IPCC Fourth Assessment Report: Climate Change 2007
Climate Change 2007: Working Group III: Mitigation of Climate Change Energy prices, pricing schemes, energy price subsidies and taxes

Market-based energy pricing and energy taxes represent a broad measure for saving energy in buildings. The effect of energy taxes depends on energy price elasticity, that is the percent change in energy demand associated with each 1% change in price. In general, residential energy price elasticities are low in the richest countries. In the UK, long-run price elasticity for the household sector is only –0.19 (Eyre, 1998), in the Netherlands –0.25 (Jeeninga and Boots, 2001) and in Texas only –0.08 (Bernstein and Griffin, 2005). However, if energy expenditures reach a significant proportion of disposable incomes, as in many developing countries and economies in transition, elasticities – and therefore the expected impact of taxes and subsidy removal – may be higher, although literature is sparse on the subject. In Indonesia, price elasticity was –0.57 in the period from 1973 to 1990 and in Pakistan –0.33 (De Vita et al., 2006). Low elasticity means that taxes on their own have little impact; it is behavioural and structural barriers that need to be addressed (Carbon Trust, 2005). To have a significant impact on CO2 emission reduction, excise taxes have to be substantial. This is only the case in a few countries (Figure 6.6): the share of excise tax compared to total fuel price differs considerably by country.

Figure 6.6

Figure 6.6: Electricity and gas prices and taxes for households in 2004

Notes: Total price is listed when no breakdown available to show taxes; total taxes are provided when no breakdown on excise and VAT (GST). Country name abbreviations (according to the ISO codes except Chinese Taipei): DK – Denmark, JP – Japan, CH – Switzerland, FR – France, GB – United Kingdom, HU – Hungary, TR – Turkey, PO – Poland, NZ – New Zealand, AU - Australia, MX – Mexico, US – United States of America, KR – South Korea, CT – Chinese Taipei, CA – Canada, ZA – South Africa*, KZ – Kazakhstan, RU – Russia. * South Africa data is for 2003.

Sources: IEA, 2006a; RAO, 2006.

In stark contrast to imposing energy taxes, energy prices are subsidized in many countries. This results in under-pricing of energy, which reduces the incentive to use it more efficiently. Energy subsidies are also typically much larger, per GJ, in developing and transition countries than in most industrial economies (Markandya, 2000). The total value of energy subsidies of eight of the largest non-OECD countries (China, Russia, India, Indonesia, Iran, South Africa, Venezuela and Kazakhstan), covering almost 60% of total non-OECD energy demand, was around US$ 95 billion in 1998 (UNEP OECD/IEA, 2002). In 1999, the IEA estimated that removing the energy subsidies in those eight countries would reduce primary energy use by 13%, lower CO2 emissions by 16% and raise GDP by almost 1%.

While it may be economically and environmentally desirable, it is a socially sensitive task to remove end-user subsidies, especially in the residential sector. Since the bulk of these subsidies are found in countries with low incomes and high fuel-poverty rates, their removal can cause a substantial financial burden for families and even institutions. This, in turn, can lead to bankruptcy, increased payment arrears, energy theft and generally increased social tensions (ERRA/LGI, 2002; Ürge-Vorsatz et al., 2003), ultimately leading to disincentives to improve efficiency. Therefore, a drastic subsidy removal is often accompanied by social compensation programmes. One potentially important form of alternative compensation – although not frequently used to date – is assistance to low-income households to invest in energy-saving measures that reduce fuel costs and GHG emissions in the long term as opposed to direct cash assistance providing short-term relief (ERRA/LGI, 2002). For a number of years, the US government has provided 1.5–2.0 billion US$/yr to help low-income households pay their energy bills (LIHEAP, 2005), and smaller amounts budgeted for grants to ‘weatherize’ many of these same households with efficiency measures that help to permanently reduce monthly fuel and electricity bills (Schweitzer and Berry, 1999).

Some forms of energy subsidies can have positive energy and environmental effects. For example, subsidies on oil products and electricity in developing countries reduce deforestation and also reduce indoor pollution as poor, rural households switch away from traditional energy sources, such as wood, straw, crop residues and dung. These positive effects, however, can be better achieved through other means – e.g., the introduction of safe and efficient cookers and heaters utilizing these renewable sources. The challenge is to design and reform energy subsidies so they favour the efficient and environmentally sound use of energy systems (UNEP OECD/IEA, 2002)