Global Energy Subsidies: Scale, Opportunity Costs, and Barriers to Reform

Attributed Authors: Doug Koplow Published: Dec 2014

Government subsidies to energy producers, transporters, and consumers are widespread throughout the world and represent a large public investment in the energy sector. In theory, this investment could be funding a variety of social goals such as providing the poor with access to basic energy services and addressing common environmental problems linked to energy extraction and consumption.

Although some subsidies do address these types of concerns, most either do not, or do not do so effectively.

Far from helping to alleviate energy poverty, subsidies distort the relative prices of energy options, resulting in over-exploitation of fossil fuels and exacerbating associated environmental costs. Below-market prices to industrial, commercial, and retail customers mute incentives to conserve energy, and can contribute to 'subsidy clusters', pockets of industries that become reliant on subsidized energy inputs in order to be competitive. Capital investment into real estate infrastructure may undervalue energy efficiency as well, locking in a region or country to excess consumption for many decades. Efforts to suppress domestic energy prices below world market levels often give rise to smuggling and black market operations as people try to profit from the pricing differentials. Finally, the fiscal cost of subsidies can absorb such a large portion of available government revenues that it crowds out spending in critical areas focused on improving population welfare or transitioning the country to a cleaner energy path.

While there is no exact global estimate, financial subsidies to energy are measured in many hundreds of billions of dollars per year. External costs of energy fuel cycles are relevant as well. They include a wide variety of negative impacts on human health and environmental quality from energy extraction, conversion, and consumption, and have been estimated to exceed a trillion dollars per year globally. Though not directly funded by government budgets as financial subsidies are, external costs nonetheless exacerbate the pricing distortions caused by financial subsidies, further skewing energy investment and conservation patterns.

Despite the clear benefits of subsidy removal, political impediments have greatly slowed the pace of reform around the world. Once governments begin subsidizing particular fuels, they are often 'trapped' in policies that make little fiscal, developmental, or environmental sense but that are protected and defended by subsidy recipients. In some cases, reforms are successfully implemented but are then rolled back due to subsequent changes in political or market conditions. Subsidies to electric or natural gas distribution and generation infrastructure represent a slightly different twist on this same problem. Pricing of energy services at levels below break-even is common, as are utilities reliant on state subsidies so that they can continue to operate despite high rates of non-payment or theft. Both result in inadequate revenues to maintain and grow the enterprise. Existing customers may benefit from artificially low power rates and therefore resist price increases. Over time, however, the utility is starved of needed capital to maintain its existing system. The low or negative returns also preclude network expansion to the very customers and service regions it needs to reach in order to ameliorate energy poverty and improve the quality of life for the billions of people without access to modern energy services.

Energy subsidies are thus not an effective policy to alleviate energy poverty. As currently structured, they tend to be part of the problem, not the solution. Only recently has the international community begun to come to terms with just how big a problem they are-remarkably, the cost of energy subsidies far exceeds the estimated cost of effective energy access policies. This chapter reviews current estimates on the magnitude of energy subsidies globally, including what remains missing from the tallies; inefficiencies with subsidy targeting; the growing opportunity costs of not reforming; and the impediments to making subsidy reform a reality.

This book chapter appears in Antoine Halff, Benjamin K. Sovacool, and Jon Rozhon, eds. Energy Poverty: Global Challenges and Local Solutions, (Oxford: Oxford University Press), 2014.  Reposted with permission.

Tags: energy poverty IMF OECD IEA subsidy reform energy subsidies