Blog Post

Calculating Various Fuel Prices under a Carbon Tax

Nov 28, 2017 | Marc Hafstead, Paul Picciano

A carbon tax puts a price on fossil fuels in proportion to the carbon content in each fuel. Because carbon content differs by fuel type, a carbon tax changes the relative prices of various fuels. By increasing the price of carbon-intensive forms of energy, a carbon tax incentivizes shifts toward energy that is less carbon-intensive (e.g., from coal to natural gas, or coal to renewable electricity generation) as well as reductions in total energy demand (e.g., reduced demand for gasoline or electricity).

We’ve previously reported estimates for carbon dioxide emissions and tax revenues under alternative carbon tax price paths. Here we focus on the impacts of a carbon tax on the price of each type of fuel, with a new fuel price calculator that translates carbon tax levels into price changes for fossil fuels. In some instances, the calculation is fairly straightforward: each dollar of a carbon tax translates into (approximately) an additional penny per gallon in the price of gasoline, for example. For select fuels, users can choose a tax rate and see how prices change, in both absolute terms and relative to average national prices in 2015.

The new fuel price calculator comes with a few important caveats:

Listed fuel price levels are average prices from 2015 as reported by the US Energy Information Administration (see links to sources below the calculator). Due to geographic differences in energy prices, the percent change in fuel prices imposed by a carbon tax will vary across the country. Further, fuel prices often vary substantially across customers. For example, the average citygate price of natural gas was $4.26 per thousand cubic feet in 2015, but the average residential price was $10.58 and the average commercial price was $7.91. As a result, the percent change in fuel prices will also vary across customers.

The price changes displayed here represent the “partial-equilibrium” price impacts. They only include the direct impacts of the tax on fossil fuel prices and do not reflect broader, general equilibrium changes in fossil fuel prices induced by varying supply or demand dynamics. For example, a steep drop in demand for coal will reduce the market price in all types of coal, reducing the overall increase in the price of coal as a result of the carbon tax.

This calculator does not estimate the effect of a carbon tax on electricity prices. This is a complex calculation—electricity price effects will vary across regions due to differences in market structure (e.g., between regions with cost-of-service pricing versus wholesale pricing) and the initial mix of generation technologies (all else equal, regions with larger coal generation fleets will have larger price effects). Stay tuned for a future post on electricity price effects by state.

The increase in energy prices induced by a carbon tax creates both economic benefits and costs. The monetary value of reduced carbon dioxide emissions is represented by the social cost of carbon. RFF’s Social Cost of Carbon Initiative offers more information on how to measure the value of these benefits. A carbon tax will also reduce local air pollutants. The “co-benefits” of reduced air pollution will differ across the United States, but some estimates suggest that the total value of these co-benefits could be as large or greater than the value of reduced carbon dioxide emissions (see, for example, Confronting the Climate Challenge, available December 2017). The costs of a carbon tax policy—both in total and how they are distributed across households and regions—depend on how the carbon tax revenues are spent. We’ll address the economy-wide costs of a carbon tax and how those costs are distributed in a separate future post.

Effects of carbon tax on specific fuels

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.