Differing Definitions of Fossil Fuel Subsidies Hinder Subsidy Reduction Efforts

Ending fossil fuel subsidies by 2020 would decrease greenhouse gas emissions by 4.7 percent. Photo credit: LC Nottaasen

In early January, thousands of Nigerians took to the streets in what has been dubbed Occupy Nigeria. However, unlike the Occupy movement in the United States, Occupy Nigeria was spurred on by one issue: the government’s decision to reduce fossil fuel subsidies. Overnight, gas prices in Nigeria more than doubled as a result of the government’s new policy. The government argues that it is bringing gas prices closer to the global market price, but the price increase has caused significant economic hardship.

Globally, advocates of renewable energy have called for the reduction of fossil fuel subsidies in order to make alternative technologies more competitive. If fossil fuel consumption subsidies were phased out by 2020, energy demand would be reduced by 4.1 percent and greenhouse gas emissions by 4.7 percent due to increased energy conservation and development of renewable resources. Furthermore, these subsidies tend to be regressive by benefiting more affluent populations globally, with only 9 percent of electricity subsidies going to the poorest 20 percent of the population.

By raising the end-user price of fossil fuels to market prices, countries can discourage inefficient industry and promote renewable energy projects and green jobs. In 2009, the G-20, recognizing their negative environmental impacts, pledged to eliminate or rationalize all inefficient fossil fuel subsidies. No country has begun cutting subsidies as a result of this pledge, however, partly because popular pressure and differing conceptions of subsidies.

According to the 2011 International Energy Agency World Energy Outlook, 80 percent of global consumption subsidies since 2007 have been implemented by countries that are net exporters of fossil fuels. In 2010 alone, subsidies in net exporters totaled US$331 billion as opposed to US$78 billion in net importers. Subsidies in the Middle East alone totaled US$166 billion, or 41 percent of the global total. Iran’s subsidies equaled US$81 billion, and subsidies in Kuwait were roughly US $2,800 per person. Fossil fuel subsidies in Iran, Iraq, and Uzbekistan all equal roughly 10 percent of the nations’ GDPs and almost 20 percent in Turkmenistan.

Reducing subsidies in net exporting countries would have the greatest impact in reducing greenhouse gas emissions. However, scaling back subsidies in these countries also proves to be the most politically contentious.

In Nigeria, a sharp increase in gas prices mobilizes protesters at Occupy Nigeria. Photo credit: Temi Kogbe 

Nigeria is a clear example of how fossil fuel subsidy reductions can cause massive protests. Since most Nigerians live on less than US$2 per day, the immediate increase in gas prices from US$0.40 to US$0.86 per liter made gas significantly less affordable and caused economy-wide inflation. State and local governments have promised that the money saved in subsidies will be used to build infrastructure. However, many of the protestors have little faith in the government, and some believe that fuel traders profited the most from subsidies. One widely circulated (though disputed) statistic among the protestors is that the actual cost of production in Nigeria is around US$0.25, and thus some protestors argue that there have never been subsidies as the domestic price of oil has always remained above this level.

Regardless of the validity of this statistic, it nevertheless indicates a popular conception of subsidies as calculated from a baseline of production cost rather than international market price. In fact, the G-20 initiative to reduce subsidies has been hindered by this dispute in the definition of a subsidy. Most net importing countries advocate for a “price gap” approach to calculating subsidies, in which the average market price is compared to the actual end-use price. Some oil exporters, on the other hand, want subsidies to be defined as the difference between production cost and end-use price. In these oil exporting nations, production costs are significantly lower than market prices, and thus the nations are able to offer oil products to their citizens at prices well below the market price but still above production cost. Saudi Arabia has the best articulation of this position, arguing that this low end-user cost represents a “comparative advantage” in global oil production rather than a subsidy.

In the 1970s, OPEC was able to exercise its control over productive oil fields and collectively charge higher prices for extraction to oil companies operating within its countries’ borders. These high charges for oil production are the main cause of the difference between oil production costs and the global market price. Thus the ‘comparative advantage’ that Saudi Arabia claims to have derives from its ability to charge its citizens a price for oil closer to the production cost, reducing the impact of the charges levied on oil production within its own borders.

Literature on subsidies tends to take an especially negative view of subsidies in oil exporting countries, often invoking the rentier economy hypothesis, which states that because resource exporting states do not need to rely on tax income, they do not need to create state legitimacy through government services. Large energy subsidies are seen as a way for these nations to bribe their people into political passivity, and anti-subsidy campaigns frequently use the rentier discourse to argue that such subsidies serve no purpose other than to support oppressive regimes in oil exporting nations. This is partially due to a historical bias against rent as a form of profit, which is sometimes characterized as “a break in the work-reward causation.” Overall, the rentier economy hypothesis tends to gloss over cultural differences between exporters and other economic factors, and ignore state building efforts and welfare programs aimed at building state legitimacy.

Despite bold pledges at 2010's G-20 summit, net-importing countries have not taken the necessary steps towards reducing  costly fossil fuel subsidies. Photo credit: IEA 

The conventional discourse surrounding the aim of reducing global fossil fuel consumption subsidies fails to engage with oil exporters on their own terms. In defining subsidies, entities like the G-20 tend to view market price as the “natural” price of oil in the world, failing to take into account the fact that the market price is artificially inflated by extramarket factors and instead regarding subsidies as perpetuating a “fundamentally unfair trading system.” Thus, the notion that subsidies must be “rationalized,” essentially assuming that they are unnatural but can occasionally benefit society, goes against the logic of exporting nations that views subsidies as acceptable unless proven harmful.

Overall, reducing fossil fuel subsidies globally is important for the advancement of renewable technologies. Literature on subsidy reduction should focus on the negative impacts of subsides, most notably their tendency to promote inefficient industry, encourage transnational smuggling, and provide benefits regressively. Literature on subsidies should avoid broad generalizations and instead should examine subsidies on a case-by-case basis in each country. Alternative subsidies that shelter the poor from the negative effects of fossil fuel subsidy reduction should be investigated. Net importers must reduce fossil fuel subsidies as well, which they have failed to do since the G-20 pledge was signed, in order to avoid a perception of holding a bias against OPEC or the Middle East by demonstrating a shared commitment.

More importantly, as seen in the failure of fossil fuel subsidy reductions in Nigeria, governments need to work with their people and gain their trust in order to avoid public backlash. Popular resistance has been further strengthened by conflicting statistics from Nigeria’s different government ministries, and what is regarded as some of the highest levels of government corruption in the world. In countries like Nigeria, fossil fuel subsidies cannot simply be reduced by fiat. Instead, governments must lay out a framework for how alternate support systems will be implemented to shelter people from the negative effects of subsidy reductions and how increased government revenue will be reinvested in the community.

Eric Anderson | March 14, 2012

Read more from the Climate & Energy team at Revolt

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