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Fossil-Fuel Subsidies Help Asia Roar

Governments have long provided subsidies, direct and indirect, on fuels for both consumers and producers. Providing subsidies on fossil fuels is costly in terms of public health and climate change. In 2009, G20 leaders agreed that subsidies should be curtailed, but Asian countries continue to fund them to support economic growth. Subsidies for consumers lead to waste, traffic and pollution. Less scrutinized, according to Will Hickey of SolBridge University, are the many subsidies for fossil-fuel producers not available to producers of alternative fuels: preferential land-acquisition policies, support for infrastructure like ports or highways, special financing for exploration, quick approval for destruction of habitat and eminent domain, resistance to pollution regulations or low penalties for violations, and even government guarantees of profits. The subsidies distort market pricing, contributing to inefficiencies and waste. For Asia's emerging economies, the subsidies are unsustainable as fuel prices rise, their exports decline, and the environmental and health costs rise. – YaleGlobal

Fossil-Fuel Subsidies Help Asia Roar

Ending subsidies for fossil fuels could slow climate change
Will Hickey
YaleGlobal, 15 March 2013
Subsidizing pollution: Traffic snarl in Jakarta (top); China’s state-owned oil refinery

DAEJEON: One reason behind greater pollution leading to global warming has been artificially lowered gas prices brought by subsidies. Governments have carried on this shortsighted policy to foster growth and satisfy consumers. But as world fuel prices begin rising again, the costs of subsidy – both budgetary and environmental – will come to the fore. While the much-talked-about carbon tax remains unpopular with consumers, curbing producer subsidies that encourage fossil fuel consumption could be a more effective way to fight environmental challenges.

In 2009, G20 leaders acknowledged world subsidy problems and sought to “phase out and rationalize over…inefficient fossil fuel subsidies.”Yet one only needs to visit bustling Shanghai or Jakarta today to see that Asian economies have taken the opposite approach during the past four years and are more reliant on fossil fuels than ever before to support economic growth.

Nominally, fuel subsidies can and do exacerbate huge traffic jams from Tianjin to Mumbai. This has two major outcomes: wasted time and money. Recently a study by economists at Texas A&M University found that Americans waste more than $181 billion a year in lost productivity and fuel consumption just sitting in traffic. Imagine the aggregate costs to the world economy when Asia is factored in – $1 trillion would perhaps be a conservative estimate. Nonetheless, reversing policy on promised consumer subsidies is a challenge. Last year, attempted political reform of consumer subsidies, in other words, raising prices to reflect market economics, in Nigeria and Indonesia led to riots.

The consumer fuel subsidy has become a right of entitlement fixed in many minds, especially in countries rich with natural resources, while demands from foreign institutions and economic experts in London or Vienna ring hollow with the average person slugging it out on the streets of Colombo, Hyderabad or Chicago. Economic theory is disconnected from reality.

Fossil Fuel Consumption Subsidy Rates. Enlarge Image

However, consumer subsidies, while visible, are the tip of the iceberg. Most of Asia’s fast-paced growth is being driven by hidden upstream producer fuel subsidies that abet the Asian export model. These subsidies strain state budgets and create a false economy. If fuel prices were aggregated for true costs – or the baseline called “zero-price gap subsidy” by OECD for transport, storage, production, taxes, health/environmental liabilities – Asian economic activity would be considerably dampened, as it is currently in the EU and US post–economic crisis.

Producer subsidies, especially in China, can be found at the state, provincial, local and corporate levels under the guise of state-owned enterprises, or SOEs. Precise data are hard to extract.

Consider a few examples of what producer subsidies have done to distort usage in Asia: In China, to attract investors, unregulated coal-fired power plants spring up in provinces, spewing pollution that violates Beijing’s national policies. In Malaysia, production-sharing contracts ensure that oil investors are backstopped. New tollways in Thailand and megalith airports in Indonesia are indirectly subsidized via preferential land-acquisition policies, below-market rate capital and tacitly approved destruction of rainforests and grasslands. Even in the US, rights of way are given to pipelines under eminent domain clauses. Such incentive subsidies are not widely available to other investors or businesses.

