Energy

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Relative subsidies to energy sources: GSI estimates 

The energy sector comprises the production, sale and distribution of energy, including fuel extraction, manufacturing, refining, transformation and transportation. Fossil fuels – oil, natural gas and coal – are the leading primary sources of energy. Other sources are nuclear energy, traditional biomass fuels, such as firewood and charcoal, and renewables, including hydroelectric, geothermal, wind and solar power. Primary fuels can be converted into final forms or carriers of energy, such as refined oil products, electricity and hydrogen, or used directly in final uses.

The way we produce, transport and use energy has important consequence for sustainability. Energy is essential for all economic activities. The prosperity generated by economic development stimulates, in turn, demand for more and better-quality energy services. But the production, distribution and use of energy can have major adverse effects on the environment and on the health and well being of current and future generations.

Governments intervene in energy markets for a variety of economic, environmental and social reasons. Often, these interventions are intended to keep prices low to households and industry, or to protect indigenous energy industries from foreign competition. But experience around the world shows that, in many instances, the net overall effects of subsidies are negative, because they distort markets, are costly and open to abuse, and, where they encourage higher energy consumption, harm the environment.

In principle, any measure that keeps prices for energy consumers below market levels or for energy producers above market levels, or that reduces costs for consumers or producers, may be considered a subsidy. Energy is most commonly subsidised through price controls, which keep prices below the full economic cost of supply. They are most common for electricity and natural gas, but are still important in some countries for oil products. The extent of under-pricing is generally bigger in countries where the energy sector is state-owned and where a significant share of production is exported.

Energy subsidies are widespread, but they vary greatly in importance and type by fuel and country. Consumption subsidies — government measures that result in an end-user price that is below the price that would prevail in truly competitive market including all the costs of supply — are large in some countries. They have been mostly eliminated in the OECD, but remain large in countries like Indonesia and Venezuela, both in gross terms and net of any taxes. Electricity and household heating and cooking fuels are usually most heavily subsidised, though several countries still subsidise road-transport fuels. Production subsidies, usually in the form of direct payments and tax breaks to producers, or support for research and development, are most common in OECD countries.

Few studies have attempted to quantify subsidies for the world as a whole, because of data deficiencies and the sheer scale of the exercise. The most prominent global study, carried out by the World Bank in 1992, estimated annual fossil-fuel consumption subsidies at around USD 230 billion. An OECD study the same year estimated global energy consumption subsidies at USD 235 billion, with USD 254 billion of net subsidies in non-OECD countries offsetting USD 19 billion in net energy taxes in the OECD. In 1997, the World Bank estimated annual fossil-fuel subsidies at USD 48 billion in twenty of the largest countries outside the OECD and USD 10 billion in the OECD. A 1999 International Energy Agency study put the total value of energy subsidies in eight of the largest developing countries at around USD 95 billion. The overall size of energy subsidies fell sharply in the 1990s, mainly due to economic reform in the former communist bloc, but may have increased recently in certain developing countries as a result of domestic price controls preventing rises in international energy prices passing through to final consumers.

The economic costs of energy subsidies can be big. Subsidies can place a heavy burden on government finances, weaken the foreign trade balance, and stunt the growth potential of economies. Depending on how they work, they can also undermine private and public investment in the energy sector, impeding energy conservation and the expansion of distribution networks. Subsidies to specific technologies can also hinder the development of competing technologies that might be more economic in the longer term. And very often, it is more affluent people who end up with the largest share of subsidies intended for the poor.

Many energy-subsidy schemes are also harmful for the environment. Subsidies that encourage the production and use of fossil fuels inevitably have some harmful environmental effects. By encouraging higher consumption, they lead to higher emissions of air pollutants and greenhouse gases as well as other forms of environmental damage, such as water contamination and spoiling of the landscape. The Kyoto Protocol explicitly requires a reduction of subsidies that encourage greenhouse-gas emissions. But subsidies to fossil fuels can also have a beneficial impact on the environment. For example, encouraging the household use of oil products can reduce deforestation in poor rural areas otherwise dependent on firewood.

Empirical evidence of the net environmental effects of introducing or removing energy subsidies is generally qualitative. This reflects the immense practical difficulties of estimating quantitatively the different effects, expressing them in consistent monetary terms, and aggregating them. A number of studies have demonstrated the harmful effects of various types of fossil-fuel subsidies. A recent study by the OECD, for example, shows that global carbon-dioxide emissions would be reduced by more than 6% and real income increased by 0.1% by 2010 if all subsidies on fossil fuels used in industry and the power sector were removed everywhere in the world. Another study by the IEA shows that the removal of consumption subsidies in eight of the largest non-OECD countries would reduce emissions by 16%.

Removing subsidies that are both economically costly as well as harmful to the environment would be a win-win policy reform. However, governments are often faced with awkward trade-offs between the economic and environmental benefits of reforming those subsidies and the short-term social costs of higher fuel prices or of lower employment in indigenous energy industries. In some poor countries, including many of those of the former Soviet Union, removing subsidies to modern household cooking and heating fuels has had a dramatic short-term impact on living standards. And removing subsidies to coal can have a devastating effect on employment and incomes in local communities that depend heavily on mining. That is why, in Europe, reform of coal subsidies has often involved redirecting public money towards retraining and other adjustment measures, as well as aid for regional economic development.

Energy subsidies have so far not attracted a lot of attention at the World Trade Organization. Technically, subsidies to the production of energy products fall under the disciplines of the Agreement on Subsidies and Countervailing Measures. The exception may be fuel ethanol, which for the moment is classified as an agricultural commodity, and is therefore subsumed into the sector-wide disciplines of the Agreement on Agriculture. Subsidies to services involved in the energy supply chain, such as to exploration for new hydrocarbon deposits, or to operate power plants, would be covered by the General Agreement on Trade in Services. Subsidies for products consumed by households, such as those benefiting kerosene in many low-income countries, would not be covered by any of these disciplines.

In addition to these formal disciplines, there have been a number of hortatory statements made at the international level on the need for reducing or eliminating energy subsidies. The Plan of Implementation (PoI), issued at the end of the United Nations World Summit on Sustainable Development (WSSD), which was held in Johannesburg, South Africa, in September 2002, contains numerous references to environmentally harmful subsidies. Concerning energy subsidies, the PoI calls upon members to: “Take action, where appropriate, to phase out [energy] subsidies . . . that inhibit sustainable development, taking fully into account the specific conditions and different levels of development of individual countries and considering their adverse effect, particularly on developing countries.” Even if certain expressions (“where appropriate”, “taking fully into account”) dilute the force of the language, it is noteworthy that countries are being invited to abolish subsidies because they are environmentally harmful, or at least inhibit sustainable development. However, since the PoI is not legally binding, there is no way to enforce its pledges regarding subsidies.

On 25 September 2009, the Leaders of the Group of Twenty (G-20) met in Pittsburgh, PA, and commited to phase out ‘inefficient' fossil-fuel subsidies over the medium term. Two months later, the Leaders of the Asia-Pacific Economic Cooperation (APEC) made a similar commitment. As of the beginning of 2010, it is still unclear which subsidies will be targetted for phasing out, and what time period constitutes the medium term. G-20 Finance Ministers are to develop implementation strategies and timeframes, and report back to Leaders at the next Summit, which will take place in Toronto, Ontario, Canada in June 2010. Meanwhile, a number of individual countries, including Iran, Nigeria and Bahrain, have also embarked on process of fossil-fuel subsidy reform.