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Getting Energy Prices Right

Ambitious new IMF research quantifies energy externalities for 156 countries.

Last month Meredith wrote about coal being too cheap and Max wrote about gasoline being too cheap. But what is the right price for energy?

Nobody in recent years has done more to try to answer this question than Ian Parry, a University of Chicago trained economist now at the International Monetary Fund.  Over the last 20 years Parry has written dozens of articles on this topic, including influential work on gasoline taxes, pollution externalities, traffic congestion, and the double dividend.

ianparry

In his latest work, Parry has turned his attention in an ambitious new direction.  Together with a team of IMF researchers, Parry set out to quantify energy externalities for 156 countries.  The result is the aptly-named study, “Getting Energy Prices Right”.  The summary can be accessed for free here, or the entire report can be purchased for $28 here.  Following best practices for open science the team has also made all of the data from the project publicly-available here including all of the information on power plant locations, mortality rates, emissions factors and transport data.

These figures begin to give a sense of the scale of the project.  You want to know local pollution damages from coal in Bangladesh?  They have it. Traffic congestion damages from gasoline in Morocco?  Sure.  Vehicle accident externalities from diesel consumption in Sri Lanka?  Yep.  Previous studies had measured marginal damages for particular energy types and for particular individual countries, but this new work provides comprehensive estimates for the entire planet.

CoalCostsGasolineCosts

The results are fascinating.  Coal is indeed too cheap.  The bars in each figure indicate marginal external damages by externality type. Local pollutant damages from coal vary widely across countries because of differences in population exposure and other factors, but external costs exceed current tax levels everywhere.  Local pollutant impacts are also large enough so that, for most countries, carbon pricing would be welfare improving even if you ignore benefits that accrue to other countries. Meredith blogged about Parry’s related paper on these co-benefits here.

Gasoline and diesel also tend to be too cheap, but the story is more complicated.  Whereas coal and natural gas taxes are low around the world, many countries do have substantial fuels taxes. In fact, according to Parry’s estimates, Germany and the United Kingdom, for example, have taxes that exceed the marginal external damages from gasoline consumption. The United States has a much lower gasoline tax, well-below external damages. This is true even here in California, with our higher-than-average state gasoline tax.

But even more interesting are the countries like Egypt, Indonesia, and Nigeria that have gasoline subsidies rather than taxes. Despite increasing calls for reform, there are about two dozen countries that continue to provide subsidies for gasoline and diesel. In a new Energy Institute working paper available here, I use Parry’s estimates to quantify the external costs of global fuel subsidies. Cheap gasoline leads people to drive more, causing increased vehicle emissions as well as traffic congestion and accidents. Based on conservative assumptions about price elasticities, I find that global fuel subsidies cause $44 billion in external costs annually. This includes $8 billion from carbon dioxide emissions, $7 billion from local pollutants, $12 billion from traffic congestion, and $17 billion from accidents. To put this in some perspective, this $44 billion is about 1/3 the total size of the fuels market in countries that subsidize gasoline and diesel ($128 billion annually).

EX_Top_Ten

This figure shows annual external costs for the top ten countries. The list is dominated by OPEC members, mostly in the Middle East and Northern Africa. Cheap energy has long been a permanent fixture in many of these countries and is often viewed as part of sharing the resource wealth. This approach to redistributing resources is expensive, however. I find that it costs more than $1 in inefficiencies for each $1 that is transferred to consumers. This is very expensive, particularly when alternative approaches exist that could achieve the same distributional goals at much lower cost. Residents of Alaska, for example, receive an annual divided ($2,000 in 2015) derived from oil and gas revenues.

Also interesting is the large degree to which these external costs are driven by traffic congestion and accidents.These externalities are rarely mentioned in policy discussions about fuel subsidies but are quantitatively very important. Riyadh, Caracas, Tehran, and even Kuwait City, are well-known for severe traffic jams, so drivers are imposing a significant negative externality on other drivers in the form of reduced driving speeds. Moreover, a growing literature including Max’s work (here) shows that accident-related externalities are a major component of the external costs from driving.

caracas

Caracas

kuwait

Kuwait City

I’m a big believer in the idea that some number is better than no number. Quantifying the external costs from energy for 156 countries is an incredibly ambitious task that is impossible to get exactly right. Can the IMF numbers be refined and improved? Absolutely. But in striving to assign actual numbers to these externalities, Ian Parry and co-authors have taken a significant step forward. If policymakers are going to make informed decisions they need to be able to weigh the full social benefits and costs of different alternatives.

Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.

Suggested citation: Davis, Lucas. “Getting Energy Prices Right” Energy Institute Blog, UC Berkeley, March 7, 2016,
https://energyathaas.wordpress.com/2016/03/07/getting-energy-prices-right/

For more see “The Environmental Cost of Global Fuel Subsidies” (by Lucas Davis), Energy Journal, 2017, 38, 7-27.

Lucas Davis View All

Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley. He is Faculty Director of the Energy Institute at Haas, a coeditor at the American Economic Journal: Economic Policy, and a Faculty Research Fellow at the National Bureau of Economic Research. He received a BA from Amherst College and a PhD in Economics from the University of Wisconsin. Prior to joining Haas in 2009, he was an assistant professor of Economics at the University of Michigan. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.

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