We Can Cut the Climate Change Problem in Half by Eliminating Fossil Fuel Subsidies

Commentary about business and finance.
Jan. 26 2012 1:20 PM

Dirty Money

The astonishing new data showing that simply eliminating inefficient fossil fuel subsidies could achieve half the world’s carbon reduction goals.

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Illustration by Robert Neubecker.

What if I told you that we could obtain half the reduction in carbon emissions needed to stave off climate disaster not with new government interventions in the economy but simply by removing existing interventions?

Fatih Birol, chief economist of the International Energy Agency is telling you exactly that. In data released this month as part of the IEA’s latest World Energy Outlook report, he shows that in 2010 the world spent $409 billion on subsidizing the production and consumption of fossil fuels, dwarfing the word’s $66 billion or so of subsidies for renewable energy. Phasing fossil fuel subsidies out would be sufficient to accomplish about half the reduction in greenhouse gas emissions needed to meet the goal of preventing average world temperatures from rising more than 2 degrees Celsius.

You don’t hear as much about this as you should largely because the biggest offenders are far from our shores. Still, the scale and scope of the issue is worth dwelling on if only because these subsidies are so wrongheaded.

Far and away the biggest problem seems to be that misguided sense that countries that are large producers of certain kinds of fuels ought to subsidize domestic consumption of the fuel in question. Thus Saudi Arabia spends more than $30 billion a year on gas consumption subsidies while Russia spends $17 billion on natural gas subsidies. Iran, which produces both, subsidizes both, spending $66 billion in total plus an additional $14.4 billion on electricity consumption subsidies. Large-population developing countries such as China, India, and Indonesia are also important players in the subsidy game. In no case do these subsidies make sense.

For starters, the mere fact that your country contains a lot of oil offers no special reason to subsidize gasoline consumption. For one thing, gasoline isn’t oil. Like other usable fuels, it needs to be refined from crude. Iran is actually a net importer of refined petroleum products, and the United States has recently become a net exporter of them, even as the situation for crude oil is the reverse. More broadly, the opportunity cost of using a domestically produced barrel of oil is identical to the financial cost of buying a barrel on international markets. In other words, if the Japanese government wants to offer subsidized oil to its citizens, it needs to go buy the oil first from Saudi Arabia. By the same token, if the Saudi government wants to offer subsidized oil to its citizens, it needs to sell less to Japan. The budgetary impact is identical in either case and the merits of the policy have nothing to do with how much oil a country has.

Saudi gas station.
A Saudi gas station. Saudi King Abdullah ordered petrol prices in the oil-rich kingdom slashed by more than 30 percent yesterday.

Photograph by Hassan Ammar/AFP/Getty Images.

And what are the merits? Not much. Consumption subsidies are typically justified as beneficial to the poor. But while it’s certainly true that in rich countries utility bills and transportation fuel costs disproportionately burden the poor, it’s not clear that this is true in the developing world. Here in the United States, only rich people go to fancy restaurants, but everyone needs to run home appliances, which is why higher energy costs hit the poor hardest. In India, however, more than a third of the population doesn’t have electricity, and most people don’t have cars. China’s not as poor as India, but the same logic applies: The people who truly need help are the people who can’t afford to take advantage of the subsidies. The IEA calculates that less than 10 percent of global fossil fuel subsidies benefit the poorest 20 percent. These subsidies would be much better spent on a mix of cash grants to the poor, lower taxes to spur growth, and investments in infrastructure and education.

But even a direct fuel subsidy for the poor is a pretty bad way to help people. America doesn’t go in for lavish spending on fuel consumption subsidies, but we do have something called the Low-Income Home Energy Assistance Program, which offers targeted subsidies to help poor families in cold-weather states to keep their families warm in the winter. This is hardly the worst idea in the world, but you’d do more for the families and the environment if you just gave them cash. Some of that cash might go to pay the heating bill, but some might go to the purchase of sweaters or better insulation, ecologically friendlier solutions that will probably help households more over the long run.

That these kinds of subsidies are misguided counts as conventional wisdom in the economics world, but it’s not clear that even economists have recognized the sheer scale of the impact. If roughly half of what needs to be done can be achieved simply by eliminating economic distortions—economic distortions that would be unwise even if there were no concern about pollution—then the whole framework of a trade-off between prosperity and sustainability is largely misguided. The outlook for greener, freer markets gets even brighter when you consider that consumption subsidies aren’t the only dirty interventions out there. The U.S. government offers generous tax subsidies for the production of oil and natural gas (each year, President Obama proposes to scrap them, and each year Congress declines), and the European Union does the same for coal. Local governments nearly everywhere require the construction of more parking spaces and lower-density buildings than a free market would provide, encouraging excessive driving and energy-intensive large detached homes.

At the end of the day, pure laissez faire can never meet the world’s environmental challenges. If you want to reduce greenhouse gas emissions, you need to cap them and then you need to reduce the cap. But a surprisingly large step toward that target can occur by simply allowing the market to do its work by removing the subsidies that encourage lavish and inefficient consumption of fossil fuels.

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