The Fuse

Low Oil Prices Trigger Long-Overdue Revisions of Fossil Fuel Subsidies

by Nick Cunningham | February 29, 2016

One byproduct of the crash in oil prices since 2014 has been a gradual but significant reduction in fossil fuel subsidies. Around the world, many governments provide subsidies for oil, gas, and coal, usually in the form of cheaper prices for consumers designed to ease the burden of energy costs.

The IMF concluded in a 2015 study that the world subsidized fossil fuels somewhere on the order of $5.3 trillion that year, or 6.5 percent of global GDP.

There are many negative effects that stem from exorbitant fossil fuel subsidies. Cheap fuels encourage wasteful consumption, sap government budgets of scarce revenues, and result in environmental fallout both in terms of local air pollution and higher rates of greenhouse gas (GHG) emissions. Moreover, subsidies tend to disproportionately benefit middle- and higher-income populations as opposed to the poor, who consume less energy.

The IMF concluded in a 2015 study that the world subsidized fossil fuels somewhere on the order of $5.3 trillion that year, or 6.5 percent of global GDP, much of which comes in the form of socializing the public health and environmental damages of fossil fuel consumption.

As a result, eliminating fossil fuel subsidies, the IMF says, can reduce premature deaths related to pollution by 50 percent, reduce GHG emissions by 20 percent, and leave governments with an additional USD$2.9 trillion in revenue.

The difficulty of removing subsidies

Once in place, fossil fuel subsidies are difficult to remove. They are politically popular, and increasing fuel prices is usually met with public ire. The rich and middle class benefit disproportionately, but lower classes also support subsidies because even a small price hike would often be excruciating for their personal budgets.

Recent history is littered with examples of governments trying to reduce subsidies only to spark violent protest, such as in Indonesia in the late 1990s, and Nigeria and Sudan in 2012. Raising fuel prices often has to be walked back almost immediately because of a public backlash.

Nevertheless, there has been significant progress in reforming fossil fuel subsidies in recent years. Using a less expansive definition of subsidies than the IMF, the IEA pegged global fossil fuel subsidies at USD$493 billion in 2014, an increase from USD$390 billion in 2009 (in 2014 dollars). That would seem to be evidence of a failure to live up to the pledge made by world leaders at the G20 conference in 2009 to “rationalize and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption.” However, the increase was largely due to a sharp surge in oil prices and consumption between 2009 and 2014. As oil prices climbed, so too did the value of subsidies.

In reality, there actually was some improvement on removing subsidies over that time period: The IEA estimates that fossil fuel subsidies would have been $117 billion higher (24 percent) had reforms not been implemented.

Take India, for example. In 2012, for budgetary reasons, India began increasing diesel prices on a monthly basis, leading to the complete elimination of diesel subsidies by October 2014. The gradual increase went a long way to reducing opposition, with the International Institute for Sustainable Development calling the measure a “significant policy achievement.”

A 2013 report from the IMF found 12 examples of successful attempts by governments to remove fuel subsidies since the 1990s. The cases are notable, but remain exceptions to the rule—globally, fossil fuel subsidies remain gargantuan.

Subsidy reform initiatives build momentum

While there have only been a dozen or so successful examples of countries removing fossil fuel subsidies in the last two decades, there have been at least as many in the past year and a half alone. The reason largely comes down to the collapse of oil prices—the oil bust has been a gift to those seeking the removal of subsidies, creating a huge opportunity to pare back government assistance while minimizing the impact on the poor and middle class.

Oil prices have fallen more than 70 percent from their peak in mid-2014, providing oil-consuming countries with a windfall.

In 2015, Indonesia entirely abolished gasoline subsidies and put a ceiling on diesel subsidies, freeing up billions of dollars for spending on infrastructure and other social priorities. Malaysia scrapped subsidies in late 2014. Ghana deregulated fuel prices beginning in June 2015. China also increased fuel taxes to take advantage of falling international crude prices.

While there have only been a dozen or so successful examples of countries removing fossil fuel subsidies in the last two decades, there have been at least as many in the past year and a half alone.

More recently, several oil-producing countries, including many members of OPEC, have started to trim fuel supports. Many OPEC member states are home to some of the cheapest retail fuel prices in the world. The crash in oil prices, however, has left gaping holes in their budgets. Rather than proactively trying to reform fossil fuel subsidies as oil-consuming nations have done, several OPEC members have been compelled to do so as their economies deteriorate along with falling oil export revenues. Putting motivations aside, the outcome is the same: Wasteful fossil fuel subsidies are being removed.

The IMF estimates that the UAE spent about $7 billion on petroleum subsidies annually before 2015, or about 6.6 of GDP. But after oil prices crashed in 2014-2015, the financial pressure became too hard to ignore. For the UAE’s budget to breakeven, it would need an oil price of about $75 per barrel. Needing an overhaul, in August 2015, the UAE government decided to deregulate fuel prices let them track international benchmarks.

Although an extension of a plan that was years in the making, in May 2015, Iran raised fuel prices from USD$0.28 per liter to USD$0.35 per liter. The move saves the Iranian government an estimated USD$1.8 billion, even though retail fuel prices remain at a fraction of typical global prices.

In December 2015, even Saudi Arabia decided to raise fuel prices to reduce the burden on public coffers. Reporting a $98 billion budget deficit, Riyadh announced that fuel prices would jump by 50 percent beginning in January 2016. “The budget comes in light of lower oil prices and economic and financial challenges on regional and international levels… our economy, with the help of God, has what it takes to overcome the challenges,” King Salman said on state television when announcing reforms.

Oman, Bahrain and Qatar quickly followed suit, announcing increases in gasoline prices in January as oil moved and stayed below $30 per barrel. Oman raised premium gasoline prices by 33 percent and regular blends by 23 percent. Bahrain hiked prices by 60 percent and the Qatari government increased prices by 33 percent.

On February 17, Venezuela announced its first increase in fuel prices in over two decades. Fuel prices will jump over 6,000 percent to 6 bolivars, which still leaves Venezuela with some of the cheapest fuel in the world. The move will be wholly inadequate to address the country’s economic crisis, but the Venezuelan public is so stretched that the government won’t be able to squeeze them any further.

There are other examples of countries taking advantage of low oil prices to eliminate or reduce subsidies, including in Angola, Morocco, Thailand and Vietnam.

Global subsidy reform has been long overdue

Economists have always hated fuel subsidies because of their inefficiency. Environmentalists hate the pollution that inevitably stems from cheap energy. Government technocrats groan at the cost to the public treasury.

The crash in oil prices has presented a golden opportunity to finally start to whittle down the wasteful public support for fossil fuels that continues to occur around the world.