Who is still subsidising fossil fuels, and why?

In an age of climate change, it seems deeply perverse to subsidise the production and consumption of fossil fuels. And yet, the world continues to spend hundreds of billions of dollars every year doing exactly that. Globally, we spend more on fossil fuel subsidies than those for renewable energy. In 2011, global subsidies for oil, coal and gas stood at $409 billion, six times more than the $66 billion spent on wind, solar and biofuels.

This is a little crazy, but to understand why it continues, we need to look at who is doing the subsidising and why. Let’s start with a definition. The Economist Glossary defines subsidies as “Money paid, usually by  government, to keep prices below what they would be in a free market, or to keep alive businesses that would otherwise go bust, or to make activities happen that otherwise would not take place.”

Fossil fuel subsidies can be paid to producers by supporting prices or by government funding for investment and infrastructure. That’s often used as a strategy to boost investment in oil production, or prolong production once it starts to tail off.

You can also subsidise the consumer end of the process by offering lower prices. You might want to promise cheaper energy prices to score brownie points with the electorate, for example, or use them as part of an industrial policy to make your exports cheaper. They could be used to protect consumers from a price spike. Or you might want to keep more of your natural resources for your own people rather than export them, and so offer cheaper domestic prices.

It’s easy to see this sort of thing as environmentally and economically perverse, but fuel subsidies can play a role in development that is easily missed. By lowering prices, you can make energy more accessible to poor people, and that’s critical in supporting small businesses and creating basic industry. There’s an environmental dimension to this too. If the poorest in society are priced out of the energy market, they may find fuel sources wherever they can – such as cutting down trees. So it’s not as black and white as it may initially appear.

Here are the top five countries spending the most on fossil fuel subsidies:

Iran – Far and away the biggest spender here is Iran, running subsidy programmes for oil, gas and electricity that total $80 billion. The country started subsidising energy to protect citizens during the Iran-Iraq war, and like most such programmes, they’re hard to get rid of once you start. Reform is pretty critical – they consume a quarter of Iran’s GDP by some estimates. There have been attempts to cut them for 20 years, with little success. President Rouhani will have to put up energy prices at some point in the near future, and that could prove destabilising.

Saudi Arabia – Oil is cheaper than water in Saudi Arabia. It is even used to generate electricity, which then runs desalination plants, so in fact oil is used to create fresh water. Because oil is so cheap, Saudi Arabia is one of the only countries in the world where the economy is getting more and more inefficient. Subsidies have removed any incentive to lower oil consumption. Cheap energy is a perk of living in the world’s most important oil producing country, a way of sharing the national wealth with the wider population.

Russia – Russia is the world’s biggest producer of natural gas, and 60% of it is burned by its own citizens at knock-down prices. Most of it goes on heating, and the cheap energy means that Russia’s housing is far less efficient than countries with similar cold climates, with huge amounts of energy wasted. There are plans to raise prices slowly, and President Putin has spoken about the need to rationalise subsidies to reduce waste and target spending better towards the most vulnerable.

India – The three biggest spenders on subsidies are fossil fuel producers. India is not, and government expenditure on its many different subsidy programmes is often cited as one of the things holding back the economy. Some argue that the money spent on subsidies would have been better spent on infrastructure – building a gas network for example, rather than subsidising bottled gas. Gas and oil subsidies are being slowly reduced, but this is unpopular and politically fraught.

China – High in total but relatively low per capita, China’s $21 billion in subsidies is used to cushion industry from volatility in global fuel prices. It is one of the few countries to subsidise coal. Air pollution is a pressing problem, and there are new efforts to clean up dirty coal power. Among the most recent measures is a levy on wholesale energy prices to help fund subsidies for renewable energy.

We can’t carry on subsidising fossil fuel use. Not when it is destabilising the climate, and holding down fossil fuel prices makes it harder for clean energy to compete too, delaying the transition to low carbon energy. They have to go, but a run through this top five shows that the challenges are not the same in every country. Not all subsidies are created equal. Some are harder to shift than others. There is no simple solution.

Two generalisations by way of conclusion. First, this is largely a developing world phenomenon. Richer countries have fewer excuses, and the tax breaks and government props to the fossil fuel industry should be swept away as soon as possible. Developing countries need to improve subsidies so that they target the poor better. IEA research shows that the poorest 20% of society receive about 8% of subsidies, with the richest benefiting disproportionately. That can change. There are also some difficult questions about whether subsidising energy is cost effective from a development perspective. Would spending the same money on education, healthcare or infrastructure reap bigger rewards?

It’s also worth remembering that 2.5 billion people still rely on traditional fuels such as wood and dung. This is a source of greenhouse emissions too, it’s a driver of deforestation and it’s bad for human health. Of course it would be great if all 2.5 billion could leap-frog straight to renewable energy, but there may be a role for transition fuels here, and it may be an environmental positive if it protects carbon sinks. That will depend on local circumstances, but pressing for a complete ban on fossil fuel subsidies may not be the best approach.

Secondly, this is also a problem for oil-producing countries, as a scan through the rest of the top 15 above shows. I can see how cheap energy is used to redistribute profits from national wealth, and that’s a legitimate aspiration. But there may be better ways to do that. Alaska pays a share of oil wealth as a citizen’s income, which means you can use the money for whatever you want, rather than just energy. Norway has created a sovereign wealth fund, safeguarding that fossil fuel windfall so that future generations can benefit too. Both of these seem like healthier alternatives.

Fossil fuel subsidies look like one of the most perverse obstacles to stopping climate change, but we could see them as an opportunity instead. According to the IEA, removing subsidies could deliver as much as half of the emissions reductions required within the next decade if we are to keep within 2 degrees of warming. Institutions such as the WTO and OECD support the idea. Doing the right thing is in line with free market principles too, so building support for removing subsidies should be easier than many of the changes we need to make to avoid climate change.