Should Energy Be Subsidized

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Should Energy be Subsidized? Critically analyze the issue of energy subsidies and their impact on an economy. Who are the ultimate beneficiaries of such subsidies? What do we mean, subsidy? We could define subsidy as a process where a govt intervenes in free market procedures to lower the cost paid by consumers for certain goods ore services, or raise the price received by producers for goods or services or allows the cost of production of certain goods or services o be lowered. In the energy sector it could mean that the govt provides monetary incentives to achieve some specific targets like promoting the sale / consumption of specific fuel types, or promote conservation, or attempt to attain higher fuel efficiencies. Govts provide energy subsidies in the form of tax reduction, grants or low interest loans. Why Governments Subsidise Energy Energy is a basic human need. Governments need to provide ‘cheap’ energy to facilitate production of food, provision of housing, medical care and education. Large scale use of energy is also a social enabler. In the ultimate analysis, govts justify the provision of energy subsidies for some or all of the following reasons: to stimulate economic development to improve the quality of life of a certain social strata, income groups, rural population or other demographic segments to protect and promote employment in certain industries to help protect the environment to reduce the energy import bill and help provide security against future imports

How much subsidy is going around Worldwide, fossil fuels are the most heavily subsidised energy sources, totaling an estimated USD 180 to 200 billion per year. Historically, ssubsidies for renewable energy have been lower compared to other forms of energy. Energy subsidies vary widely among countries, sectors and fuel types. They also fluctuate widely over time. According to the latest estimates by the International Energy Agency today, energy subsidies are of the order of USD 250 to USD 300 billion per year, equal to 0.6% to 0.7% of world GDP.i A larger share of the subsidy is among the non-OECD countries where the subsidy is largely granted for consumption (govts reduce the cost at which fuel is available to the citizens), while in the OECD countries a greater proportion of subsidies goes to production and R&D. The US government spent an estimated $16.6 billion in energy-specific subsidies and support programs in Fiscal Year (FY) 2007. Energy-specific subsidies have more than doubled since FY 1999. In FY 2007, in USA, the subsidies on various forms of energy were as follows: Renewables (highest)ii – 4.8 B $ End use – 2.8 B$ Refined coaliii – 2.37 B$ Natural Gas / Petroleum liquids – 2.1 B$ Nuclear – 1.26 B$ Electricity (non fuel specific) – 1.23 B$

Should Energy be Subsidized? Coal – 932 M$ Conservation – 926 M$iv

Subsidies are not a cure-all Energy subsidies cause a loss of economic efficiency, industrial efficiency, and, in the present form, contribute heavily to environmental pollution. Some of the ways we know that this happens in are: if the govt reduces the sale price of energy, the producers receive money that their fair share which reduces their return on investment and also reduces their power to invest in new infrastructure, technology and R&D. energy available at ‘cheap’ prices removes any incentive for the consumer to reduce consumption or use energy more efficiently. any subsidies to producers removes any desire or incentive for them to improve their production efficiency or invest in more productive or efficient technology or processes Direct subsidies in the form of tax incentives are a direct drain on the govt’s coffers. Indirect subsidies reduce economic growth and also lead to lower government revenues Subsidies affect the balance of payments adversely by increasing a demand for imports The country’s energy security is threatened as reliance of energy imports is increased Subsidies to a specific fuel type, mainly the fossil fuels, can divert funds and attention away from development of more efficient and environmentally friendly technologies


Does it make Economic sense? - The price we pay There are a number of social and environmental ill-effects of energy subsidies. Many subsidies, primarily those that encourage the use of fossil fuels, tend to worsen environmental conditions through higher emissions of noxious and/or climate-unfriendly greenhouse gases. Energy subsidies often go to large capital projects such as hydroelectric dams, at the expense of local, small-scale projects such as biomass burners. This often contradicts the govt’s aims and policies of strengthening the community at the grassroots levels. Energy subsidies do not necessarily benefit those for which these are intended the most. It is a widely observed and accepted phenomenon world wide that the maximum benefits are reaped by the urban middle and higher income groups while the poor only participate in paying the price. Even if the poor are able to derive some benefit for the reduced sale price, the economical benefit to them would be small as their consumptions are generally much lower than higher income households. While subsidies reduce govt’s earnings, increase the fuel bill by encouraging consumption and introduce technological inefficiencies in the system, there is also an economic cost to be paid for increased healthcare necessitated by the ever increasing levels of environmental pollution. These costs (externalities) have never been fully factored into calculating the true cost of subsidies. Let us examine briefly the economic impact of removing fuel subsidies. The resulting high price of oil will be instantly transmitted to other sectors as well: Higher prices of goods produced,