Producer subsidies are not easily understood or transparent. Much focus is on easily quantifiable consumer subsidies. There are two key reasons: First, many producer subsidies do not affect fuel prices in the short term, especially in regards to oil. These are known as “legacy programs,” such as health and environmental costs, long-term issues where future liability will generate economic distortions. Second, many new producer-subsidy programs are not actively drawing funding from a financial ministry or treasury. Such programs encompass new roads, bridges, ports, and more for transporting fuel.

The consumer fuel subsidy has become a right…economic theory is disconnected from reality.

Producer subsidies at the national level consist of preferential tax rates; land rights, including public domain; and credit subsidies for fossil-fuel exploration, production and shipping. An example would be in the production-sharing contract used in developing countries for oil production – or government guarantees to oil investors to insure their capital outlays via full cost recovery. In other words, guaranteed profits.

Provincial or subnational subsidies are especially endemic in China, where provinces compete against one another for investment.  For example, Hebei and Guangdong provinces have created their own “strategic petroleum reserves” outside the national government. Regional petrol-pricing differences and fuel quotas can foster smuggling activity.

Municipal subsidies include public transport such as buses in Delhi and ferries in Bangkok, both burning polluting underpriced diesel fuel, to create subsidized ticket prices. Municipal electric utilities also have access to low-cost capital through guarantees by local government credit ratings.

Even at the corporate level, collusion between government officials and companies can create a perverse subsidy. In Indonesia for coal mining, transport regulations, workers safety and environmental laws are routinely ignored. State-owned utility companies in Asia, supported at the federal, regional and local levels are energy- intensive and garner a significant source of recurring subsidy activity via rights-of-way for pipelines or transmission corridors which reduce operating costs.

In these local cases, producer-subsidized fuel prices are an unquantifiable black hole below consumer subsidies that create false economic activity. Such wasteful activity and subsidization cannot last.

Two immediate challenges flow from fuel subsidies. The first, climate change, is well publicized, held either in respect or contempt by politicians worldwide. The problem with fossil-fuel addiction and global warming is that it’s a “public goods” problem – no one government wants to take ownership. As long as individual countries seek to promote their economic agendas first, the consequences of climate change will be a problem for other governments. Humanity will pay the price from this denial.

The fossil-fuel subsidy model – consumer and producer – is not tenable long term.

The second issue is that most economies in Asia are export economies, which means they pay low manufacturing wages to keep shipping products abroad to the wealthier EU and US. As long as they have more exports than imports, surplus budgets can easily offset the real-market input costs of fuel subsidies. In other words, underpriced labor is underpinning low cost fuel. Yet cracks are already starting to show, as countries like Indonesia and Sri Lanka report larger trade deficits due to slowing exports and rising import costs.

Governments’ response to slowing exports has been the standard playbook: devalue their currency. Nonetheless, fuel prices have a  real market cost, and a devalued currency buys less fuel on the open market, putting pressure on the consumer subsidy and creating budget overhangs. This tends to exacerbate producer subsidies to make up for slowing growth. If left unchecked, both trends pose ugly consequences for all.

While global warming may be a long-term threat, economic shortfalls are more pressing. The fossil-fuel subsidy model – consumer and producer – that emerging Asia is so highly dependent on for economic growth led by exports for political stability is not tenable long term.

Attacking only the consumer subsidy, with its visible contributions to pollution and bottleneck traffic jams, does nothing to alleviate entrenched and opaque producer subsidies. It will only be possible to address concerns about growth and efficiency when leaders make the hard decisions to reduce both. This requires a mindset change about how energy is viewed, as the subsidies precipitate a deeper addiction to fossil fuels. A total systems rethink is more critical than ever before, for the world’s health and economic viability.

