One step forward, two steps back: fossil fuel subsidies and reform on the rise

 This article is part of Friends of Europe’s latest discussion paper ‘The overlooked side of the ecological transition’, available here. 

Over the past decade, there has been widespread agreement on the benefits of reforming subsidies to fossil fuels, a move supported by the commitments and discussions that have taken place within international forums. It is reassuring to note that between 2012 and 2016, fossil fuel subsidies (FFS) to consumers almost halved, going from $504bn to $260bn. This reduction was due to a combination of reform efforts and a decrease in international prices for crude oil, both of which provided a window of opportunity for action and allowed governments to implement long-awaited reform plans.

In a review of reform efforts, the Global Subsidies Initiative (GSI) has mapped the countries that have implemented some level of FFS reform between 2015 and 2018, acknowledging the various policy changes that have contributed to declining fuel subsidies. Some fifty countries have implemented some level of policy change during this time – change that ranges from alterations in fuel prices to the deregulation of energy tariff reforms. While this map is not an exhaustive picture of all subsidy policy change, and although it does not cover all subsidies within a country, it does illustrate the broad engagement of countries, as seen at a national level, in tackling the FFS issue.

Despite these reforms, the International Energy Agency (IEA) found that consumer support for subsidies increased slightly in 2017, reflecting pressure on previously implemented reforms due to the rise of oil prices in the international market. The IEA finds that consumer FFSs (price-gap methodology) increased from $270bn in 2016 to $302bn in 2017. The increase is linked to a change in the average oil price from $42 per barrel in 2016, to $52 per barrel in 2017. However, the 12% increase in consumption subsidies was considerably less than the 25% increase in oil price; this indicates that there is still a level of ongoing reform that has taken place and is being maintained. In this context, governments will need strong encouragement and support to maintain existing energy reforms, while also introducing additional energy sector reforms and enabling domestic prices to reflect changing international ones. Reforming FFSs and shifting to renewable energy are two processes by which governments are afforded the opportunity to protect themselves from the volatility of international oil prices.

Moreover, the IMF recently released a working paper with updated global estimates of consumer price support for FFS estimates using pre-tax and post-tax subsidies approaches. The latter differs from the IEA method, given that it includes un-priced externalities arising from fossil fuel usage, such as GHG emissions and emissions of air pollutants, as well as social costs associated with driving (e.g. traffic congestion). According to the authors, these costs are 15 to 20 times larger than pre-tax subsidies, which stood at $296bn in 2017. They reached $5.2tn in 2017, up from $4.7tn in 2015, starkly illustrating the broader negative costs and the impact that fossil fuels have on the environment and the economy as a whole. Furthermore, the research highlights the reality that there has not been a sharp increase in the pricing of environmental costs at the global level, despite the 2015 Paris Agreement and implementation of reforms in several countries.

Yet, even without including huge externalities, GSI estimates that the scale of subsidies to fossil fuels is still significant, sitting at around $400bn in 2017 ($300bn per year for consumer subsidies and between $70bn and 100bn for producer subsidies, which are consistently underreported).

It is crucial to implement and acknowledge the importance of FFS reform and the correct pricing of fossil fuels, even more so when the world is made aware of the high costs that accompany fossil fuels. When envisioning future steps, countries can observe successful reforms and pricing efforts which have been implemented by other countries around the globe, for example, through the research and networks that allow for knowledge exchange and provide important lessons for governments pursuing FFS reform.

India, for instance, has been succeeding in many different aspects in its phasing out of FFSs. Between fiscal year (FY) 2014 and FY 2017, the country cut subsidies to oil and gas by 76%, from $26.1 bn to $5.5bn, thanks to a combination of various reforms and a decrease in international oil prices. During the same period, government support for renewable energy grew almost sixfold — from INR 2,608 crore ($431mn) in FY 2014 to INR 15,040 crore ($2.2bn) in FY 2017. Meanwhile, in 2015, liquefied petroleum gas subsidies began to consumers’ bank accounts, putting in place the world’s largest benefit transfer scheme as a way to avoid diversion and eliminate duplicate connections and non-existent users. Moreover, the country has also implemented communication campaigns to assess consumers’ views on developments, which is a key part of delivering successful reforms.

On the other hand, some countries have been struggling to maintain efforts to phase out FFSs for many different reasons. In 2015, Indonesia completed its reform of gasoline and diesel subsidies, saving up to $15.5bn. However, the country has not implemented fuel price changes in a consistent and regular manner, as evidenced by the gaps that have become apparent when prices were adjusted over time. Prices were last locked in 2019 in the leadup to recent presidential elections. More importantly, the island country has continued to invest in  coal power plants, going against the encouraged global practice of moving toward cleaner sources of energy.

Whatever the case, the importance of FFS reform is clear and unanimous: FFSs are socially regressive, failing as a social welfare policy tool and potentially preventing government funding of more sophisticated social security nets, including investment in health and education.

Furthermore, such subsidies lock us into a high-carbon future and their elimination could contribute to reducing carbon emissions, as stated in the Paris Agreement. Despite considerable efforts to reform FFSs, the absolute value of subsidies increased in 2017, both in subsidies captured within the economy and those yet unpriced, which brings massive broader costs to society (the externalities). It is therefore crucial that countries persist with efforts to phase out subsidies to fossil fuels and usher in more efficient social welfare and sustainable energy systems. To succeed in doing so, it will be imperative that they are supported in their endeavours by the international community.

This article is republished from GSI Subsidy Watch Blog, May 23^rd 2019.
https://www.iisd.org/gsi/subsidy-watch-blog/fossil-fuel-subsidies-and-reform-on-the-rise