which requires changes in public policy, policy, and regulatory frameworks, economic incentives, innovation, among others. In this context, ECLAC, within the framework of the EUROCLIMA+ program, is promoting a regional initiative, "Social price of carbon in the evaluation of public investment projects in Latin America."

This initiative aims to support countries in the analysis of carbon valuation options to guide investments towards lower-carbon alternatives and thereby contribute to compliance with the Paris Agreement and sustainable development in Latin America.

This work arose from the National Public Investment Systems (SNIPs) interest of the countries that participated in the VIII Seminar of the Network of National Public Investment Systems of Latin America and the Caribbean, held in Panama in April 2018. The technical work that has been carried out to date has involved the cases of Chile, Costa Rica, Honduras, Nicaragua, Panama, who expressed to ECLAC their interest in being part of this regional work; however, this initiative is open to all member countries of the EUROCLIMA+ program.

Results

To date, five technical studies have been prepared to document methodological aspects of the implementation of a social price on carbon, the institutional legal powers to define the social price of carbon, and the effects of the price on public investment in key sectors such as energy, transportation and road infrastructure.

The following conclusions can be drawn from each study:

1. Methodology for the Estimation of the Social Price of Carbon in Chile and Capacity Building for its Application in Latin American and Caribbean (LAC) Countries

The study analyzes the existing methodologies for estimating the social price of carbon and highlights the Marginal Emission Reduction Cost Method applied in Chile. This method requires primary input the marginal abatement cost curves (MAC curves), estimated in different projects carried out in recent years in LAC countries. However, the information available is not up to date, so the LAC SNIPs are called upon to jointly advance in the training of professionals to develop products that can be replicated in the different countries without incurring duplication.

A case that can serve as an example is that of Chile since recent sources of information are available that estimate the projection of GHG emissions in the period 2017-2030 for the different sectors at the national level, as well as the costs and mitigation potential of a set of measures. In Central America, it is not known if there is updated information that allows estimating MAC curves, but it is suggested to use sources such as Climate Watch or the OECD's compendium of Environmental Statistics.

2. Analysis of the Legal Powers of Governments to Incorporate this Incentive in the SNIP

This study analyzes the legal powers of national and subnational governments in Chile, Costa Rica, Honduras, Nicaragua, and Panama and their institutional framework for setting a social price on carbon within the framework of national public investment systems. In terms of social evaluation of public investment projects and incorporation of social prices and, in particular, the social price of carbon, there are different levels of development. While some countries incorporate the social price of carbon, others contemplate social prices without explicitly including carbon. In contrast, other countries do not contain it. The study identifies challenges in three key areas.

First, the legal framework, since generally countries that integrate social prices in the evaluation of public investment projects do so at the infra-legal level (methodological guidelines). Although conferring an advantage in terms of flexibility, this constitutes a disadvantage in countries where public policies lack stability over time due to fluctuations linked to changes in government. Secondly, the institutional framework, as the study concludes that in general, the evaluation of public investment is carried out in coordination with at least two institutions, which requires fluidity and cooperation that can end up making public investment projects more expensive. Finally, in the area of transparency, which is essential to prevent undervaluation of the social price of carbon and to increase investor confidence.

To overcome these barriers, it is essential to provide the administration with the necessary skills and flexibility to act in accordance with the economic situation, to ensure stability by including social prices in the legal framework, to ensure a progressive increase in ambition in line with international commitments and to monitor their implementation, ensuring transparency.

3. Simulation of the Effects of the CO2 Tax on the Energy Sector

This study models the impact of a CO2 tax on the development and future operation of electricity generation systems in Honduras, Nicaragua, Costa Rica, Panama, and Chile for the years 2030 to 2050. The main cross-cutting conclusions are the following:

First, the CO2 tax is an effective tool to achieve significant emission reductions. Still, its impact is different in each country. There is no cross-cutting tax rate that allows achieving high reduction levels. Thus, for example, in Costa Rica and Nicaragua, a low tax (5%) produces significant reductions (25-30%), while in Panama and Chile, high rates (40%) are necessary to achieve the same level.

Second, the tax rate affects the electricity system through three main mechanisms. First, the installation of intermittent renewables is brought forward in time with respect to the base case since they become competitive for the system ahead of schedule. Second, there are changes in decisions regarding the type of plant to be installed, benefiting the selection of plants with lower GHG emissions. Third, new renewable power plants are installed, replacing part of the generation of existing plants with high CO2 emissions.

Finally, the abatement cost represents only a fraction of the additional private cost of the system, which is composed of the sum of the abatement cost and the collection. In fact, for the range of tax rates studied, tax revenues are higher than the abatement costs of the system in all countries. On the one hand, CO2 tax revenue is higher as the CO2 tax rate increases but at a slower rate. On the other hand, abatement costs are increasing as the tax rate increases. However, average abatement costs are always lower than the tax rate.

