MAY 2024 2024/133 A KNOWLEDGE NOTE SERIES FOR THE ENERGY & EXTRACTIVES GLOBAL PRACTICE Mobilizing Carbon Finance to Meet the Socioeconomic Costs of Reforming Energy Tariffs and Subsidies in Uzbekistan The bottom line. Across the globe countries are looking to cut greenhouse gas emissions to reach carbon neutrality and combat climate change. But doing so can be complicated. Countries are putting a price on carbon emissions (or carbon equivalents for other gases). In a landmark pilot in Uzbekistan, the World Bank is testing a way to reward countries for improving their sustainable energy policies. The program monetizes carbon-cutting efforts and prepares the country to sell carbon credits on the international carbon market.  What is unique about this program? subsidies. For the term of the program, iCRAFT will help Uzbekistan access international carbon funds to reward the The project is the Bank’s first global initiative to country for reforms that achieve specific emission reduc- support policy reforms through payments for emission tions. Projections suggest that Uzbekistan could cut some reductions 60 million metric tons of carbon dioxide equivalent (tCO2-e) The goal of the Innovative Carbon Resource Application through the iCRAFT implementation period. The program for Energy Transition Project for Uzbekistan (iCRAFT) is to will “buy” approximately 2–2.5 million metric tons of those encourage and reward policies that incentivize the rational reductions, enabling Uzbekistan to sell the rest on the inter- use of energy resources and thereby reduce carbon emissions national carbon markets. The innovation and ambition of in Uzbekistan’s energy sector, which accounts for 74 percent the program depart from previous practice, in part because of the country’s emissions. Additional goals are to create previous carbon finance operations have been quite small infrastructure, systems, processes, institutional frameworks, and focused on specific investments. and standard documents for international carbon market transactions under the Paris Agreement. In the case of iCRAFT, the government of Uzbekistan asked the World Bank to assist in the design and implementation The policy-crediting program will reward Uzbekistan for of energy subsidy reforms and energy efficiency measures. carbon reductions achieved through the removal of energy The proceeds are intended to fund the next wave of broader energy reforms, strengthen the social safety net for vulner- able households, fund communication campaigns, and scale up the use of renewables to advance the clean energy transition. Maksudjon Safarov is a senior energy specialist in the World Bank’s Europe and Central Asia region Authors Jason James Smith is a senior climate finance specialist at the World Bank 2 Mobilizing Carbon Finance in Uzbekistan Beyond its global significance as the first policy-crediting Why Uzbekistan? program by the World Bank and the first carbon finance Despite its energy-intensive economy, which is transaction in Central Asia under the Paris Agreement, characterized by low tariffs and high energy subsidies, iCRAFT is expected to establish a framework for Uzbekistan the country has signed on to the global climate agenda to access and engage in international carbon market trans- actions. If proven successful, the program holds the potential The demand for fossil fuels in Uzbekistan has grown steadily for wider adoption by other countries. in recent years, making the country one of the most energy- and emissions-intensive countries in the world. (For example, The $46.25-million project is financed by the Transformative its energy intensity is 50 percent higher than Kazakhstan’s Carbon Asset Facility (TCAF), a World Bank trust fund that and three times higher than Türkiye’s.) Its energy sector faces offers a unique combination of capacity building, results- significant challenges because of its dependence on natural based climate finance, and carbon market funding. iCRAFT gas and gas reserves that are expected to be exhausted is the first operation supported by TCAF to help develop- within the next 20 years. If no further progress is made in ing countries meet their Paris Agreement commitments of exploration and discovery, Uzbekistan will soon reach its reducing national emissions and adapting to the impacts peak gas production, followed by a significant reduction in of climate change. TCAF benefits from financial support the coming years. This scenario carries a significant energy from the governments of Canada, Germany, Norway, Spain, security risk for the country’s people and businesses. Sweden, Switzerland, and the United Kingdom, as well as the Climate Cent Foundation (Switzerland). Figure 1. Uzbekistan is one of the most energy-intensive economies in the world 4,500 4,000 Uzbekistan 3,500 t CO2-e per $ million GDP 3,000 2,500 2,000 1,500 1,000 500 0 Sweden Switzerland Norway France Iceland Luxembourg Austria United Kingdom Ireland Andorra Italy Germany Netherlands Belgium Spain Finland Latvia