Technical Assistance Consultants Report

Project Number: 44068-012August 2015

Economics of Climate Change in Azerbaijan,Kazakhstan, and Uzbekistan: The Economics ofReducing Greenhouse Gas Emissions in the Energyand Transport Sectors

TA8119-REG Economics of Climate Change in Central andWest Asia Mitigation Component(Financed by the Asian Clean Energy Fund under the Clean

Energy Financing Partnership Facility)

This consultants report does not necessarily reflect the views of ADB or the Governmentsconcerned, and ADB and the Government cannot be held liable for its contents. (For projectpreparatory technical assistance: All the views expressed herein may not be incorporated intothe proposed projects design).

Prepared by Abt Associates, Bethesda, United States in association with Stockholm EnvironmentInstitute, Somerville, United States and Nazar Business and Technology, LLC, Tashkent, Uzbekistan

For the State Agency on Alternative and Renewable Energy Sources of the Republic of Azerbaijan, theMinistry of Energy of the Republic of Kazakhstan, and the Ministry of Finance of the Republic ofUzbekistan

ABBREVIATIONS

ADBAZN

Asian Development BankAzerbaijan manat

BAU Business as usualCCNG Combined cycle natural gasCCS Carbon capture and storageCDMCFL

Clean Development MechanismCompact fluorescent light

CHP Combined heat and powerCNG Compressed natural gasCSP Concentrated solar powerCO2e Carbon dioxide equivalentETSGDP

Emission trading schemeGross domestic product

GHGGJ

Greenhouse gasGigajoules

GWP Global warming potentialHFCs HydrofluorocarbonsIEA International Energy AgencyIPCC Intergovernmental Panel on Climate ChangeKZT Kazakhstan tengeLEAP Long-range Energy Alternatives Planning systemLPGMACCMJNAMANEOECD

Liquefied petroleum gasMarginal abatement cost curveMegajoulesNationally Appropriate Mitigation ActionNon-energyOrganization for Economic Co-operation and Development

O&MPMPPP

Operating and maintenanceParticulate matterPurchasing power parity

PVRETA

PhotovoltaicRegional Technical Assistance

SAARESSCNG

Azerbaijan State Agency for Alternative and Renewable Energy SourcesSingle cycle natural gas

SEISOCARTA

Stockholm Environment InstituteState Oil Company of the Azerbaijan RepublicTechnical assistance

T&D Transmission and distributionTOETPES

Tonne of oil equivalentTotal primary energy supply

TPP Thermal power plantUNDP United Nations Development ProgrammeUNFCCC United Nations Framework Convention on Climate ChangeUSC UltrasupercriticalUZS Uzbekistan somWtE Waste to energy

NOTE In this report, "$" refers to US dollars

CONTENTSPage

ABBREVIATIONS

I. INTRODUCTION AND BACKGROUND 1

II. EXISTING REGIONAL CONTEXT IN AZERBAIJAN, KAZAKHSTAN, ANDUZBEKISTAN 3

III. STUDY APPROACH AND METHODOLOGY 8

A. Modeling Tools 8B. Model Scope and Boundaries 9C. Indirect Co-Benefits 11D. Scenarios 11E. Projection Methods 17

IV. GHG EMISSION PROJECTIONS TO 2050 FOR AZERBAIJAN, KAZAKHSTAN, ANDUZBEKISTAN THE NO ACTION SCENARIO 23

A. Energy and Transport System Results 23B. GHG Emissions 31

V. COSTS AND BENEFITS OF MITIGATION IN AZERBAIJAN, KAZAKHSTAN, ANDUZBEKISTAN 37

A. Direct Costs and Benefits of Mitigation 37B. Indirect Co-Benefits of Mitigation 51C. Sensitivity Analysis 59D. Policy Implications of Mitigation Scenarios 60

APPENDIX 1: DOCUMENTATION 70

A. Structure of the National Models 70B. Key Variables in the Econometric Submodels of Final Energy Demand 76C. Historical Fuel Price Data 77D. Technical and Cost Parameters in the Power Sector Submodels 80E. Energy Resource Reserves and Yields 83

APPENDIX 2: METHOD FOR PROJECTING ENERGY USE 84

APPENDIX 3: METHOD FOR PROJECTING NON-ENERGY GHG EMISSIONS 93

APPENDIX 4: BASELINE DATA SOURCES 94

APPENDIX 5: SENSITIVITY OF NATIONAL MODELS TO KEY PARAMETERS 97

APPENDIX 6: REFERENCES 104

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I. INTRODUCTION AND BACKGROUND

