The Fuse

IEA: “Hard-Earned” Progress at Removing Fossil Fuel Subsidies Under Threat

by Nick Cunningham | November 30, 2018

The rise of oil prices over the last two years has erased years of “hard-earned” progress at reducing fossil fuel subsidies around the world. The rebound in oil prices from the 2016 nadir has led to a proliferation of, or at least a reversion to, a renewed commitment to government largess for energy consumption, which could stretch public finances, distort public policy and exacerbate a range of environmental problems.

Progress on subsidies

Between 2012 and 2016, the total value of global subsidies on fossil fuels fell by half, down from nearly a half a trillion dollars at its peak in 2012, according to recent data from the International Energy Agency (IEA). However, the IEA estimates that, after years of progress, the total value of global subsidies rose by 12 percent in 2017 to more than $300 billion.

Governments have subsidized fossil fuels for decades, for a variety of reasons. Typically, subsidies are intended to curry political support or to shield populations from costly energy. But the negative effects stemming from the state subsidizing fossil fuels are clear. Subsidies lead to worse air pollution, deleterious effects on public health, higher greenhouse gas emissions, misaligned foreign policy goals, a drain on public coffers and less money left over for other critical social services. Moreover, subsidies usually disproportionate benefits to the rich, encouraging wasteful consumption.

That is why economists have long advised governments to phase out public supports for fossil fuels. “Phasing out fossil fuel consumption subsidies is a pillar of sound energy policy,” IEA analysts wrote in an October report.

While the evidence of the damage related to the subsidizing oil and gas has been clear for some time, it took the 2014 collapse in oil prices to make extraordinary progress on this front. Cheap oil made it vastly more palatable for various governments to begin cutting fossil fuel subsidies. India, China, Indonesia, Mexico, Saudi Arabia, Kuwait and a long line of other countries took advantage of plunging oil prices to remove price supports.

Cheap oil made it vastly more palatable for various governments to begin cutting fossil fuel subsidies. India, China, Indonesia, Mexico, Saudi Arabia, Kuwait and a long line of other countries took advantage of plunging oil prices to remove price supports.

However, the agency is now warning that the “hard-earned” progress made at a paring back price supports for fossil fuels is “under threat.” The rise of oil prices in 2017 and 2018 (until only recently) has led to a rebound in subsidies around the world, as governments grow concerned about the political and economic fallout from costly energy.

The problem is made much worse because of the strength of the U.S. dollar. Crude oil is priced in dollars, so a stronger greenback makes energy more costly in much of the world. Moreover, rising interest rates and dollar strength destabilized a long list of emerging market currencies this year, magnifying the pricing impact on consumers. “A 75% rise in the dollar-denominated Brent crude price since January 2018 translates into a more than a 100% rise expressed in Indian rupees, and a 250% increase in Argentinian pesos,” the IEA explained.

The sudden spike in fuel prices has created huge headaches for governments around the world. Fearful of a political backlash, many governments reflexively put subsidies or pricing regulations back into place. Brazil, for instance, saw huge upheaval earlier this year when truckers staged a nationwide protest, forcing the government to backtrack on market pricing. Indonesia and Malaysia froze domestic fuel prices, even as international crude oil prices continued to rise. India slashed the duties on gasoline and diesel. Mexico’s incoming president could rollback market-based pricing reforms.

“These price controls can shield consumers from short-term changes in international market price, but at a fiscal and environmental cost,” the IEA said. The sudden collapse of oil prices since October has taken a lot of pressure off of governments in the short run. But the reapplication of price supports since 2017, in response to a jump in oil prices, demonstrates that progress on subsidy reform has been tenuous and may not survive if prices do not remain low.

Subsidies stoke oil demand

There are also macro impacts related to the oil market. To the extent that governments rush in to cap fuel prices, it blunts the impact of the price mechanism. Reinstituting subsidies could prevent the demand destruction that would otherwise occur from a rise in prices.

In other words, oil demand could remain elevated despite the uptick in crude prices, at least compared to a scenario in which market pricing won out. All else equal, an increase in prices should depress demand, but price supports could keep consumption humming along.

“The Middle East is endowed with some of the best solar irradiation rates in the world, reaching around 2,400 kilowatt-hours per square meter per year, but the share of solar generation in the power mix remains very low,” the IEA wrote.

Subsidies also prevent or slow the transition to cleaner sources of energy. The IEA took particular interest in the Middle East, where rock bottom fuel prices (because of subsidies and price fixing) keep the region burning crude oil for electricity. “The Middle East is endowed with some of the best solar irradiation rates in the world, reaching around 2,400 kilowatt-hours per square meter per year, but the share of solar generation in the power mix remains very low,” the IEA wrote.

Public handouts for fossil fuels come with huge economic, social, public health and environmental costs. The IEA, the IMF, and many other economists have long advocated for reducing or phasing out market interventions to subsidies gasoline and diesel. The crash of oil prices in 2014 provided a unique and very rare opportunity to eliminate subsidies without stirring up public ire. However, as the rise of oil prices over the past year and the backtracking on pricing reforms have made clear, the progress might have been temporary or even illusory.

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