Should Energy be Subsidized? Higher food prices due to increase in price of fertilizers (higher production cost), operating farm equipment (tractors, pumps, generators) and higher cost of transportation of farm produce, Higher transport and electricity prices, Demand for wage increase, Increase in core inflation (even after excluding food and energy) Spillover inflation in neighbouring countries with higher cost of exports


Not every individual subsidy has an impact on energy prices. Many subsidies to domestic producers, for example, simply keep these producers competitive vis-à-vis less expensive imports (which have themselves been subsides in the exporting country). Subsidies that have little or no effect on commodity prices will not likely change the consumption patterns for that particular fuel.. The removal of subsidy will however always save the government a very large sum of money. This increased revenue can be used to finance short-term income support for the poor and long-term programs like education, health, infrastructure, etc. Energy subsidies can and do incur macroeconomic costs. In particular, direct subsidies such as tax benefits reduce govt’s earnings. In the long run, indirect subsidies that reduce economic growth also lead to lower government tax revenues. Taxes must also be taken into account when attempting to quantify subsidies. There is a peculiar situation in India where a price control mechanism lowers the wholesale supply cost of fuel to lower than the fuel supply cost, but the application of excise duties then raises the retail price to consumer considerably. In effect, the energy subsidies are being reduced by the application of special taxes and duties – the end user still does not benefit substantially from the perceived reduction in cost. Are all men created equal? By its very nature, the costs of an energy subsidy are borne by the entire population, while its benefits are usually enjoyed by only a small group of citizens, who may not even be the intended target group. Many energy subsidies intended for the poor are instead enjoyed by middle- and high-income groups. For example, Indonesia had a policy of subsidising kerosene to encourage its use by the poor households. While the poor did benefit from it to some extent, a disproportionately high advantage was also taken by the middle and higher income households.v In Ecuador subsidized kerosene was diverted to the transport sector and much of it never reached the poor, especially in rural areas (ESMAP 1994). There is also a classical case of LPG subsidies in India. The total cost of LPG subsidies to the state oil companies and the government amounted to almost 7000 crore Rupees in the first half of the 2007/08 financial year. A study on the effectiveness of this subsidy indicates that almost 40 per cent of the LPG subsidy benefits a mere 7 per cent of the population. Moreover, the subsidy represents less than 5 per cent of expenditure for this segment of the population. This is a far lower share than what Indians living below the poverty line spend on kerosene. In some cases the subsidies meant fro the poor are not correctly structured. In the electricity sector, the misuse of lifeline rates is a case in point. A lifeline rate is a cross subsidy where the wealthy, who consume more electricity, pay a higher rate than the poor who are expected to

Should Energy be Subsidized? consume less. The welfare benefits of this cross subsidy can be sufficiently high to justify its implementation. in some countries however the lifeline rates are set so high that the poor do not effectively benefit anything at all. Thus even fundamentally sound subsidies can be wrongly applied, with the result that those who are able and willing to pay higher prices for electricity receive more benefits than the poorer households. In India, during the early years after independence, the govt decided to lower the cost of electricity for farming to promote higher farming yields. The situation since then has improved considerably and the reduced electricity tariff is no longer justified. The farmers lobby has not only been successful in keeping the existing subsidies in place, but in some states has persuaded politicians to provide farmers free electricity. The farmers that use electricity not only get free or nearly free electricity, but also keep the profits from increasing agricultural production. As a result, the state electricity boards are nearly bankrupt and cannot finance the necessary investments to maintain reliability and smooth service. The most important criteria to consider when deciding to apply energy subsidies are of course what to subsidise, how to subsidise, whom to subsidise and how much to subsidise. There is no justification for subsidies to the large commercial businesses or to industries that provide services mostly to better-off households. But it is definitely reasonable to use subsidies to promote access to energy for the poorest households, which now get by with such fuels as dung and straw for cooking, and candles and kerosene for lighting. The challenge for government is to find more effective ways of meeting social goals than through energy subsidies that avoid or minimise environmental harm. One approach is to use the money saved in removing energy subsidies to finance directly social-welfare programmes, such as direct income support, health and education.

