Ending fossil fuel subsidies is essential for ending climate change
Summary
Three sources of fossil fuel subsidy are described and their dangerous delaying effects on our efforts to reverse global warming are outlined. Carbon pricing is possibly the only means to end the subsidies and speed up our transition towards zero carbon energy sources.
Introduction
Fossil fuels are heavily subsidised in most countries. Historically, this may have made sense when there were no alternative sources of cheap energy to support growing populations and modernising societies: and there was little awareness of climate change. Now we have increasingly abundant sources of zero carbon energy and climate science has revealed the damaging effects of fossil fuel emissions. But large subsidies to fossil fuels are blocking the transition to zero carbon energy that is essential for slowing and reversing climate change.
A predictably rising carbon price will aid this transition efficiently and with minimal disruption. Returning the revenue from the price to households as a dividend will ensure that the changeover is affordable to all citizens.
Subsidies
Subsidies come in two main forms;
Explicit subsidies are government grants, tax breaks or concessions that support fossil fuel exploration, production and consumption – currently estimated at $10.3 billion in Australia in recent research by The Australia Institute.
Recent estimates show these may have doubled in 2021-22 in response to post-COVID recovery and the global energy crisis.
It's important to note that $7.3 billion of the $9.1 billion federal subsidies in TAI’s table are fuel tax credits rebated to miners and farmers for use of fuel on private roads. There are varying opinions as to whether this is a subsidy or removal of a penalty (i.e. having to pay a tax despite not driving on publicly-funded roads). Many will argue the latter, making it difficult to discuss calmly. But whatever we call it the result is a significant increase in fuel consumption.
Implicit (or indirect) subsidies arise from the “social costs” (damage to climate, environment, health, etc.) caused by carbon pollution that are not incorporated in the price of the fuel. Producers are not required to include these “negative externalities” in the prices they sell at. Put simply, this allows fossil fuels to pollute for free, leaving the taxpayer to pay the costs. As there are no payments or monies exchanged these subsidies are largely hidden and unknown. In Australia they amount to over $50 billion per year (see table below). As the damage bill from climate change grows with every extreme weather event and other consequences of global warming, this number will grow rapidly.
A third and even more hidden subsidy occurs where government pays for emissions reduction instead of -
requiring the producer to reduce emissions and pass on the cost in the selling price, or
levying a tax on the source of the emissions to pay for the damage, thus encouraging emissions reductions.
Every dollar that a government spends on emissions reduction gives fossil fuels further incentive to keep producing. For example, the Emissions Reduction Fund (ERF) that replaced the Clean Energy Act (Australia’s carbon price) uses government funds ($4.5 billion to date) to pay industries and landholders to reverse, store or avoid emissions. This created the Australian carbon market in which trading of carbon credits (ACCUs) takes place. Companies can buy ACCUs to offset their emissions. A safeguard mechanism was also legislated to discourage companies from raising their emissions and undermining the intent of the ERF. Neither policy has worked well for a number of reasons and emissions have risen in Australia in all sectors except electricity and Land Use, Land Use Change and Forestry (LULUCF).
This is effectively a carbon price in reverse – taxpayers are paying three times - first for the subsidies (implicit and explicit), second for the social costs of the damage done to society and environment and third to help producers reduce their emissions.
What's wrong with subsidies?
Subsidies make fossil fuels artificially cheap and ensure that they will be produced and burned for much longer than is necessary or safe. We can see this in the supply and demand graph (Figure 1). The ‘socially efficient’ price of fossil fuels, P*, results in Q*, the quantity of fossil fuels consumed. Where they intersect is the true social cost.
However, the approximate $10.3 billion in explicit subsidies has the effect of shifting cost down, making fuels artificially cheap and consumed in excess (Q_1, P_1). The implicit subsidies of $53 billion shift this cost curve even further down, such that fossil fuel consumption is excessively high - Q_2. The social cost – in taxes, ill-health and environmental damage – that results from this excess consumption is equivalent to the green shaded triangle.
Figure 1
Subsidies undermine the efficiency and effectiveness of many important and expensive policies, like the Emissions Reduction Fund. They increase emissions while other policies are trying to reduce them.
They increase harm to the environment which other policies attempt to prevent, protect or repair. They damage human health, causing health systems to spend big on prevention and treatment and society to bear the costs and consequences of many premature deaths.
Subsidies are like a foot firmly on the accelerator while other policies and programs are applying the brakes. They cancel out or undermine other policies while society and governments pay the costs, over and over. (See Climate and Energy - competing policies for more detail).
How big are these subsidies?
The International Monetary Fund (IMF) reports of 2016 and 2021 show how huge these economy-distorting subsidies are;
$US 4.7tn or 6.3 percent of global GDP in 2015
$US 5.9tn 6.8 percent of global GDP in 2020, an increase of 25% in just 5 years
Australia’s subsidies were
$US 29 billion in 2015
$US 44 billion in 2020, an increase of 52%, double the global rate of increase
The table shows how Australia ranks with the top 25 subsidising nations on the following metrics;
total subsidies - #14
subsidies as a percentage of GDP - #16
subsidies per capita - #5
Only 4 countries subsidise at a higher rate per capita than Australia.
