The economics of energy - Ending fossil fuel subsidies

In order for the world to transition to a low-carbon economy the economics of energy must change. It must become cheaper to both generate and consume energy with a lower greenhouse gas intensity. And while the private sector plays a critical role in facilitating this transition, public policy that encourages low-carbon forms of energy and discourages high-carbon energy is also required.

Companies that understand the market opportunities that a low-carbon economy represents are making major investments in R&D in energy generation, developing products that use less energy, and even creating new business models. A new UNEP report just released at Rio+20 (to which SustainAbility contributed) lays out the business case for a green economy, and identifies numerous examples of companies making money on low-carbon solutions.

Despite some positive commitments that came out of Rio+20, particularly from the private sector, one of the high profile failures was the lack of agreement to end fossil fuel subsidies. There has been an increasingly widespread and strong call for the end of subsidies in the run-up to the conference. Back in 2009 the G20 pledged to phase out inefficient fossil fuel subsidies, but little effort has been made by those countries since then. More recently, many environmental organizations pushed for a phase-out to be included in the conference Outcome Document. A Twitterstorm was launched, with 100,000 tweets going out to #endfossilfuelsubsidies. Even Richard Branson made the pitch in an interview from Rio with GreenBiz head Joel Makower.

On the surface this is an easy call. After all, if we are to transition to a low-carbon economy, it makes no sense to continue to subsidize a high-carbon industry. Eliminating payments, tax breaks and discounted royalties is one clear and direct way to change the economics of energy, while also reducing budget deficits that now plague many governments. By some accounts, ending fossil fuel subsidies could by itself result in a 6 per cent reduction in greenhouse gas emissions.

Estimates of the size of the subsidies on a global basis range from $400 billion to $1 trillion, depending on exactly what is counted as a subsidy. Analysis by the Natural Resources Defense Council (NRDC) has pegged the number at $775 billion, citing data from the International Energy Agency and OECD (see graphic below). But while much of the political focus in the west (or at least here in the US) is on tax breaks to big, publicly-traded oil companies, about 81 per cent of subsidies worldwide are consumption subsidies in developing countries, and another 6 per cent goes to consumption subsidies in developed countries. These are subsidies focused on keeping the price of gasoline at the pump low, and keeping home heating costs down. Countries like Venezuela, Indonesia, Iran and Nigeria (yes, all major oil producers) are doling out the subsidies to keep their citizens happy. Eliminating consumption subsidies abruptly in these countries could not only hurt those whose livelihoods are dependent on driving an automobile (the poor as well as the wealthy), but also could more broadly cause prices of goods reliant on transportation to increase. That is why when these governments have attempted to move prices closer to market prices, turmoil, and sometimes violence in the streets, has ensued.

NRDC Natural Resources Defense Council, Fuel Facts, June 2012

The remaining 13 per cent of fossil fuel subsidies are going to the energy producers… Still a sizeable amount at $100 billion, these are the royalty discounts and tax breaks that extractive companies receive. They encourage drilling for oil and mining coal by making production profitable at a lower price point. The fossil fuel industry appears deeply offended by any allusion that they are receiving subsidies they don’t deserve. ExxonMobil has written a string of opinion pieces explaining why the tax breaks the industry receives should remain in place.

Of course the best outcome is to use less energy in the first place through improvements in energy efficiency, as Marc Gunther recently reminded us. That too is dependent on economics, and as Marc points out, the incentives here in the US aren’t aligned with the desired outcomes.

Ending subsidies for fossil fuels will be difficult. Some individuals, companies and communities – and yes, some politicians as well – will be negatively impacted by the change. But keeping subsidies in place will have a bigger negative impact: slowing down the transition to a low-carbon economy, increasing the magnitude of climate change (and all of its related effects on quality of life), and contributing to growing government budget deficits. Though Rio+20 did not produce a transnational agreement to end the subsidies, it’s time for policy-makers around the world to take a hard look at all the costs of subsidizing the fossil fuel industry.

Jeff Erikson is a senior vice-president at independent think tank and strategy consultancy SustainAbility. For more SustainAbility blogs, go to www.sustainability.com.

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