Regulating Subsidies

Brent Crude Oil Price PredictionsThe figure above shows the price of Brent crude oil as recorded at the end 2014, along with predictions by two respected financial organizations and the futures market for this past year. The real price today (December 30, 2015) is $36.50 – a drop of about 70% in a year and a half’s time. As it turns out, nobody was right. 🙁

One of the holy grails of the much-needed transition away from fossil fuels toward sustainable energy sources is finding a way to make sources such as solar and wind price-competitive with fossil fuels. Indeed, over the last few years, a combination of technological developments and production shifts to developing countries, combined with market expansion, did considerably reduce the price of sustainable energy resources and their use expanded considerably.

To help this trend, everyone agreed that we needed to increase the price of fossil fuels at the same time as lowering the cost of the sustainable energy sources. Countries or regions could make that transition to being more “green” (see the map in the May 19, 2015 blog) by changing the price of carbon either through a Cap and Trade policy or a carbon tax.

Carbon pricing was one of the key recommendations of the Kyoto Protocol, but you hardly heard a mention of it in Paris this past year. It was there within the individual country reports but was notably missing from the COP21 agreement itself. By now, everybody has realized that pricing is not the only game in town. If it were, one would expect that a 70% price drop in fossil fuels over a year and a half would lead investors to completely stop acquisitions of sustainable energy sources. In that case, the market would shift back toward fossil fuels, restoring the old balance of global supply and demand and weakening the growth of sustainable energy. As I already showed six months ago (July 2015), this did not happen. Global installation of wind and solar continues to increase.

However, there were major efforts to reduce (or stop) subsidies of fossil fuels – both on the consumption and production sides. This effort did not find its way into the final agreement but, in my opinion, it will have a major impact regardless of the price of oil.

The FFFSR (Friends of Fossil Fuels Subsidy Reform) is a recently formed organization whose chief objective is to lobby countries and organizations to stop fossil fuel subsidies. They made their efforts known throughout the conference. The UNFCCC’s Newsroom summarized their goals:

Paris, 30 November 2015 – An unprecedented coalition of close to 40 governments, hundreds of businesses and influential international organizations has called today for accelerated action to phase out fossil fuel subsidies, a move that would help bridge the gap to keep global temperature rise below 2°C.

On the opening day of the UN Conference on Climate Change (COP21), New Zealand Prime Minister John Key formally presented the Fossil Fuel Subsidy Reform Communiqué to Christiana Figueres, Executive Secretary of the UN Framework Convention on Climate Change (UNFCCC), on behalf of the Friends of Fossil Fuel Subsidy Reform, The Prince of Wales’s Corporate Leaders Group and other supporters of the Communiqué.

The Communiqué calls on the international community to increase efforts to phase out perverse subsidies to fossil fuels by promoting policy transparency, ambitious reform and targeted support for the poorest.

Governments spend over $500 billion of public resources a year to keep domestic prices for oil, gas and coal artificially low. Removing fossil fuel subsidies would reduce greenhouse gas emission by 10 per cent by 2050. It would also free up resources to invest in social and physical capital like education, healthcare and infrastructure, while leveling the playing field for renewable energy.

Here are some important details to keep in mind:

Setting the scene

There is a widespread high-level consensus that in order to rewire the economy towards de-carbonisation, fossil fuel subsidies will need to be phased out. This is, however, politically, socially and economically complex with a series of barriers preventing rapid progress.

The IEA’s World Energy Outlook on Energy and Climate (2015) states that “despite the recent prolonged period of high oil prices, which pushed the cost of subsidies to crippling levels in some countries, the political climate to enact reform has become more conducive in many cases as international prices have fallen”. The report shows that in particular lower prices have been fundamental to recent fuel pricing reforms in parts of Asia such as Indonesia (recently eliminated gasoline subsidies and capped diesel subsidies). Other countries have also eliminated subsidies such as Malaysia for both gasoline and diesel, Thailand for liquefied petroleum gas (LPG) with an increase in the price of compressed natural gas (CNG). Of note is also the Indian government’s recent deregulation of diesel prices.

Recent reforms have been concentrated in net-energy importing countries, but there are also good reasons for reforms in net-exporting countries as oil export revenues decline and governments seek to protect other spending priorities. As in importing countries, reforms may be more palatable to consumers at a time of relatively low international prices. Venezuela and Kuwait (among the largest subsidisers) are reported to be considering reforms, while Iran has previously made reforms and has more scheduled.

The G8, G20, IMF, IEA, OECD and the World Bank have all referred to the phase out of in-efficient fossil fuel subsidies as essential to transition to a low carbon economy and necessary to reduce our global carbon footprint. It has been estimated that the total elimination of fossil fuel subsidies globally will reduce GHG emissions by 13 per cent. However, we recognize that some countries face circumstances under which they believe there are powerful short term drivers for the maintenance of subsidies and that reform will be dependent on particular national circumstances and changing market conditions.

How big are fossil fuel subsidies?

The International Energy Agency (IEA) estimates the total fossil fuel subsidy to amount to $548 billion in 2013. This is based on the gap between what consumers pay and the actual cost of supply, but doesn’t consider the environmental and health costs. The OECD calculate that direct budgetary support and tax expenditure for fossil fuel consumption and production in OECD countries amounted to $50-90bn annually between 2005 and 2011. A recent report by an IMF working group estimates that the total cost of subsidies for fossil fuels, including direct subsidies and the environmental and health costs their use imposes were $4.9 trillion (6.5 percent of global GDP) in 2013. In addition to reducing emissions, the IMF calculates that eliminating these subsidies in 2015 could raise government revenue by $2.9 trillion and cut premature air pollution deaths by more than half.

Although it is important to note that the IMF, IEA and OECD do not define subsidies in the same way and hence the estimated costs from subsidies vary between at least $548 billion to $4.9 trillion, the most important message from all three organizations and others is that the costs are high and that the elimination of subsidies would have a net positive impact on the reduction of GHG emissions and pollution.

The issue is complex, especially because there are differences between the subsidies to producers and those to consumers in developing countries; we will follow it closely.

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About climatechangefork

Micha Tomkiewicz, Ph.D., is a professor of physics in the Department of Physics, Brooklyn College, the City University of New York. He is also a professor of physics and chemistry in the School for Graduate Studies of the City University of New York. In addition, he is the founding-director of the Environmental Studies Program at Brooklyn College as well as director of the Electrochemistry Institute at that same institution.
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