Recent OECD figures show that subsidies almost doubled in 2021 across 54 countries as energy prices rose with the post-COVID rebound. The energy crisis triggered by the Russian-Ukrainian conflict is further increasing subsidies.
The Australia Institute table shows that our explicit subsidies were AUD 10.3 billion in 2020-21. This is about one-sixth of the AUD 60 billion subsidies identified in the IMF report - so Australia’s implicit subsidies are around AUD 50 billion per year.
What would be the effect of removing the subsidies?
The IMF estimates that by raising the price of fossil fuels to their “efficient” price (i.e. their cost of production plus their ‘social costs’) would reduce global emissions to 32% below 2018 emission levels in the four years from 2021 to 2025 (blue dotted line in the graph).
This is an impressive rate of reduction and compares very favourably with the current trend (grey dotted line) and the world’s Paris Agreement commitments (dotted orange line). This measure on its own would put the world on track to achieve the Paris Agreement target of limiting global temperature rise to between 1.5° and 2°C. (It would move supply and demand to P* Q* intersection on Fig x)
Additional measures to reduce non-fuel emissions would speed the transition further. To achieve this the IMF recommends price increases phased-in over time, combined with measures to protect the poor. A climate dividends policy does both of these.
The 2009 London Summit of the G20 (group of 20 advanced and emerging market economies) called for a phase-out of inefficient fossil fuel subsidies in all countries and reaffirmed this again in 2012. Despite this good intent, the IMF figures show that subsidies grew between 2015 and 2020 (25% globally and 52% in Australia). At COP26 (the 26th meeting of the Conference of Parties) in 2021, 197 countries agreed to accelerate efforts to phase-out “inefficient” fossil fuel subsidies.
A new report from the OECD and IEA indicate they are still rising. They add that they “have consistently called for the phasing out of inefficient fossil fuel support and argue that subsidies intended to support low-income households often tend to favour wealthier households that use more fuel and energy and should therefore be replaced with more targeted forms of support.”
It seems it is too difficult for governments around the world to phase them out. The obstacles are many and complex and include the huge inertia in our energy and economic systems, the global addiction to fossil fuels, the power of the industry, and the enormous complexity of the situation. These are all discussed elsewhere in this Playbook.
What’s the easiest way to phase out subsidies?
The $10.3bn explicit subsidies are the result of government decisions and can be phased out through normal government budgetary processes. This won’t be easy due to the lobbying power of those who benefit from the subsidies but is feasible in the context of Australia’s recent climate election and the government’s mandate.
The $50bn implicit subsidies are more difficult to address as they are not the result of government legislation or budgets. They are more the result of inaction or oversight - an historical acceptance of the many advantages of fossil fuels outweighing their disadvantages, that is, their ‘negative externalities’ or social costs. Ill health due to air pollution, urban sprawl, environmental damage from industry and transport were largely considered acceptable in exchange for abundant cheap energy and all the convenience and wealth that it delivered.
It is only recently that the balance has been tipped by a slowly growing community awareness of the additional climate risks posed by fossil fuels. It is even more recently that viable alternatives have been available. And it is only a few years since those alternatives became cheaper than fossil fuels. But fossil-fuelled energy continues to deliver great convenience and wealth to most citizens.
This makes it very difficult for the government to even acknowledge the existence of implicit subsidies. To consider charging for the damage they are doing is risky in the current political climate. And how would they assess the damage, apportion the cost to different providers and charge them for it?
Taxation is the most viable tool for incorporating negative externalities into the price of a commodity. But taxation has been fraught with difficulty in recent decades. The repeal of the Clean Energy Act in 2014 and the anti-tax campaign that preceded it has immobilised our political system and silenced almost all talk of carbon pricing. The result is that a complex web of piecemeal solutions are being put in place that will leave implicit subsidies in place and ensure that fossil fuel production and carbon emissions keep rising until their market value collapses.
Only a tax that is demonstrably favourable for most stakeholders and a clear majority of citizens can hope to address implicit subsidies. A dividend that delivers a ‘climate income’ to citizens from the revenue of a carbon tax is the most likely to succeed. (see the benefits to stakeholders listed in Why have a dividend in a carbon price?)
A predictably rising carbon tax on fossil fuels would steadily internalise the full cost of fossil fuels and raise the price to an ‘efficient’ level, i.e. the point at which it has reabsorbed the estimated $50billion worth of external costs. Fifty billion dollars would amount to just under $2000 per Australian per year. As fuel use and emissions reduce, the revenue and the dividend also reduce until the subsidy is no longer needed.
Conclusion
A ‘climate dividend’ is a simple but powerful policy tool that has the ability to phase out implicit subsidies in just a few years and enable low and middle-income households to manage costs that would arise from the rising price of fossil fuels. It fulfils both the IMF recommendations mentioned above - it raises the price and protects the poor.
It has many other benefits that are described in other parts of this playbook.
It is the preferred policy of CCL Australia.
References
Fossil Fuel Subsidies (imf.org)
