Written by Caroline Ott, Scott Cantor and Stephanie Rogers
Limiting global warming to below 2 degrees Celsius will require policy and financial mechanisms that enable quick, large scale, and low cost greenhouse gas (GHG) mitigation. In this article, we consider emerging evidence that auctions, which have been used by companies like eBay and Alibaba to revolutionize consumer markets, will be crucial in fostering market-oriented solutions to climate change.
Economic approaches to climate protection must address three significant barriers:
First, firms in the private sector have GHG mitigation costs that are highly variable. These issues complicate the investment case for these firms and create uncertainty in the public sector regarding appropriate levels of funding.
Second, public institutions face budget constraints in supporting industries to reduce emissions, limiting the volume of financial assistance they can make available.
Third, carbon pricing often relies on carbon markets. Price volatility in these markets has added additional risk to climate-friendly investments. Coupled with a lack of long-term certainty on carbon pricing, private sector investment has been deterred.
The World Bank’s Pilot Auction Facility for Methane and Climate Change Mitigation (PAF) has sought to overcome these challenges by allocating climate finance through auctions. The program has turned past logic on its head by requiring private sector bidders, rather than governments, to determine the price of GHG reduction. In an auction, the price of climate-friendly practices is revealed by market participants in a process that is competitive, transparent, and fair.
Here’s how the PAF works:
1. Public or private funders commit resources to achieve a specific outcome. In the case of the PAF, four countries (Germany, Sweden, Switzerland, and the United States) contributed $53 million for carbon credits representing greenhouse gas emission reductions in developing countries.
2. Private firms bid in an online auction to receive a share of these funds to pay for their investment in green technology, for example methane capture at their landfills. Firms that can deliver results at the lowest cost all win the auction. In the case of the PAF, winners deliver these “results” in the form of carbon credits.
3. Winners don’t sign direct purchase agreements to sell their carbon credits to the PAF. Rather, they purchase put options, which give them the right, but not the obligation, to sell carbon credits to the PAF in the future at a guaranteed price. To show they are committed, private companies pay a small price up front for the put options.
4. The PAF only disburses payment for results once emission reductions have been verified by a third party. And if auction winners cannot deliver results as planned, they can seek to recoup their investment by selling their options to another firm that can deliver credits, maximizing the likelihood of achieving the funders’ desired mitigation goals.
Regarding unknown mitigation costs, PAF auctions generate real-time marginal abatement cost curves, uncovering the cost of mitigation for firms that can reduce emissions.
In addition, the PAF addresses the second barrier of limited climate finance resources by using auctions to identify lowest-cost mitigation opportunities, thus minimizing the amount of climate finance required to make the maximum impact. The put options also ensure that the public sector only pays for verified results when market prices for carbon credits are low (if carbon prices rise, option holders can sell their credits to other buyers in the carbon market at a higher price).
Finally, the PAF addresses the challenge of volatile prices, and thus risky investments, by offering a guaranteed price for future emission reductions.
To date, the PAF has hosted three auctions and allocated over $53 million in climate finance for projects that reduce emissions. Whereas the first two auctions targeted methane reductions, the most recent auction, hosted on January 10, 2017, focused on nitrous oxide emissions from nitric acid production.
As an innovative and now tested solution, the PAF model can be used to offer prompt, scaled up, and results-based support for climate investments, maximizing gains for both the public and private sectors.
With the pilot phase nearing its close, the PAF is looking at replicating and scaling up its model to include new sectors such as energy efficient buildings and forest protection. The PAF recently published a study on Opportunities Beyond the Piloting Phase that explores these replication opportunities. Going forward, this auction model offers promise to countries seeking to raise their ambition under their climate plans, or Nationally Determined Contributions.
Published in January 2017
About the authors
Scott Cantor is a Carbon Finance Specialist with the World Bank in Washington DC, where he supports the development of new financial instruments in the Climate and Carbon Finance Unit. His primary responsibilities include the Pilot Auction Facility for Methane and Climate Change Mitigation (PAF), stakeholder outreach and fundraising. Prior to joining the World Bank, Scott worked in the Renewable Energy Group at Booz Allen Hamilton. He has held previous positions with Lehman Brothers, the Overseas Private Investment Corporation (OPIC), the Institute of International Finance (IIF), the Atlanta-based lobbying firm, Reece & Associates, and the United Nations in Geneva, Switzerland.
Caroline Ott is a Consultant with the World Bank in Washington, D.C., where she supports the design and implementation of climate finance mechanisms in the Climate and Carbon Finance Unit. Her primary responsibilities include knowledge product management, communications, and research and analysis in support of the Pilot Auction Facility for Methane and Climate Change Mitigation (PAF). Prior to joining the World Bank, Caroline worked as a strategy consultant at California Environmental Associates and as a carbon markets analyst at Ecosystem Marketplace (a project of Forest Trends). She holds a bachelor’s in Economics from Barnard College at Columbia University and a master’s in Development Economics from The Fletcher School at Tufts University.
Stephanie Rogers is a Financial Specialist in the Carbon Markets and Innovation team of the World Bank, focusing on the development and implementation of new financial instruments to address climate change. She is a team member of the Pilot Auction Facility for Methane and Climate Change Mitigation. Stephanie previously worked in Corporate Risk and Sustainability at the International Finance Corporation and as an attorney in government and private practice. She holds a JD from Stanford Law School, MA in International Economics and Development from Johns Hopkins SAIS, and a BA from the University of Illinois at Urbana-Champaign and has completed the Chartered Financial Analyst program.