Phasing out fossil fuel subsidies would facilitate the cost-effective deployment of the some of the Middle East’s huge renewables potential, whose development has been limited by the availability of subsidized oil and gas for power generation.

Higher oil prices putting fossil fuel subsidies reform under pressure

This article was published by the International Energy Agency on Oct. 29, 2018.

The World Energy Outlook has been tracking fossil fuel consumption subsidies for many years; our latest data shows that they are rising again. All the data are available on our WEO energy subsidies page. The data referenced in this commentary are from World Energy Outlook 2018, which will be released on 13 November.

Worldwide fossil fuel consumption subsidies almost halved between 2012 and 2016, from a high point in 2012 of more than half a trillion dollars. But the estimate crept higher again in 2017, according to new data from World Energy Outlook 2018, and the run-up in the oil price in 2018 is putting pricing reforms under pressure in some countries.

The new data for 2017 show a 12 per cent increase in the estimated value of these subsidies, to more than $300 billion. Most of the increase relates to oil products, reflecting the higher price for oil (which, if an artificially low end-user price remains the same, increases the estimated value of the subsidy).

In 2016, for the first time, the value of subsidies to fossil-fuelled electricity were higher than for oil.  The 2017 data sees oil return as the most heavily subsidized energy carrier.

Fossil fuel consumption subsidies are in place across a range of countries. These subsidies lower the price of fossil fuels, or of fossil-fuel based electricity, to end-consumers, often as a way of pursuing social policies including energy access.

There can be good reasons for governments to make energy more affordable, particularly for the poorest and most vulnerable groups. But many subsidies are poorly targeted, disproportionally benefiting wealthier segments of the population that use much more of the subsidized fuel.

Such untargeted subsidy policies encourage wasteful consumption, pushing up emissions and straining government budgets. Phasing out fossil fuel consumption subsidies is a pillar of sound energy policy.

The period of high oil prices from 2010-2014 provided strong motivation for many oil-importing countries to pursue subsidy reform. The fall in price that began in 2014 presented the opportunity. A host of countries, from India to Indonesia and from Mexico to Malaysia, have implemented pricing reforms in recent years.

Pricing reforms have also gained ground among fossil fuel exporters. In many cases, subsidies represent an opportunity cost, i.e. foregone revenue, rather than an explicit financial burden, but the straightened circumstances of many oil and gas exporters in recent years gave impetus to changes in energy pricing.

Kuwait, Oman, Qatar, Saudi Arabia and the UAE have all increased domestic prices for gasoline, natural gas and electricity in recent years.

The rise in international fuel prices in 2018 could set back efforts to phase out fossil fuel subsidies. Consumers in many oil-importing countries are facing a hike in retail prices, particularly in developing economies with depreciating local currencies against US dollar.

A 75 per cent rise in the dollar-denominated Brent crude price since January 2018 translates into a more than a 100 per cent rise expressed in Indian rupees, and a 250 per cent increase in Argentinian pesos.

Facing these pressures, some countries have started pushing back their reform schedules by postponing price increases or otherwise protecting consumers from their efforts – while in most cases keeping the overall policy goal of market-based pricing in place.

For example, despite higher international prices, Indonesia and Malaysia have maintained domestic prices at the previous levels, while India has cut the excise duty on gasoline and diesel, and Brazil has increased its subsidy on diesel.

These price controls can shield consumers from short-term changes in international market price, but at a fiscal and environmental cost. Moreover, they diminish the potential for higher prices to curb demand and bring the market into balance.

The IEA continues to be a strong supporter of international efforts to phase out inefficient fossil fuel consumption subsidies, and the WEO has consistently been highlighting this issue with data and analysis.

In the newly released Outlook for Producer Economies, we highlight the low tariffs for end-use electricity consumption across many parts of the Middle East, which is underpinning very rapid growth in residential electricity use – largely for appliances and cooling.

Some progress has been made in raising residential electricity prices in several countries, including in Saudi Arabia, but prices are still relatively low across the region – failing in many cases to cover the cost of supply.
If subsidies to electricity were to remain at their current levels, rising electricity demand in the residential sector would increase the subsidy bill to around $65 billion by 2040 in the Middle East, a huge fiscal burden.

Further efforts at pricing reform are a major part of the solution. Raising fuel and electricity prices reduces the payback period for products with higher efficiency, and helps raise public awareness of the links between efficiency and the cost of the energy they consume.

However, a push is typically also required on the supply side to ensure that more efficient products are available on the market.

A number of countries are introducing efficiency policies: the UAE have introduced an efficiency labelling programme for refrigerators and air conditioners, while Saudi Arabia has introduced minimum efficiency performance standards (MEPS). But much more could be done.

Phasing out fossil fuel subsidies would also facilitate the cost-effective deployment of the region’s huge renewables potential, whose development has been limited by the availability of subsidized oil and gas for power generation.

The Middle East is endowed with some of the best solar irradiation rates in the world, reaching around 2 400 kilowatt-hours per square metre per year, but the share of solar generation in the power mix remains very low. The share of all renewables is only 6 per cent of the region’s generating capacity and 2 per cent of electricity production.