4. Simulations of the Social Price of Carbon in the Public Transport Sector in Latin America and the Caribbean

The transportation sector is one of the main contributors to GHG emissions. Public bus transportation represents the primary means of mobility in Latin American cities, in some of them more than 50% of the modal split. This study evaluates the feasibility of implementing low-emission or zero-emission public transport systems through the comparative cost of implementing bus fleets of different technologies. This study presents a tool for socio-economic and financial evaluation by incorporating the social price of carbon into the total costs of public bus transportation projects. It considers the base information of 7 types of 12-meter buses of diesel (EURO IV, V, and VI), CNG, hybrid (EURO VI), battery-electric, opportunity charge electric (OppCharge) technologies. Scenarios with different carbon ton prices were conducted in the study to evaluate the changes in equivalent annual costs of various bus fleet alternatives. The scenarios assessed are $5, $10, $20, $30, and $50 dollars per ton of carbon.

The main difference in annual costs between diesel and battery electric buses is that in the former, the acquisition costs are low (from 16%) and the fuel cost high (up to 37%). In comparison, it is the other way around (up to 50% and from 5% respectively) in the latter.

Contrary to common belief, electric technologies are not exempt from GHG emissions since it is necessary to consider the consumption emission factors of the energy matrix. Carbon reduction is effective when energy generation is clean and preferably renewable.

In Latin America, there is a very high potential for the implementation of clean bus fleets. Due to the high implantation of the bus as a vehicle, there is an attractive market for establishing companies that assemble and produce units. Therefore, it is possible to generate economies of scale that allow cost reduction. Furthermore, the more cities have low-carbon fleets, the more incentives there will be for the development of the industry.

The main challenges to the implementation of low-carbon fleets pertain to the institutional framework. Local governments are generally responsible for mobility systems, while national governments are responsible for environmental policy. Unfortunately, this framework generates a flaw because incentives and plans are usually not aligned.

Therefore, it is recommended to invest in formalizing institutional instances in charge of multilevel and intersectoral coordination, establish a financing program for low-emission public transportation systems, adjust concession and/or bidding models, and elaborate green bonds instrumentation for sustainable mobility projects.

5. Simulations of the Social Price of Carbon in the Road Infrastructure Sector

This study presents the results of simulations with different social carbon prices for the road infrastructure sector in Chile and Honduras. In addition, a conceptual framework is proposed for the calculation of GHG emissions in the life cycle of a road, including the phases of material production, construction, and use.

The differences in emissions according to the material used (asphalt or concrete) were studied; however, although emissions vary in production, construction, and use phases, overall emissions are practically equivalent. Therefore, it is concluded that the use phase originates the largest amount of emissions, equal to more than 95% of the total emissions in the life cycle.

This conclusion indicates that it is essential to seek alternatives that lead to the reduction of emissions in this phase, such as: changing vehicle fuel (biofuels, green hydrogen, green synthetic fuels, or electric vehicles), constant improvement of the surface evenness of pavements, surfaces with determined friction, modal shift solutions (transferring part of the interurban transport of cargo and passengers to means with lower emissions, such as railroads), among others.

Lessons Learned and Good Practices

The process of incorporating the social price of carbon among the criteria for evaluating public investment projects faces different challenges: perhaps the methodological strategy is one of the most important because of the information required. To date, in Latin America and the Caribbean, only Chile and Peru have implemented a social carbon price in their national public investment systems. One of these methods involves using marginal cost curves to reduce greenhouse gas emissions, which is costly and with little updated information, given the periodicity with which national inventories of GHG emissions are published.

Not all countries in Latin America have marginal cost curves for reducing greenhouse gas emissions. Therefore, more cost-effective methodological alternatives should be explored, which require less detailed sectoral information and allow the estimation of reference values for the social price of carbon for the different countries in the region.

Final Thoughts

This initiative seeks to create incentives to promote changes in the methodologies of social evaluation of projects, incorporating carbon emissions as a variable to be considered in their social assessment and calculating the profitability of public investment projects, so the countries of Latin America may move towards more sustainable and low-carbon development through public investment.

When incorporated into national public investment systems, the social price of carbon would help change the relative profitability of investment projects, generating signals that encourage lower-carbon projects and support the transition of countries towards more sustainable modes of production and consumption.

More Information

• Documents: the technical documents are being edited and will be published in the coming months.
• Contact: Jimy Ferrer, Economic Affairs Officer, Sustainable Development and Human Settlements Division, ECLAC jimy.ferrer@cepal.org