Will Hickey is an associate professor and chair of Global Management at SolBridge University.
Rights:Copyright © 2013 Yale Center for the Study of Globalization

Comments on this Article

26 March 2013
Thanks Will for another great article!!
from my point of view, fuel subsidies are a global issue with environmental,political, economic and social consequences..supporting and subsidizing the consumption of fossil fuels at the beginning of the 21st century souds like madness, especially after I read and heard so many speaches of politicians and presidents proclaiming a green future based on renewable technologies, the same politicians and presidents who approve this massive wasting of money and resources on subsidizing oil and gas consumption (or production) which has quantifiable negative impacts on every aspect of our society and our environment..but its all about people who benefit from these subsidies..they elect their representatives, who are following the wishes of the voters - get us a good job and keep the economy running so we can buy a new car and a new fridge, so the politician is just listening to his own people and looking for the easiest way how to fulfill their wishes..subsidizing fuel consumption is a social benefit and people love social benefits and the politicians just need to collect enough money to keep the system running..but what happens, when the money runns out? there is a good example - Indonesia - where as Will mentioned, the government is spending more than 31 billion USD to sell gasoline for a discounted price..at the end of the last year, the consumtion of gasoline run out of control and the subsidized fuel became scarce..tensions and violance started and forced the government to spent extra money to cover the growing demand..since the 1960s people have been granted gasoline for a subsidized price and every attempt to lower the subsidies ended in a bloodshed and social disorder..I call it "spoiling the masses" - offering people cheap fuel to support their development, but when we look at the costs of this "spoiling", its more than double the amount of money spent on education and healt care!! with a growing population and growing industrial production in developing countries, the costs of fuel subsidies will hit the ceiling and put an enormous pressure on the state budgets..what will the politician do then? cut fuel subsidies (which people love, because they can drive their cars almost for free the whole day), or cut spending on education and environment protection (because people do not care about their environment unless their car is running for free)???
subsidizing procucers in the developed world is a political business, but subsidizing fuel consumption in the developing world is a matter of social stability and political survival..letting the "spoiling" outgrow the market forces will cost even more than the 400-600 billion USD already spent on the fuel subsidies..is there any hope (or will) to get rid of the fossil fuel subsidies and support education and renewable energy?
-Jan Bocora , SK
23 March 2013
The argument I make is that of a policy and ownership rights issue. Namely, attacking consumer subsidies firstly, (as the IMF and World Bank do) especially in countries with a wealth of oil (Kazakhstan) and coal (Indonesian) reserves is barking up the wrong tree to reduce oil and gas addiction and also to promote a serious agenda that addresses climate change. Producer subsidies tend to enslave and exacerbate an ongoing situation that cannot and will not change on its own. I believe this article inlined that was posted in CNN recently sums much of it up, consider that no other industry in the world has military involvement (again, a de facto producer subsidy) at its disposal.
Breaking the fossil fuel addiction starts with breaking the process, not sticking it to the common person.
Dr. Will Hickey
Daejeon, RoK
http://edition.cnn.com/2013/03/19/opinion/iraq-war-oil-juhasz/index.html...
-Will Hickey , Daejeon
23 March 2013
Dear Professor Will Hickey,
Thank you for your reply and the reference to Doug Koplow's paper. I certainly do agree with you that producer subsidies are much more opaque than consumer subsidies, and that the importance of their reform is no less significant. In fact, a lot of the GSI work is exactly about this and is aimed to underscore the importance of fossil-fuel producer subsidy reform. Further, I agree that PSAs/PSCs are often "black boxes" with little information available to the general public. And Central Asia, to which you refer, is a "black box" in itself, especially countries like Uzbekistan and Tukmenistan.
My comment was aimed to highlight the importance of bringing transparency to producer subsidies by digging further into the disaggregated data. How are we going to reform producer subsidies if we cannot identify or quantify them? Policy makers need numbers and scenario evaluations to base their decisions on, they often do not realize the scale of the problem.
