Fossil Fuel Subsidies: Environmentally Dangerous & Economically Counterproductive!

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Fossil Fuel

The recent wildfires in the Amazon are not only a burning injustice with long-term socio-economic and ecological implications, it marks a lack of urgency in addressing the anthropogenic causes of climate change despite several inter-governmental panels and commitments, reiterated in several conventions, summits and multilateral agreements i.e the G7, the Kyoto Protocol and the Paris Climate Agreement. The lack of action and policy inertia matches the scale of devastation, clearly outlined in the IPCC’s detailed analysis of loss of biodiversity and species. From the loss of private property, displacement, renewed pressure on government public finances and the resulting impact on economic growth, the business, the environmental and social case for a more coordinated approach and urgency towards phasing out financing for fossil fuel industries are equally justified and imminent.

Greater transparency is needed to better understand the impact of subsidies

Despite all the best efforts to understands the implication of fossil-fuel subsidies on the environment, public finances and long-term economic growth, the absence of information outlining government support for carbon-intensive industries limits understanding on their impact and possible actions designed to address the climate emergency. Despite retreating from and committing to slowly phasing out government subsidies, some governments such as Germany regularly report on fiscal support and Italy launched the first inventory of environmentally harmful subsidies. Meanwhile, Italy, Germany and the U.S. committed to undertake a peer review of their fossil fuel subsidies in other to provide a better understanding of government inaction and facilitate the creation of a path towards reducing fossil fuel subsidies in a sustainable and economically beneficial manner.

While this does little at present, it provides a roadmap on how G7 economies might begin to phase out environmentally detrimental subsidies and divert ill-designed subsidies towards cleaner energy sources with positive spillovers for employment. The U.K. meanwhile, denies providing any subsidies, but the lack of verifiable data and nuanced definitions of what constitutes subsidies suggest significant support for fossil-fuel industries. This is marks a certain policy inertia to the issue of subsidies, but inaction will be environmentally damaging, economically counterproductive as piecemeal innovations will reduce the competitiveness of otherwise innovative companies and place greater pressure on the government’s finances in the future.

Figure 1: G7 public finance to fossil fuels (annual average in 2015 and 2016)

Fossil Fuel

As illustrated in Figure 1, most G7 economies provide significant support to fossil fuel industries, with fuel-based power and oil and gas production benefiting from the majority of government subsidies. Not only is coal the most potent pollutant amongst fossil-fuel-based energy sources, but it can also increase long-term structural unemployment if such industries are not placed at the heart of the energy transition. Furthermore, by failing to document the full extent of subsidies, it is difficult to hold themselves to account for achieving pledges of slowly phasing out government subsidies (see chart, note: the scale of coal mining is too small to represent visually in this figure).

A significant portion of public finances are used to finance fossil-fuel industries; by failing to outline what the types and level of support via direct transfers of funds (grants, equity infusions and budgetary transfers), forgone government revenue (fiscal incentives and tax expenditures) and income price support and government provision of goods and services, it is challenging to manage the transition in a manner that limits the unfortunate effects of the energy transition. Even more worrying is the U.K.’s annual capacity market criticized for discriminating against low carbon options, delaying coal plant decommissioning and overestimate future supply needs. The case for phasing out subsidies can, and therefore, should be overstated.

Not only are subsidies to fossil-fuel industries environmentally costly, but it is also economically counterproductive for a government to dedicate significant resources to Brexit-contingency planning and public investment plans to design an environmental policy that understands the scale and urgency of the problem. Additionally, there is little emphasis on how to transfer current fossil-fuel subsidies to address the oncoming deindustrialization, which is all but unlikely as governments seek to reduce their carbon emissions.

This will not enable industrial towns and cities to transition and create new industries to reduce the employment shock, but exacerbate current trends of deindustrialization and regional inequality. Meanwhile, all other G7 members currently have fiscal deficits, which are unlikely to improve if a financial downturn places renewed pressure on governments’ finances.

As illustrated in the chart above, Germany provides subsidies to fossil-fuel based power both domestically and internationally, as does France. The U.K. meanwhile, provides subsidies for coal mining and fossil-fuel based power, together with Japan, and providing the most subsidies, from exploration to production. Even if G7 countries phase out domestic support for fossil-fuel industries, support for international exploration runs counter to the Paris Climate Agreement and will negate the environmental gains from any domestic policies designed to address climate change.

Any progress, however tepid, in reducing carbon emissions in advanced economies will be counterbalanced by rising emissions in developing economies with weaker climate regulatory regimes. This trend will be specially reinforced in the absent of novel climate technology and significant gaps in infrastructure financing. For example, France is providing fossil fuel exploration in Mozambique, whilst “Saft” a French company providing floating solar panels supports China’s green energy push and transition to cleaner energy.

Meanwhile. President Macron recently advocated quelling subsidies to firms who pollute. Not only will this complement the Paris Climate Agreement, but it will also enable the focus on advertising, financing and development initiatives to shift towards cleaner energy providers. The adverse economic implications of fossil-fuel subsidies for the government’s fiscal balances cannot be understated; this inadvertently increases capital misallocation as funds outlined for subsidies can be better used to support the climate transition, redress regional imbalances and create new markets for climate technology and energy.

Figure 2: Figure 2 G7 fiscal support to fossil fuels (annual average in 2015 and 2016) Some Progress is being made

Fossil Fuel

There’s disproportionate support for fossil fuel use, which reduces the incentive to build the infrastructure to support the transition to cleaner energy. All this is occurring against a backdrop of G7 and G20 commitments to phase out fossil fuels since 2009, with Italy, France, Canada, and the U.K. committing to end coal production between 2023 – 2030. Meanwhile, France isn’t granting new licenses for crude production and hopes to end production by 2040, a credible way to reduce its carbon emissions as stipulated in the Paris Climate Agreement. Similarly, Scotland, Germany, Wales, and France have already banned fracking; other countries must follow suit if said countries are to credibly reduce carbon emissions as reiterated by the G7 and other multilateral initiatives.

