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Energy subsidies

Tracking the impact of fossil-fuel subsidies

The IEA has been measuring fossil-fuel subsidies in a systematic way for more than a decade. The analysis performed by the World Energy Outlook team highlights the scale of these subsidies, and the beneficial impact of fossil-fuel subsidy removal for energy markets, climate change and government budgets.

Key findings

Value of fossil-fuel subsidies by fuel in the top 25 countries, 2020


Global fossil-fuel consumption subsidies were down in 2020, but they are far from out

In 2020, the fall in fossil fuel prices and energy use brought the value of fossil fuel consumption subsidies down to a record low – the estimate of just over USD 180 billion is some 40% down from 2019 levels. This is the lowest annual figure since we started tracking these subsidies in 2007. Almost all countries had lower estimated subsidies year-on-year; Iran remains the single largest provider of these subsidies, although the value of the implicit support to domestic consumers fell by more than USD 50 billion in 2020, due to low crude prices and weak economic conditions. One of the very few categories where our subsidy estimate grew year-on-year was oil products in China (notably for residential use), reflecting a relatively rapid recovery from the pandemic. Overall, the weighted-average subsidy rate was some 10% - meaning that consumers receiving these subsidies paid on average around 90% 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 90 billion out of the total USD 180 billion). Subsidies for residential consumption of oil products overtook those for transport fuels, which fell by half because of lower demand for mobility during lockdowns and the economic slump. Subsidies to fossil fuels used to produce electricity are the next-largest element of the overall subsidy estimate (USD 50 billion in 2020), followed by natural gas (USD 35 billion) and coal (USD 1.7 billion).
Our work

The IEA estimates subsidies to fossil fuels that are consumed directly by end-users or consumed as inputs to electricity generation (see explanation of the price-gap methodology). A time series of these estimates from 2010, by country and fuel, is available as a free download. This database also now separates out the country-by-country estimates for subsidies to the transport sector.

Alongside these estimate of fossil-fuel consumption subsidies, the IEA also collaborates with the OECD to produce a joint estimate that includes measures that provide a benefit or preference for fossil-fuel production.

The work of the IEA on energy subsidies is incorporated into major publications in the World Energy Outlook series. In addition, the IEA has provided regular input to G20 and other international subsidy removal efforts since 2009, when G20 leaders committed to “rationalize and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption”.

Methodology and assumptions

The IEA estimates subsidies to fossil fuels that are consumed directly by end-users or consumed as inputs to electricity generation. The price-gap approach, the most commonly applied methodology for quantifying consumption subsidies, is used for this analysis (Kosmo (1987), Larsen and Shah (1992) and Coady et al. (2010), for example, have used this approach). It 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 falls short of the reference price and 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

The data required for the price-gap calculations are extensive. End-user price and consumption data are drawn from IEA data and, where necessary, from government sources and other reports. Furthermore, the estimate is sensitive to reference prices, which are calculated for fuels on the basis of international prices. Electricity reference prices are derived from annual average-cost pricing (see below for further explanation of how reference prices are calculated).

For economies that export a given fossil-energy product but charge less for it in the domestic markets, the domestic subsidies are implicit; they have no direct budgetary impact so as long as the price covers the cost of production. The subsidy, in this case, is the opportunity cost of pricing domestic energy below international market levels, i.e. the rent that could be recovered if 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 may sometimes be implicit. Many economies, Indonesia for example, rely extensively on domestically produced fuels, but supplement domestic supply by importing 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 to end-users below those that would prevail in a competitive market. While such subsidies account for the majority of subsidies to fossil fuels, there are numerous others that are not captured by the price-gap approach. It does not, for example, capture subsidised research and development or subsidies for fossil fuel production. Estimated based on the price-gap approach 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 of subsidy levels across economies to support policy development.

For net importers, reference prices 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, reference prices were 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. All calculations are carried out using local prices and the results are converted to US dollars at market exchange rates.

Assumed costs for transporting oil products vary according to the distance of the country from its nearest hub; these are taken from average costs as reported in industry data. Average internal distribution and marketing costs for oil products in all economies are assumed to be equal to costs in the United States. For natural gas and coal, transport and internal distribution costs are estimated on the basis of available shipping data.

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, such as steam coal in India, which relies heavily on low-quality domestic coal but imports small volumes of higher quality coal.

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 were 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 were set to account for the cost of production, transmission and distribution, but no other costs, such as allowances for building new capacity. They were determined using reference prices for fossil fuels and annual average fuel efficiencies for power generation. An allowance of $15/MWh and $40/MWh was added to account for transmission and distribution costs for industrial and residential uses, respectively. To avoid over-estimation, electricity reference prices were capped at the levelised cost of a combined-cycle gas turbine (CCGT) plant.

Some authorities regard the above method of determining reference prices as inappropriate. In particular, a number of energy resource-rich economies are of the opinion that the reference price in their markets should be based on their cost of production, rather than prices on international markets as applied within this analysis. The basis for their view typically is that natural resources are being used to promote their general economic development, and that this approach more than offsets the notional loss of value by selling the resource domestically at a price below the international price. The counter-argument is that such an approach results in an economically inefficient allocation of resources and reduces economic growth in the longer term.