9. Policy instruments needed for implementing a green transition in the industry

In this chapter, we will discuss what types of policy instruments that are needed for a green transition in the industry. Our starting point is in pricing policies, and we then continue to discuss complementary policies, using a framework proposed by Michael Grubb and others (2017).

9.1 Carbon pricing and complementary policies

Standard economic theory suggests that carbon pricing– either through a carbon tax or cap-and trade – factoring in the environmental costs of the myriad decisions through which we emit carbon is the most cost-effective way to incentivise greenhouse gas emission reductions (Nordhaus, 1996). There are many good arguments for why a global uniform price of carbon for all sources and countries, in combination with technology policies to internalise the positive externalities of innovation, is appealing (Baranzini et al., 2017). However, the implementation of such an integrated global scheme has proven to be politically and practically challenging (Victor, 2005; Ostrom, 2014).

The global climate regime, as formalised in the Paris Agreement, is instead characterised by an increasingly decentralised and polycentric policy landscape (Jordan et al., 2018; Livingston et al., 2018). The main thrust in the global climate policy arena currently originates out of domestically or regionally driven policies including cap-and-trade systems, carbon taxes, and sectoral and regulatory policies aimed at improving energy efficiency and developing and deploying renewable energy sources and zero carbon technology (Green et al, 2014; Meckling et al., 2015). Still, progress is needed on several fronts. IPCC:s 6th assessment report (IPCC AR6 WGII, 2022) describes how limiting warming to 2°C at this point may require “unprecedented” government policy and cooperation that extend beyond what the IPCC could identify as plausible “best case” examples from history (Erickson and Achakulwisut, 2022). Thus, there is a need to develop complementary policies and business models as well as collective initiatives to be part of an overall portfolio of policies and strategies, which can complement “conventional” carbon pricing and channel an increased willingness to contribute towards combating climate change in business and among the public (Tvinnereim and Mehling, 2018; Stoll and Mehling, 2021).

9.2 The three domains framework

Grubb et al (2017) present a framework for categorising the processes involved in transforming complex systems, for example for transforming the economy to very low carbon emissions. The framework consists of three behavioral domains (Grubb et al, 2017 pp. 23–24):

The first domain addresses the “behavioral, social and contractual characteristics that influence (and frequently impede) the adoption of existing, cost-effective technologies”. This domain is targeted towards individuals and industries. Economists use the term ‘satisficing’ behavior – the term used to reflect situation in which people appear to be ‘satisfied enough’ not to change demonstrably sub-optimal conditions.
The second domain characterises optimising behaviour. This domain is targeted towards industries and potentially some individuals. Here consumers, firms, and other agents, following the principles of neoclassical economics, minimise costs and maximise revenues or other benefits.
The third domain addresses “evolutionary and institutional processes” including technological innovation, research and development, but also the role infrastructure, institutions and networks in technological and societal change processes. This domain is targeted towards governments and potentially industries.

These three domains require different types of policy instruments, which is listed below in table 31.

Domain	Main policy instruments	Outcome
Domain 1. Satisfice	Regulation, standards, information, labelling	Smarter choices
Domain 2. Optimise	Carbon pricing, use of markets to increase effectiveness	Incremental improvements leading to cleaner products and processes
Domain 3. Transform	Strategic investment, innovation support	Innovation, infrastructure, new products and services

Table 31: Overview of the three domains main policy instruments

Note: Adapted based on Grubbs et al, 2017

Pricing policies assume that self-interested individuals and organisations will adopt cost-effective technologies, but practical experience shows that people often will fall short of this. For instance, although most car owners know that pumping the tires will reduce fuel consumption and costs, they fall short of doing this.

Table 31 indicates that one type of policy instrument, for instance carbon pricing, is attributed to one domain, in this case Optimising. This is a simplification since carbon pricing is also relevant for sufficing and transforming. Environmental regulation (Domain 1) can stimulate innovation (Domain 3). To be precise, Grubb et al. (2017) presents a domain-policy matrix.

9.3 Three examples

Using three examples, we illustrate the role of different types of policy instruments in supporting the implementation of low carbon technologies in Sweden.

9.3.1 First example – Wind power

The first wind power installations were developed in the 1970s, but without being implemented in any significant scale. During the1980s wind technologies were further developed and from approximately year 1990 wind power experienced a substantial market growth. This early growth has been attributed to R&D in combination with growing experience through testing centers and deployment (Klaassen et al, 2005, Zachman et al, 2014). After gaining experience from this initial technology development, wind power then experienced a significant market growth between year 2000 to 2020, mainly due to different policies that created market pull – state subsidies, regulation, carbon pricing and other market-based instruments.

