Externalities occur when economic decisions create costs or benefits for parties other than the decision maker (Visser, 2014). There are both negative and positive externalities. A positive externality occurs when an action by one party results in benefits for others, so the social benefit is greater than the private benefit. A negative externality occurs when an action by one party produces harmful effects on the other. In terms of negative externalities, the social cost is greater than the private cost. Market failure occurs when private costs do not equal social costs. The electricity sector in developing countries is growing rapidly, however, there are numerous externalities related to energy production and the price of energy does not reflect all associated costs. These externalities include effects on human health, the environment, climate, subsidies, agriculture as well as reactor accidents and economic effects (Bernal-Agustin & Dufo-Lopez, 2006) (Friedrich & Voss, 1993) ( Edkins, Winkler, Marquard, & Spalding-Fecher, 2010). In the uncontrolled market, there is a tendency to produce more energy and produce a larger supply of waste fuel than is socially optimal (Aronsson, Backlund, & Lofgren, 1998), so economic tools are needed to internalize the cost of externalities for a pollution optimal. In this paper, the externalities of three types of energy production will be discussed: coal, nuclear and photovoltaic (PV). Economic tools for internalizing externalities will also be examined. Coal Power Generation In South Africa, Eskom supplies 95% of the electricity, of which coal electricity accounts for 86% (Pegels, 2010). Eskom's coal-fired power stations have high… medium paper… sustainable and carbon-free energy sources. However, the FIT is not pro-poor because even with subsidies the price of electricity will increase and subsidies distort market prices (Visser, 2014). Other ways to internalize external costs include; integrated resource planning, using resources within the Southern African Development Community, which include hydropower and natural gas (Spalding-Fecher & Matibe, 2003)l as well as using the Clean Development Mechanism (Spalding- Fecher & Matibe, 2003). South Africa still has a long way to go before the externalities associated with energy production are internalized into costs or eliminated completely. The entire electricity supply sector must be restructured towards the renewable energy sector. However, economic tools need to be implemented before the sector can move away from coal-intensive electricity generation.