CHARACTERISTICS

Setting energy prices below actual cost provides incorrect market signals to producers and consumers alike. Such pricing policies distort the allocation of resources, further entrenches the use of established fuels/technologies, and creates artificial market barriers for the entry of new, more efficient technologies.

One study estimates that conventional energy technologies benefit from direct subsidies of more than $300 billion per year worldwide. This subsidy absorbs a large amount of capital, reduces the possibility of financing investments in energy efficiency, RD&D in low CO₂-emitting technologies, and other economic activities. By adopting marginal cost pricing and eliminating–or at least minimizing–energy price subsidies, technologies can compete on a "level-playing field", where more efficient power generation technologies would not be disadvantaged.

Subsidies have led to poor credit ratings for utilities, often making it difficult for them to raise capital in commercial markets. Short-term subsidies can be used, however, to support the initial market entry of GHG mitigation options such as renewables or clean coal technologies. In fact, such price guarantees or technology risk compensation mechanisms applied to low-carbon technologies would help reduce barriers to adopting those technologies that are not yet determined to be "commercially viable".

Finally, where retail prices (tariffs) are competitive, users are encouraged to use electricity efficiently and to modify their consumption patterns to purchase electricity when rates are lowest, during off-peak periods. Any reduction in fossil-fuel generated electricity would result in reduced GHG emissions.

SIZE:
Applicable for retail and wholesale electricity prices.

FEATURES:
Electricity prices reflect market rates.

COST:
N/A

CURRENT USAGE:
Many countries are undergoing energy sector market reforms and are removing subsidies to electricity and fuel prices.⁷

POTENTIAL USAGE:
Currently there are no countries whose electricity prices fully reflect market prices. In some countries rate caps are in place; in other, renewable energy is subsidized, etc. Also, no country's pricing policies internalize the costs of environmental protection, or reflect distance transactions.

ISSUES ASSOCIATED WITH IMPLEMENTING ACTION

• The form of tariff regulation will affect the economic incentive of a utility to undertake end-use efficiency programs. Where rate regulation is based on total sales, there is no incentive to reduce kilowatt-hour (kWh) sales, so few DSM measures besides load management are deemed cost-effective.
• The external costs of existing and new technologies are likely to vary greatly among countries and regions. Unilateral national adoption of full-cost pricing may, in the short run, adversely affect international economic competitiveness.
• Electricity tariffs may be subsidized to meet other public policy goals such as protecting various industries or localities. In such situations, tariff reform may be hampered by political resistance.
• Government price subsidies to energy-intensive industries in effect protect the pollution produced by such industries.
• Without effective metering, billing, and collection, price signals will be ineffective in encouraging efficient electricity use patterns.

CLIMATE CHANGE IMPACT

EMISSION EFFECT:
    

CONDITIONS FOR EMISSIONS MITIGATION:

• Subsidies to fossil fuels in developing countries is estimated to be about 20-25% of the value of world fossil fuel consumption at world prices. Removal of such subsidies so that electricity prices reflect market levels, would reduce demand such that a reduction of 7% of global GHG emissions would occur.

EMISSION ESTIMATE:
Will vary according to changes in electricity demand before/ after price reforms and changes in the capacity mix.

COST-EFFECTIVENESS:
Will vary according to individual country circumstances, but will likely be moderately to highly cost-effective.

SECONDARY EFFECTS:
Where use of fossil fuels is reduced, the associated emissions of air pollutants will also be reduced.

RESOURCES

• The Energy Partnership Program (EPP), an exchange program of the U.S. Agency for International Development (USAID) and the U.S. Energy Association, has hosted training seminars on tariff-setting.
• The National Association of Regulatory Utility Commissioners (NARUC) provides information on tariff-setting at http://www.naruc.org.
• The University of California Energy Institute posts several working papers on pricing, with studies of U.S. and international power markets at: http://www.ucei.berkeley.edu/UCEI/pubs-pwp.html

CONTACTS

National Association of Regulatory Utility Commissioners (NARUC)
Washington, DC
Tel: (202) 898-2200
Fax: (202) 898-2213
http://www.naruc.org

U.S. Energy Association
Washington, DC
Tel: (202) 312-1230
Fax: (202) 682-1682