And speaking from my own experience, including at a country level, I can also assure you that "enough digging" makes a lot of difference. provided that you know what is going on the ground, know the local language (or work with local partners) and spend months on it. I can only once again invite you to have a look at our four country case studies, especially the Canadian and Russian ones. Before I did the Russian one people also told me that "it's unquantifiable". There are of course still data gaps remaining, and some of them are difficult to fill. E.g. how about regulator loopholes allowing transfer pricing as a producer subsidy? But it's often not the exact number that often makes the difference, but the order of magnitude. Your example on Indonesian PSCs is a good illustration: it does give an order of magnitude. Though there are serious methodological issues with benchmarking the level of corporate income, a devataion from which would be considered a subsidy (see Ron Steenbik's remarks).
To summarize, digging further will certainly help improve the transparency over the issue, quantify a lot of subsidies, and call policy makers' attention to the issue. Isn't this what we are both doing?
-Ivetta Gerasimchuk, PhD , Geneva
23 March 2013
I wanted to reply to Ivetta Gerasimchuks comments. I have been working on the issue of fuel subsidies now for a few years, since my oil work in Central Asia, and mining work in South East Asia. There are things going on on the ground that most economists in Brussels, Geneva, or the Beltway have no inkling about about and big oil and big mining INTEND to keep it that way. Ms. Gerasimchuk states that with enough 'digging' information can had. Let me draw her attention to a study written by the same IISD she recommends, " UNTOLD BILLIONS: FOSSIL-FUEL SUBSIDIES, THEIR IMPACTS AND THE PATH TO REFORM (2010)" by Doug Koplow, Cynthia Lin, et al...witha foreword by Mark Halle, the study spotlights the producer subsidies of 4 countries: US, Germany, Indonesia and China. What is interesting are the large information gaps in the quantitative fields under its "Ease of Valuation" columns, with adjectives such as "varied, complex, difficult [multiple times], etc... with an executive summary stating that "The data review also suggests that support for producers is likely to be grossly underestimated by current studies". That does not seem like something 'more digging' will unearth.
The point is, that producer fossil fuel subsidies are a murky, and non-tranparent area, in my estimate, and having worked in and researched big oil's "PSC" [production sharing contracts] the amounts promised to bail out producers is enormous, easily dwarfing any consumer subsidy by hundreds of billions, and perhaps well over a trillion USD. I have pointed out in an earlier aritcle in the Jakarta Post, that just 2 PSC's in Indonesia alone (under proprietary secrecy and thus 'unquantifiable' by line item) are backstopping losses and guaranteeing paybacks of $30 Billion over a timeline, but this is almost equal to the entire consumer fuel subsidy budget of Indonesia for 2012 at $31 billion. Again, only 2 projects in Indonesia will recieve reimburseables of $30 billion, when there are litterally HUNDREDS of such projects in ASEAN, Africa, Latin America, etc.... the aggregate timeline payouts in Indonesia alone for PSC's make consumer subsidies seem small.
http://www.thejakartapost.com/news/2012/08/27/stop-reimbursements-indone...
I also address her Asia note. For the record, most fuel subsidies are driving the Asian export model (the point I was making in the article), Asia is now the driver of the worlds economy (think China with its trillions in USD reserves), it certainly isnt the sick man of Europe, sub-saharan Africa or the ethereal printing presses of the US, with it credit card financed wars. Asian needs to be taken seriously. It has 60% of the worlds population, besides its economic clout, and is more addicted to fossil fuels than ever before. If one sits in the traffic jams of Jakarta, Bangkok, Mumbai, or Beijing, it quickly dawns on you that Asia has a problem with its addiction, and alternative energy and climate change is an abstraction. To get to solutions, the man in the street who uses the consumer subsidy to improve his life should not be penalized before processes and systems, however inocuous they seem that reward producers first. I think the climatologists like Bill McKibben have it right: If Asia is allowed to develop along the lines of a US or EU, using the same fossil fuel model of the past century, it will change the earth as we know it.
Dr. Will Hickey
Daejeon, South Korea
-Will Hickey , Daejeon, ROK
22 March 2013
@Anne, S
Sorry, I just noticed that you asked about PRODUCER subsidies. (Haste makes waste!)
See previous response about our ability to display maps.
Regarding producer subsidies, nobody has yet quantified producer subsidies in non-OECD countries.
As for OECD countries, we have tabulated budgetary support (a few billions of dollars in total) and tax expenditures for fossil-fuel production in OECD member countries, but have not established the benchmarks needed to enable us to provide a solid basis for making cross-country comparisons.