Should Energy be Subsidized? Do you think giving subsidies to the energy sector is essential? Give reasons. Would you distinguish between different energy sources when providing subsidies? To be or Not to be To determine if it is essential to give subsidies to the energy sector, perhaps we should examine the issue from a different perspective and evaluate the pros and cons of removing an established subsidy in the energy sector. Benefits of removing such a subsidy would be: it would, to a very large extent, create a sense of responsibility among the energy consumers to limit the use of energy will reduce the emission of greenhouse gases and reduce pollution will encourage investments in creating greater energy efficiencies will provide a fillip to investors in areas of renewable / clean energy production removing subsidies from fossil fuel production will allow the cost of developing alternative energies to be more equitably compared. can pave the way for removing governmental control over production of energy can create a mechanism for a more rational price structure for energy provision can provide a better framework for calculating the economical cost of pollution associated with the use of energy removal of subsidy would have an adverse economic impact on the low income groups industries that are high energy users would be severely affected if cost of energy usage goes up use of alternate energy sources may not scale up sufficiently fast to compensate for reduction in use of fossil fuel energy Food items may require additional subsidy if fuel subsidy is removed Governments may take the opportunity, as they are most often susceptible to, to create unreasonable or insensible legislation, that could make the life of the average citizen unduly harsh i.e. we may pay a much higher price than anticipated.

Some arguments to support the continued provision of subsidies to the energy sector would be: -

The eventual goal of most subsidy programs is ‘social benefit’ like improving the quality of life of the underprivileged or providing them with some economic benefits indirectly handed down from the more affluent groups of society. In practice though, these objectives have been seen to be hard to meet, for a number of reasons: some elements of society may ‘extract’ the benefit by refusing to pay electricity bills benefits that are meant for a group of people are in fact enjoyed by all the quantum of subsidy may far exceed that which is needed for economic rebalance within society

Should Energy be Subsidized? may be too complex to administer effectively subsidy is often too narrowly focused on a particular source or channel, thus depriving the user of exercising any choice

Traditional ways of delivering subsidies, particularly cross-subsidization of consumption, often fail to help the poor. New ways of delivering subsidies has to be found. A ‘correct’ subsidy would be one that promotes use of energy by the poor, while still retaining the necessary incentives for lowering consumption overall and improving the efficiency of production and delivery. Finally, all of this must be delivered while keeping a sharp eye on the present and future levels of green house gas emissions. Subsidies are not about economics – they are about politics. In India, the government currently subsidises petrol, diesel, cooking gas and kerosene. The subsidies come in the form of oil bonds provided by the govt to the oil companies. It is well accepted that subsidies to fossil fuels should be reduced while also bringing in some tax reforms that rationalise the costs paid by end users. In practice though governments are faced with a number of economic, social and environmental dilemmas when deciding to remove subsidies, apart from facing tremendous pressure from various interest groups and vote banks. In many poor countries, the general public often considers energy to be a basic social benefit, like food and housing, the pricing of which can not be left solely to market forces. For this reason, it can be very hard for policy makers to remove subsidies that are firmly in place. Political pressures and inflation concerns continue to prevent India, and many other countries, from ending subsidies and letting domestic prices rise and fluctuate. According to a UNEP study in 2008, while energy subsidies do improve the quality of life of the poor, the benefits are not as much as previously assumed and do not necessarily last for very long. Also it is possible to target specific economic groups for subsidy without doling it out to the entire population. The ultimate goal and target of subsidy reform would be to reduce their overall size. It is now generally agreed that social objectives are better met through alternative channels such as direct financial support to poorer households. Fuel consumptions should not be subsidised, as it skews the fuel bill for an average citizen towards high consumption. Without the subsidies the consumption bill for a majority of the population would certainly come down, while also having the added advantage of being gentler on the environment. While it is clear that energy subsidies for fossil fuels need to be removed, it is also important that reforms need to be implemented in a phased manner so as to soften the financial pain of those who stand to lose out and give them time to adapt. There are better options available From an environmental standpoint, energy subsidies can be either beneficial or damaging to the environment. Damaging subsidies can work in both directions – in the ‘forward’ direction, an increased consumption of fuel creates more harm to the environment, while in the ‘backward’ direction an increased consumption causes more of the earth to be ‘emptied’ by scavenging the earth for oil. Beneficial subsidies would of course help to promote investments in technologies that are environmentally sound.

Should Energy be Subsidized?

