Fuel Subsidies and the Politics of Higher Priced Energy

July 28th, 2008

Posted by: Roger Pielke, Jr.

Today’s New York Times has a very interesting article by Keith Bradsher on fuel subsidies in developing countries, which sheds some light on the politics of efforts to increase the costs of energy. Here is an excerpt:

From Mexico to India to China, governments fearful of inflation and street protests are heavily subsidizing energy prices, particularly for diesel fuel. But the subsidies — estimated at $40 billion this year in China alone — are also removing much of the incentive to conserve fuel.

The oil company BP, known for thorough statistical analysis of energy markets, estimates that countries with subsidies accounted for 96 percent of the world’s increase in oil use last year — growth that has helped drive prices to record levels.

In most countries that do not subsidize fuel, high prices have caused oil demand to stagnate or fall, as economic theory says they should. But in countries with subsidies, demand is still rising steeply, threatening to outstrip the growth in global supplies.

While it is easy to call for the end of subsidies so as to let prices better reflect supply and demand, the politics are enormously complicated. The NYT reports (emphasis added):

Political pressures and inflation concerns continue to prevent many countries — particularly in Asia, where inflation has become an acute problem — from ending subsidies and letting domestic prices bounce up and down.

You talk about subsidies, you’re not only talking about the economy, you’re talking about politics,” said Purnomo Yusgiantoro, Indonesia’s minister of energy and mineral resources. He ruled out further price increases this year beyond one in May that raised the price of diesel and regular gasoline to $2.30 a gallon.

Central to the politics are the impacts of removing fuel subsidies on the poor. A UNEP meeting held in Sweden earlier this year found that these impacts are real but not well understood (PDF):

Due in part to differing price elasticities of consumption, subsidy removal has different impacts in various regions and among various classes of people of the world. More needs to be done to understand the ways in which subsidies and their potential reform will impact various socio-economic groups. Indeed, energy subsidies seem to improve energy supply and the standard of living of the poor in some cases, but may not help them as much as was previously assumed, and especially not in the long run. In addition, there may be ways to retain these benefits without also providing large subsidies to groups that don’t need them. The degree to which a major reform of energy subsidies will disproportionately and negatively impact the world’s poor requires further study.

Removing subsidies in rapidly developing countries will have the effect of making fuel more expensive. Climate policies that seek to wean the world off of fossil energy will require increasing the costs of fuels to even higher levels. The willingness and ability of governments to remove subsidies will say something about the prospects for increasing the costs of fossil fuels in developing countries. Presently, there absolutely no indication that developing countries will be willing to increase the costs of energy in any significant way to better reconcile supply and demand, much less address the challenge of decarbonizing the global economy. The obvious solution of course is for carbon-free technologies to become cheaper than their (subsidized) fossil fuel competitors. Easy to say, of course.

Not only are the politics of addressing subsidies difficult, but the discussion of the issue is hampered by multiple definitions of a “subsidy”. While there are good reasons for multiple definitions, it also allows political debates to enter the technical discussions. For instance, are countries without strong climate mitigation policies subsidizing fossil fuel use according to the expected costs of future climate changes attributable to the human emissions? Or should the baseline of subsidies reflect a baseline of global market supply/demand?

Wisely, UNEP has recommended moving past such debates:

The conventional wisdom on energy subsidies has been that a reliable working definition of the term is needed before reform efforts can go forward. The logic behind this idea is that subsidy data will not be comparable across sectors and regions if different figures capture different things. Proponents of a single definition have argued that a clear definition, even if not agreed upon by all parties, will help greatly with data gathering and analysis, as well as give subsidy studies credibility in the eyes of policy makers.

However, there is now disagreement as to the appropriateness of a single subsidy definition. Rather, definitions may depend on the particular organisation, or the question that is being answered. Instead of binding all studies by a universal and inflexible definition, a hierarchy of definitions could be employed with the recognition that not all analysts will use the same exact ones. This would also allow for a more nuanced approach that can account for various localised biases.

The NYT reports that President Bush has criticized subsidies for fuel use in developing countries, but you don’t see the president or other politicians raising concerns about fuel subsidies in the United States. And you probably won’t, especially as politicians top priority seems to be concern over high gas prices.

The bottom line? The politics of energy reform — whether to better align supply/demand, to address rising costs, to enhance security, or to address climate change — are going to be impossible if based on an approach that requires higher-priced energy. By contrast, progress toward these goals will be far simpler if accompanied by cheaper energy. How long will it take for this lesson to sink in?

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