E n v i r o n m e n t S t r a t e g y Mainstreaming Environment in the 38177 Energy Sector -- The Case of the Energy-Environment Review for Iran Hayato Kobayashi, Sherif Arif, and Fernando Loayza No. nergy-environment reviews (EERs) aim at integrating environmental con- siderations in energy policy. Typically, cost-benefit analysis is used to 17 E evaluate damage costs from energy consumption, assess the effectiveness of proposed actions, and arrive at recommendations for a set of priority investments D E and policy reforms. EER is one of the policy tools proposed in Fuel for Thought: C An Environmental Strategy for the Energy Sector, which was approved by the Bank's E Board of Executive Directors in 1999. M B The EER for the Islamic Republic of Iran illustrates how placing environmental is- E R sues in the context of key economic indicators was useful to incorporate environ- mental considerations on the country's Fourth Five-Year National Development 2 Plan. This EER can be considered an SEA because it focuses on identifying prior- 0 0 ity investments and policy reforms needed for the incorporation of sustainability 6 considerations into energy planning. Methodology and Key Findings oF theeeR In a report issued in 2004, the United Nations Development Programme (UNDP) warned that Iran's efforts to meet the environmental targets of the Millennium Development Goals were lagging. Environ- Box 1 mental problems such as air pollution were becoming a concern for the country. The the externe Project challenge before Iran was how to improve The ExternE project is the first comprehensive attempt to evaluate externalities as- environmental protection while promoting sociated with energy use. The project was launched in 1991 by the European Com- economic growth in a context where energy mission, and sincethen, it developed theconceptual approachandthe methodology has been traditionally subsidized due to its needed for its application. The project uses `damage function' or `impact pathway relative abundance and low income levels of approach' for impact assessment and valuation, with methods ranging from simple most of its population. The government ac- statistical relationship to complex models fed by databases. cordingly requested World Bank assistance in reforming Iran's energy policy to enhance Source: ExternE Project: http://www.externe.info/ economic and environmental sustainability. An energy-environment review was selected time sequences for implementing price reforms1--was used to construct as the tool for carrying out the necessary twelve scenarios. Each of the scenarios was then evaluated in terms of local analysis. The study, which cost US$350,000, environmental damages, cumulative opportunity costs,2 and impact on was funded by the Trust Fund for Environmen- inflation. The latter was selected as an indicator of the political feasibility tally and Socially Sustainable Development, to implement the proposed measures. supported by the Governments of Norway Price reform entails setting domestic energy prices equal to the oppor- and Finland. tunity cost of energy. In the EER analysis, energy subsidies--the difference The first steps in the review were to between energy prices in Iran and the full costs of energy, including all establish a baseline for energy use in Iran, external costs--were estimated at 118.3 trillion rials in 2001, which is in project growth in the sector, and calculate good agreement with a calculation in a separate study.3 In 2019, in the the corresponding environmental damage reference scenario, which assumes that no price reform and no sectoral costs, with specific attention to air pollution. measures are implemented, energy subsidies were estimated to reach 287.7 Damages to health, buildings, crops and trillion rials, or 20 percent of GDP, clearly showing the significant challenges eco-system were considered in the study. faced by the Iranian energy sector. To estimate the impacts of price reform, Environmental damage costs were principally price elasticity was used to construct demand curves for future years. Price estimated through valuation of health impacts, reform by 2009, for example, was estimated to reduce energy demand and changes to crop yields and damage to build- environmental damages by nearly half of their 2019 levels corresponding to ing materials based on the method used by the reference scenario. On the other hand, however, price reform by 2009 the European Commission's ExternE project would result in a 12.6 percent increase in inflation, as measured by the to assess environmental damage costs in consumer price index (CPI). Deferring price reform to later planning periods member states (see box 1). The estimates (2014 or 2019) had lower inflationary impact but it would be associated were adjusted by the purchasing power parity with higher opportunity costs. exchange rate between Iran and the European Sectoral measures are proposed government actions intended to reduce Union. The aggregate environmental damage environmental damage associated with energy use. The efficiency and from air pollution originating in energy use effectiveness of 25 sectoral measures, selected from an extensive list, were was estimated to be US$4.7 billion, equivalent estimated in the EER using the opportunity costs of energy and the damage to 5.7 percent of Iran's nominal gross domestic costs of emissions. Sectoral measures were then categorized as Class A, B, product (GDP) in 2001. The transportation or C, on the basis of their expected attractiveness to the government.4 Class sector was