Green view: How to save $300 billion

By The Economist online

LAST time it met, in 2009, the G20 took a stand against a little discussed problem that unites environmentalists and economists: fossil-fuel subsidies. Over the course of the subsequent year, the nations contributed to a list of the “inefficient” subsidies they supported and the things they planned to do about it. So far, this list is unimpressive. According to an analysis of the G20 documents by Doug Koplow, who works with an environmental watchdog called Oil Change International, many of the countries are reporting only superficially, and the standards against which they measure themselves are far from uniform. Most damningly, none has as yet put a new subsidy-cutting policy on the table.

For a more objective view of the scale of subsidies for fossil-fuel consumers (as opposed to subsidies for production, which are a different kettle of fish) than that provided by the subsidisers themselves, turn to the World Energy Outlook of the International Energy Agency (IEA), a respected annual compendium of data and analysis. In the 2010 edition, released this week, the IEA puts the global total at $312 billion a year. The reduced energy demand that would follow on an abolition of these subsidies, it reckons, would be 5% of the world's total, making it equal to the current energy consumption of Japan, Korea and New Zealand combined.

Some environmentalists try to turn this situation to their tactical advantage by comparing these figures to the much lower absolute level of subsidy given to renewables. This is a mistake in terms of logic, and quite possibly in terms of tactics, too. It is quite plausible to argue that the “size” of the subsidies in contention should be measured in terms of the amount of energy contributed. Since renewables contribute hugely less to world energy use than fossil fuels do, renewable subsidies ($57 billion in 2009) are already larger than fossil-fuel subsidies on a per-kilowatt-hour or per-tonne-of-oil-equivalent basis. Over and above that, renewable-energy boosters may not want governments to focus too closely on the benefits of cutting subsidies, lest they get a taste for it.

Better to eschew comparisons and concentrate on the straightforward case against the fossil-fuel subsidies, which is overwhelming. They encourage inefficient energy use, and they represent a lot of foregone export revenue in countries that produce oil and gas and at the same time subsidise their home markets (a common arrangement; Iran, Saudi Arabia and Russia are the three countries most invested in subsidising). Though they are often justified in terms of helping the poor, the lion's share of the benefits—85% to 90%—typically accrue to those on middle incomes and the wealthy; the poor are typically not big energy users, and rarely drive. Money that could be invested in services the poor do need and use is spent on subsidising energy for the rest. And as Mr Koplow and his colleague Steve Kretzmann point out, subsidised fossil fuels for the rural poor can tip the balance away from renewable energy sources, such as solar, in the off-grid applications to which they are particularly well suited, and where they would otherwise be most competitive.

Subsidies can, if governments are willing to spend enough money, keep prices stable within a country even as they rise on the international market, which is another justification sometimes offered. But this is invidious. When some consumers are sheltered from a price signal, that signal has to get stronger in order for those who are facing it to take more drastic action than would otherwise be needed. Damping volatility in sheltered markets increases it in open ones. Fatih Birol, the chief economist at the IEA, points out that 95% of current growth in oil demand is coming from countries where the oil price is subject to subsidies.

And then there's the climate. People obviously don't need subsidies in order to produce carbon dioxide, but at the margin they help. The IEA estimates that removing all fossil-fuel consumption subsidies would reduce global carbon-dioxide emissions by 1.5 to 2 billion tonnes by 2020. Current emissions from fossil fuel are about 30 billion tonnes; but that potential 1.5 billion reduction is more than a third of the difference between business-as-usual emissions and the level needed to stand something like a 50:50 chance of limiting global warming to two degrees centigrade.

An attractive cut
One of the striking aspects of the IEA's $312 billion figure is that more than a fifth of it comes from a single country: Iran. To get fuel prices as low as ten American cents a liter for gasoline (two cents for diesel) cost the government some $66 billion in 2009, according to the IEA: that's $895 per person, or 20% of GDP. Saudi Arabia's subsidy is actually higher per capita, but lower overall and under 10% of GDP; Uzbekistan's is a remarkable 32% of GDP, but only $11 billion in total.

The outrageous subsidies are making Iranian industry inefficient as well as costing the government a bomb; the amount of energy used per unit of GDP in Iran has been rising by 1.6% a year since 1990, and the country spent about $5 billion in 2009 importing gasoline and diesel. Cognisant of the madness this all represents, the government has passed a new subsidy reform law aimed at moving the country to market-based prices by 2015, though, as the IEA notes, “the path to implementation is still unclear”. Among other things, driving up energy costs in a country that already has more than 10% inflation poses obvious problems.

Elsewhere there has already been some progress. The fall back of oil prices from their 2008 peak gave nations the possibility of reducing subsidies, which some, including China, took advantage of. Indeed while China's subsidy is still quite large in absolute terms ($18 billion) consumers are paying 96% of market prices. Russian subsidies are falling; Indonesia hopes to get rid of its altogether by 2014.

Still, there remains a great deal to be done. As Mr Koplow points out, concerted G20 action will require common definitions of what a subsidy is and how to value it, as well as greater transparency from the countries involved. The case for removing such subsidies in general is obvious to all. The politics of removing each one in particular will doubtless prove trickier, even with better orchestrated peer pressure there to provide a helping hand. But there's a lot of money to be saved, and good to be done, if countries can get this right.

(Photo credit: AFP)