Subsidies to support renewables and energy-efficient technologies can be an effective way of overcoming barriers to their development and deployment, and helping to reduce greenhouse-gas emissions. Targeted subsidies to clean energy can play an important role in mitigating emissions. While the choice of fuel to subsidise is a complex issue, overall, the large subsidies to fossilfuels worldwide undoubtedly contribute to higher greenhouse-gas emissions and worsen climate change. According to the OECD, subsidies to coal and oil, represent greater threats to the environment than subsidies to renewable energy. However, environmental problems are not limited to fossil fuels. Nuclear power production gives rise to radioactive waste and the risk of contamination. Although nuclear power production leaves the environment fairly clean in terms of air pollution and climate change, it is fraught with serious environmental and safety issues of high level environmental damage. Certain types of renewable energy can have severe environmental consequences, such as the ecological effects of hydroelectric dams or toxic heavy metals used in batteries for home solar systems. Subsidies for biofuels, used by several OECD countries, usually results in more intensive farming. This results in greater use of fertilisers and pesticides, which can damage local eco-systems and increase both soil and water pollution. Subsidies to support renewables, nuclear power and energy-efficient technologies may help to reduce noxious and greenhouse-gas emissions depending on how the subsidies are structured and the specific market conditions. Solar power (solar thermal, as opposed to solar photovoltaic) has the ability to compete against fossil fuels without subsidies. There area large number of hidden subsidies for fossil fuels e.g. the govt spends a very large sum of money in keeping the shipping lanes clear for oil tankers to transit. This subsidised cost is actually an indirect benefit to the oil companies. If these subsidies are removed, or accounted for, price of oil would certainly go up for the consumer. The consumer then has the right to decide to use more oil or not. Otherwise, the consumer is simply paying for this subsidy indirectly through higher taxes. Removing this subsidy to oil will also create a level playing field for renewable energy technologies which other wise look very expensive to develop. Some clear advantages of removing subsidy from oil fuels and passing these to renewable energy would be: Generation of clean power Improving energy conservation and efficiency Cutting money spent overall on consuming energy Improving technological and industrial capabilities Creating green-collar jobs

A study by Earth Policy Institutevi suggests that investing in renewable energy certainly helps to create new jobs, reduce carbon emissions and reduce oil imports – a perfect win-win situation. It seems, in the very present times, when companies worldwide are cutting their workforce rather dramatically, the renewable energy industry in USA is on a hiring spree. In the industries that build wind farms, install solar panels, and build solar thermal and geothermal power plants, the

Should Energy be Subsidized? output is expanding at 30 percent per year. These industries are creating more jobs while keeping the environmental degradation under control. According to the same study, every billion dollars invested in wind farms creates some 3,350 jobs—nearly four times the 870 jobs created with a similar investment in coal-fired power plants. A billion dollars invested in solar cell installations generates 1,480 jobs. For solar thermal power plants, its 2,270 jobs per billion dollars invested. A large number of ‘collateral’ jobs are also created in the process e.g. construction of wind farms gives a fillip to allied industries like manufacturing parts for wind turbines or the thermally efficient windows for retrofitting. Oil Major BP has determined in a survey, that in countries that provide oil subsidies, demand is rising steeply, threatening to outstrip the growth in global supplies.vii In most countries that do not subsidise fuel, high prices have caused oil demand to stagnate or fall, as economic theory says they should. It is also an issue of energy security, as much as it is of environmental protection. With rapidly depleting sources of fossil fuels, it is certainly important to start switching to renewable sources of energy, lest we completely run out of energy one day. The time to start is now. There is no better way to provide the necessary fillip to R&D in renewable energy sources that to provide the subsidy, in some form or another. While removing the support to fossil fuels will no doubt be painful in the short term, it is imperative for survival of the planet, and that of mankind, that short term pains are endured for long term stability and quality of life. Can better sense prevail? To give credit where its due, it must be said that governments worldwide have initiated increasingly bolder steps to rise above narrow political gains and focus on the far more disastrous environmental and economic impact of subsidies. In Jan 2009, in India the Cabinet approved a Planning Commission-drafted Integrated Energy Policy (IEP), which aims to make energy prices market-determined and target subsidy to those below the poverty line.viii In Iran, President Mahmoud Ahmadinejad has presented a plan to parliament to scrap energy subsidies. This is a significant change in a major oil-producing country where petrol is sold for 36 cents a gallon. Though economists have warned that the move could adversely raise inflation and unemployment, President Ahmadinejad has urged Parliament to vote for the bill because of the need to curb costly energy consumption, which the subsidies have encouraged. The plan would abolish all government subsidies for things like heating gas, petrol, electricity and water within the next three years and allow prices to reach international levels. In USA, ‘Proposition 87’ taxes California oil producers and takes this money to create short term subsidies for the development and implementation of an alternative energy system. This could create an environment where alternative energy has a more equal footing with fossil fuels, while still creating a competitive marketplace for all fuels.


UNFCC report Renewable energy resources are energy resources that are naturally replenishing but not easily available. Renewable energy resources include biomass, hydropower, geothermal, solar, wind, ocean thermal, wave action, and tidal action. iii coal that is chemically enhanced to reduce certain emissions iv Source: Energy Information Administration, Federal Financial Interventions and subsidies in Energy Markets 2007 (April 2008) – reproduced from, article by John Laumer v ESMAP (1990) vi, Lester R.Brown vii viii Business Standard

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