Portugal Bulgaria Croatia Slovenia ECA Cyprus Lithuania Romania Slovakia Greece Hungary Czech Republic World Poland Turkey Albania Estonia Montenegro Armenia Macedonia Georgia Belarus Moldova Russia Serbia Bosnia and Herz Kazakhstan Azerbaijan Kyrgyzstan Tajikistan Ukraine Turkmenistan Uzbekistan Denmark Source: Climate Watch 2018. Note: tCO2-e = tonnes of carbon dioxide equivalent; GDP = gross domestic product; ECA = Europe and Central Asia region of the World Bank. Mobilizing Carbon Finance in Uzbekistan 3 Additionally, Uzbekistan ranks among the world’s top 25 coun- emissions per unit of GDP from 10 percent to 35 percent by tries with the largest energy subsidies (figure 2). Eliminating 2030 compared with 2010 levels. those subsidies is the key to reducing excessive energy use. High subsidies keep electricity and natural gas prices low, Subsidy reform can be a politically sensitive issue, but the resulting in insufficient revenue generation against the costs country has demonstrated its commitment to iCRAFT by of production and delivery. In Uzbekistan, natural gas tariffs combining reforms (figure 3) with social protection measures are half their actual cost and electricity tariffs 70 percent of to address the potential impact of price hikes on vulnerable cost, which strains fiscal budgets, limits public investments, consumers. While energy tariffs will increase incrementally, and discourages energy conservation and efficiency.  Low the government plans to launch an awareness campaign to prices also limit the government’s ability to address other help people understand why the reforms are necessary. pressing priorities, such as education and health. Citizens’ willingness to pay higher tariffs in exchange for However, despite these challenges, Uzbekistan is emerging reliable energy supply is growing, especially following the as a climate leader willing to make bold policy decisions. severe weather conditions of the 2022–23 winter, when gas Since 2017, the government has prioritized energy tariff shortages and electricity outages were frequent. In 2023, reforms to improve the efficiency of energy supply and use the country increased electricity and gas costs for nonresi- while protecting vulnerable households. In 2021, the coun- dential users and announced plans to increase residential try scaled up its pledge to reduce greenhouse gas (GHG) tariffs in 2024. Figure 2. In 2020 Uzbekistan was among the 25 countries with the highest energy subsidies 0% 4% 8% 12% 16% 20% Iran China India SaudiArabia Russia Algeria Egypt Indonesia UAE Venezuela Iraq Kazakhstan Argentina Uzbekistan Total subsidies as % of GDP (MER): 6.6% Libya Kuwait Ukraine Mexico Angola Turkmenistan Bangladesh Pakistan Azerbaijan Ecuador Oil Electricity Gas Coal Qatar Source: World Bank 2024. Note: UAE = United Arab Emirates; GDP = gross domestic product; MER = market exchange rates. 4 Mobilizing Carbon Finance in Uzbekistan Figure 3. The iCRAFT model incentivizes efficient and sustainable energy use through reform of energy subsidies and tariffs Government End user demand Result Government 1 2 3 4 Energy subsidy Reduction in energy Reduction in carbon Measurement & reporting reform consumption emissions of emission reduction World Bank/Transformative Carbon Access Facility (TCAF) 7.1 $15/t Payments for verified Carbon trade simulation TCAF-hired independent firm 1. CO2 7.1 emission reductions 6 5 2. CO2 Independent verification Government of emission reduction 7.2 Payments for verified 1. CO2 7.2 emission reductions Flow of funds Flow of emission reduction International carbon trade $30/t Source: World Bank 2024. In addition, given its decarbonization plans and Nationally How does iCRAFT work? Determined Contribution (NDC) targets, the government has An Uzbek governmental working group was established been ramping up efforts to develop renewable energy. It in 2022 to prepare the project jointly with the World announced a target of deploying 12 GW of solar and wind Bank power through private sector participation by 2030 (start- ing from an installed capacity of 0.2 GW in 2022), thereby The group—composed of the Ministry of Economics and increasing the share of renewables in the capacity mix from Finance; the Ministry of Investment, Industry, and Trade; the around 1 percent in 2022 to 30 percent in 2030. Ministry of Energy; the Ministry of Investment, Industry, and Trade; and the Agency for Hydrometeorological Service of the Republic of Uzbekistan—has been providing overall stra- tegic and policy guidance and coordination. The emission reductions resulting from changes in end user demand will be measured With support from the World Bank, the government has pre- pared new electricity and gas tariff methodologies as well through an energy policy monitoring, as plans to reach cost recovery by 2026, thereby eliminating reporting, and verification methodology inefficient subsidies. designed to examine the effects of energy The emission reductions resulting from changes in end user pricing policies