Fossil fuel subsidies

The Scientific Alliance

In addition to the efforts of governments to increase the penetration of renewable energy sources via generous public subsidies, we are reminded from time to time that coal, oil and gas are also subsidised, which works against the policy of emissions reduction. Most recently, the Guardian has carried the story under the headline Fossil fuels subsidised by $10m a minute, says IMF. According to this, the £5.3trillion subsidy is more than all the world’s governments spend on healthcare. That’s a pretty eye-catching statement, and deserves some digging.

The story is based on the IMF working paper How large are global energy subsidies? To quote from the abstract, this study “…focuses on the broad notion of post-tax energy subsidies, which arise when consumer prices are below supply costs plus a tax to reflect environmental damage and an additional tax applied to all consumption goods to raise government revenues.”

The argument is not so much that fossil fuels are being sold below cost because there is a direct handout from the public purse, but that a great deal of potential revenue is being foresworn. This potential revenue, according to this line of thought, would be justified on the basis of payment for environmental damage.

There are certainly cases of direct public subsidies, generally of fuels in oil-producing countries such as Nigeria, Saudi Arabia and Venezuela (Money to burn: OPEC’s wasteful energy subsidies). More than half of the total subsidies are paid in OPEC countries: “Subsidies account for 82 percent of the cost of electricity and fuel in Venezuela, 80 percent in Libya, 79 percent in Saudi Arabia, 74 percent in Iran, and 56 percent in Iraq and Algeria.” In total, these subsidies cost emerging economies more than $500bn each year.

To make matters worse, although lowering the cost of fuel is supposed to benefit the poorest in society, it is the more prosperous households who consume more and benefit most. Nor do subsidies boost economic growth, as intended, and they can provide a further drain by encouraging fraud and smuggling of cheap fuels to neighbouring countries. There is a strong case for abandoning such measures.

On the other hand, there is an enormous difference between the half a trillion dollars paid currently and the $5.3tr in subsidies estimated by the IMF. The IMF study breaks down the ‘real’ cost of fuels into three components: the cost of supply (ie, cost of production or purchase on international markets), external (environmental) costs and consumption tax. The externalities are outdoor air pollution from fine particulates (PM10 and PM2.5), CO2 emissions (on the basis of their impact on climate) and a broad category of the further impact of vehicle use (including congestion and accidents).

The report breaks down subsidies into pre-tax and post-tax categorie. Pre-tax subsidies are those already mentioned, the direct support of consumer fuel prices by governments, worth 0,7% of global GDP (that’s the half a trillion dollars) and set to fall by about a third with current reforms. Post-tax subsidies – payment for externalities and consumption taxes – on the other hand are estimated as eight times higher than 2011 pre-tax subsidies and a massive 16 times higher than the projected level of a third of a trillion dollars this year.

These figures are considerably higher than previous estimates, mainly because of changes to assumptions about air pollution levels and their impact on mortality. This, of course, is a critical point; the results depend on what assumptions are made, and would perhaps be better reported as a range based on likely maximum and minimum input figures. The figures reported should be seen as a worst case scenario.

Not that everyone would agree. Lord Stern, has made the case for things on the climate front being even worse than we thought ever since the publication of his eponymous report in 2006. He is quoted in the Guardian article: “A more complete estimate of the costs due to climate change would show the implicit subsidies for fossil fuels are much bigger even than this report suggests.”

The fact is that little is likely to happen in practice following the IMF report. There is already a move towards cutting the egregious direct price support in many developing countries, and there are few who would question that this is good news. But, despite the arguments of campaigners that imposing additional costs on fossil fuels would have a range of benefits to health and climate, there is little sign of any change.

The worst outdoor air pollution is generally in major cities in emerging economies. Bejing is notorious, and Delhi is equally bad. However, already China is cutting down on coal use in the capital in a bid to make the air cleaner. This, plus the use of modern pollution control measures as used in Europe, can make a really big difference. But this would not reduce carbon dioxide emissions, and India (whose growth might well outpace China’s in coming years) has made it clear that it will not compromise its development by cutting coal use: Not correct to expect India to shift from coal, India tells UN.

The other increasingly important contributor to urban air pollution is the growing number of cars. Indeed, in the developed world, vehicle emissions are the main controllable contributor of particulates and nitrogen oxides. But the air in most European towns is much cleaner than it was a few decades ago, and standards are continually improving. Bejing and Delhi will doubtless follow the same trend, albeit some years behind at present. The Chinese and Indian governments will certainly not want to limit the ambitions of their citizens to run their own cars.

We also need to put the air pollution issue into context. About half the deaths from dirty air are actually caused by smoky indoor cooking fires in poor countries, which is an issue which can be very effectively tackled in the short term.

There remains the issue of climate change. The figures used by the IMF to estimate the external costs of fossil fuels are notional, based on assumptions which are not necessarily valid (temperature sensitivity, in particular, looks to be below the lower end of IPCC estimates). And even if governments worldwide were to load coal and oil with additional taxes, the basic demand for energy would not be likely to be reduced very much. Since higher energy costs are almost certain to slow economic growth, it looks like very little would be achieved and the cost would be very significant. The moral of this is: don’t read too much into headlines.

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