The Right Price
Author | Ian Parry |
The Right Price Finance & Development, December 2015, Vol. 52, No. 4
Ian Parry
Raising the cost of fossil fuels to reduce greenhouse gas emissions presents policymakers with practical, but manageable, issues
Unless steps are taken to reduce greenhouse gas emissions, global temperatures are projected to rise by about 3 to 4 degrees Celsius above preindustrial levels by 2100, with risks of more severe warming and climate instability. Both advanced and developing countries are pledging to reduce emissions in what are called Intended Nationally Determined Contributions, at the December 2015 United Nations climate conference in Paris (see table). If fulfilled, these pledges would significantly slow global warming, though probably not by enough to contain projected warming to 2 degrees Celsius, which is the official target of the international community.
The key practical challenge facing policymakers is how to fulfill these pledges, preferably with policies that do not overburden the economy and that deal with such sensitive issues as the strain higher energy prices place on vulnerable households and firms. Carbon dioxide is by far the most important source of atmospheric greenhouse gases, which essentially trap the earth’s heat and cause warming of the planet. Putting a price on emitting carbon dioxide from burning fossil fuels should be at the center of any policies and, because of domestic environmental benefits, may actually be in a country’s national interest regardless of what other countries do.
Global carbon dioxide emissions from fuel combustion are slightly more than 30 billion metric tons a year, and without mitigating measures are projected to roughly triple by 2100 due to expanding energy use, especially in the developing world. In fact, developing economies, including emerging markets, already account for nearly three-fifths of global emissions, roughly half of which go into the atmosphere and remain for about a century.
Although mitigation is needed everywhere, 20 advanced and emerging market economies accounted for nearly 80 percent of global emissions in 2012 (see Chart 1). The success of the Paris effort will hinge critically on the collective actions of those countries.
Coal produces the most carbon emissions per unit of energy, followed by diesel, gasoline, and natural gas. Broken down by fuel type, 44 percent of global carbon dioxide emissions come from coal, 35 percent from oil products, and 20 percent from natural gas.
Reducing carbon dioxide emissions requires reducing the demand for fossil fuels, especially high-carbon fuels such as coal. Basic economics tells us the best way to do that is to raise the price of fuels. A higher price causes a wide range of behavioral changes that result in fewer emissions. For example, energy demand will decline as firms and households switch to more energy-efficient products and capital (including lighting, air-conditioning, cars, and industrial machinery) and conserve on the use of these products. Users will also switch to cleaner fuels—for example, from coal to natural gas in power generation and from these fuels to wind, solar, hydro, and nuclear, all of which produce no carbon. Ultimately it may be possible for some large industrial sources to capture the carbon dioxide emissions from fuel combustion and store them underground.
The beauty of carbon pricing—imposing charges on the carbon content of fossil fuels or their emissions—is that a single instrument can encourage the entire range of these behavioral responses across an economy, as carbon charges are reflected in higher prices for...
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