Fossil-fuel consumption subsidies are down, but not out – IEA

Phasing out subsidies means a better allocation of resources across the energy system

By Toshiyuki Shirai and Zakia Adam, International Energy Agency

Getting energy prices right is critical for sound policymaking. But because of government energy subsidies prices that consumers pay in many countries are often well below their real market value, let alone the price that would reflect energy’s full environmental and social cost.

The estimated value of global fossil-fuel consumption subsidies decreased by 15% to $260 billion in 2016, the lowest level since the International Energy Agency started tracking these subsidies in the World Energy Outlook (WEO) ten years ago.

Analysis in the new WEO-2017 showed that for the first time the largest share of global subsidies that benefit fossil fuel consumption went to keep electricity prices artificially low (41% of the global total), ahead of oil (40%) and natural gas.

But while the figure for fossil-fuel consumption subsidies may be coming down, it remains much higher than estimated government support to renewable energy: subsidies for renewables in power generation amounted to $140 billion in 2016.

There can be good reasons for governments to make energy more affordable, particularly for the poorest and most vulnerable groups.

But many subsidies are poorly targeted, disproportionally benefiting wealthier segments of the population that use much more of the subsidised fuel. In practice, the effect of most subsidies is to encourage consumers to waste energy, putting added pressure on energy systems and the environment, and often straining government budgets.

Such subsidies are a roadblock on the way to a cleaner and more efficient energy future; that is why the IEA continues to be a strong supporter of international efforts to get them removed and why the WEO has consistently been shining a spotlight on this issue.

The dip in oil subsidies in 2016, and the higher share of electricity, reflect some short-term price developments but also reveal a new set of challenges to remove them. Reforms in many countries often focus in the first instance on oil products used for transport.

Some notable developments in 2016 were in the Middle East, where many countries increased prices for gasoline and diesel, including Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates. Although the Middle East remains the region with the largest share of total subsidies (some 30% of the total), the estimated value of these subsidies has declined sharply, from around $120 billion in 2015 to $80 billion the following year.

The battle to reduce oil-based subsidies is far from over. Governments could well come under pressure to reinstate subsidies for gasoline and diesel when oil prices start to rise. But our analysis also highlights the need to move beyond the transport sector to other areas that may be even more difficult to reform.

For example, a separate analysis conducted by the WEO team in 2017 on subsidies in the Asia-Pacific Economic Cooperation (APEC) economies showed that the value of subsidies to oil products for transport has fallen by more than half since 2010, mostly due to pricing reforms. As a result, most of the remaining subsidies in this region are now in the residential sector, primarily for electricity but also for natural gas and liquefied petroleum gas (LPG).

Electricity price reforms are on the agenda in many countries, with Argentina and Indonesia two prominent examples of reform in 2017. Subsidy policies are also a major underlying reason for the poor financial state of some state-owned power utilities, undermining their ability to invest in new energy infrastructure.

Reform is never an easy task, as pricing reforms have a direct impact on people’s daily lives. But a failure to tackle electricity pricing threatens an unsustainable burden in the future, given the likelihood of rising fuel costs and the rising share of electricity in final consumption.

The benefits of a well-planned reform are wide-ranging. Phasing out subsidies means a better allocation of resources across the energy system, revealing incentives for energy savings and for investments in more efficient and cleaner technologies.

Financial resources saved by subsidy reform can be used to pursue other public policy objectives, including targeted support to ensure continued access to energy among the poor. There is a growing body of evidence, based on numerous case studies, to support the view that well-designed, carefully implemented reforms can bring strong dividends.

*The IEA estimates subsidies to fossil fuels that are consumed directly by end-users or consumed as inputs to electricity generation. The price-gap approach, the most commonly applied methodology for quantifying consumption subsidies, is used for this analysis. It compares average end-user prices paid by consumers with reference prices that correspond to the full cost of supply. The country-by-country data are available, as is additional information on the methodology.

There are some other subsidies that are not captured by the price-gap approach, such as those to support production of fossil fuel, fuel vouchers or other payments directly paid to low-income households. The OECD compiles and publishes data on these fossil fuel subsidies, with information collected mainly from government budget or tax information.