Fossil Fuels: The Case For Ending Producer Subsidies

February 2, 2018

In October, a group of researchers published an article in the journal Nature. Their findings were stunning. The researchers concluded that US subsidies are responsible for pushing nearly half of new, yet-to-be-developed oil investments into profitability. The resulting increase in oil production makes up 20 percent of the amount of oil the United States could pump up under a 2°C carbon budget.[1] To get serious about the Paris climate commitments, such economic shenanigans have to stop.

The discussion around the global energy transformation often hones in on the costs of change. What we ignore is the economic burden of current policies. Among these, fossil fuel subsidies are an especially egregious anachronism. In particular, this is the case for producer subsidies, which remain prevalent in rich and emerging economies. Scholars have developed a thorough understanding of consumer subsidies and the ways in which reform efforts have to take into account the political economy of fossil fuel consumption.[2] By contrast, producer subsidies do not receive the same attention, and therefore remain pervasive.

The WTO defines a subsidy as any financial contribution by a government, or agent of a government, that confers a benefit on its recipients in comparison to other market participants.[3] Measuring the scale of subsidies, however, is a notoriously difficult exercise. Subsidies range from direct financial transfers and regulations, to tax breaks and credit guarantees. Ipek Gencsu, whose work at the Overseas Development Institute (ODI) focusses on fossil fuel subsidies, says that the OECD database is most useful in terms of identifying specific opportunities for subsidy reform.[4]

Joint research by the ODI and the NGO Oil Change International found $444 billion in producer subsidies and loans within the G20 alone.[5] A recent report states that, between 2013 and 2015, public finance from G20 institutions and multilateral development banks supported oil and gas production to the tune of $62 billion annually.[6][7] Absurdly, European countries continue to subsidize coal production by several billion euros, even with money officially earmarked to support the energy transition.[8]

The impact of fossil fuel subsidies is dramatic. For one, they are a fiscal burden, particularly in times of austerity. The opportunity costs associated with these subsidies mean that other, more productive investments cannot be made. Jakob and colleagues show that “phasing out fossil fuel subsidies would free up enough funds to finance universal access to water, sanitation, and electricity.”[9] Subsidies also contribute immensely towards the growth of global greenhouse gas emissions. According to one analysis, fossil fuel subsidies alone accounted for 36 percent of the growth in global carbon emissions between 1980 and 2010.[10]

On the producer side, a significant share of fossil fuel production is only profitable because it continues to benefit from subsidies. A recent report labelled this phenomenon as “zombie energy”.[11] This means that public money is being used in order to sustain artificially generated private profits. Removal of such zombie energy subsidies alone would reduce global emissions by 37 billion tons of CO² by 2050, which is equal to the entirety of expected emissions from aviation.[12]

Fossil fuel subsidies can also be regarded as possible weapons of financial mass destruction. In a 2°C warming scenario, large quantities of current fossil fuel reserves will have to be left under the ground as unburnable carbon.[13] These reserves will turn into stranded assets, a phenomenon otherwise known as the carbon bubble.[14] Notwithstanding, fossil fuel exploration for new reserves continues to benefit from G20 public finance averaging $13.5 billion annually. By throwing good money after bad, subsidies are therefore likely to contribute to global financial instability and asset write-downs.

What to do? Transparency is the crucial first step. G20 governments should start by developing a common reporting template. This would allow for a fair comparison of apples to apples, and define a baseline from which serious and profound subsidy reform could emerge. The development of such standards would also aid fossil fuel subsidy peer reviews. Recently, Peru and New Zealand, in addition to the two biggest emitters, China and the United States, have engaged in such peer review mechanisms to highlight ongoing subsidization of fossil fuels.