EU policies have supported this growth. The renewable energy directive (European Parliament, 2003) regulated renewables by setting a goal to reach at least 20% renewables by the year 2020, with differentiated obligations on each member state, where Sweden was given the highest goal of 49%. In 2018, the EU directive was updated with a target of 32% renewables by year 2030 (European Parliament, 2018).

An important instrument for Sweden to reach its renewables target was the introduction of tradable green certificates, implemented jointly with Norway in 2003 (and is planned for closure in 2035). Producers of renewable power production (wind, photovoltaic new hydro) are awarded green certificates and a demand for these was created by adding a quota obligation on electricity retailers to purchase these certificates corresponding to a share of their power sales (Swedish Energy Agency, 2020). From 2020, emissions trading has also been important for the growth in wind. The EU emissions trading system (EU ETS) was established in 2005 and puts a price on carbon emissions. However, due to a surplus of emission allowances, the carbon price was low for a long time (between €3 and €8 per ton during 2013–2017 (ICAP, 2022) and irrelevant for incentivising low carbon technologies. Nevertheless, in 2018, the EU ETS was reformed which led a significant increase in allowance price, from €8 in 2017 to between €31 and €84 in 2021 (ICAP, 2022). This has led to phasing out coal in favor of natural gas and renewables.

When the technologies became interesting alternatives in the energy systems there were impediments due to public acceptance (Klaassen et al, 2005), planning permissions, grid connections and challenges due to inherent characteristics of intermittent production with need for backup systems. In the early years it was understood that grids could cope with no more than 5 to 10% of the total production (Grubb et al, 2017). The emergence of improved power electronics, interconnecting national grids and creation of markets with responsive demand has dramatically changed this.

Looking forward, according to the industry body Wind Europe, slow permitting procedures permissions constitute the main barriers to the introduction of new wind within the EU (Komusanac, 2022). In Sweden for instance, following often long permitting procedures, municipalities can put in a veto against new establishment. This is expected to stall the development after 2026 (Energiforsk, 2022). This can be explained by split incentives - that the municipalities have few benefits of new wind power (and sometimes negative effects on recreation and tourism), while the earnings go to the owners. The Swedish defense authority also regularly puts in veto against offshore wind (Karlsson, 2021).

The example of wind power illustrates that the introduction of renewables is a result from innovation programs (Domain 3), followed by subsidies such as feed-in tariffs (Domain 3) and market mechanisms such as EU ETS and green certificates (Domain 2). Future expansion is most likely market driven (Domain 2), but also governed by public acceptance and permitting procedures (Domain 1).

9.3.2 Second example – Domestic heating and road transportation

Sweden was together with the neighboring Nordic countries among the first countries in the world to adopt a carbon tax in the early 1990s (Hammar et al., 2013), and today has one of the highest carbon prices in the world (World Bank, 2022). The full carbon tax rate is levied on heating fuels (used by in individual households or for district heating) and transport fuels. Evaluations of the Swedish CO₂ tax suggest that the tax has successfully contributed to reducing emissions from these sectors relative to a business-as-usual scenario (Tvinnereim & Mehling, 2018; Andersson, 2019). Hammar et al. (2013) describe how the CO₂ tax has incentivised fuel switching in the district heating sector where biofuels and other non-fossil energy sources have largely replaced fossil fuels. Dzebo and Nykvist (2015) describe a similar development related to heating of single-family houses where the carbon tax has contributed to driving fuel switching, energy efficiency improvements and replacement and conversion of individual heating systems. However, in both cases, the phasing out of fossil fuel have been the result of a combination of economic instruments.

Domestic heating

The Swedish municipal district heating systems which were expanded rapidly in the 1960s and 1970s initially relied predominantly on oil as fuel (Werner, 2017). However, the oil crisis in the 1970’s spurred municipal energy companies to search for alternatives including both traditional fuels such as coal, wood fuels and peat, but also new fuels and heat sources such as municipal solid waste (MSW) and industrial surplus heat (Di Lucia and Ericsson, 2014). Thus, the diversification of the fuel mix begun well before the CO₂-tax was implemented. Di Lucia and Ericsson (2014) describes how the introduction of the Swedish CO₂ tax, governmental investment schemes (1991–1996 and 1997–2002) to support construction of new biomass-fired CHP plants, and initially also the retrofitting of fossil-fired CHP plants for the use of biomass-based fuels, in combination with the introduction of Tradable Renewable Electricity Certificates in 2003 where all important pillars in the switch away from fossil fuels. Similarly, to promote away from fossil fuel in the single-family heating market multiple instruments including, e.g., R&D support for technological development and investment subsidies for heat pumps and wood pellets heating systems, building regulation and information campaigns promoting energy efficiency (Johansson, 2017) were enforced in parallel to the carbon tax.

