Making Fossil Fuel Subsidies Obsolete

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Written by Tobias S. Schmidt and Tyeler Matsuo

In early 2012, the Nigerian government drastically cut diesel and petroleum subsidies causing local fuel prices to more than double overnight. Violent public protests broke out in response, leading the Nigerian government to quickly reinstate national fossil fuel subsidies. While the Nigerian case is extreme, it illustrates a common challenge facing many countries: Despite the recognized benefits of fossil fuel subsidy reform, the reality of subsidy removal can be a political nightmare. Past reforms focused on the politically unpalatable policy of making fossil fuels more expensive, ignoring the possibility that reform can also be tackled by making fossil fuels more obsolete.

Phasing out fossil fuel subsidies is crucial to avoid dangerous levels of climate change. Estimates of global fossil fuel subsidies range from the $400—500 billion per year that the International Energy Agency cites for consumption subsidies, to the $5.3 trillion IMF estimate that includes both production and consumption subsidies as well as external effects. While such numbers certainly grab headlines—especially when juxtaposed with estimates for support for low-carbon technologies (about $120 billion) or Green Climate Fund pledges ($100 billion)—they also risk masking the complexity of fossil fuel subsidy reform.

While the IMF figure attempts to capture some of the environmental or health impacts of fossil fuel subsidies, it still cannot reveal the effect these subsidies have on distorting public investments and creating political and social vulnerabilities as state budgets drain. Indeed, many cases of national subsidy reform occur in times of major fiscal imbalance, when international organizations, such as the IMF, step in with substantial loans and make their lending conditional on fossil fuel subsidy phase-out. However, in times of crisis, a government’s capacity to manage the distributional impact of subsidy removal is often limited. While low international fuel prices temporarily suppress these negative consequences, subsidies may simply return as soon as international fuel prices rise.

Reducing fossil fuel subsidies to a single number may also give the idea that fossil fuel subsidy reform means simply reducing this sum. To date, subsidy reform has been synonymous with subsidy removal—or taking away a negative distortion. As a result, much work on fossil fuel subsidy reform has analyzed the political power balances involved in subsidy removal, and concludes that subsidy phase-out should be coupled with an appeasement strategy to win buy-in from affected stakeholders. One common strategy therefore proposes a partial redistribution of the fiscal savings from the subsidy reductions to compensate stakeholder groups perceived as particularly powerful in opposing reform. Such approaches to subsidy reform are not only fiscally unsustainable, but also can only be a superficial solution to a much deeper socio-technical problem.

While the ultimate goal should be to reduce fossil fuel subsidies, strategies for achieving this goal need to better target the underlying energy systems that create the demand for cheap fossil fuels. Ultimately, it is this system that generates the economic and political rents that make fossil fuel subsidy reform difficult and short-lived. Combining reform with policies that incentivize technological change can thus help make subsidy reform more sustainable. In parts of Indonesia, for example, technology-oriented policies enabled the elimination of kerosene subsidies for cooking: As in Nigeria, public opposition thwarted earlier attempts to phase out kerosene subsidies. What enabled successful and permanent kerosene subsidy removal were policies that incentivized a significant number of consumers to switch to alternative cookers running on cleaner liquefied petroleum gas. These technology-oriented policies weakened politically powerful kerosene stakeholders and provided a cost-effective alternative for users, thereby reducing their dependence on—and thus their opposition to the removal of—kerosene subsidies. Such an approach could also work for other sectors such as transport, industry and electricity generation.

Hybridizing fossil fuel subsidy reform with technology-oriented policies also critically reframes the political economy of reform. Rather than a one-sided focus on removing a financial flow in an often already investment-starved economy, these hybrid approaches seek to build advocacy for subsidy reform by creating real economic activity. In the electricity sector, for example, policies that support emerging fossil-free technologies open the typically monopolistic sector to new independent power producers. Renewable energy technologies also can create local jobs in construction, maintenance and manufacturing. The emergence of these low-carbon actors entrenches new “green” interests in the sector, thus altering the political balance of power in subsidy debates. Directing finances into low-carbon investments, rather than into the pockets of opposition stakeholders, also helps provide a natural sunset clause for public intervention – both by weening the energy system off of fossil fuels and by setting in motion processes of technological learning that drive down the cost of fossil-free alternatives. In many cases, low-carbon technologies are already cost-competitive; and diversifying the technology mix decreases the vulnerability of a country and its consumers to future fuel-price shocks.

Finally, it should be in the interest of international organizations to advocate for and, where necessary, financially support hybrid policies. These approaches provide an opportunity for international organizations to move from being the scapegoat for driving up energy prices, to enablers of new, job creating alternatives. The G20, comprised of leaders as well as laggards regarding fossil fuel subsidy reform and clean technology-oriented policies, could play an important role. The G20 could act as driver of ambitious targets for both fossil fuel subsidy reform and technological change and promote the exchange of experiences and best practices between the international community.

Editor’s Note: This opinion piece is informed by the research performed by both authors. Relevant publications include: Matsuo, T. and Schmidt, T.S., 2017. Environmental Research Letters, 12(1); and Schmidt, T.S., Born, R. and Schneider, M. (2012). Nature Climate Change, 2(7)

About the authors: Tobias Schmidt is an Energy Politics Professor at ETH Zurich where he earned his PhD in Management, Technology, and Economics. He was a post-doctoral visiting scholar at Stanford University, and consulted for the UN Development Programme. In recent years, he gave talks at T20 meetings in Turkey, Germany and China. Tyeler Matsuo is a doctoral researcher in ETH Zurich’s Energy Politics Group. She has also worked as a consultant in climate and energy policy with organizations such as the World Bank.