Oil companies prefer to work in competitive markets

As governments try to soften the blow of higher international oil prices, subsidies have gone up quite substantially in the last couple of years. What do we know about the scale of energy subsidies around the world? What types of energy sources are the biggest benefactors of these subsidies?
Trevor Morgan is the principal author of the UNEP report released last month on energy subsidies and climate change, titled 'Reforming Energy Subsidies: Opportunities to Contribute to the Climate Change Agenda'. He recently re-joined the International Energy Agency (IEA), having previously founded the independent energy-consulting firm, Menecon Consulting. The GSI reached Morgan at his office in Paris.

GSI: What do we know about the scale of energy subsidies around the world?

TM: There are no recent studies that have attempted to calculate energy subsidies worldwide. The most recent and comprehensive report on the subject was the IEA’s World Energy Outlook 2006, which looked at energy-consumption subsidies in 20 non-OECD countries. The figure we arrived at was 220 billion U.S. dollars, using 2005 data. We concluded that if you scale up the figure to represent the other non-OECD countries, it would suggest that globally energy-consumption subsidies are in the order of 300 billion dollars. This is about 0.7 percent of world GDP. I should point out that this estimate is based on a price-gap approach, whereby we calculate the difference between consumer prices and the price that would exist without government subsidies. We know that producer subsidies also exist in OECD countries, but they are in aggregate a lot lower and go mainly to production, so they don't necessarily lead to lower prices to end users. A few years back, the IEA estimated subsidies in these countries to be in the range of 30 billion dollars.

GSI: What types of energy sources are the biggest benefactors of these subsidies?

TM: The simple answer is fossil fuels. We estimated that 170 billion dollars out of the 220 billion dollars of consumption subsidies in non-OECD countries goes to fossil fuels. As a percentage of the price, however, subsidies to natural gas are the highest. In Russia, for example, we found that industry and households pay less than half the true cost of supply, which encourages waste and discourages investment in energy efficiency. In absolute terms, subsidies on oil products are the biggest, at close to half of the total. In Iran, oil subsidies are now running at about 35 billion dollars a year – that’s equal to more than 10 percent of the country’s GDP! Gasoline sells at about 9 cents a litre – one of the lowest prices in the world. If you’ve ever been to Tehran, you’ll know what that means in terms of traffic congestion and pollution.

GSI: Generally speaking, are energy subsidies going up or down?

TM: We are actually in the process now of updating our figures on energy subsidies for the IEA’s World Energy Outlook 2008, to be released in November. The preliminary results show that subsidies have gone up quite substantially in the last couple of years as governments try to soften the blow of higher international oil prices. The final number for the 20 countries we survey is likely to be over 300 billion dollars, suggesting a global figure of closer to 400 billion dollars. That’s more than the entire GDP of North African countries combined!

GSI: We are seeing countries that provide consumption subsidies for fossil fuels struggling to afford this support as the prices for these fuels have risen. What types of guidance can you offer governments that are looking to reduce their fossil-fuel subsidies, but are concerned about the social cost of raising fuel prices?

TM: Subsidies usually benefit certain categories of consumers or social classes. However, politicians have to communicate as clearly as they can that there are also costs associated with these subsidies - financial, economic and environmental - borne by everybody. People understand that if energy is provided at below market prices it is more likely to be used wastefully. One of the things we always say is that politicians need to work harder at explaining to the general public just what the costs are involved in subsidising energy.

How to you go about reforming energy subsidies? An obvious way to soften the blow is by doing it gradually. Removing energy subsidies in one fell swoop is not always politically feasible or socially desirable. At the same time, it shouldn’t be so slow as to allow the costs to persist for too long. Another approach is to directly link subsidy removal with another measure that is likely to be seen by all or most of the public as favourable to them, like an across-the-board tax cut. That measure should, of course, be prudent and appropriate in its own right.

GSI: Can you point to subsidy policies in the energy sector that can be counted as a success? In other words, a subsidy scheme that achieved its policy objective and did not outlive its usefulness?

TM: I tend to avoid describing any sort of energy subsidies as good. In principle, no subsidy is good as it always creates a market distortion and leads to economic inefficiencies. Some people say that subsidies are needed to address market failures, but I think these are often better dealt with using taxes on bad things rather than subsidies on good things.

That said, there are certainly some cases where it can be argued that subsidies are a sensible way to achieve certain energy-policy objectives. Perhaps the most obvious instance of a justifiable subsidy is that of social tariffs for electricity in poor countries. But it is crucial that electricity subsidies are designed carefully so as to reach the households that are in the greatest need of support; otherwise, the costs of the subsidies can turn out to be much bigger than the social benefits. For example, in India, rural electricity tariffs recover only 85 percent of the cost of supplying electricity. This has resulted in huge losses for state electricity boards, which prevents them from investing in new infrastructure and electrifying villages that still have no power supply.

I’m not sure that there is a strong case for these social tariffs for electricity in rich, industrialised countries. Moreover, as a rule, I think social-policy objectives such as helping the poor should be dealt through welfare payments and social programmes, rather than through subsidies to energy.

GSI: Where do the large oil companies normally position themselves with respect to fossil- fuel subsidies?

TM: The oil companies, in my experience, have mixed feelings. On the one hand, they see benefits to the extent that subsidies can encourage people to consume more oil. But that depends on whether they have to share any part of the cost of the subsidy, or whether the subsidy gives an advantage to nationally-owned companies over privates ones. It really depends on how the scheme works. In some cases, the companies actually lose money on the downstream because of subsidies, but they are willing to accept these losses in return for receiving access to upstream resources.

Generally, however, the oil industry people with whom I have discussed the issue tend to speak negatively of subsidies. Oil companies normally prefer to work in competitive markets. But of course, where they see an opportunity to make money because of a subsidy, they are not going to complain.