‘Climate finance can help exit fossil fuel subsidies’

March 27, 2013 | 5 min read

The amount of money spent on fossil fuel subsidies dwarfs the amount spent on international climate finance. According to the International Energy Agency (IEA), fossil fuels consumption was subsidized in the amount of USD 523 billion in 2011. An additional USD 100 billion is estimated for fossil fuel production subsidies^[1].

The following figure shows the top 20 countries with the highest levels of fossil fuel subsidies, estimated by the IEA. Notably, thelist includes several countries which were also top 40 recipients of climate finance in recent years (so-called fast start finance) such as China, Indonesia, Iraq (within OPEC), India and Mexico^[2].

Figure 1: Top 20 countries in terms of absolute fossil fuel consumption subsidies, OPEC countries shown together.
Figure 1: IEA estimates of top 20 countries in terms of absolute fossil fuel consumption subsidies, (OPEC countries shown together).

In sharp contrast, during the period 2010-2012, developed countries already experienced difficulty in mobilizing even USD 10 billion per year in fast-start climate finance^[3].Based on these figures, roughly 50 times more money was spent world-wide on fuel subsidies than on fast start climate finance in 2011.Fossil fuel subsidies often have goals that are directly opposed to those of climate finance. Conversely, the IEA estimates that phasing out consumption-based fuel subsidies up to 2020 would reduce CO2 emissions by 2 gigatonnes (Gt) by 2020^[4].

At Climate Focus, we are committed to the development of policies and projects that reduce greenhouse gas emissions. Given the crucial importance of reducing fuel subsidies to the success of climate finance (see below), Climate Focus proposes to use climate finance to help reduce fuel subsidies. This can be done through:

providing a vehicle to support subsidy reform; and
helping the economy adapt to higher fuel prices with energy efficiency programs and other climate policies.

Negative effects fossil fuel subsidies

Fossil fuel subsidies consist of consumption subsidies and production subsidies. Consumption subsidies artificially lower the price of fossil fuels for industry, business and domestic consumers and tend to increase demand. Production subsidies seek to lower the cost of production, thus increasing supply. The form of subsidies can vary significantly, and may range from direct transfers and regulation of end-user prices to tax breaks, loan guarantees and market-access restrictions.

In many countries fossil fuel subsidies are established with the stated intention of reducing energy poverty and sharing natural resource wealth. However, IEA studies have shown that subsidies on the whole disproportionately benefit middle and high income earners who, on average, consume more energy.^[5] Another common rationale provided for fossil fuel subsidies is supporting industrial development and employment and increasing domestic energy production.

In contrast to the stated objectives of the subsidies, analyses have pointed to a range of negative effects of fossil fuel subsidies. These include:

Creation of large burdens on state budgets and, if a certain fuel price level is guaranteed by the government, creating particular strain in times of high fuel prices, leading to difficulty in budget planning (note the annual variation in figure 1).
Creation of incentives for higher and less efficient levels of consumption, as well as inefficient production leading to increased local pollution and global emissions levels.
Their disproportionate benefit of middle and high income earners means that fossil fuel subsidies are socially-regressive in nature.
Fuel subsidies discourage investment in energy infrastructure, such as in oil exporting countries like Nigeria, where it is cheaper to import refined oil products than to refine the oil domestically.
Large diversity in fuel prices between nations due to subsidies often leads to the creation of illegal fuel markets (fuel smuggling).

While there are clearly important benefits to be achieved from removing fossil fuel subsidies, their removal brings economic, social and political risks. Raising energy prices can cause inflation and might even trigger social unrest. While the rich tend to benefit disproportionately, the poor tend to suffer most from their removal. This is because the poor often spend a larger proportion of its income on energy. Reforms therefore require social protection or compensation measures.^[6]

Climate finance as an alternative

Climate finance can play a role in phasing out fossil fuel subsidies. Under the Cancun Agreements, developed nations have committed to mobilise USD 100 billion in international climate finance from public and private sources annually by 2020. The presence of fossil fuel subsidies in a country receiving climate finance often forms a key barrier to the success of emission reduction programmes in the energy sector. Energy efficiency programmes, for example, will be less likely to succeed where wasteful use continues to be encouraged through artificially low prices. Similarly, such subsidies make it difficult for renewable energy to compete with fossil fuels, thereby reducing the effectiveness of renewables programmes.

Climate finance can potentially provide a viable means of attaining funding and capacity-building for a broad spectrum of policies and measures required for removing fossil fuel subsidies, mitigating negative consequences and leveraging co-benefits. This can have the dual benefit of facilitating the effectiveness of climate finance and, through reducing strain on public finances, providing an important “multiplier” or leverage effect that could be crucial to ensuring adequate global funding for responding to climate change.

Measures for successful subsidy removal

Many of the key features of successful subsidy removal already find many parallels in existing climate finance mechanisms. Potential measures include the following:

Research and analysis to map out a structured taxonomy of subsidies, assess their success and identify the likely effects of removal, thus allowing for comparing their costs and benefits and informing decisions on removal.
The development of supporting legal, regulatory and institutional frameworks to ensure effective subsidy removal and introduce mitigation measures, ensuring consistency with domestic and international law.
Programmes for raising capacities to implement the range of measures to support subsidy removal.
Developing measurement, reporting and verification (MRV) frameworks to track the success of reforms and inform ongoing adjustments.
Developing policies and programmes that reduce dependence on fuel subsidies, including through energy efficiency measures, expansion of rural electrification and renewable energy and transportation infrastructure.
Enabling public acceptance of subsidy removal.

We believe these measures could be achieved through a range of climate finance programmes, includingnationally appropriate mitigation actions (NAMAs)^[7], the World Bank’s Programme for Market Readiness (PMR) or the initiatives around New Market Mechanisms (NMM).

References

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as: “Climate finance can help exit fossil fuel subsidies”, Jelmer Hoogzaad and Darragh Conway,www.tias.edu, March 27, 2013.

References

IEA, OPEC, OECD, “World Bank Joint Report, Analysis of the scope of energy subsidies and suggestions for the G-20 initiative”, (16 June 2010).
UNFCCC, Climate Portal for Climate Change, (5 March 2013).
Clifford Polycarp et al. “Developed Country Fast-Start Climate Finance Pledges: A Summary of Self-Reported Information”, World Resources Institute, (November 2012).
IEA, OECD and World Bank, “The Scope of Fossil Fuel Subsidies in 2009 and a Roadmap for Phasing Out Fossil Fuel Subsidies”, (2010).
Ibid.
African Development Bank Group, Vincent Castel, “Reforming Energy Subsidies in Egypt”, (2012).
Climate Focus, “Design Options for NAMAs and their regulatory framework”, (Amsterdam, 2011).