on energy consumption. demand will be measured through an energy policy mon- itoring, reporting, and verification methodology designed Mobilizing Carbon Finance in Uzbekistan 5 Figure 4. iCRAFT is helping Uzbekistan to reduce its emissions intensity while generating new income through carbon markets Outcomes Activities Outputs Short term Mid-term Long-term Greenhouse gas emissions reduced Cost recovery tariff Rational use of Energy subsidy reforms trajectory established energy resources implemented Pilot international Uzbekistan’s clean and implemented facilitated carbon trade energy transition Reduction in simulated, tested, accelerated carbon emission and implemented through subsidy reforms and Policy-based climate leveraging of and carbon funds policy-based leveraged climate and carbon Adequate systems, Monitoring system, funds infrastructure and infrastructure, and institutional capacity for Reduction in end-use Effective systems, International carbon processes set up; policy-based climate and energy consumption infrastructure, market transactions standard legal carbon finance initiatives processes, pilot rolled out to support documents prepared established design, and standard Uzbekistan’s green documents tested agenda Source: World Bank 2024. to examine the effects of energy pricing policies on energy emission reductions will be transferred to the World Bank consumption. The reductions will be measured based on and then transferred back to the government of Uzbekistan reporting by the Uzbek government and verified by an as a simulation and test of a carbon trade transaction. independent third party. The verified reductions will serve as the basis for payments to the government. The project A series of negotiations between the Uzbekistan’s govern- envisages an implementation period of five years. The theory ment and TCAF contributors resulted in the unit carbon price of change underpinning the project is illustrated in figure 4. of $15 per ton of emission reductions. The agreement was shaped by Uzbekistan’s need to pursue proposed policy The two components of iCRAFT are climate financing (pay- actions; the need for adequate systems and infrastructure ments for emission reductions) and carbon finance (pay- for carbon and climate finance transactions; and a need to ments for internationally transferred mitigation outcomes), strengthen the country’s institutional and human capacity. as summarized below and described in box 1. Based on the estimated funding envelope of $20 million, $15 per ton will result in payment for 1.33 MtCO2-e of emis- Component 1: Climate finance ($20 million). The climate sion reductions over the project period. Once the allocated finance component of the iCRAFT project encompasses financing envelope is reached, the Emission Reductions the results-based payments to be made under an Emission Payment Agreement will expire. Reductions Payment Agreement between the TCAF and the government of Uzbekistan. Emission reductions will be Component 2: Carbon finance ($26.25 million). The key gauged from the change in end-user energy demand result- difference between the two project components is that ing from the gradual adjustment of electricity and natural payments for the emission reductions under Component 2 gas tariffs. The reductions generated under this component will be transferred out of Uzbekistan and become interna- will count toward the country’s NDC goals. The verified tionally transferred mitigation outcomes (ITMOs). In other 6 Mobilizing Carbon Finance in Uzbekistan Box 1. The Paris Agreement, carbon markets, and climate finance The Paris Agreement is a legally binding treaty Agreement establishes a mechanism for trading under adopted by 196 countries at the climate change the supervision of the Conference of the Parties, the conference in Paris in 2015. The main goal of the decision-making body of the UN Framework Conven- agreement is to cut global greenhouse gas (GHG) tion on Climate Change. When these reductions, also emissions enough to limit global temperature increases known as “mitigation outcomes,” are traded, they to no more than 1.5° Celsius by the end of the century. become known as internationally transferred mitiga- tion outcomes and represent transactions in carbon How will countries do this? finance markets. Countries have submitted carbon reduction targets Reductions that have been authorized for transfer known as Nationally Determined Contributions that by the selling country’s government may be sold to outline how each country will cut its carbon emissions. another country, but only one country may count There is no one-size-fits-all approach for the NDCs, the reduction toward its NDCs. The Paris Agreement and different countries are taking climate action in established an accounting mechanism to ensure that different ways, from investing in renewable energy to double counting does not occur. introducing carbon taxes. The NDCs are to be updated every five years by the parties to the Paris Agreement, Article 