Getting fuel prices right is key to reducing carbon emissions, IMF chief says

Global fossil fuel subsidies amounted to $6 trillion in 2020, with more than 70 per cent reflecting "undercharging" for environmental costs, which makes it imperative to set the right price for fuels to reduce carbon emissions, the International Monetary Fund has said.

Global carbon emissions would fall by a third – in line with keeping global warming to 1.5 degrees celsius – if fossil fuel prices increase to fully reflect environmental and supply costs by 2025, Kristalina Georgieva, the IMF's managing director, told an energy summit at the UN General Assembly on September 24.

"Raising fuel prices is, of course, very challenging. I don’t want to understate how difficult it is – but doing nothing will pose far greater challenges," she said.

In August, the Washington-based fund urged countries to scale up green investments and set a higher global carbon pricing floor to mitigate the adverse effects of climate change.

"It would help to get the right price on fuel and accelerate global climate action. And now is the time to do it," Ms Georgieva said.

Increasing the price of fossil fuels, in a bid to reduce carbon emissions, would have additional significant benefits.

"Almost one million deaths due to air pollution would be avoided every single year," Ms Georgieva said. "Additional revenues would rise by nearly 4 per cent of global GDP – which could be used to boost green investment and social spending, and thus ensure a just transition to the new climate economy for us all."

On the other hand, under-pricing fossil fuels would undermine domestic and global environmental objectives, hurting people and the planet, she said.

"It is also a badly-targeted policy that predominantly benefits higher-income households and deprives governments of precious fiscal resources," the IMF chief said.

Globally, fossil fuel subsidies are expected to rise to 7.4 per cent of GDP in 2025, up from about 6.8 per cent of output in 2020, the IMF said in a working paper.

Only 8 per cent of the 2020 subsidies reflect undercharging for supply costs (explicit subsidies) and 92 per cent for undercharging for environmental costs and foregone consumption taxes (implicit subsidies), according to the fund.

Efficient fuel pricing in 2025 would reduce global carbon dioxide emissions 36 per cent below baseline levels, which is in line with keeping global warming to 1.5 degrees, it said.

"Getting fossil fuel prices right is critical for efficiently allocating an economy’s scarce resources and investment across sectors and activities – the efficient price includes both the supply and environmental costs of fuel use," the paper said.

Under-pricing leads to overconsumption of fossil fuels, which speeds up global warming and worsens domestic environmental problems including losses to human life from local air pollution, road congestion and accidents, it said.

"This has long been recognised, but globally countries are still a long way from getting energy prices right," the fund said.

The paper, which analysed 191 countries, found gaps between efficient prices and user prices for fossil fuels remain "large and pervasive".

"The largest price gaps are generally for coal, followed by natural gas, diesel, and gasoline," it said.

The right price is the "socially-efficient price" that reflects the full social costs of fuel use – not just the supply costs (for example, labour, capital and raw materials) but also the environmental costs, including CO2 emissions, local air pollution and broader factors associated with fuel use (such as road congestion), as well as general taxes applied to household products.

Underpricing fossil fuels not only undermines domestic and global environmental objectives but is a highly inefficient policy for helping low-income households and has a sizable fiscal cost – too little revenue is raised from fuel taxes, meaning other taxes or government deficits must be higher or public spending lower.

The IMF's call for adjusting fossil fuel prices comes as all 191 parties to the Paris Agreement on climate change are submitting revised mitigation pledges ahead of Cop26 in November 2021 – many have made substantial commitments for 2030 and have specified emissions neutrality targets for mid-century.

"Time is of the essence – in the absence of a drastic cut in fossil fuel use over the next decade the planet will become locked into risks of dangerous and irreversible instabilities in the global climate system," the paper concluded.