found to be the largest source of A measures are the most beneficial, as their associated economic benefits air pollution, accounting for 41 percent of in the form of opportunity cost savings outweigh their implementation cost. environmental damage in 2001. Class B measures are also beneficial because the sum of opportunity cost The EER estimated that without price savings and avoided costs of domestic environmental damage are greater reform and policy intervention, environmental than implementation costs. Class C measures are not cost-effective as the damage costs would grow to US$12 billion, opportunity costs and avoided domestic environmental damage does not or 6.6 percent of nominal GDP, by 2019. The outweigh their implementation cost as indicated by the 0.51 benefit-cost main underlying cause for this significant cost ratio. For class C measures to become cost-effective, Iran would need to was the use of subsidized fossil fuels. A com- receive monetary transfers from abroad in exchange for avoiding greenhouse bination of two policy interventions--price gas emissions. The EER estimated a very high benefit-cost ratio (6,213) if reform and sectoral measures plus different reductions of methane were eventually sold as certified carbon reductions Table 1 Sectoral measures and their benefit-cost ratios Examples of sectoral measures Class A Class B Reduction of electricity Exhaust emissions Class C transmission and standards for new Management of methane distribution loss vehicles from landfills Benefit-cost ratio based on economic benefits only 1.5 >1 No benefit if flared Benefit-cost ratio with local damage savings 1.57 2.3 0.51 Benefit-cost ratio with local and global damage savings 1.69 1.8a 6,213b Notes: Yellow shaded areas denote cost-effective measures. a. The benefit-cost ratio for exhaust emissions standards decreases when global environmental damage savings are included because this measure, although it reduces nitrogen oxides and other local pollutants, leads to higher carbon dioxide emissions. b. The extremely high benefit-cost ratio is a consequence of the high global warming potential of methane, the relative efficiency with which methane is converted to carbon dioxide, and the low cost of a flare. emissions in the global market. In such a situation, as management. Although environmental legislation in Iran indicated in table 1, class A, B and C measures generate is fairly comprehensive, the EER pointed to the absence of benefits greater than the costs incurred to achieve them. a comprehensive environmental database, the lack of in- outcoMes frastructure such as a monitoring mechanism, and a great need for capacity building in all fields of environmental The scenario analysis showed that only a combination protection. These shortcomings need to be addressed to of price reform and sectoral measures can bring envi- create an institutional setup that favors mainstreaming of ronmental damage costs below the 2001 level in 2019. the environment. Toward this end, four training workshops Furthermore, it demonstrated that phasing out subsidies were organized during the EER, and 130 participants by 2009 holds the greatest benefits for the environment from sector ministries and private sector consulting firms but corresponds to a larger increase in inflation. received training on energy and environmental issues in The political feasibility of the proposed price reform Iran, on cost-benefit analysis techniques, and on economic was discussed with government officials at consultation evaluation of environmental damage costs. In addition, a workshops. The EER concluded that early price reform temporary EER office and a steering committee made up would be politically difficult, and it therefore proposed of representatives of all ministries that are stakeholders in scheduling the elimination of subsidies for 2014 or 2019. environment and energy matters were established in Iran's A combination of price reform in 2014 and Class A and Department of Environment. Both contributed effectively B sectoral measures was selected for the Action Plan, as to a policy dialogue at a time when the government was the best feasible intervention. preparing its Fourth Five-Year Development Plan.5 In case that comprehensive price reform is not feasible iMpleMentation oF eeR Results even in 2019, the EER recommended as the second-best option a partial price reform focusing on transportation A policy note summarizing the EER process, analysis, fuels. The transportation sector is the largest contributor recommendations, and Action Plan was distributed to and to air pollution and environmental damage, and targeting debated by Iranian decision makers and parliamentarians. the price of transportation fuels, especially gasoline, would The note was designed to make the results of the study result in the largest environmental benefits. In addition more accessible to those who might not be familiar with to the elimination of subsidies for transportation fuels, cost-benefit analysis techniques and economic evalu- the plan recommended the implementation of Class A ation of damage costs. Some of the recommendations sectoral measures. This should be part of the core set of contained in the EER--notably, those on price policy in- actions, as the promotion of Class A measures will have struments--were included in the Five-Year Plan. The note the greatest impact, although other measures with less has recently been translated into Farsi by the Department impact should not be ignored. of Environment for further dissemination. The Environ- ment Management Support Project is supporting the EER institutional issues recommendations by promoting capacity building and The EER also evaluated environmental regulations and in- institutional strengthening of the Air Quality Monitoring stitutional issues related to energy use and environmental Network and the EIA system. To implement measures that fall under policy makers with a set of straightforward, ------. Forthcoming. "Islamic the jurisdiction of multiple ministries, the comparable alternatives for consideration Republic of Iran: Cost As- sessment of Environmental EER proposes the establishment of inter- in the light of both national goals and po- Degradation." Sector Note sectoral coordinating bodies or task forces litical feasibility. 