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New Paths to Fossil Fuel Subsidy Reform?

by Michael Levi
August 12, 2014

Geopolitics Fossil fuel subsidy reform REUTERS/Henry Romero

Fossil fuel subsidies are an economic, environmental, and security scourge. Used mostly in developing countries and often defended as pro-poor, they are typically ineffective at combatting poverty, waste scarce government resources, and encourage overconsumption of energy.

Yet it has proven incredibly difficult to reform and reduce them. Two thought-provoking new studies suggest ways forward.

The first is a fascinating new paper by Andrew Cheon, Maureen Lackner, and Johannes Urpelainen of Columbia University in Comparative Political Studies. (If someone wants to point me to an ungated working paper version, I’d be happy to link there. UPDATE: Ungated working paper version here.) They look at the relationship between oil and gasoline prices between 2002 and 2009 for 175 countries. Higher oil prices should lead to higher gasoline prices; anything that works against that connection is a sign of a subsidy. Not surprisingly, they find that on average, changes in the price of oil have a big impact on gasoline prices. What’s extraordinary is how much that link is undermined in countries that have national oil companies (NOCs). The numbers depend on how exactly the analysis is done, but typically, having an NOC cuts the impact of higher oil prices on domestic gasoline prices in half. The authors show that this phenomenon cuts across oil exporting countries (such as Saudi Arabia) and oil importing countries (such as Argentina). They theorize that having an NOC makes it easier to put and keep subsidies in place both because governments have political influence over NOC behavior and because NOC budgets can often be structured to hide costs.

The authors then distinguish among different types of NOCs in order to push those theoretical ideas further. Again the results are intriguing. Countries with NOCs whose chairs are appointed by the government – and hence more amenable to being used as instruments of policy – are more likely to have large fuel subsidies. Countries with NOCs that set their budgets autonomously – and hence are less likely to be able to hide the costs of subsidies – are far less likely to have large fuel subsidies.

All of this should be useful insight to international policymakers deciding where to aim their efforts to promote fossil fuel subsidy reform: in addition to focusing on the largest and most distorting subsidies, they would do well to concentrate on countries that either lack NOCs or have relatively independent ones.

My colleague Isobel Coleman has a new memo out proposing a new arrow that they should include in their quiver as they target those opportunities. Subsidy reform is politically difficult. International efforts to promote subsidy reform have aimed to persuade elites that it would nonetheless be wise. Isobel’s memo argues that this needs to be supplemented with financial and technical assistance aimed at persuading publics to get behind beneficial reforms. Her proposed Global Subsidy Elimination Campaign would be housed at the World Bank and pursued in partnership with private players. In addition to supporting public campaigns, it would also bolster technical help for countries struggling to design acceptable reform strategies.

One might be skeptical that a PR effort can move the needle much. (After all, if it were a useful thing, wouldn’t governments be doing it themselves already?) Isobel points out, though, that such a campaign needn’t do all that much in order to more than pay for itself. One hundred million dollars a year could yield a twofold return on investment if it cut world subsidies by a mere 0.04 percent. That doesn’t even include the external benefits that would come from reduced fuel consumption.

Fossil fuel subsidies have proven remarkably difficult to reduce. It’s exciting to see new insights into where it might be most possible to reform them, and ways that such reforms might be effectively pursued. With all luck there will be more of this – and more on-the-ground successes – to come.

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  • Posted by Chris

    I would not call it “extraordinary” that i) having an NOC increases the likelihood of having fuel subsidies; and ii) having an NOC that is controlled or highly influenced by government also increases the likelihood of having fuel subsidies. This is fairly well-known if you review case studies on fuel subsidies internationally. It is nice to have the generalization validated by reference to a global review of data, but it would be more useful to see exports focus their energy on how an NOC that is highly influenced by government can transition to become an NOC that sets its budgets independently.

    The subsidy figures that they provide in their abstract are surprising. Total fossil-fuel subsidies globally in 2008 were $558 billion (source: WEO 2010), while subsidies for oil were around $275 billion (ibid). (And it’s not really clear how these subsidies “peaked” in summer, since this is an annual estimate. International oil prices are what peaked in the summer.) Expenditure was $523 billion globally in 2011 (source: WEO 2012). I can’t find a point estimate for petroleum subsidies with this, but it is usually around 50% – so let’s say ~$260 billion. I can’t think of a method of defining “subsidy” that would identify $520 billion in petroleum subsidies in 2008 and $212 billion in 2011. I hope this is a typo in the abstract and is not repeated in the study itself.

    [ML: The estimate they reference isn't annual. Hidden subsidies that are implemented through fixed prices will generally peak when market prices do.]

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