Price energy according to its true cost



The environmental and health costs of energy production and consumption are usually not fully captured by market prices of energy. As a result, market prices will fail to encourage a sustainable level of consumption and development of sustainable energy sources. The liberalisation of energy markets may make this failure more pronounced. To correct the market failure in the energy area, legislators could use a combination of instruments, including fiscal measures such as energy taxes, suspension of subsidies, reduced VAT rates on energy saving equipment, reduced property tax for energy efficient buildings, and co-generation power plants.


The idea: 

Market prices for energy usually fail to capture the full environmental and health costs of energy production and consumption. As a consequence, the use of fossil-fuels with many side-effects tends to be too high while the use of renewable sources of energy with few environmental side effects tends to be too low. This is a trend that the liberalisation of the energy market may make even more pronounced. Because of the failure by the market to reflect the full price of energy, the incentive to use energy efficiently and to switch to cleaner sources of energy is weaker than it would otherwise be.

Legislators can adopt a series of measures to internalise all external environmental and health costs into the price of energy. This will help renewable energy to compete with fossil fuel energy on a fair footing in a well-functioning energy market. These measures include steps to:

  • Phase out subsidies (e.g. for coal), or tax rebates for certain energy intensive industries that have negative health and/or environmental effects.

  • Apply strategic pricing, subsidies and reduced VAT rates on energy saving equipment, as well as on energy enhanced materials, and efficient products in general.

  • Set reduced rates of property tax for buildings that meet high standards of energy efficiency.

  • Promote tax rebates or fair feed-in prices for co-generated and renewable energy production.

  • Offer an attractive package for energy savings in transportation - such as tax benefits for fuel efficient cars, mandatory standards for car manufacturers, kilometer/ton freight charges and use of innovative IT solutions.

  • Apply import/export restrictions and other means of preventing the import/export of second-hand and inefficient machinery and vehicles.

  • Use energy taxes with constant and steadily growing levies on energy use e.g. stipulating a steady increase of energy prices of three or four percent per annum, fluctuating within a range of plus or minus two percent. Such a measure would give innovators and investors a clear and reliable signal to invest in energy efficiency to meet steady and predictable energy price increases. If energy efficiency rises at the same rate as energy prices, the annual energy bill will remain constant, while considerably less energy would have to be imported or produced.