The example from the heating sector illustrates how the switch away from fossil fuels in the Swedish domestic heating sector has been the result of a combination of instruments. The CO₂ tax (Domain 2) has been complemented with a portfolio of policy instruments including governmental innovation programs and support schemes (Domain 3) and in the case of heating in single family houses information campaigns (Domain 1).

Road transportation

At 15 MtCO₂-eq per year road transport account for roughly a third of Swedish territorial greenhouse gas emissions and while emissions per km travelled have gradually been reduced, emissions reductions in absolute terms have been small. While alternative drivetrains (i.e., battery electric or fuel cell vehicles) have been on the horizon for decades, but remained to costly or impractical, efforts to reduce greenhouse gas emissions from road transportation have since the 1990s largely focused on implementing stricter fuel and emissions standards, and fuel switching in internal combustion engines. Expenditures on policies (including R&D, infrastructure and sales incentives) to develop and deploy plug-in electric vehicles (PEV) in Sweden has until recently in an international comparison been relatively low (Wesseling, 2016). A recent public inquiry (SOU, 2021:48) suggested, among other things, further public efforts to accelerate and coordinate the deployment of charging infrastructure and actions to put into place zero emissions vehicle mandates on the EU level.

Tvinnereim and Mehling (2018) describe how the Swedish carbon tax (Domain 2 policy) has contributed to incremental emissions reduction but argues that the transformative technological shift required to achieve deep emission reductions from the transport sector requires a broader policy portfolio. A combination of fuel economy and emissions standards (Domain 1) has put pressure on manufacturers in the EU and United States and beyond to improve combustion engine performance (An et al., 2010) and in the Swedish context a greenhouse gas reduction obligation (Domain 1) which mandates fuel distributors to reduce the climate impact of their gasoline and/or diesel (i.e., through gradual increases in the biofuel blend) has contributed to put downwards pressure on emission. There is plenty of evidence to suggest that the more transformative technical shift away from internal combustion engines to electric vehicles (and possibly fuel cells in certain segments) will require policies targeting all domains (Domain 1–3). Actors on the rapidly growing markets for battery electric vehicles have already benefited from e.g., spillover effects resulting from improved performance and reduced cost in battery technology in other sectors (Stephan et al. 2020), innovation driven by RD&D (Domain 3) and performance standards (Ye et al., 2021) (Domain 1), policy efforts to encourage the uptake of EVs (including e.g., traffic control incentives and fiscal incentives) (An et al., 2011; Barton & Schütte, 2017).

Further efforts to increase the market share of battery electric vehicles (and other zero emission vehicles) include information (Domain 1) to overcome skepticism (e.g., range anxiety), a massive and coordinated effort to ensure access to charging infrastructure (Domain 3) along continued measures to price CO₂ (Stock, 2021; Johansson et al., 2021).

Electric vehicles (battery electric, plug-in hybrid and hybrid electric) are finally becoming mainstream on the vehicle markets in many parts of the world, including in Sweden. As briefly discussed, the R&D and early deployment process has been long and involved a wide set of policy instruments, across many countries, including innovation policies (Domain 3) carbon pricing (Domain 2) and standards and information (Domain 1). The full transformation of road transportation will most likely require further infrastructural support (Domain 3) and potentially phasing-out policies, e.g., in the form of bans (Domain 1).

9.3.3 Third example – Bio energy carbon capture and storage in Sweden

Negative CO₂-emissions are prevalent in most global emissions pathways that meet the Paris Agreement temperature targets and are a critical component for reaching net-zero emissions in year 2050. According to Sweden’s climate target, greenhouse gas (GHG) emissions should be at a net-zero level by year 2045 (Swedish Government, 2017). This includes a reduction of domestic emissions of at least 85% (relative to the level in year 1990) and offsetting up to 15% of emissions. A recently conducted public inquiry in Sweden (SOU2020:4) has examined the supplementary measures (Swedish Government, 2020) and has identified BECCS as the most promising source for creating offsets, with an estimated potential in Sweden of over 20 Mt CO₂ per year (Johnsson et al., 2020).

