Carbon pricing in the power sector – Role and design for transitioning towards net-zero carbon development

Electricity is the lifeline for a modern economy. At the same time, the power sector is the world’s main source of greenhouse gas emissions. Limiting the worst effects of a changing climate requires that the supply of clean electricity grows rapidly. This presents challenges as the power sector is technologically complex and requires costly infrastructure development. The sector is also highly regulated and dependent on domestic natural resources and fluctuating international commodity markets.  

Electricity is the lifeline for a modern economy. At the same time, the power sector is the world’s main source of greenhouse gas emissions. 

For policymakers, carbon pricing stands out as one of the most potent tools available to reduce emissions in the power sector. The EU and the UK are prime examples of how carbon taxes and cap-and-trade systems can help significantly advance the decarbonization of the power sector. However, the path to implementing carbon pricing in low- and middle-income countries is fraught with challenges, including financing obstacles, the urgent need to boost supply, and social priorities different from those of more advanced economies with more carbon pricing experience.

For policymakers, carbon pricing stands out as one of the most potent tools available to reduce emissions in the power sector.

The report “Carbon Pricing in the Power Sector – Role and Design for Transitioning Towards Net-zero Carbon Development” delves deep into the power sector value chain dynamics, demonstrating how well-designed carbon pricing instruments can be instrumental in helping low- and middle-income countries reach their decarbonization goals. Focusing on how decisions are made in diverse power sector models in several developing countries, our research establishes that the carbon pricing instrument must be carefully positioned at the right regulation point in the power sector’s value chain—rather than merely adding a burden for the sector.  Getting it right can influence everything from power generation options to investment decisions and customers’ behaviors.

Getting it right can influence everything from power generation options to investment decisions and customers’ behaviors.

Carbon pricing, which generated a record $104 billion worldwide in 2023 alone, can provide governments with new income sources. Several developing countries, such as China, Colombia, and South Africa, are in the early stages of managing distributional impacts on the poorest while facilitating the adaptation of energy-intensive industries. The report builds on these early experiences.

Predictable carbon pricing can help attract private sector investment in cleaner technologies. In capital-intensive sectors like the power sector, both investors and policymakers need long-term plans for decarbonization based on clear and credible communication on carbon price evolution.

This report is a valuable resource to support policymakers in transforming their power sectors to be more reliable, green, and sustainable. The wealth of country experiences that it draws from can highlight the diversity of situations, national contexts, and carbon pricing implementations, empowering policymakers to make informed decisions and strengthening global knowledge on carbon pricing.

Source: blogs.worldbank.org