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ECONOMIC & MARKET MECHANISMS

Removal of Fossil Fuel Subsidies

Legislation to repeal and remove subsidies for production and use of fossil fuels is the most direct measure to promote clean energy. Subsidy removal not only is a costless measure, but by definition, it is a certain revenue enhancing one. In many countries fossil fuel subsidies amount to tens or more millions of dollars. Global annual energy subsidies are estimated at about $250-300 billion in the mid-1990s, and that doesn't count the huge U.S. subsidies required to secure the supply of oil imports which has been estimated to produce a true oil cost of over $100 per barrel. Revenues saved from subsidy-removal can be used to promote clean energy alternatives internally. The problem in achieving subsidy removal is political -- recipients of subsidies get addicted to them and feel they can not survive without them. But these subsidies both encourage increased use of fossil fuels and discourage the use of clean alternatives by making them less economically competitive.

Subsidies are usually granted by governments under the pretext of protecting domestic jobs, promoting use of domestic resources and protecting the poor from high energy prices. In fact, subsidies are enacted under pressure from the wealthiest elements of society to increase their profits. In most developing countries, the poor do not even have electricity or automobiles and thus receive virtually no benefit from the subsidies. In many countries, fossil fuels are imported at great cost, displacing the ability to invest in basic needs such as education, health care and the environment. In those countries that have domestic fossil resources, more beneficial use can be made of the subsidy funds to retrain and place workers and acquire clean energy resources, which also can be domestically produced.

Developing countries like China are eliminating coal subsidies, downsizing coal production, and creating major renewable energy industries that can be exported worldwide. China's actions are particularly remarkable. Between 1990 and 1997, annual fossil fuel subsidies in China fell from $24.5 billion to $10 billion. Coal subsidy rates fell from 61% in 1984 to 37% in 1990 to 29% in 1995, and further since then. Petroleum subsidies fell from 55% in 1990 to 2% in 1995. In 1999, 26,000 coalmines were to be closed out of the 75,000 mines remaining; between 1990 and 1999 over 1.3 million jobs were lost in this sector.

Poland has decreased its fossil fuel subsidies by $3 billion per year. These reductions led to an overall 30% decrease in the amount of coal used between 1987 and 1994. Since 1990, Russia has lowered fuel subsidies by more than 50%, decreasing its carbon emissions beyond 30%. The United Kingdom decreased coal
subsidies from $7 billion in 1989 to zero in 1995. This has led to an increase in the use

of North Sea natural gas by 62% while carbon emissions have fallen consistently during the five-year period between 1990 and 1995.

On the other hand, there are countries that are not making comparable strides in reducing incentives and subsidies promoting greenhouse gas emissions. For instance, the United States is delving out fossil fuel supports as high as $18.3 billion a year. Germany is still requiring its electric utilities to purchase domestic coal, and has increased the amount of money funding subsidies by more than 50%. Canada's tax
incentives amount to $6 billion per year. France and Japan, while reducing the amount of money available for fossil fuel supports are still providing substantial incentives for the use of coal, $722 million and $149/ton.

The political difficulties of eliminating subsidies and the transition problems for local economies in fossil-producing countries can not be minimized. Nevertheless, countries such as Brazil, China, the Czech Republic, India, the Netherlands, Poland, the United Kingdom and Russia have reduced or eliminated fossil subsidies successfully. Eliminating fossil subsidies really is a sine qua non of reducing carbon dioxide emissions.

Inclusion of Externality Costs

A legislative or regulatory requirement for consideration of externality costs can materially promote clean energy use. When the costs of fossil fuel use are compared to the costs of clean energy resources, the costs to society from fossil fuel emissions are generally ignored, thus effectively placing a zero value on these costs. Numerous studies have now shown that these external costs are substantial, especially with respect to the increased incidence of human health problems and early mortality. Some of these studies calculate that the externality costs of burning coal for electricity can be greater than the generation costs. No accurate assessment can be made of the comparative costs of clean energy without inclusion of externality costs. Some state utility regulatory commissions in the United States had required that externality costs be included in selection of new electric service resources, but these measures were abandoned by many utilities with the prospect of deregulation.

Use of Life-cycle Costs

The costs of introducing clean energy resources often entail substantial first cost investments, but the savings over the life of these resources make them cheaper than fossil fuel alternatives over time. This phenomenon is particularly evident with efficiency measures and with solar, hydroelectric and wind energy resources where the first cost of equipment acquisition can be considerable, but the total absence of fuel costs and very low maintenance costs result in their being much more economically competitive to fossil fuels over the anticipated life of their use. The costs of fossil fuels should always be compared to efficiency and renewable resource costs on a life-cycle basis. Legislative or regulatory requirements for the utilization of life cycle costing are feasible
and costless. Life-cycle costing also was required by utility commission regulations in a
number of states in the United States, but this requirement, too, has now been abandoned by many utilities due to perceived competitive pressures from deregulation.

Pollution Taxes

Taxing pollutants or polluting fuels can be an effective way of promoting emission reductions in the marketplace. Such taxes make the polluters pay the externality costs of the damages to society from their pollution. They raise the price of emissions-intensive goods and lower profits for fossil fuel use, thus allowing market forces to reduce emissions.

Taxation of carbon dioxide emissions or polluting fuels is one of the most direct ways of addressing global warming. Carbon taxes have been imposed in Brazil, Denmark, Finland, Italy, Latvia/Lithuania, Sweden and the United Kingdom (which funds its Renewable Purchase Obligation subsidies with electricity taxes). For example, Sweden instituted environmental taxes including one on carbon dioxide in 1991 (except the generation of electricity), and on NOx emissions in 1992. The carbon tax was levied at 25% of the rate applied to other users in 1993 but rose to 50% of that levied on other users in 1997.