As illustrated in Fig.2 fiscal support for fossil fuel companies remain high, even as most G7 countries (see chart), absent Germany are currently running a current account deficit. With the U.K. currently allocating £6.4 billion for Brexit contingency planning and debt-fuelled public spending, providing subsidies for fossil-fuel companies will reduce the government’s ability to support the inevitable climate transition and lessen the employment shock.

Admittedly, some jobs will be lost in the fossil-fuel industry, but new and better-skilled jobs will be created in the wind and solar energy sector. To that effect, active labor market policies to support and encourage retraining are not only a necessity but suggest better economic planning and pragmatism. G7 government including Britain should slowly phase out subsidies and create an energy transition fund to that effect, rather than facilitate tax-payer funded subsidies for ecologically dangerous companies with adverse socio-economic implications. Not only will these enable governments to achieve the sustainable development goals (SDGs) and the Paris Climate Agreement, it will facilitate a global energy transition by creating markets for companies producing green energy and technologies, and reduce prices for green technology by fostering innovation and competition in domestic markets.

Domestic solutions ultimately support the much-needed global approach to climate change

The axiom for a global and coordinated approach to climate change is widely regarded to be true. But the success of such an approach is contingent on domestic environmental and subsidy policies in G7 economies as well as support for the development of green industries companies. In an attempt to support the transition towards electric vehicles (EVs), the U.K government grant currently pays for 35% of the purchase price, up to a maximum of £3,500. Meanwhile, the U.K and French governments also expect to ban petrol vehicles by 2040. In spite of these laudable achievements, no G7 country has made specific pledges to end public finance for oil and gas, which is indicative of the level of commitment to the Paris Climate Agreement signed in 2015 and designed to prevent global temperatures from rising above 1.5%. To that effect, fiscal support and public finances to fossil-fuel rose to $7 billion in 2016 from $5 billion in 2015, which runs contrary to the expectations of the landmark agreement.

Contrary to the narrative that subsidies for fossil fuel consumption are primarily a challenge for emerging markets and developing countries, findings by Whitley et al (2014) find 64% of total fiscal support is directed towards fossil fuel use across the G7. This includes significant support to fossil fuel use in transport ($26 billion), industry ($9 billion), households ($11 billion), and in other sectors ($5 billion). Although some of these subsidies reduce increase household consumption over the short-medium term, the withdrawal of subsidies will impose a greater adjustment cost. In other to preserve consumer purchasing power, the case for the green energy transition has never been clearer.

The Economic Case for the energy Transition is clear

If the environmental case for phasing out subsidies is unclear – to climate change skeptics at least- the economic case is most compelling. Most G7 governments currently run a deficit, likely to widen in the event of a crisis or other exogenous shocks. By maintaining support for fossil fuel subsidies, the deficit will likely widen in the coming years lessening the government’s ability to respond effectively to the next crisis despite interest rates being at record lows. Furthermore, an aging population in most advanced economies will place a significant strain on government public finances. In such as scenario, the government will be fiscally strained, further constraining its ability to support the transition to cleaner sources of energy such as wind and solar power whilst providing sufficient support to unemployment insurance and active labor market programs to lessen the labor market shock.

In the absence of sufficient fiscal space, the sudden transition to cleaner sources of energy will cause a larger employment shock and could worsen, already present, policy inertia, which has plagued most G7 governments, also signatories to the Paris Climate Agreement. Rather than simply phase out fossil-fuel subsidies, the climate-transition fund built from previously issued subsidies should be used to directly support vocational training and apprenticeships programs, provide wage subsidies and support green technology and businesses. The plight of the Amazon and the Great Barrier Reef cannot be overemphasized if governments do little to reduce incentives for fossil-fuel consumption.

Not only will the energy transition reduce air, water, and land pollution, which is becoming increasingly important, but it will also prevent the environmental, economic and social ramifications of a slower transition and continued subsidies from becoming a reality. Furthermore, this will prevent the need for future restraint on government spending by reducing pressure on future government spending. Lower interest rates indeed facilitate greater government spending, but higher debt levels nonetheless restrain the potential growth rate. It is, therefore, indispensable that governments phase-out subsidies for fossil-fuel sooner rather than later if the positive spillovers from a climate transition are to be realized.

Finally, an organized and belated transition away from fossil-fuels will allow a more competitive clean energy and technology to emerge. This will lower prices for consumers and enable new industries to emerge, creating employment in coastal & industrial towns and improving countries’ exports to markets like China currently going through a green revolution, and other emerging markets such as India, Brazil, South Africa and Kenya. If the environmental case of a climate transition is unclear – for skeptics – the economic case for a transition has never been clearer.

Reference List

1). G7 fossil fuel subsidy scorecard: Tracking the phase-out of fiscal support and public finance for oil, gas and coal (June 2018). Shelagh Whitley, Han Chen, Alex Doukas, Ipek Gençsü, Ivetta Gerasimchuk, Yanick Touchette and Leah Worrall

Henri Kouam Tamto Henri Kouam Tamto is a macroeconomist focusing on Oil, FX and Credit markets in Advanced and emerging market economies. Working both independently and as part of a team, Henri forecasts and writes both thematic as well as research notes on economic data releases, Central bank policy, and global commodity prices. He also has a strong interest in trade policy and the implications of globalization for countries and asset classes.

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