Fossil Fuel Subsidies

This approach compares average end-user prices paid by consumers with reference prices that correspond to the full cost of supply. The price gap is the amount by which an end-use price is short of the reference price. Its existence indicates the presence of a subsidy. In a given economy, the basic calculation of subsidies for a product is:

Subsidy = (Reference price - End-user price) × Units consumed

These calculations require substantial data. End-user price and consumption data are drawn from IEA data and, where necessary, from government sources and other reports. The estimates are also sensitive to reference prices, which are calculated based on international prices. Electricity reference prices are derived from annual average-cost pricing (see the section below for more on how reference prices are calculated).

For economies that export a given fossil-energy product but charge less for it domestically, the domestic subsidies are implicit; they have no direct budgetary impact, so long as the price covers the cost of production. The subsidy, in this case, is recorded as the opportunity cost – or the rent that could be recovered if domestic consumers paid world prices, adjusting for differences in variables such as transportation costs. For net importers, subsidies measured via the price gap approach may be explicit, representing budget expenditures arising from the domestic sale of imported energy at subsidised prices, or implicit. Many economies rely extensively on domestically produced fuels but import the remainder. In such cases, subsidy estimates represent a combination of opportunity costs and direct expenditures.

Estimates using the price gap approach capture only interventions that result in final prices for end users below what would prevail in a competitive market. They do not, for example, capture subsidised research and development, or subsidies for fossil fuel production. These estimates therefore understate total fossil fuel subsidies, as well as their impact on economic efficiency and trade.

Despite these limitations, the method is a valuable tool for estimating subsides and for undertaking comparative analysis across economies to support policy development.

For net importers of oil, natural gas and coal, these are based on the import parity price: the price of a product at the nearest international hub, adjusted for quality differences, if necessary, plus the cost of freight and insurance to the net importer, plus the cost of internal distribution and marketing and any value-added tax (VAT). VAT was added to the reference price where the tax is levied on final energy sales, as a proxy for the tax on economic activities levied across an economy. Other taxes, including excise duties, are not included in the reference price.

For net exporters of oil, natural gas and coal, reference prices are 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.

Reference prices are adjusted for quality differences, which affect the market value of a fuel. Reference prices are assumed to be below observed import prices in some cases.

All calculations are carried out using local prices and the results are converted to US dollars at market exchange rates.

Unlike oil, gas and coal, electricity is not extensively traded over national borders, so there is no reliable international reference price. Therefore, electricity reference prices are based on annual average-cost pricing for electricity in each country (weighted according to output levels from each generating option). In other words, electricity reference prices are set to account for the cost of production, transmission and distribution, but no other costs, such as allowances for building new capacity. They are determined using reference prices for fossil fuels and annual average fuel efficiencies for power generation.