Improved transparency would enable policy-makers to be much more confident in highlighting the distortionary effects of fossil fuel subsidies in international trade.[15] Remarkably, while subsidies for renewable energy periodically turn into hot button topics in WTO trade disputes, fossil fuel subsidies are conspicuous mostly by their absence. This remains the case in 2017, even as subsidies for oil, gas and coal still dwarf public spending on renewables. In making trade policy, governments should thus follow the example of a recent agreement between the EU and Singapore, which includes a provision to aim for a reduction in fossil fuel subsidies.[16]

Even though the G20 committed to phasing out fossil fuel subsidies in 2009, implementation has been anemic. What is needed is a club of countries willing to push the agenda on producer subsidies. While rich countries are engaged on the consumer subsidy front, there is a lack of ambition to act quickly in ending producer support, particularly with regard to exploration subsidies. Such an effort could be tied to climate finance in the form of the Green Climate Fund. Rich countries should commit to channeling savings generated by subsidy cuts to the fund, which would act as a double dividend for global climate efforts. Poorer countries such as India or Indonesia, on the other hand, should direct savings towards their own national efforts to boost sustainable energy and energy efficiency.[17]

While carbon-pricing instruments are frequently en vogue among economists, they can also be difficult to implement.[18] At the same time, fossil fuel subsidies amount to nothing more than a negative carbon price. The Paris Agreement commits countries to make financial flows consistent with a sustainable energy transition.[19] Moreover, the Sustainable Development Goals apply to rich countries as much as poor ones. Given that some $45 trillion in investment is likely needed,[20] every dollar going to producer subsidies is a wasted one. The urgency of action before 2020 is clear.[21] Against this evidence, the low-hanging fruit of producer subsidies should be harvested.

 

References

[1] Peter Erickson, Adrian Down, Michael Lazarus and Doug Koplow, “Effect of Subsidies to Fossil Fuel Companies on United States Crude Oil Production,” Nature Energy, published online October 2, 2017, https://doi.org/10.1038/s41560-017-0009-8.

[2]  See e.g. Jorge Alberto Rosas-Flores et al., “Distributional Effects of Subsidy Removal and Implementation of Carbon Taxes in Mexican Households,” Energy Economics 61 (January 2017): 21-28; Allen Dennis, “Household Welfare Implications of Fossil Fuel Subsidy Reforms in Developing Countries,” Energy Policy 96 (September 2016): 597-606; Michael Jakob, Claudine Chen, Sabine Fuss, Annika Marxen, and Ottmar Edenhofer,, “Development Incentives for Fossil Fuel Subsidy Reform,” Nature Climate Change 5 (August 2015): 709-712; Jun Rentschler and Morgan Bazilian, “Principles for Designing Effective Fossil Fuel Subsidy Reforms,” Review of Environmental Economics and Policy 11, no. 1 (Winter 2017): 138-155.

[3]  WTO (World Trade Organization), “Agreement on Subsidies and Countervailing Measures,” (1994), https://www.wto.org/english/docs_e/legal_e/24-scm.pdf.

[4]  Interview conducted by author on 10/19/2017.

[5] Elizabeth Bast, Alex Doukas, Sam Pickard, Laurie van der Burg, and Shelagh Whitley, “Empty Promises: G20 Subsidies to Oil, Gas and Coal Production,“ Overseas Development Institute and Oil Change International (November 2015), https://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/9957.pdf.

[6]  Alex Doukas, Kate DeAngelis, Nicole Ghio, Kelly Trout, and Elizabeth Bast, “Talk is Cheap: How G20 Governments Are Financing Disaster,” Oil Change International, Friends of the Earth US, WWF, Sierra Club (July 2017), http://priceofoil.org/content/uploads/2017/07/talk_is_cheap_G20_report_July2017.pdf.

[7] At the recent One Planet Summit, the World Bank announced it would cease upstream support for oil and gas.

[8]  Shelagh Whitley, Laurie van der Burg, Leah Worrall, and Sejal Patel, “Cutting Europe’s Lifelines to Coal: Tracking Subsidies in 10 Countries,” Overseas Development Institute (May 2017), https://www.odi.org/sites/odi.org.uk/files/resource-documents/11494.pdf.

[9]  Michael Jakob et al., “Development Incentives for Fossil Fuel Subsidy Reform,” 710.

[10]  Radoslav Stefanksi, “Dirty Little Secrets: Inferring Fossil-Fuel Subsidies from Patterns in Emission Intensities,” OxCarre Research Paper 134, Oxford Centre for the Analysis of Resource Rich Economies (April 2014), https://www.oxcarre.ox.ac.uk/files/OxCarreRP2014134(1).pdf.

