NEWS AND VIEWS

Fossil-fuel subsidies assessed

Many governments subsidize the production and consumption of fossil fuels. Contrary to expectation, a study finds that removing these subsidies would only modestly reduce global carbon dioxide emissions.
Ian Parry is in the Fiscal Affairs Department, International Monetary Fund, Washington DC 20431, USA.
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The 2015 Paris climate agreement was signed by 195 countries, with most pledging to reduce their emissions of carbon dioxide and other planet-warming gases. Many countries have a long history of subsidizing fossil fuels, and it seems logical that removing these subsidies — as the G20 group of nations has agreed to do — would help them to achieve their Paris climate commitments. However, in a paper in Nature, Jewell et al.1 report a comprehensive and convincing analysis suggesting that reforming these subsidies would cause only a modest reduction in global CO2 emissions. Nevertheless, I think that there is an urgent need for broader reform of fossil-fuel prices to fully reflect the costs associated with global warming and other environmental considerations.

Subsidy reform would increase domestic fossil-fuel prices to match the production costs. Its impact on the climate would therefore depend on how energy demand is affected by these higher fuel prices — for example, through people driving less, power generators switching to cleaner fuels such as those from renewable energy sources, and households and businesses adopting energy-saving technologies. Because these responses are inherently uncertain, Jewell et al. used five different models to assess the consequences of subsidy reform. These models compared projections of fuel use and CO2 emissions with and without subsidy reform by region or country, using diverse assumptions about future economic growth, technological trends, energy prices and so on.

The authors found that removing all fossil-fuel subsidies would have a limited impact on global energy demand by 2030 (a reduction of about 1–4%). In addition, the share of energy from renewable sources would rise by less than 2%, and global CO2 emissions would fall by only 1–4% (under both low and high oil prices). Consequently, in most regions, the CO2 reduction from subsidy reform would fall far short of what is needed to meet the Paris climate pledges (Fig. 1). The exceptions are regions such as Russia, the Middle East and North Africa, where subsidies are heavily concentrated and pledges are less ambitious.

Figure 1 | Impact of fossil-fuel-subsidy reform. Fossil fuels are subsidized in many countries, and it was thought that removing these subsidies would lead to a substantial reduction in carbon dioxide emissions. However, Jewell et al.1 report an analysis suggesting that the resulting change in CO2 emissions by 2030 would be modest. The exceptions are regions in which current subsidies are heavily concentrated (shown in red), such as the Middle East and North Africa (MENA). The bars denote the range of emission changes predicted (under low oil prices), and asterisks indicate regions that constitute more than the designated country. (Adapted from Fig. 3b of ref. 1.)

There are two main reasons for the generally modest impact of subsidy reform on CO2 emissions. The first is that coal (the fossil fuel that emits by far the most CO2 per unit of energy) currently receives little subsidy. Instead, 60% of subsidies are for oil, and the remainder is largely for natural gas and for the electricity generated from fuels (see Figure 2a of the paper1). The second reason is that global subsidies have declined sharply, from US$570 billion in 2013 to $330 billion in 2015.

However, I think that reform of fossil-fuel prices needs to go well beyond aligning them with production costs. Fuel prices should also reflect the consequences of their use for global warming and other environmental considerations, such as the costs of deaths resulting from air pollution and, in the case of road fuels, traffic congestion and accidents. Furthermore, prices for fuels purchased by households should include the general sales or value-added taxes that are applied to other consumer products.

A study2 in 2017 estimated that if fossil-fuel subsidies had been defined more broadly to reflect undercharging for environmental costs and general taxes, as well as production costs, these subsidies would have totalled $5.3 trillion in 2015 (6.5% of global gross domestic product). Furthermore, the study suggested that if prices had fully accounted for production costs, global and domestic environmental impacts and general taxes in 2013, global CO2 emissions would have been 21% lower than they were, air-pollution deaths associated with fossil fuels would have been 55% lower, and government revenues as a percentage of gross domestic product would have been 4% higher.

Broader reform of fossil-fuel prices is therefore urgent for both developed and developing countries. However, such a reform must be carefully crafted to enhance the prospects for success. A comprehensive plan should be developed, in consultation with stakeholders, that has clear goals and timetables. It should specify the taxes to be cut or the public investment programmes to be expanded, using revenue raised by fuel-price reform. In addition, there should be measures to compensate low-income households for the effects of higher energy prices and to help workers who might lose their jobs in energy-intensive industries.

Researchers and international organizations (such as the International Monetary Fund, World Bank and the Organisation for Economic Co-operation and Development) have an important role in providing information and guidance to help policymakers drive forward subsidy reform and communicate the case for reform to the public. The information required includes the fossil-fuel prices that countries should adopt, both to meet their Paris climate pledges and to reflect the broader environmental costs.

But it also includes the effect of reform on energy systems, the economy, fiscal balances and vulnerable groups, and the trade-offs between higher fuel prices and other policy approaches, such as requirements for energy efficiency and renewable fuels. Analysis of ongoing reform experiences in different countries could also help governments to navigate around the political obstacles.

Rigorous studies, such as that by Jewell and colleagues, are essential. But there is a need to focus these studies on the broader reform issues discussed here, for which the stakes are especially high.

Nature 554, 175-176 (2018)

doi: 10.1038/d41586-018-01495-3
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References

  1. 1.

    Jewell, J. et al. Nature 554, 229–232 (2018).

  2. 2.

    Coady, D., Parry, I., Sears, L. & Shang, B. World Dev. 91, 11–27 (2017).

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