32043-IR, World Bank, Wash- formed by different ministries. It also sug- ington, DC. gests setting up monitoring and evaluation Notes agencies. The creation of a policy support 1. The different price reform scenarios are: unit within the Department of Environment no reform, and reform by 2009, 2014, to help relevant ministries mainstream and 2019. Authors environmental issues and further elaborate 2. Opportunity cost is the difference between the subsidized fuel price in Iran hayato Kobayashi, consultant, ENV; the Action Plan is also recommended. Once and the real value of the fuel after all ex- Sherif Arif, regional environmental this unit is fully operational, it will take ternalities are internalized. Cumulative and safeguards advisor, MNACS; and over the functions of the EER Office and opportunity costs represent the burden Fernando Loayza, senior strategic envi- ronmental assessment specialist, ENV, the steering committee referred to above. to the Iranian economy in the form of all of the World Bank. This unit will be established as part of energy subsidy accumulated over time. 3. The Energy Balance Report for 2001 by the Environment Management Support the Office of Energy Planning, Ministry Reviewers Project, which is being implemented with of Energy estimated total subsidies in This Note was reviewed by Masami co-financing from the World Bank.6 Kojima, lead energy specialist, CoCPo; 2000 to be 114 trillion rials. ranjit Lamech, sector leader, EASEG; Within the World Bank, the recom- 4. Measures that were not cost-effective and Ernesto Sanchez-Triana, senior mendations will feed into the forthcoming were categorized as Class D, and environmental engineer, SASES, all of measures that could not be quantified country assistance strategy for Iran. The the World Bank. were omitted from the analysis. It is Bank's Carbon Finance Business Unit has important to note that measures which used the EER as the basis for examining are already attractive under present The Environment Strategy Notes series reductions in carbon emissions in waste conditions and thus do not require ad- aims to provide a forum for discussion on a management activities in Iran. The EER ditional incentives are classified in the range of issues related to the Environment EER as not cost-effective options for Strategy, to help the transfer of good prac- was also used in the transportation sector government action because the goal of tices across countries and regions, and to study and was part of the cost assessment the study was to identify the impact of seek effective ways of improving the Bank's of environmental degradation approved environmental performance. government intervention, not the impact in June 2005. The results of the analysis of the activity itself. The views herein are those of the author(s) are included in a sector note (World Bank 5. Those ministries and organizations were and should not be considered official policy of, nor attributed to, the World Bank forthcoming) on cost assessment of envi- the Ministry of Oil, the Ministry of Indus- try and Mining, the Ministry of Housing Group. ronmental degradation. and Urban Development, the Ministry of lessons the Interior, the Ministry of Health and T Medical Education, the Management Executive Editor The most important lesson of the EER for and Planning Organization, and the Kulsum Ahmed Iran is that environmental considerations Atomic Energy Organization. Editor can influence energy policy if their econom- 6. The Environmental Management Support Nancy Levine ic and welfare relevance is highlighted and Project (P0744990) was approved by the Designer / Bank's Board of Executive Directors on Production Manager if they are presented in a format adapted to April 8, 2003. Jim Cantrell the mindset and outlook of policy makers. In particular, assessment of environmental ReFeRences impacts by estimating environmental dam- age costs in monetary terms, and analysis European Commission. 2006. "ExternE--Exter- of alternatives for environmental protection nalities of Energy. A Research Project of the T h E W o r L d B A N K European Commission." http://www.externe. through a range of scenarios using cost- info/. Environment department 1818 h Street, N.W. benefit analysis, can form the basis for a UNDP (United Nations Development Programme). Washington, d.C. 20433 USA compelling argument that has the potential 2004. "Islamic Republic of Iran. The First Millennium Development Goals Report 2004: Tel: 202 473 1000 to influence strategic decision making. Not Achievements and Challenges." http://www. Fax: 202 477 0565 only are environmental issues presented on undp.org.ir/reports/Iran_MDGR_2004.pdf. E-mail: eadvisor@worldbank.org World Bank. 2000. Fuel for Thought: An Environmen- Web: <> indicators; this type of assessment provides DC: World Bank.