Pollution taxes are politically difficult since inevitably some energy-intensive industries and jobs are affected. However, if the pollution taxes are offset by reductions in other business taxes, they can produce a net economic benefit. The political difficulty is illustrated by the fact that in a number of the countries that have legislated carbon taxes, major industries have been exempted to avoid competitive disadvantage to domestic production. Ideally, carbon taxes should be imposed internationally to eliminate adverse competitive effects, but the political difficulty is so great that such taxes are not even on the table for discussion at the Kyoto implementation negotiations of the conferences of the parties. The competitive effects of carbon taxes can be ameliorated with border tariffs and rebates.

Emission Trading

An interesting innovation in reducing the costs of sulfur dioxide and Nox emissions in the United States has been to provide for emission trading rights. Polluters may accumulate trading rights by reducing their emissions below adopted standards and then sell these rights to other polluters for whom pollution reduction is more expensive. The advantage of emission trading rights over pollution tax is that the pollution cap underlying trading rights assures specified carbon dioxide emission reductions, whereas the effects on emissions of taxes is somewhat speculative. The Norwegian government therefore has just decided to consider replacing its carbon tax, which has not resulted in sufficient carbon reduction to meet its goals, with an emissions cap and emission trading rights. Some environmental groups object to the grant of a legal right to pollute. International emission trading rights for carbon dioxide are now being debated as a means of reducing the costs of climate change measures in the Kyoto Protocol conferences of the parties' implementation negotiations.

Technology Incentives

While long-term subsidization of any fuel, technology or product distorts the market and is therefore theoretically undesirable, temporary subsidies to bring new technologies into the marketplace can be effective, useful, and often essential to accelerate their market acceptance. Also, where fossil fuel subsidies persist, non-fossil fuel subsidies are justifiable to level the playing field for them.

A good example of effective use of such temporary incentives is found in Denmark's introduction of wind power. From the start of its wind power program in 1976 through 1996, the Danish Government spent $75 million on wind turbine R&D. The Government then provided subsidies for up to 30% of the investment costs of a turbine in 1980, which was reduced to 15% in 1984 and repealed in 1989 as the market accepted the new technology. The Government now requires Danish power companies to pay 85% of the retail electricity price of wind energy, paid for by rebates of carbon taxes on fossil fuels. Consumers now pay less for wind power than for power from coal. As a result of this program, Denmark now has over half of the world sales of wind turbines. Its turbine production now provides about 60% of new wind turbines installed throughout the world, produces revenues of nearly $1 billion a year and has provided over 16,000 jobs. Today, 100,000 Danish families own wind turbines or shares in wind cooperatives.

The Poland Efficient Lighting Project, financed by the GEF and administrated by the International Finance Corporation established a 3-year program to subsidize compact fluorescent lamp sales. At the end of the program in 1997 some 1.2 million lamps had been installed and 80% of the buyers indicated an intent to buy these efficient lights again. Energy savings from the program were estimated at 725GWh and 206,000 tons equivalent of carbon emissions over the lifetime of the lamps. The subsidy cost less than $25 per ton of avoided carbon emissions.

Germany has had great success with its Electricity Feed Law (EFL) subsidizing the purchase of renewable resources. EFL requires utilities to pay 90% of the retail residential price for electricity produced by wind, solar, hydropower and biomass resources. For wind resources, the law also provides subsidies based on electricity output or capital costs. By the end of 1997, Germany had an installed wind capacity of 2,081 MW, the highest in the world. EFL also stimulated a 450% increase in photovoltaic installations from 1991 to 1997, with a 37% drop in prices. German companies such as Siemens now lead the world in PV sales. Germany has begun a A100,000 Roofs@ PV program, with low interest loans to be issued by private banks, which promises to be the largest single PV subsidy program in the world.

Sweden used a competition among suppliers to encourage manufacturers to improve the efficiency of a wide variety of home appliances. The improved performance of the winning model of a refrigerator-freezer was remarkable, using more than 30% less electricity than the most efficient model then on the market. There have been similar successful competitions run by the U.S. Department of Energy under its "Golden Carrot" program discussed below.

Vehicle Replacement Incentives

Since the most polluting vehicles tend to be older models, legislation creating an incentive to replace existing vehicles with new less polluting models could be very effective. Such incentives have been proposed but not adopted in the U.S. Congress. The opportunities for emission reductions are enormous. For example, 65% of the cars in Egypt are over 10 years old, 25% are more than 20 years old, and 25% of the buses are over 15 years old. These figures are typical for most developing countries. "Feebates" have been suggested -- charging a fee on inefficient vehicles which would pay for granting a rebate for the purchase of more efficient models, best calibrated to the difference in efficiency between the old vehicle, which would be required to be scrapped, and the newer one purchased with the rebate. Unfortunately, there were no programs identified to retire older vehicles. There also are no international measures to prevent the sale of inefficient retired vehicles by industrialized countries to developing countries, a major problem for the latter.

Environmental Disclosure

A number of states have required disclosure by their utilities of their emissions and the sources of their power generation. Information required typically includes the reporting of generation sources, fuel mix, fuel emissions, kWh price, price volatility, and contract terms. Market studies and polls consistently show that consumers want clean energy resources. In competitive retail markets, this disclosure requirement enables consumers to make informed decisions about the environmental consequences of their choice among suppliers. Disclosure requirements have been imposed by many U.S. states.

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