Commentary: Putting the right price on energy

Toshiyuki Shirai, Senior Energy Analyst, WEO

By Toshiyuki Shirai
Senior Energy Analyst, WEO
27 April 2017

fossil fuel subsidiesThe IEA is a strong supporter of policies aimed at removing fossil fuel subsidies (Photograph: GettyImages)

Getting energy prices right is critical for sound policymaking. But because of government subsidies in many countries around the world, energy prices paid by consumers are often well below their real market value, let alone the price that would reflect energy’s full environmental and social cost.

There can be good reasons for governments to make energy more affordable, particularly for the poorest and most vulnerable groups without access to modern energy. But many subsidies are poorly targeted, disproportionally benefiting wealthier segments of the population. In practice, the effect of most subsidies is to encourage consumers to waste more energy, putting added pressure on energy systems and the environment, and often straining government budgets. Such subsidies are a roadblock on the way to a cleaner and more efficient energy future.

Momentum has been building to get these subsidies removed. In 2009, the leaders of the G20 and the Asia-Pacific Economic Cooperation economies declared they were committed to rationalise and phase out inefficient fossil fuel subsidies that encourage wasteful consumption, a pledge which they reaffirmed in 2015.

The IEA has been a strong supporter of these reform efforts. The flagship World Energy Outlook (WEO) has for many years been analysing fossil-fuel consumption subsidies and examining the strategies and benefits of phasing them out, including in the latest WEO 2016. The latest update can be found in a new report called “Tracking fossil fuel subsidies in APEC economies,” which was launched today at a meeting of the APEC Energy Working Group in Singapore.

subsidies graphic

The global value of fossil fuel subsidies in 2015 was around USD 320 billion, compared with an estimated USD 460 billion in 2014. These estimates have fluctuated considerably since 2008, primarily because of oil-price movements. Oil accounts for 45% of total subsidies, at around USD 140 billion, followed by electricity subsidies of around USD 100 billion.

Fossil fuel subsidies have also dwarfed governments’ subsidies for renewable energy. Even with the  2015 drop, fossil fuel subsidies were more than twice as large as subsidies for renewables, which amounted to USD 150 billion globally. These consisted of USD 120 billion for non-hydro renewables for power generation and around USD 30 billion for other sectors, notably biofuels.

Among countries that import fossil fuels, the plunge in oil prices since 2014 has added to the impetus for pricing reform. Pressure to phase out subsidies has built up during the high oil-price period of 2011-2014 and today’s lower oil-price environment presents an opportunity to follow through, as reforms can be achieved without causing a major impact on prices or inflation.

The new report highlights a number of recent examples of pricing reform, particularly for oil products in transport. Both Malaysia and Indonesia have recently removed gasoline subsidies, for instance, and Mexico is on the verge of completely liberalising gasoline prices. The value of oil product subsidies in APEC countries has fallen by more than half since 2010, and the report estimates that most of the decline was due to pricing reforms rather than changes in international prices. It is however too early to declare victory on this front. Governments could well come under pressure to reinstate subsidies if oil prices were to rise again.

Among the oil and gas producing nations, where subsidies are generally quite prevalent, the fall in prices is also acting as an impetus for reform. The drop in hydrocarbon revenue since 2014 has created huge pressure on government spending. Cuts to wasteful fuel subsidies are seen as an obvious way to relieve budget pressures. In the Middle East, the value of fossil-fuel subsidies in 2015 was estimated at around USD 130 billion.

Signs of change are multiplying across the region, not only in countries such as Iran – where subsidy reduction has long been a stated priority – but also in the countries of the Gulf Cooperation Council including the United Arab Emirates (UAE), Kuwait, Qatar and Saudi Arabia.

The focus of pricing reforms is often on gasoline and diesel used for transport, but the APEC report highlights the importance of other fuels and sectors. It finds that around 60% of fossil-fuel subsidies in APEC economies is now in the residential sector, for electricity, gas and LPG. Subsidised electricity prices in some economies are a major underlying reason for the poor financial state of utilities, undermining their ability to invest in new energy infrastructure and diminishing the attractiveness of low-carbon investment in particular. A failure to tackle pricing reform in this sector threatens to create an unsustainable burden given the likelihood of rising fuel costs and growing power demand.

The benefits of a well-planned reform are wide-ranging. Phasing out subsidies means a better allocation of resources across the energy system, revealing incentives for energy savings and for investments in more efficient and cleaner technologies. Financial resources saved by subsidy reform can be used to pursue other public policy objectives, including targeted support to ensure continued access to energy among the poor. Reform is never an easy task, as pricing reforms have a direct impact on people’s daily lives. But there is a growing body of evidence based on numerous case studies to support the view that well-designed, carefully implemented reforms can bring strong dividends.

For additional information, consult the IEA’s new web page on fossil fuel subsidies, including a country-by-country subsidy database and details of the methodology used.