OECD and IEA recommend reforming fossil-fuel subsidies to improve the economy and the environment

Governments and taxpayers spent about half a trillion dollars last year supporting the production and consumption of fossil fuels. Removing inefficient subsidies would raise national revenues and reduce greenhouse-gas emissions, according to OECD and IEA analyses.

The G-20 Leaders in 2009 agreed to phase out subsidies that “encourage wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change”. OECD and IEA data and analysis are contributing actively to the follow-up on this commitment by the G20.

“Both developing and developed countries need to phase out inefficient fossil fuel subsidies. As they look for policy responses to the worst economic crisis of our lifetimes, phasing out subsidies is an obvious way to help governments meet their economic, environmental and social goals,” said OECD Secretary-General Angel Gurria, “For this to succeed, we need well-targeted, transparent and timebound programmes to assist poor households and energy workers who might be adversely affected in the short-term. OECD and IEA data and analysis can help guide the process.”

The OECD Secretary-General and IEA Executive Director Maria van der Hoeven emphasised that subsidies to fossil-fuel consumers often fail to meet their intended objectives: alleviating energy poverty or promoting economic development, and instead create wasteful use of energy, contribute to price volatility by blurring market signals, encourage fuel smuggling and lower competitiveness of renewables and energy efficient technologies.

“In a period of persistently high energy prices, subsidies represent a significant economic liability,” said IEA Executive Director Maria van der Hoeven, noting IEA estimates that subsidies that artificially reduce the price of fossil-fuels amounted to USD 409 billion in 2010 – almost USD 110 billion higher than in 2009. This is based on the IEA’s global survey to identify economies that artificially lower end-use prices for fossil fuels to below the full cost of supply.

Phasing out fossil-fuel subsidies will also provide an impetus for investment, growth and jobs in renewable energy and energy efficiency. Despite the many benefits of phasing out fossil-fuel subsidies, reform efforts have been hampered by a lack of information on the support measures in place, particularly in OECD countries. To assist governments’ understanding of the nature and scale of their policies supporting fossil fuels, the OECD has compiled the first-ever Inventory of Estimated Budgetary Support and Tax Expenditures For Fossil Fuels. With detailed information of over 250 mechanisms that support fossil fuel production and use in OECD countries, the Inventory will be updated regularly and expanded over time to cover more countries and more support mechanisms.

Covering 24 countries, which account for about 95% of OECD’s total primary energy supply, the Inventory shows that 54% of this support was for petroleum. Overall, the support to fossil-fuel production and consumption in OECD countries was USD 45 – 75 billion annually during the 2005 – 2010 period. The Inventory furthers transparency and accountability, providing estimates that will help governments and stakeholders assess these policies as they look at ways to reform subsidies. For example:

• Germany’s historically generous subsidies to hard-coal mining fell from EUR 4.9 billion in 1999 to EUR 2.1 billion in 2009, and should be phased-out entirely by 2018
• France gradually phased out its support to the coal industry: from more than EUR 1 billion in 1990, producer support decreased to EUR 92 million in 2007 and then ended. This was accompanied by a range of measures meant to address the social costs associated with mine closures
• Government energy support to consumers in Mexico was USD 629 million in 2009, but will decrease as the new national energy strategy is put into place and the government better targets subsidies directly to low income households, rather than to energy use
• And in the United States, where support for energy producers was about USD 5 billion on 2009, the 2012 federal budget proposes eliminating a broad group of subsidies – thereby increasing government revenues by more that USD 3.6 billion

Work by the IEA, to be published in the World Energy Outlook 2011 on November 9, demonstrates that phasing out subsidies to fossil fuels, if well-executed, can generate important economic, energy security and environmental benefits.

Fortunately there are some signs of progress: nearly half of the countries identified by the IEA as artifically lowering the price of energy to below the full cost of supply have taken steps since the beginning of 2010 to rationalise energy prices. “While this is an encouraging start, much work remains to be done in order to realise the full extent of benefits. It is crucial that countries follow through on their commitments by implementing reforms that are well-designed and durable”, said IEA Executive Director Van der Hoeven.

Some of the strategies that governments are using to phase out fossil fuel subsidies as reviewed by the OECD and IEA analyses highlight keys to success:

• Available and transparent data are essential to inform objective discussion
• Financial support for economic restructuring and assisting poor households can help to protect vulnerable groups
• Integrating reforms to fossil fuel subsidies into broader structural reforms can help build support for the reforms, particularly when the money saved is used to benefit the wider public

“The room for policy manoeuvres is increasingly limited, especially in more advanced economies” noted OECD Secretary General Angel Gurría. “In this context, structural reforms are essential to stimulate growth and employment. There are very few quick fixes though. One of them is the removal of inefficient fossil fuel subsidies. Countries must seize this opportunity and we stand ready to help”, said Mr. Gurría.

More OECD and IEA work on fossil fuel subsidies can be found here.