[11]  Ivetta Gerasimchuk, Andrea M. Bassi, Carlos Dominguez Ordonez, Alexander Doukas, Laura Merrill, and Shelagh Whitley, “Zombie Energy: Climate Benefits of Ending Subsidies to Fossil Fuel Production,” International Institute for Sustainable Development (February 2017), http://www.iisd.org/library/zombie-energy-climate-benefits-ending-subsidies-fossil-fuel-production.

[12]  Ibid.

[13]  Bill McKibben, “Global Warming’s Terrifying New Math,” Rolling Stone, July 19, 2012, http://www.rollingstone.com/politics/news/global-warmings-terrifying-new-math-20120719.

[14]  Jeff Rubin, The Carbon Bubble (New York: Random House, 2015); Carolyn Kormann, “There’s a Dangerous Bubble in the Fossil-Fuel Economy, and the Trump Administration Is Making It Worse,” The New Yorker, October 19, 2017, https://www.newyorker.com/tech/elements/theres-a-dangerous-bubble-in-the-fossil-fuel-economy-and-the-trump-administration-is-making-it-worse.

[15]  Cleo Verkuijl, Harro van Asselt, Tom Moerenhout, Liesbeth Casier, and Peter Wooders, “Tackling Fossil Fuel Subsidies through Trade Agreements,” Climate Strategies (October 2017), http://climatestrategies.org/wp-content/uploads/2017/10/CS_WP3-Brief_FINAL.pdf.

[16]  EU-Singapore Free Trade Agreement, Article 13.11, European Commission (2013), http://trade.ec.europa.eu/doclib/docs/2013/september/tradoc_151766.pdf.

[17]  For a description of a possible mechanism, see e.g. Laura Merrill et al., “Making the Switch: From Fossil Fuel Subsidies to Sustainable Energy,” Nordic Council of Ministers (2017), http://norden.diva-portal.org/smash/record.jsf?pid=diva2%3A1094676&dswid=-8535.

[18]  Tom Tietenberg, “Carbon Pricing in Practice,“ Review of Environmental Economics and Policy 7, no. 2 (July 2013): 313-329.

[19]  See Article 2.1c: “Making financial flows consistent with a pathway towards low greenhouse gas emissions and climate resilient development,“ Paris Agreement, United Nations Framework Convention on Climate Change (2015), https://unfccc.int/files/essential_background/convention/application/pdf/english_paris_agreement.pdf.

[20]   Global Commission on the Economy and Climate, “Better Growth, Better Climate: The New Climate Economy Report,” (2014), http://static.newclimateeconomy.report/wp-content/uploads/2014/08/NCE_SynthesisReport.pdf.

[21]  Alice Larkin, Jaise Kuriakose, Maria Sharmina, and Kevin Anderson, “What If Negative Emission Technologies Fail at Scale? Implications of the Paris Agreement for Big Emitting Nations,” Climate Policy, published online August 3, 2017, http://dx.doi.org/10.1080/14693062.2017.1346498.

Christiana Figueres, Hans Joachim Schellnhuber, Gail Whiteman, Johan Rockström, Anthony Hobley, and Stehan Rahmstorf, “Three Years to Safeguard Our Climate,” Nature 546 (June 2017): 593-595; Johan Rockström, Owen Gaffney, Joeri Rogelj, Malte Meinshausen, Nebojsa Nakicenovic, Hans Joachim Schellnhuber, “A Roadmap for Rapid Decarbonization,” Science 355 (March 2017): 1269-1271; Detlef P. van Vuuren, Heleen van Soest, Keywan Riahi, Leon Clarke, Volker Krey, Elmar Kriegler, Joeri Rogelj, Michiel Schaeffer, and Massimo Tavoni, “Carbon Budgets and Energy Transition Pathways,” Environmental Research Letters 11, no. 7 (July 2016), published online, https://doi.org/10.1088/1748-9326/11/7/075002.

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Tim Pfefferle

Tim Pfefferle studied international relations, global governance and diplomacy in London and Oxford. Previously, he worked for the German development agency GIZ in Bonn and Brasília, as well as for the European Commission in Brussels. His work focuses on climate change, and currently deals with how to approach a managed decline of fossil fuels and guarantee a just transition. In his spare time, Tim runs the Divestment Post Twitter account.