-Ronald STEENBLIK , Paris
22 March 2013
@Anne, S
In answer to your question, "Does OECD have a similar map for subsidies on the production side?"
No, alas. For two reasons. First, because of sensitivities over conflicting claims over certain parts of the territories of some of the OECD's member countries (particularly in the eastern Mediterranean), our lawyers have pretty much banned us from displaying maps.
We could make a schematic map (e.g., blocks of rectangles) instead of a representational one, but that runs into the second problem: we have agreed, for now, not to display national totals. This is because we have not yet established a common benchmark, especially for tax expenditures on the consumption side. As it stands, two countries with similar levels of fossil-fuel consumption can have vastly different levels of tax expenditures on the consumption side. The one that applies a low rate of excise tax on transport fuels, and exempts 20% of consumption from that tax, would have a much smaller total value of tax expenditures than one that applies a high tax rate and exempts 20% of consumption from that tax.
-Ronald STEENBLIK , Paris
20 March 2013
Does OECD have a similar map for subsidies on the production side?
-Anne S , US
18 March 2013
Dear Professor Hickey,
Thanks for starting a conversation on this important topic. Those of us working on energy subsidies, especially fossil-fuel subsidies, at the OECD also agree that producer subsidies need more attention. And we agree that they are generally harder to
Regarding what constitutes a true producer subsidy, however, we generally base our classifications on what tax economists would call "formal" or "statutary" incidence. And we would divide "production" from "consumption" at the point that the good enters the supply chain to consumers that then use or use up the good. In the case of petroleum and natural gas that would include refining and dedicated petroleum or NG transport infrastructure, and in the case of coal, mining and washing. Of course, subsidies downstream of these points may well benefit producers, but the degree to which they do depends on the market situation.
We would agree that the ability of governments to assign rights-of-way for pipelines or transmission corridors confer a benefit. But quantifying that benefit in any particular case is tricky. If the beneficiaries pay market prices for the access, what is the subsidy value of eminent domain?
We have generally not included public expenditure on maintaining “strategic petroleum reserves” as subsidies to production, as the beneficiary is ambiguous. Both producers and consumers may benefit, so we put it under our "general services" category.
Running municipal buses on underpriced diesel fuel would definitely fall into the category of consumption subsidies in our view.
The subsidy values of other policies you mention -- allowing unregulated coal-fired power plants, and providing municipal electric utilities with access to low-cost capital through guarantees by local government credit ratings -- we would classify as benefits to electricity production; in the latter case, only if the loan guarantees are contingent on the building of coal-fired power plants (as opposed to some other kind) or the use of coal would we treat them as benefiting fossil-fuels, and then for consumption not production.
-Ronald STEENBLIK , Paris
18 March 2013
Thank you for the op-ed, its message is very relevant and often overlooked in debates over fossil-fuel subsidy reform. We at the Global Subsidies Initiative (GSI, part of the International Institute for Sustainable Development) have looked at this issue in depth. Based on our research, there are three important points to make:
* fossil-fuel producer subsidies are not unquantifiable as argued in this article. Both the OECD and GSI have the methodology to inventory and quantify them, though it does take a lot of time and data digging. You are welcome to look at OECD's inventories (http://www.oecd.org/site/tadffss/oecd-ieafossilfuelsubsidiesandothersupp... ) and at GSI's four country case studies (on Indonesia, Canada, Norway, Russia http://www.iisd.org/gsi/fossil-fuel-subsidies/fossil-fuels-what-cost ).
* Unlike fossil-fuel consumer subsidies, fossil-fuel producer subsidies are also found in large numbers in developed countries such as the US, Canada, Germany, Spain (see the links above). Therefore it would be unfair to pick at Asia only, as is somehow done in this article.
* While reforming fossil-fuel producer subsidies is very important, it's unfair to say that "consumer subsidies, while visible, are the tip of the iceberg" compared to producer support. IEA estimates consumer subsidies between USD 400 - 600 billion a year, depending on the year's average oil prices. The GSI estimates the value of producer subsidies worldwide at USD 100 billion. It's significanly less.
-Ivetta Gerasimchuk , Geneva