Who subsidizes fossil fuels, why, and what to do about it

The G20 group of major economies spend $452 billion per year supporting fossil fuel industriesAccording to the IEA, “fossil-fuel consumption subsidies worldwide amounted to $548 billion in 2013, …with subsidies to oil products representing over half of the total.” Why do we still see such extensive subsidies? And what to do about it?

There may be two reasons that come to one’s mind: 1) inertia in the system – governments may find it difficult to change the status quo of industries; 2) politicians do not yet know that renewable sources of energy tend to be at least as cheap, if not cheaper, than these fossil fuels. These points are obviously those that jump directly to one’s mind, don’t they? But hey, this is WEO_2014_subsidies_map_thumb(mostly) wrong! Indeed, take a look at the map by the International Energy Agency. It shows the fossil fuel subsidies around the world. What one quickly notices is that the countries that seem to subsidize fossil fuels the most are actually fossil fuel exporting countries! Why would they subsidize their products?

Let’s do some simple maths. Let P(ff) be the price of fossil fuels, and let P(rr) be the price of renewable resources. Then there will be a demand for fossil fuels only if P(ff)<P(rr). Easy. But what if P(ff)>P(rr)? Then it is clear that fossil fuel exporting countries will not see any demand for their product.

So what can they do to induce exports? They subsidize their product. So assume they subsidize their product by S(ff), which is the subsidy to fossil fuel. Then if they set S(ff) only marginally larger than P(ff)-P(rr), the difference between the price for fossil fuels and renewable resources, then there will be demand for fossil fuels again.

When is this profitable for fossil fuel exporting countries? Simply if the subsidy they give is lower than the price they receive, thus if P(ff)>S(ff).

So, one very often finds the claim that renewables need to be cheaper than fossil fuels in order for the world to shift towards renewables. In the light of these findings this is not enough. Indeed, allowing for these extensive subsidies from the fossil fuel exporting countries, we find that renewables must be roughly half the price of fossil fuels in order to stop the demand for fossil fuels.

This obviously is highly stylized and could be extended, for example there are extraction costs for fossil fuels, there are costs of transportation that need to be taken into account, and also renewables are subsidized. Furthermore, not all subsidies of the fossil fuel exporting countries are used to subsidize the price, others are used for investment purposes etc (which nevertheless has an impact on the price). Also, some fossil fuels, like oil, are currently still essential for example for the transportation sector, and can not be easily substituted (for the moment) with renewables.

So the problem here really is that there is no level playing field, since the fossil fuel exporting countries seem to highly subsidize their fossil fuels. And this logically means that they can only export those fossil fuels due to the subsidies. And this, in return, means that actually renewables like wind, solar and hydro, are already not only competitive but apparently cheaper than fossil fuels, since otherwise the fossil fuel exporting countries would not need to subsidize their fossil fuels so extensively.

What is the road ahead? Of course, all the money that fossil fuel importing countries spend on fossil fuels is money that is lost for these countries. While some of the money may come back via stock market investments, this in return implies a loss of ownership and control over one’s own companies. It is clear that these foreign investments are mostly profit oriented, and mostly tend to be void of social interests that play important roles in countries like Japan or regions like Europe. Thus, fossil fuel importing countries lose ownership of their own companies to fossil fuel exporting countries because they buy the cheaper fossil fuels, which is only due to the fact that these fossil fuels are highly subsidized by the fossil fuel exporting countries.

Naturally, levelling the playing field should be the fossil fuel importing countries’ objective. This implies providing sufficiently many subsidies to make their own energy production as attractive as fossil fuels. In effect, since the argument raised above shows that renewable resources are most likely already cheaper than fossil fuels, the subsidies that fossil fuel importing countries need to give to their own renewable industry can be much lower.

What will be the impact of levelling the playing field? The industry at home will flourish; ownership of one’s own companies does not get transferred to those countries that have no interest in one’s companies apart from reaping profits; and this policy will reduce climate change. Plus, in terms of the overall economy, the subsidies to renewable resources will be GDP improving, since there will not be an outflow of money for fossil fuel exports.

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