Climate Change 2001:
Working Group III: Mitigation
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5.3.2 Prices

Prices can have an important influence on the consumption of resources and hence on GHG emissions. There is extensive literature on the use of prices to reflect environmental and other social costs associated with resource use. If such costs were fully reflected in prices, they would encourage producers and consumers to adopt environmentally sustainable technologies and practices. Where an adequate legal framework exists, it should be possible in principle for those suffering the effects of pollution or climate change to seek compensation from those responsible. In practice, markets in environmental and social damages function poorly, if at all, because transaction costs (e.g., the costs for victims to identify polluters and seek compensation) are high compared with the environmental and social costs suffered.

Where environmental and social costs are not reflected in markets (i.e., they are externalities), there are many ways in which governments can internalize them, notably through environmental regulations and taxes. However, governments have to balance a large number of objectives and the outcome may not be efficient in linking resource prices to GHG emissions. A variety of different types of government policy tend to reduce prices, in addition to the direct budgetary subsidies that are often introduced to support employment in particular sectors or to enable the poor to meet basic energy needs (OECD, 1997b). Examples include policies requiring electric utilities to provide universal, low-priced access to grid systems or even to maintain supplies when consumers fail to pay their bills (EBRD, 1999; World Bank, 1999). In India, electricity has historically been subsidized for residential consumers, serving as a disincentive for the adoption of efficient lighting and appliances (Alam et al., 1998). When energy subsidies are reformed or removed, transitional or permanent supports are often required for some of the former recipients (OECD, 1997b). For example, in Russia, the introduction of long-run marginal cost electricity pricing has led to pensioners being unable to afford their electricity bills, requiring support that amounts to 20%-35% of local authority budgets (Gritsevich, 2000).

Government policies to address a wide range of environmental and social problems can encourage GHG mitigation by increasing the prices of carbon-intensive energy sources or decreasing the prices of non-carbon options. Such policies include pollution taxes and charges for the use of infrastructure and services, subsidies for renewable energy, and regulations requiring producers to sell electricity generated from low-carbon sources.

The developers of new technologies often seek to recover their investment in R&D through license fees for the use of their innovations. Such license fees may inhibit the adoption of the best available technology for GHG mitigation in developing countries.

Energy price expectations can have a strong influence on investments in low-GHG technology. Where energy prices fluctuate in unpredictable ways, investors may tend to delay investments in new technology, and be unwilling to adopt low-emission technology where this entails increased up-front costs. The next section discusses the effects of risk on investment.

A substantial literature has developed on the tendency of consumers and businesses to pay more attention to initial investments than operating costs, when considering technology choices (Hassett and Metcalf, 1995; Jaffe and Stavins, 1995). In the past, prices for some types of appliance, such as refrigerators, have tended to show little correlation with energy intensity within a given range of size and performance characteristics (Greening et al., 1997). The prices of appliances and vehicles are influenced by many factors, not least their aesthetic features, and energy efficiency is usually a minor source of variation. On the other hand, several governments have used taxation to introduce a price incentive for buying cars with smaller engines, lower fuel consumption, and to encourage the use of alternative fuel vehicles (IPCC, 1996; ECMT, 1997).

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