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How Can Fossil Fuel Subsidies Be Reformed?

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Efforts have been under way for decades to tackle fossil fuel subsidies, but they have proved remarkably resistant to change. Reform is difficult at the best of times and even more so in the midst of the Ukraine war — with governments recently rolling back taxes and increasing support for consumers facing surging bills. However, fossil fuel subsidy reform has perhaps never been more relevant as part of wider conversations around the energy transition: The recent report from the Intergovernmental Panel on Climate Change (IPCC) suggests that removing fossil fuel subsidies could be critical in efforts to avoid overshooting 1.5°C of global heating. 

Fossil fuel subsidies are often difficult to quantify. Research released recently by B Team, the climate-oriented nonprofit cofounded by Richard Branson, reckons that $640 billion of support a year is received by the fossil fuel industry, while the International Energy Agency (IEA) and OECD reckon that government support for the production and use of fossil fuels across major economies totaled $351 billion in 2020.

They also far outweigh subsidies for clean energy. The International Renewable Energy Agency (Irena) describes the imbalance as “staggering.” In 2017, subsidies to fossil fuels of $447 billion accounted for around 70% of the world’s total direct energy sector subsidies of at least $634 billion. Subsidies to renewable power generation technologies at the same time accounted for just 20% of total energy sector subsidies, biofuels for about 6% and nuclear for at least 3%.

Widely Panned

Fossil fuel subsidies are widely condemned. The IPCC report states that they “undermine the credibility of public climate commitments, reduce perceived energy transition risks and limit financial sector action.”

The IEA and OECD warn, too, that they are distortive, generating inefficiencies in the production and use of energy economy-wide and skewing long-term capital investment toward fossil-fuel producers or fossil fuel-intensive industry, enhancing the risk of lock-in to those high-emission technologies. They are also costly, either increasing public expenditure or reducing tax revenue, the IEA and OECD say.

Why So Resilient?

Subsidies can include a wide range of measures. On the production side, they include tax breaks to reduce costs for oil, gas and coal output. On the consumption side, they include price controls for cooking, heating or transport fuels. The latter are more common in lower-income countries, and tampering with them can be particularly tricky for governments. As the International Monetary Fund (IMF) notes, “when reforms are made, prices increase, and this has often led to widespread public protests.”

This problem is particularly challenging in oil-exporting countries, where subsidies are seen as a mechanism to distribute the benefits of natural resource endowments to their populations, the IMF says. Producer subsidies in places such as the US are also politically sensitive — especially with energy prices so high.

Many have talked of fossil fuel reform for decades, with little to show for it, although efforts continue to advance. Governments from 197 countries agreed at COP26 in Glasgow to accelerate efforts to phase out “inefficient” fossil fuel subsidies. And G20 finance ministers, meeting more recently in Jakarta, supported the phaseout and rationalization of inefficient fossil fuel subsidies over the medium term. First made in 2009, the G20 pledge to phase out fossil fuels has been reiterated at multiple subsequent summits. Nevertheless, G20 country support levels remain unchanged in nominal terms to those of a decade ago, the IEA and OECD note.

The EU has also taken more steps recently, adopting a new Environmental Action Program at the end of March that mandates the phasing out of fossil fuel subsidies. Europe has however been slow so far in matching its rhetoric with action. According to a review published January by the European Court of Auditors (ECA), fossil fuel subsidies in the EU have remained relatively constant over the last decade, despite commitments from the European Commission and some member states to phase them out. Overall, member states’ subsidies for fossil fuels amount to over €55 billion per year, and 15 spend more on fossil fuel subsidies than on renewable energy subsidies, according to the ECA.

Recipes for Success

So what should governments do? The IEA points to some ingredients for success that it says are well known, including a clear and graduated timetable for subsidy reform that is clearly communicated and explained to consumers, as well as schemes to mitigate the impact on the poorest and most vulnerable sections of society.

The IMF suggests, too, that while there is “no single recipe” for successful subsidy reform, country experiences suggest other necessary ingredients include: a comprehensive energy sector reform plan with clear long-term objectives; improved energy efficiency; and institutional reforms that depoliticize energy pricing, such as the introduction of automatic pricing mechanisms.

In contrast to fossil fuel subsidies, support for renewables is generally seen as productive — providing early stage support that ultimately helps a technology to scale up and stand on its own feet. Irena research suggests that as renewable power becomes increasingly competitive and early high-cost subsidies to solar photovoltaic, in particular, expire, subsidies for renewable power generation will decline and be virtually eliminated by 2050. Total energy sector subsidies could also decline, from 0.8% of global GDP in 2017 to 0.2% in 2050, according to Irena projections.

Ronan Kavanagh is an editor of World Energy Opinion at Energy Intelligence. A version of this article originally ran in EI New Energy.

Topics:
Low-Carbon Policy, Policy and Regulation, Fiscal Terms
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