9 (climate finance) and each new iteration is expected to be more ambi- tious than the previous one. Article 9 of the Paris Agreement stipulates that devel- oped countries party to the agreement are to provide What is Article 6 (carbon finance)? financial resources, known as climate finance, to assist developing country parties with respect to both miti- Article 6 of the Paris Agreement allows countries to gation and adaptation in continuation of their existing voluntarily cooperate with each other to achieve obligations under the UNFCCC. emission reduction targets set out in their NDCs. This means that under Article 6 of the Paris Agreement a Furthermore, as part of a global effort, developed country (or countries) may transfer or trade carbon country parties should continue to take the lead in credits earned by reducing GHG emissions to help one mobilizing climate finance from a wide variety of or more countries meet their climate targets. Article sources, instruments, and channels, and taking into 6.2 of the Paris Agreement creates the basis for trading account the needs and priorities of developing country in GHG reductions across countries. Article 6.4 of the parties. words, Uzbekistan will begin to sell its emission reductions. Why does iCRAFT matter? This will require the government to perform the necessary Leveraging climate and carbon finance to pursue tracking, measuring, and reporting as required by the Paris sustainable subsidy reform and promote efficient Agreement. The transferred portion of emission reductions use of energy resources is a novel approach for both will become ITMOs and will not count toward Uzbekistan’s Uzbekistan and the World Bank NDCs. This component of the project will pilot an interna- tional carbon market transaction for Uzbekistan and be This is the first policy crediting program in the world under contingent on the country’s compliance with the accounting the Paris Agreement and can be used in other contexts and reporting requirements of the Paris Agreement. beyond just energy policy. Mobilizing Carbon Finance in Uzbekistan 7 Piloting Uzbekistan’s first carbon transaction through 3 It raises the chances of successful project delivery by pro- iCRAFT—leading to Uzbekistan’s access to international car- viding an additional revenue stream to cover operating bon markets—adds to the innovative nature of the project. costs. The World Bank has more than 20 years of experience in 3 It generates verifiable emissions reductions for client the climate and carbon finance space. The Bank’s Climate countries and development partners to cover NDC Change Fund Management Unit has more than $5 billion in commitments. capital and is home to climate finance initiatives that deliver innovative and scalable climate and environmental action. 3 It catalyzes upfront capital investments for climate These initiatives have supported activities in 65 countries action, including by private sector actors, by providing the and made $2 billion in emission-reduction payments since collateral of an ongoing revenue stream during project the first carbon fund—the Prototype Carbon Fund—was operation. launched in 1999. The lessons learned from those early efforts are being applied to the next generation of climate The authors thank Charles Cormier of the Bank’s Europe and funds and facilities. The newly established umbrella trust Central Asia region for his vision and leadership. Likewise deserving fund, Scaling Climate Action by Lowering Emissions (SCALE), of thanks for their support of the project are Erwin De Nys, prac- will deploy results-based climate finance at scale. tice manager of the Bank’s Climate Change Fund Management Unit; Stephanie Gil, energy practice manager in the Bank’s Energy Increasing results-based climate finance, when part of an and Extractives Global Practice; and Sudeshna Ghosh Banerjee, overall climate finance package, yields multiple benefits for of the Bank’s East Asia and Pacific region. Tatiana Proskuryakova, developing countries. Central Asia country director, helped immeasurably through her willingness to support this new and innovative project. Marco 3 It incentivizes ambitious climate goals and action from Mantovanelli, the Bank’s country manager for Uzbekistan, was client countries by rewarding achievement of emis- invaluable during discussions with the Uzbek government. sions-reduction targets. References and sources BP. 2021. Statistical Review of World Energy, 70th edition. IEA. 2022. Uzbekistan 2022 Energy Policy Review. Paris: /www.bp.com/content/dam/bp/busi- London: BP. https:/ /www.iea.org/reports/ International Energy Agency. https:/ ness-sites/en/global/corporate/pdfs/energy-economics/ uzbekistan-2022. statistical-review/bp-stats-review-2021-full-report.pdf. World Bank. 2023. “Uzbekistan to Cut Fossil Fuel Subsidies and Climate Watch. 2018. Washington, DC: World Resources Reduce Emissions with Support from the World Bank.” Press /www.climatewatchdata.org. 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