Low fuel prices provide a historic opportunity to phase out fossil fuel consumption subsidies

Periods of low fuel prices typically represent a golden opportunity to pursue the pricing reforms that are the only durable way to eliminate consumption subsidies. Countries that are net importers of fuels find it politically easier to phase out subsidies when prices are low, as the adjustment to end-user prices (and impact on inflation) is smaller. A plunge in oil prices also adds urgency to domestic pricing reforms in major oil and gas producing nations, where fossil fuel consumption subsidies are generally concentrated. In these cases, the abrupt falls in hydrocarbon revenues in 2020 mean that reforms to wasteful fuel subsidies become a crucial way to relieve fiscal strains.

The overriding economic priority for policy makers so far in 2020 has been to limit the damage from the crisis: governments are providing direct and indirect support to keep households and companies afloat. As such, there are few signs so far that low fuel prices are prompting an accelerated effort to phase out subsidies, although pre-existing reform efforts have continued. In some countries, there have been examples of the opposite tendency, particularly in the electricity sector, as governments have stepped in with additional price interventions to protect newly vulnerable consumers.

As economic conditions improve, there needs to be a redoubling of efforts to phase out fossil fuel subsidies to ensure that recoveries are sustainable. This would not exclude well-targeted protection for the poorest and most vulnerable groups – as successful subsidy reform efforts around the world have demonstrated. But it would prevent countries with artificially low fossil fuel prices from locking in a new cycle of market distortions that favour polluting and inefficient technologies.

Fossil fuel consumption subsidies are in place in more than 40 countries around the world, according to the price-gap methodology used by the IEA in its assessment.1 There can be good reasons for governments to make energy more affordable, notably in pursuit of important social goals like universal access to modern energy. But in practice, many subsidies are often poorly designed and targeted – creating structural risks to government budgets and the financial performance of the energy sector, encouraging wasteful consumption among wealthier segments of the population, and pushing up emissions across economies as a whole.

These subsidies create a roadblock to a cleaner and more efficient energy future. That is why the IEA has consistently been shining a spotlight on this issue and continues to be a strong supporter of international efforts to get them removed.

There has been only fitful progress on subsidy phase-outs in recent years. IEA tracking of subsidy-related policy announcements highlights good examples of countries (such as India, Tunisia and Egypt) reinforcing this pillar of sound energy policy-making, and other countries announcing their intention to follow suit. But they also show multiple examples of policy reversals or postponements, with the protection afforded to consumers coming at significant fiscal and environmental cost.

Measures introduced in response to the Covid-19 crisis add an additional layer of complexity to the picture. They are largely concentrated in the electricity sector, where many countries and utilities around the world have made commitments to avoid hardship during the crisis, including payment moratoria, additional assistance with bills or pledges not to disconnect customers in arrears. The short-term justification for action is clear, but it will be vital for the health of these power systems that temporary measures introduced during the crisis do not crystallise into longer-lasting subsidy programmes.

New data for 2019 from the IEA provide a detailed picture of global consumption subsidies and how they are changing over time. After two years during which the global aggregate rose, 2019 saw a decline in fossil fuel consumption subsidies of USD 120 billion, related in large part to lower average fuel prices over the course of the year.

Almost all countries had lower estimated subsidies year-on-year, the only exceptions being Bahrain, Sri Lanka and Iran (which remained the single largest provider of these subsidies, despite a gasoline price increase of at least 50% in November). The overall weighted-average subsidy rate was some 15%, meaning that consumers receiving these subsidies paid on average around 85% of the competitive market reference prices for the energy products concerned.

Among the fuels, subsidies to oil products remained the largest single component of the total (USD 150 billion out of USD 320 billion). India is the country with the largest single bill for oil subsidies, but the vast majority of this is LPG supplied as part of the drive for clean cooking facilities – the main transport subsidies for diesel were phased out in the early 2010s.

Electricity is the next largest element of the overall subsidy estimate (USD 115 billion in 2019). Iran has some of the lowest electricity prices in the world, and this underpinned a very large overall subsidy estimate. Electricity is followed by natural gas (USD 50 billion, but with notable examples of price reform in Egypt and Ukraine) and coal (USD 2.5 billion).

Energy subsidy reform remains a tough political challenge when societies and economies are feeling the strain of the Covid-19 pandemic. But the prospects for building better after the crisis, in many parts of the world, are inextricably linked with getting price signals right, especially if subsidy reform is combined with a broader suite of policy measures aiming at more robust, secure and sustainable energy sectors.

Ultimately, if households and industries have the incentive to opt for more efficient equipment, and investors can see greater advantage in cleaner technologies, the implications for long-term growth – and for global emissions – can be profound. Although this year has brought tremendous upheaval, it also offers a historic moment to act on fossil fuel subsidies.