Dr. Andreas Poullikkas
Electricity Authority of Cyprus, Limassol, Cyprus

Environmental costs are difficult to quantify, but they are still real. Although there is a general agreement as to the broad definition of environmental costs, there are widespread variations in defining the boundaries. For example, arguments for the environmental costs attributable to oil fired generation range from super tanker spillages to a substantial proportion of western defence budgets.

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In other words, environmental costs for energy are inherently complex, but can be divided into three main categories:

  • Hidden costs borne by respective governments
  • Costs of the damage caused to health and the environment by emissions other than carbon dioxide (CO2)
  • The costs of global warming attributable to carbon dioxide.

The first category includes the cost of regulatory bodies, pollution inspectorates, energy industry subsidies and research and development programmes.

The second category makes up 10-20 per cent of the environmental cost of power generation, depending on the fuel used. It includes a wide variety of environmental impacts, including damage from acid rain and damage to health from sulphur oxides and nitrogen oxides. The cost of damage to health is estimated by calculating the loss of earnings and cost of hospitalization of people susceptible to respiratory diseases. Other costs included in this category are accidents, whether they occur in coal mines, on offshore oil or gas rigs, or in nuclear plants.

The third category is the largest with some 40-80 per cent of the hidden costs from the world’s consumption of electricity. It is also the most contentious area of the environmental cost debate. The range of estimates for the possible economic implications of global warming is huge in the studies conducted to date. Costs associated with climate change, flooding, changes in agricultural patterns and other effects all need to be taken into account.

Clearly, the discussions on the make-up of environmental costs are endless. But it is important that governments and regulators do not allow the uncertainties surrounding environmental costs to inhibit acknowledgment of their existence when energy policies are being made. Many studies over the past eight years have identified and quantified the pollution caused by the electricity business, and have also tackled the job of pricing pollution through the so-called “monetarization” of environmental costs.

Calculating costs

Many studies have looked at overall damage potential on health and the environment, assigning a cost penalty to each generating technology and fuel. This approach enables the difference in environmental costs between, say, coal and natural gas, to be easily compared.

Another approach calculates costs per pollutant. Typically these penalties, as proposed by some states in the USA, are around $10/t for CO2 and up to $25/t for sulphur dioxide (SO2). Since the quantities of each pollutant emitted are well known for the differing fuels, calculation of the environmental cost of each unit of electricity is possible: coal fired generation produces the most pollutants, about one kilogram of CO2/kWh, plus SO2 and other pollutants, thus attracting the highest penalties.

Assigning various cost penalties to technologies brings market forces into play. The price of dirty technology is pushed up and other clean technologies become relatively cheap.

The European Union (EU) proposal for a carbon tax is still pending due to an inter-government disagreement on whether environmental costs should be reflected in electricity prices.

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The EU approach would alter the balance between coal, gas, nuclear and renewables, with the proposed tax levels clearly reflecting the mid-range of estimates for the damage shown in Table 1. They are also consistent with other tax proposals.

If applied, renewables would undercut coal, oil and nuclear, but not natural gas. The proposed EU levy includes an “energy” element as well as a “carbon” component, which is why nuclear is penalized. The tax is intended to be fiscally neutral, with tax revenue used for energy saving measures.

Relief from the tax is proposed for energy intensive industries, but some countries, particularly the UK and France, remain concerned that energy taxes would reduce their competitiveness in global markets.

Several European countries have gone ahead and introduced carbon taxes, including Denmark, the Netherlands, Sweden, Finland and Norway. As one of the first, Denmark has implemented a wide range of measures aimed at encouraging its energy industry to be more efficient and reduce emissions. The taxes are applied to fuels and electricity, but also focus on consumption, with space heating attracting the highest tax rates. Denmark aims to reduce CO2 emissions by 20 per cent by 2005, one of the highest targets in the world, albeit from a country with an electricity industry emitting more pollution per head of population than almost anywhere in the world.

The carbon tax concept

Deregulation of energy sectors around the world has brought competitive forces into play, and energy policies that encourage environmentally friendly energy technologies are being abandoned. New policies are therefore needed to make further progress towards sustainability. By introducing carbon taxes, electricity prices will increase, discouraging the production of energy from carbon-intensive fuels.

Carbon tax would reduce taxes on “goods” (work effort, business activity) and increases taxes on “bads” (pollution, energy use). It offers the promise of an improved economy and environment.

But carbon tax is not a panacea for all social ills. It is constrained by the societal objectives of a tax system and its functional requirements, which pollution taxes alone cannot fulfil. These include equity (whose main vehicle is a progressive personal income tax), and a reliable and steady flow of revenues, which attenuates the impacts of the business cycle. Thus, a significant portion of the current tax system must be maintained. Carbon tax could have an effect on all of society, not just the environment, as it introduces a new revenue which can be used on public investments.

Revenues from carbon taxes could provide the means for simplifying existing economic development incentives. Carbon taxes with offsets in traditional taxes could give a clear and consistent signal to businesses. Some countries are already engaged in policies to foster the “greening” of businesses, and carbon tax could enhance this policy goal.

The effect of this new business climate should be positive. Some energy-intensive businesses could benefit from the technological advancements that higher energy prices could trigger. It is common that energy efficiency investments improve overall productivity and thus reduce energy-related costs. Some countries already maintain economic development programmes that seek to enhance business productivity through eco-efficiency (which encompasses energy efficiency and pollution prevention).

A carbon tax would increase the cost of fossil fuels and electricity and generate tax revenues. Electricity producers, industrial and commercial enterprises, and households would respond to these higher fuel prices in three ways:

  • Reduce energy-consuming services and activities
  • Invest in energy saving technologies
  • Switch to less carbon-intensive fuels.

Shifting from coal and oil-fired generation to gas, wind and other low carbon-intensive technologies could have a huge impact. For commercial and residential sectors, the response to higher fuel prices could be improved thermostat controls, tighter building shells, and a shift from oil to gas. For industry, it could be output changes, process technology changes (e.g, cogeneration), and shifts to gas or biomass.

The biggest concern voiced about a policy of carbon taxes with other tax reductions is that it would harm the international competitiveness of industries. This is concern for a small number of energy-intensive industries, and this needs to be addressed through special mechanisms designed to reduce the negative impacts of carbon tax on these industries. However, it is believed that most industries would experience a net cost decrease from the policies, and as trade flows respond to cost differentials, industries could gain market share in response to the tax policies.

Aside from the economic advantages, carbon tax has the potential to give direction to the technological changes that the economy is undergoing, by steering it onto a path of less carbon-intensive, and advanced methods of production and consumption. The design of a specific carbon tax must take into account a range of equity issues. These include maintaining the society’s commitment to progress in the modified tax system, and transitional assistance to workers and communities.

It is evident that a carbon tax would help meet national climate policy goals, and improve environmental quality and public health through a reduction in pollution. It would also provide the opportunity for a consistent economic development policy by yielding revenues to modernize infrastructure and support other economic development policy objectives, and foster technological progress and the development of niche markets.