The world is waking up to the $5.3 trillion cost of fossil fuels

Prospects for global energy markets have been reshaped by two recent pieces of news, one of which helps to explain the other.

The first is a report from the International Monetary Fund (IMF) released on Monday, estimating that global fossil fuel use is subsidised to the tune of US$5.3 trillion a year (6.5% of global GDP).

The second is the continuing decline in coal production and use in China, which began in 2014. The latest reports show April 2015 coal production in China was down 7.4% on April 2014.

To understand the link between the two, it is necessary to look at the way the IMF obtained its estimate.

The real cost of coal

In part, the estimate refers to subsidies in the traditional sense of the term: for example, policies that provide cheap cooking fuel to urban consumers in many developing countries.

However, the majority of the estimated subsidy arises from a comparison between the actual price of fossil fuels and the price that would prevail if fossil fuel users were charged the full costs associated with fossil fuel use, including the costs of pollution, as well as being subject to general sales taxes like the GST.

Given this starting point, the IMF identifies four main forms of subsidy:

• Traditional or “pre-tax” subsidies, that is, publicly financed payments to producers or consumers of fossil fuels which lead to a gap between the cost of production and the market price

• Subsidies to motorists arising when revenue from fuel taxes is less than the economic cost of providing (toll-free) road networks

• The failure to tax appropriately the costs of “local” air pollution, such as smog generated by cars and particulate air pollution from burning coal

• The failure to tax appropriately the global climatic costs arising from carbon dioxide emissions.

Of these subsidies, the costs of the first three are borne by the people of the country concerned, either as imposts on government budgets or in the form of adverse health effects from pollution, while the fourth cost is global. So, in a purely domestic political calculus, the first three kinds of cost must be weighed against the political benefits arising from cheaper fuel.

The striking finding of the IMF, echoing previous work by economists such as Nicholas Muller, Robert Mendelsohn, and William Nordhaus for the United States, is that the third category of costs, smog and particulates, is easily the largest. Within this category, the biggest cost is due to particulate emissions from coal.

It follows that, even disregarding impact of climate change, the costs of burning fossil fuels outweigh the benefits in many cases. So, a reduction in fossil fuel use, and particularly in coal use makes economic sense.

The coal boom is fading

Nowhere is this more obvious than in China. A densely populated country, heavily dependent on coal and with large numbers of inefficient and poorly maintained power plants, China has some of the worst urban air pollution in the world, estimated to kill more than half a million people a year

In an authoritarian regime like that of China, these costs could be disregarded as long as the needs of industry and the imperative of rapid growth were politically paramount.

On the other side of the coin, as soon as concerns about air pollution became pressing, the government has been able to impose changes that would have faced strong political resistance in a more democratic and less unitary system. These include closing down more than 1,000 coal mines this year and shutting down all four coal-fired power stations supplying Beijing.

The Australian government, and the political class remains in denial about these developments. The decline in Chinese coal demand is seen as a temporary aberration, with demand expected to keep growing well into the 2020s. And even when Chinese coal use finally turns down, the expectation is that India will take its place.

The logic of the IMF analysis says otherwise. The unpriced costs of burning coal are just as high in Delhi as they are in Beijing, and the development of an urban middle class ensures that they will be taken into account

India is already taxing coal to promote the development of renewables. The IMF analysis suggests that this is the right policy, but needs to be taken even further.

For the moment, the capacity to expand renewables is too limited to meet India’s growing demand for electricity, so coal use may continue to increase for some time. But the global experience of the boom in solar and wind power has shown that no constraint remains binding for long. In a few years, India’s aspirations to become a “renewables superpower” are likely to be realised.

What does this mean for Australia? Almost certainly, the coal boom that is now fading will never be repeated. For the future, it is our nearly unlimited capacity to generate wind and especially solar power that is likely to be our biggest energy asset.

John Quiggin is a Member of the Climate Change Authority.