In principle, there is little difference between Bio Energy Carbon Capture and Storage (BECCS) technologies and capture fossil-origin emissions (CCS). The post-combustion capture technology is a commercially available technology that has been used in the chemical industry for several decades (Bui et al., 2018) and which is also applied in current CCS schemes.

However, economic incentives supporting commercialisation and deployment of BECCS are missing. A common way to create incentives for reducing the environmental impact of emissions is the so-called Polluter Pays Principle, PPP. But in the case of BECCS, there is no pollution, but instead a common benefit (or a positive externality). Who should pay for this positive externality? This situation requires other types of funding and policy models than used for pollution abatement.

Zetterberg et al (2021) identifies five different models for creating incentives and financing for BECCS, using Sweden as an example: 1) governmental guarantees for purchasing BECCS outcomes; 2) quota obligation imposition on selected sectors to acquire BECCS outcomes; 3) allowing BECCS credits to compensate for hard-to-abate emissions within the EU ETS; 4) private entities for voluntary compensation; and 5) other states acting as buyers of BECCS outcomes to meet their mitigation targets under the Paris Agreement.

In 2021, the Swedish government commissioned the Energy Agency to implement a support system for BECCS based on Model 1 type in the form of a reversed auctioning system, were potential producers of BECCS can present bids and the government can choose producers with the most appealing bids (Swedish Energy Agency, 2021). This policy is an example of a Domain 3 policy, with the government as a procurer of BECCS, a positive externality.

BECCS has also acquired funding from two major innovation programs – the Swedish “Industriklivet” program and the EU Innovation fund (Domain 3).

Sweden’s government support programme will be important for establishing the first-of-a-kind installations, which will provide lessons for the next generation of production units. Nonetheless, after this initial funding instrument, other policies are needed to scale up this technology. For instance, this could be that the government imposes a quota obligation on selected sectors to acquire BECCS credits corresponding to a share of their emissions. This would broaden the financing basis and reduce costs for the state. It would increase the demand for BECCS and contribute to scaling up and optimising the technology (Domain 2).

In later years, interest in carbon offsets on the voluntary market has increased as corporations adopt net-zero GHG targets that will require offsetting to meet their climate targets (Hamrick and Gallant, 2017). Voluntary carbon markets have so far included, inter alia, forestation activities, biochar, enhanced soil carbon sequestration, increased use of wood in buildings, direct air capture technologies, and enhanced weathering

Enhanced weathering is a theoretical method of removing CO2 by spreading finely ground rock material on land, beaches, or sea. It mimics the natural weathering of rocks, which absorbs about one billion tonnes of CO2 annually.

(Poralla et al., 2021; PuroEarth, 2021). Once BECCS is implemented, BECCS credits could be included to this market. Voluntary markets strongly depend on engaged consumers that have expectations on the firms they want to buy products and services from (Domain 1). Voluntary markets could in the long run support the growth and optimisation of BECCS (Domain 2).

In summary, experience shows that pricing is not enough to drive deep decarbonisation in industry. Other types of policy instruments are needed. Grubb et al (2017) argue that the current landscape of policy instruments address three different domains of behavioral processes: Domain 1- satisfying behavior; Domain 2 – optimising behavior; and Domain 3 - evolutional and transformative processes. These three domains require different types of policy instruments:

Domain 1 policies (addressing adoption, satisficing, engagement) requires instruments such as:
- Standards
- Information
Domain 2 policies (addressing optimising, cost effectiveness and scaling up) requires instruments such as
- Pricing policies, for instance taxes, emissions trading
- Tradable green certificates
Domain 3 (addressing transformative changes) requires instruments such as:
- Innovation and investment support. This is often needed at early stages of technology development, particularly for transformative technologies, shifting from one technical solution to another whilst fulfilling the same societal needs. For instance: EVs replacing combustion engines; hydrogen direct reduction replacing blast furnaces in the iron and steel industry.
- Support and development of infrastructure for new technologies, for instance charging infrastructure for EVs, building power transmission capacity from new wind farms and to electrified industries, transport and storage of captured carbon dioxide. This type of support is often state-run.

These three types of policies depend on each other and interact. For instance, the establishment of transformative technologies is not an outcome of mere strategic innovation, but pricing and engaging instruments are also needed.