1. The Asian Development Bank (ADB) Central and West Asia developing member countries ofAzerbaijan, Kazakhstan, and Uzbekistan have growing populations and abundant naturalresources which have helped them liberalize their economies and stimulate development sincegaining independence from the Soviet Union in the early 1990s. Between 2000 and 2010, realGross Domestic Product (GDP) grew 95% in Uzbekistan, 220% in Kazakhstan, and 400% inAzerbaijan. The countries rich hydrocarbon reserves have been a key contributor to this growth,both as a source of export revenue and for meeting domestic energy requirements. However,reliance on fossil fuels has also led to notably carbon-intensive economies. Fossil-intensiveindustries are an important source of greenhouse gas (GHG) emissions in Kazakhstan andUzbekistan, and fossil fuel production for export and domestic use contributes significant fugitiveGHG emissions in all three countries. In addition, Azerbaijan, Kazakhstan, and Uzbekistan arestill dealing with a legacy of carbon-intensive Soviet infrastructure and capital equipment (inspite of substantial improvements in energy efficiency over the last 15 years), such as powersectors dominated by fossil technologies.

2. Anticipated future population and economic growth promises to put further pressure onenergy resources, including greater demand for motorized transport and electricity. If the energyand transport systems of Azerbaijan, Kazakhstan, and Uzbekistan remain as carbon-intensiveas today, significant increases in GHG emissions will follow. But this situation also presents anopportunity to re-examine resources and energy options and pursue green-growth strategiesthat enable increased development with lower climate impacts. The utilization of cost-effectiveclean energy technologies and the promotion of energy efficiency, fuel switching, and low-carbon transport can play a crucial role in achieving these goals. Understanding the potential ofsuch approaches will also support the region in leveraging public and private sector finance forprioritized mitigation options that contribute to national development goals.

3. This report is a product of a regional technical assistance (RETA) 8119 on the Economics ofClimate Change in Central and West Asia (the TA) (Box 1) which was conducted over a two-year period to increase the availability of information on the options and costs for reducing GHG

Box 1: Asian Development Bank Regional Technical Assistance 8119: Economics of ClimateChange in Central and West Asia

Regional Technical Assistance 8119 (the TA) was approved by the ADB board in July 2012 and is co-financed by the Asian Clean Energy Fund under the Clean Energy Financing Partnership Facility andthe Climate Change Fund. The Mitigation Component of the TA started in May 2013 and will becompleted in September 2015.Two main project outputs are expected under the TA:

Output 1: The cost of climate change mitigation in energy and transport is estimated in Azerbaijan,Kazakhstan, and Uzbekistan.Output 2: Climate change mitigation investment opportunities are identified in Azerbaijan, Kazakhstan,and Uzbekistan.

The TA will result in the publication of regional reports on the economics of climate change, nationallyappropriate mitigation actions (NAMAs), and climate change investment concept notes. Thedevelopment of these reports has been complemented by a two-year capacity development programthat has trained decision-makers in economic analysis of mitigation measures and systems forgreenhouse gas (GHG) emission monitoring, verification, and reporting. A consultant team of AbtAssociates, Stockholm Environment Institute, and Nazar Business and Technology, LLC, implementsthe TA.

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emissions (Mitigation Component) and reduce the negative effects of climate change(Adaptation Component) in Central and West Asia. This TA covers the Mitigation Component ofthe TA, which estimates the cost of reducing GHG emissions and identifies climate changemitigation investment opportunities in the energy and transport sectors of Azerbaijan,Kazakhstan, and Uzbekistan.

4. This report focuses on the first of the Mitigation Components objectivesanalyzing the costsand benefits of mitigationand is based on a study of potential energy and transport-relatedabatement options that are aligned with national development priorities. The optionseffectiveness in terms of GHG abatement, social costs, and co-benefits was evaluated; andtheir potential interactions were assessed in a range of scenarios. The study wascomplemented by a capacity development program for energy and transport experts inAzerbaijan, Kazakhstan, and Uzbekistan focused on analyzing mitigation scenarios using thenational models developed during the study.

5. The report is structured as follows:

Section II summarizes the existing regional context for the energy and transport sectorsof Azerbaijan, Kazakhstan, and Uzbekistan in terms of economic activity, energyproduction and use, structure of electricity generation, GHG emissions, and energyresource potentials.

Section III describes the studys methodology, including techniques used to projectenergy supply and demand,1 estimate GHG emissions2, and analyze the costs, benefits,and co-benefits of mitigation.

Section IV summarizes the results of the GHG emissions baseline analysis for the studyperiod of 2010-2050. The baseline analysis is built around a scenario where nosignificant action is taken to reduce emissions beyond existing efforts to improve energyintensity and where countries continue to rely primarily on fossil fuels for energy andtransport. This is called the No Action Scenario.

Section V presents the results of the cost-benefit and co-benefit analyses of the selectedmitigation options and