Subsidy or no subsidy, that is the question

gas price difference

It has been told in many shades and colors, apparently fossil fuels are subsidized. I have never really perceived this as truthful, but also never looked into what actually is being claimed. It at least seemed exaggerated: my thoughts where that this “subsidy” was probably something else, but dressed up as a subsidy.

A couple days ago I read an article about those alleged fossil fuel subsidies and in it they even went a step further this time. The claim was not only that these subsidies amount to 544 billion dollars per year, but that we could use these subsidies to “invest” in renewable sources of energy (for which we would need 800 billion dollars per year):

Much of the hundreds of billions of dollars worth of renewable energy investment that is needed to prevent the worst effects of climate change could come from the substantial subsidies given to fossil fuels, a new report has found.

Maybe a good time to start checking what these subsidies actually consist of. I had a hard time believing the statement that there is 544 billion dollars of subsidies on fossil fuels. As far as I know, fossil fuels fuel the economy. I can’t believe that someone in its right mind would subsidize something that is generating money. At least in our country, but also in our neighboring countries, fossil fuels are taxed heavily and governments EARN money from fossil fuel use. There are however some things that could indicate some sort of a subsidy. There are some groups of people that get their energy cheaper. For example, farmers are taxed less on the fuel for their tractors and other machinery. Also the poor pay less for their energy use. But the government doesn’t pay for their fossil fuel use, but get a little bit less income from it. The reasons for these are to keep the local food prices low or preventing that the poor come into problems. Another thing I considered was that the price of oil is not only the price of the product, transport and profit, but there are also other elements in it, some of it political, that make it much more expensive than just the product itself. Everybody needs it, so this will drive prices up. In that sense some subsidies could exist.

The first thing I found was the distribution of the energy subsidies globally and this information was telling. This is how the International Energy Agency displays it:

fossil-fuel-subsidy2012_small

It was surprising to see that none of the countries in which those subsidies were given were European, USA or Australian (these are the countries that are willing to do something or at least talked about it in the past). Even more surprising was to see the countries with the highest subsidies (in dark red): it were predominantly countries in the Middle East and North Africa! Surprising because these are oil PRODUCING countries. The report seem to rest on the same IEA data and came to the same conclusion:

Oil-exporting countries were responsible for approximately two-thirds of total fossil subsidies, while greater than 95% of all direct subsidies occurred in developing countries.

This made me think about what this elusive “subsidy” is actually about. Apparently the inhabitants of these oil/gas producing countries pay less for the use of fossil fuels. But less against what? In most discussions it is not really defined and seems to be the “international market price” or the “world market price”. But the price of oil in the international market bears little relationship to the cost of production. So of course those people don’t pay the international price. They live in a country with plentiful resources. Their product is not scarce for them at all. To countries that they export to (countries with less of no natural fossil fuel resources like our little country), this oil or gas has more added value than in the country were it is plentiful available.

A clear definition of fossil fuel subsidy is mostly missing from the discussions. Does it really mean that this subsidy is the difference in price of the product on the local market compared to the international market? Those governments will not really pay money to keep price low, but will have less income (compared to when they would sell it internationally). Or do they let them sell cheaper than the production cost plus the profit for the producer? In that case they are actually paying community money for the local distribution of their product and I would have no problem calling that a subsidy. So I am not really sure how much of these 544 billions of “subsidy” is actually a subsidy or rather an artifact of their price gap approach.

According to the IEA methodology they define it as such:

[…] The price gap is the amount by which an end-use price falls short of the reference price and its existence indicates the presence of a subsidy.[…]

For net exporters, reference prices were based on the export parity price: the price of a product at the nearest international hub, adjusted for quality differences if necessary, minus the cost of freight and insurance back to the net exporter, plus the cost of internal distribution and marketing and any VAT. […]

But this reference price of a product can be substantial. This was made clear in a paper of the University of Uyo. Nigeria is the largest oil producer in Africa and the president came to the idea that the fuel prices of petrol and household kerosene (which were the fuels that were regulated at that time) were too low. Before 2012 those fuels were sold for 65 Naira per liter at the pump. The imported price was 138.81 Naira per liter, so the president called the difference of 73.81 Naira a “subsidy”, as whispered in by the IMF, World Bank and others. The investigators now calculated the production price as 34.03 Naira per liter, this when the prices would be dictated by the forces of demand & supply, in stead of international demand which is substantially higher.

But then there is that other issue. The claim was that much of the hundreds of billions of dollars needed for subsidizing renewable energy could come from the fossil fuel subsidies. Even if it would be actual subsidies, it is a developing nations thingy and the money that was used as a “subsidy” was for about two thirds generated by the selling of … fossil fuels, probably with a huge profit.

How much chance is there that these “subsidies” could go to investments for renewables? Whatever the developed countries would save would be insignificant. Unless of course the developed nations could get the developing nations that crazy by adopting the international prices in stead of the prices of demand & supply and to use the “saved” money to invest in renewable energy in stead of other pressing priorities such as for example health care or education.

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One thought on “Subsidy or no subsidy, that is the question

  1. Pingback: These items caught my eye – 7 July 2014 | grumpydenier

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