Fossil fuel subsidies

This is the first in a series of posts on the costs of addressing (or failing to address) global warming, and which policy tools work best: subsidies to other energy sources? tax? cap and trade? Writers frequently refer to fossil fuel subsidies, and I wondered how large they are. I begin with this, because if fossil fuels are not highly subsidized, either through direct subsidies or failure to require polluter to pay, there are no market distortions that need to be addressed.

[Notes: A market distortion is defined to be a situation where the price of the commodity does not make sense—it is higher or lower than it should be, so that decisions people make do not include full knowledge of benefits or damage. This is discussed in more detail below.

[People often leap to defend fossil fuel subsidies without checking whether their particular concern is addressed in policy solutions. These solutions will be discussed in coming posts.]

Bottom line

Largest subsidies: not requiring polluters to pay for air pollution ($1.6+ trillion/year) and climate change ($1.4 trillion+++++/year and growing). These are more commonly called externalities, costs or benefits going to those who did not pay for them.

Much lower are consumption subsidies ($400 billion), which lower consumer prices for gasoline, electricity, etc.

Lower yet are productions subsidies, which reduce costs for energy producers (perhaps $100 billion).

These subsidies average more than $500/year for every person on Earth. Those who use more fossil fuel energy receive more subsidies.

Production subsidies

Good statistics on production subsidies, which partially offset industry losses or costs, don’t exist.

To give an idea of their magnitude, Joseph Aldy asserts that almost $5 billion per year in US subsidies to fossil fuel producers, mostly oil and gas, are a waste of money. The Global Subsidies Initiative estimates world production subsidies may total $100 billion/year.

Consumption subsidies

Consumption subsidies reduce consumer prices. In Venezuela, gasoline is sold for 6 cents/gallon. In Saudi Arabia, oil is made available for domestic use, including electricity production, at under $15/barrel. In both Venezuela and Saudi Arabia, more than 3/4 of the price of fossil fuel consumption is subsidized.

International Energy Agency provides an analysis of fossil fuel subsidies, which disproportionately go to the rich and middle class, drain state budgets, increase pollution, distort markets, encourage waste, and discourage investment in methods to reduce energy use. Subsidies increased by $110 billion between 2009 and 2010, to $409 billion, to keep up with rapidly rising energy prices. IEA says consumption subsidies may reach $660 billion in 2020.

Subsidies are especially high in countries which export fossil fuels, more than $325 billion of the 2010 subsidies. Importers see their budgets suffer, and exporters see a valuable resource depleted more rapidly.

An IEA map shows consumption subsidies around the world—they are found in most of Asia, a good portion of Central and South America, and North Africa. These 10 countries subsidize the majority of the price of fossil fuels (percents vary with the price):

South America
• Ecuador (52%)
• Venezuela (82%)

• Algeria (57%)
• Egypt (54%)
• Libya (80%)

• Bangladesh (51%)
• Iran (74%)
• Iraq (62%)
• Saudi Arabia (79%)
• Uzbekistan (61%)

Pollution subsidies for global warming—polluter isn’t paying
climate risks are higher than estimated because they are erratic
Climate risks may be higher than estimated because they are erratic

Another market distortion occurs when we don’t include the costs of global warming, currently estimated at $37/ton carbon dioxide, $41/metric ton, for pollution emitted today. All agree the cost of keeping temperature increase manageable will rise.

This market distortion is called an externality, because the cost is external to the price. It effectively acts as a subsidy, with the purchaser paying far less than the actual cost.

[Notes: there is disagreement about the $41/ton CO2 estimate. A number of prominent economists feel it should be higher because economic models are insufficient:
• History tells us transitions will not be as smooth as economists predict.
• Productivity, productivity growth, and the value of buildings, farms, and infrastructure will decline. Additionally, threats from major conflict and societal and economic collapse are not included in current economic models.
• Ecosystems will collapse, making them a more valuable commodity.
• Economists explicitly discount the future more than scientists, often discounting it at a constant rate, even though we as individuals see more difference between today and a year from now, than between 20 and 21 years from now; scientists point out that this method discounts almost entirely the costs of global warming in a few decades, no matter how high.

[A recent analysis examines only the effect of the slowdown in economic growth and produces an estimate of social cost of carbon dioxide which is several times higher than $41/ton. International Energy Agency suggests a $46/ton CO2 cost in 2020, rising rapidly to $160 in 2050.]

In 2013, the world consumed 33 billion barrels of oil, releasing 0.43 metric ton carbon dioxide per barrel oil. The subsidy to polluters who use oil is

$41/ton CO2 x 0.43 ton CO2/barrel x 33 billion barrels/year = $600 billion/year

In 2013, the world consumed 7.8 billion metric tons of coal, each releasing 2 tons of CO2/ton of coal. The subsidy to polluters who use coal is

$41/ton CO2 x 2 tons CO2/ton coal x 7.8 billion tons coal = $600 billion/year.

In 2013, the world consumed 3,300 billion cubic meters, 120,000 billion cubic feet, of natural gas. Each billion cu ft produces 54,400 tons CO2. The subsidy to polluters who use natural gas is

$41/ton CO2 x 54.4 million tons CO2/billion cu ft x 120,000 billion cu ft = $250 billion

These total over $1.4 trillion.

Ignored in these calculations are significant contributions from methane (natural gas), black carbon, and other climate forcings.

Pollution subsidies for air pollution other than those causing global warming—polluter isn’t paying

Air pollution
Air pollution, indoor and outdoor, kills 7 million annually, according to World Health Organization.

