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Consumption subsidies for fossil fuels remain a roadblock on the way to a clean energy future

The new IEA Net Zero by 2050 report stresses that the world needs a “historic surge in clean energy investment” to avoid severe impacts from climate change. However, sustainable energy investments sometimes face an uphill struggle because regulated prices or taxes favour fossil fuels.

These market distortions are a roadblock to a cleaner energy future, and the IEA has long supported international efforts to phase them out. At their recent Summit, G7 leaders reaffirmed their own commitment to eliminate inefficient fossil fuel subsidies by 2025 and called on all countries to join their undertaking, “recognising the substantial financial resource this could unlock globally to support the transition”.

A key IEA contribution to this process is our monitoring of the energy prices that consumers pay around the world, which we compare with reference prices reflecting their full market value (the so-called “price gap” methodology for estimating consumption subsidies.)1 In this way, we can estimate the size of global fossil fuel consumption subsidies over time.

In 2020, the fall in fossil fuel demand and prices pulled the value of these fossil fuel consumption subsidies down to a record low: our estimate of just over USD 180 billion is some 40% down from 2019 levels and is the lowest annual figure since we started tracking these subsidies in 2007. However, rebounding fuel prices and energy use, coupled with hesitant progress on pricing reforms, are likely to push the value of these consumption subsidies higher again in 2021. This is a worrying trend at a time when countries need to be redoubling efforts to accelerate energy transitions.

Economic value of global fossil-fuel consumption subsidies and year-on-year change, 2010-2020

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Value of fossil-fuel subsidies by fuel in the top 25 countries, 2020

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The decline in consumption subsidies in 2020 was supported by initiatives from some governments to align domestic prices with international ones (see examples in the table below). However, a much larger share of the fall was a purely mechanical effect from lower global prices and consumption, which narrowed the gap between regulated prices and market-based ones.

The different approaches to pricing are clearly visible in the IEA’s tracking of energy prices. Countries with market-based pricing follow changes in the underlying crude prices (with a time lag as these work their way through the refining sector to consumers). This is visible in the data below for the United States, Germany and Italy. Still, actual price levels are far from uniform as taxes and charges on diesel, gasoline and other fuels vary widely from country to country. These are often important sources of revenues, providing as much as 10% of public revenues in some countries (and, therefore, a serious public policy dilemma as fossil fuel consumption decreases during transitions).

Changes in gasoline prices in selected countries versus the crude oil price, January 2019 - April 2021

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However, there are also countries where the response to international price levels is either absent or constrained in some way. In the data above, end-user gasoline prices hardly changed in Nigeria and Uzbekistan following the huge crude oil-price declines in 2020. Multi-country IEA price data (shown below for gasoline) clearly show the wide range of end-user prices across countries, with the lowest prices found in countries that subsidise consumption.

Note: If 2020 prices were not available, those in the most recent year were used.

The complexity of fuel pricing reform was illustrated again during the social and economic upheaval caused by the pandemic. Lower global oil prices opened up an opportunity for reform, as the narrower gap with market-based prices reduced the risk of political or social backlash, or a jolt to inflation. In major oil‑ and gas‑producing countries, lower revenues from hydrocarbons created severe fiscal strains, increasing the pressure to eliminate implicit fuel subsidies. 

However, while pricing reforms made progress in some countries, the severe economic and public health crisis caused by Covid-19 led some governments to maintain or even reinforce consumer subsidies as a way of supporting household and business finances; such initiatives tended to be concentrated in the electricity sector.

Country Selected changes announced or implemented in 2020-2021
Armenia As a result of Covid-19, eligible consumers received additional state assistance to pay gas and electricity bills.
Egypt In April 2020, the authorities announced plans to halve spending on fuel subsidies in its budget for the 2020/21 fiscal year. In July, the government raised electricity tariffs by 17% and 27% (depending on consumption), while the schedule to lift subsidies was pushed back to the 2024/25 fiscal year instead of 2021/22. 
India In May 2020, the government raised excise duties on gasoline and diesel in response to the drop in international prices.
Indonesia In March 2020, the government through state power utility PLN announced a plan to subsidise electricity for 31 million households for three months in response to Covid-19. The 2021 budget cut the subsidy for diesel by 50% to IDR 500/litre.
Kazakhstan In March 2020, the government reduced electricity tariffs in response to the first wave of Covid-19. After that, in July, electricity prices were raised by 16% on average.
Malaysia Starting in January 2020, the gasoline price was adjusted weekly to approach international price levels. The maximum price cap for the fuel was also removed. In July, the government decided to cancel a new targeted subsidy programme in part due to economic conditions during the pandemic. In February 2021, responding to the rise of crude prices, the government set price ceilings for gasoline and diesel.
Saudi Arabia In May 2020, the government announced the increase of the value added tax rate from 5% to 15%, including on gasoline. Based on a price mechanism linked to export oil prices, gasoline prices were reduced by almost 50% in May, while they rebounded more than 30% in July. In May 2021, prices returned to pre-crisis levels.
Sudan Based on the announcement of gradual rises in fuel prices in 2019, the government successfully removed the subsidies over the course of 2020.
Thailand In April 2020, due to Covid-19, the government temporarily reduced the electricity bills of more than 20 million households by 30%, 50% or 100%, depending on consumption. In January 2021, in response to the second wave of pandemic, the government announced another electricity tariff discount.
Tunisia The government introduced an automatic monthly price adjustment mechanism for domestic sales of gasoline and diesel, with the aim to eliminate fuel subsidies. In May 2021, the Finance Minister revealed part of their economic reform plan which includes abolishing LPG subsidies completely in the second half of 2021 and the gradual removal of subsidies on electricity and natural gas by 2024.
United Arab Emirates Dubai’s state-owned utility asked permission to increase power tariffs for the first time in 22 years.

Fossil fuel prices have risen in 2021 after the initial shock of the pandemic, widening the gap between international market prices and low, fixed prices for consumers in some countries. In the absence of additional reform efforts this will increase pressure on government budgets, and favour wasteful fuel consumption and higher emissions – all outcomes that the world can ill afford.

Renewed impetus behind pricing reform is essential. The new IEA Net Zero by 2050 analysis underlines once again that removing inefficient fossil fuel subsidies is an integral part of the policy mix to tackling climate change. There are many examples of successful reform to guide policy makers, showing the multiple benefits of well-designed phase-out programmes. The ingredients for success are well known: a clear and graduated timetable that is clearly communicated and explained to consumers, schemes to mitigate the impact on the poorest and most vulnerable sections of society, and efforts to increase the supply of high-efficiency appliances to cushion the impact on all consumers. Pricing reform is politically challenging but economically and environmentally essential if the world is to get on track for a more sustainable energy future.

References
  1. While these consumption subsidies account for the largest share, there are other types of subsidies such as those for fuel production or research and development, which are not fully captured by price-gap methodology.