A working paper from the International Monetary Fund looks at the top 20 CO2 emitting nations, responsible for 79% of world greenhouse gas emissions. These countries emitted 27.1 billion tons of CO2 in 2012. IMF says in these countries, air pollution other than greenhouse gases, and congestion from incorrectly priced fuels, cause an extra $57.50 in damage per ton of carbon dioxide, although the damage is not from the CO2.

$57.50/ton CO2 x 27.1 billion tons = $1.6 trillion

In 2013, 33 billion tons of CO2 were emitted from fossil fuels and cement, so even assuming lower pollution in other countries, subsidies due to polluters not paying the cost of their air pollution is likely higher.

Pollution subsidies are real market distortions

Poor countries are harmed when energy use is subsidized. The rich use more energy and get more benefit from the subsidies. The result is that in poor countries, other important needs of society, such as education, are shortchanged or even ignored. Once these subsidies are in place, it is hard to convince people to give them up since they look on them as a right.

People I talk to understand that direct consumptions subsidies harm countries, but say they cannot see that pollution subsidies are in any way unfair. They agree that the cost of pollution from fossil fuels has been estimated at $41 a ton, just for climate change. However, they say, too, this is not the real cost since it fails to take into account the benefits of cheap fossil fuel to society.

Unfortunately, failing to make the polluter pay exacts a high cost on society. The damage done by the polluter (without the polluter having to pay) has to be seen as a subsidy because in an undistorted market (where all costs are taken into account), the polluter pays for the cost of the damage along with the other costs of energy. In today’s world, climate change and air pollution affect people’s health and lives, and cost society. The costs can also be seen in increased costs to agriculture because of decreased yields due to floods and drought. There are other definite costs: costs when buildings suffer damage from sea level rise, storm surges and floods; costs when we have to take steps to protect ourselves from rapid climate changes; coats when we have to deal with the results of permafrost melt; costs when land loses value because of climate change. Economists may limit their assessment to the near future, but the damage we do today will continue to cost future societies for many thousands of years.

People use the price of fossil fuels in determining how much to buy, and they are priced too low, so we buy more than makes market sense. I have heard a number of economists call improperly priced fossil fuels “the greatest market failure ever”. Nicolas Stern says this as well,

The problem of climate change involves a fundamental failure of markets: those who damage others by emitting greenhouse gases generally do not pay…Climate change is a result of the greatest market failure the world has seen.

The series
• Fossil Fuel Subsidies
Can we address climate change fairly cheaply?
Why add a cost to GHG instead of subsidizing renewables?
• Tax or cap and trade?

6 Responses to “Fossil fuel subsidies”

  1. Good work, Karen! I’m going to share this one with others.

  2. G.R.L. Cowan says:

    It is conceivable for fossil fuels not to be highly subsidized and the market still be distorted. Conceivable, and in my opinion actual.

    Look at the extreme slowness with which the government of Japan is allowing the country’s electricity providers to restart their nuclear power plants. It turns out that since a few years ago they have had a special tax measure “aimed at stemming global warming”. There is a schedule for this carbon tax occasionally to be raised, but even as it was when it began, it was giving the central government $140 million a month. Letting the plants restart means giving up that revenue.

    It also means alleviating the country’s enormous trade deficit. But does a trade deficit threaten any civil service paycheque?

    Isn’t it obvious that the tax measures that stem global warming are those that make it less profitable for government, not more so?

    The market distortion I see is that the net subsidy from government to fossil fuel consumers and producers is large — and negative. So it does everything it deniably can to impede fossil fuel conservation and substitution.

    You have to look at the taxes especially high for fossil fuels or

  3. G.R.L. Cowan says:

    Somehow that comment got submitted in midstream. I meant it to close this way:

    You have to look at the taxes that are special to fossil fuels, or especially high for them, along with the subsidies.

  4. Karen Street says:

    Yes, in parts of Europe, the tax on gasoline may be higher than the cost of road repair, air pollution, greenhouse gas pollution, and so on. Then the tax is high enough to be considered a market distortion. The spending of huge amounts of money to import fossil fuels affects other parts of the economies of countries involved, but I don’t understand the issue well enough to know how that should be costed. I believe that it is part of what Japan considers.

    I don’t really understand your point on a negative subsidy of fossil fuels.

  5. G.R.L. Cowan says:

    I don’t really understand your point on a negative subsidy of fossil fuels.

    If allowing the replacement of fossil fuels with other, non-carbon-emitting ways of getting the same benefits reduces a government’s income, that government is subsidized by the fossil fuel sector.

  6. Karen Street says:

    Ah, no wonder I didn’t understand, you use non-traditional terminology. I suppose that if a country opts for nuclear over coal for absolutely no reason, then coal loses out. But coal is not subsidizing the government.

    Also, both Japanese industry and the government are invested in restarting nuclear power plants, which reduces both the direct taxes paid by fossil fuels to the government, and the enormous financial costs fossil fuels exact which are currently paid by the government and private individuals both. I haven’t checked the Japanese tax carefully, but as I recall, the tax on fossil fuels is less or far less than the actual costs to society, which means that coal continues to be subsidized. You can check for me—if the tax on coal is more or considerably more than $100/ton CO2, then it is possibly a negative subsidy. That is using the $40/ton CO2 figure for greenhouse gas emissions, and the $60/ton CO2 figure for air pollution. As mentioned, a number of economists believe that the $40 estimate is way too low, and so any tax below $200 – $250/ton might be too low.