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Carbon - the Huge and Yet Overlooked Fossil Fuel Subsidy

Posted on 11 July 2012 by dana1981

The International Energy Agency (IEA) made headlines recently by concluding that fossil fuels received far more global subisides than renewable energy in 2010.  However, it appears that the IEA survey only included data from the countries with the largest fossil fuel subsidies, which are mainly developing countries whose economies largely depend on fossil fuel production.  National Geographic's The Great Energy Challenge also includes fossil fuel subsidy data from developed countries (Figure 1), bringing the total global value close to $500 billion for 2010.

Bear in mind that exactly what is defined as a "subsidy" can be rather subjective, so these are just rough estimates.

fossil fuel subsidies

Figure 1: Global fossil fuel subsidies in billions of dollars per country from National Geographic.  Click the image for a larger version, and click here for more information.

It's worth noting that this trend is changing.  For example, in the USA in 2011, fossil fuel subisidies in the form of tax breaks were down to $2.5 billion while renewable energy and energy efficiency programs received $16 billion in subsidies.  Even many developing countries like Iran (with the largest orange circle in Figure 1 at over $80 billion in 2010 fossil fuel subsidies) dramatically reducing their subsidizing of fossil fuels (in 2011 Iran's subsidies were down to $20 to $30 billion).

Nevertheless, despite the movement in the right direction, global fossil fuel subsidies are still much higher than renewable energy subsidies, despite the fact that fossil fuels and associated technologies have been established for decades to centuries.  Fossil fuels also receive another massive subsidy which is rarely taken into account in these types of calculations - carbon emissions.

Social Cost of Carbon

As we know, carbon emissions impact people and our economies through their contribution to climate change through the increased greenhouse effect.  The climate change associated with these emissions has a myriad of effects (i.e. rising temperatures, changing precipitation patterns, more frequent extreme weather events, etc.), many of which result in bad effects on people.

It's very challenging to quantify the total dollar impact of these changes, but economists try to estimate the economic damage done by a each ton of carbon (or carbon dioxide) emissions, which they have termed the "social cost of carbon" (SCC).  SCC is effectively an estimate of the direct effects of carbon emissions on the economy, and takes into consideration such factors as net agricultural productivity loss, human health effects, property damages from sea level rise, and changes in ecosystem services.

SCC estimates generally range from $5 to $68 per ton of CO2 emitted, though a few more conservative ecoomists put the figure lower, and some economists argue it could potentially be much higher in the near future.

The Huge, Overlooked Fossil Fuel Subsidy

Global CO2 emissions from fossil fuels in 2011 totalled 31.6 billion tons.  Given the SCC range of $5 to $68 per ton of CO2, those emissions correspond to a cost of $158 billion to $2.1 trillion per year, globally - roughly $23 to $300 per person.  Note that the IEA and National Geographic listed global fossil fuel subisides at $400 to $500 billion.  The central estimate of the social cost of carbon emissions is roughly twice that total.

These carbon emissions may reasonably be considered a subsidy because they impose various costs on society (on agricultural productivity, property damage, human health, etc.), but since most countries don't yet put a price on carbon emissions, these costs are not reflected in the fossil fuel market price.  Rather than fossil fuel producers and consumers paying these costs, society as a whole picks up the tab.  Therefore, fossil fuel prices are kept artificially low (Figure 2), which is generally the purpose of subsidies.

coal costs

Figure 2: Average US coal electricity price vs. Muller, Mendelsohn, and Nordhaus (2011) and Epstein (2011) best estimate coal external costs.

Fossil Fuel Industries Benefit, You Pick Up the Tab

However, with all subsidies, somebody has to pick up the tab.  Usually it's taxpayers who provide the funds to implement the subsidy, but in this case it's everyone who is adversely impacted by climate change, which is basically everybody in one form or another.  For example, you pay higher food prices as climate change impacts agriculture (i.e. wheat prices rose as a direct consequence of the 2010 record Moscow drought, heat wave, and wildfires).

Worse yet, as Samson et al. (2011) showed, the countries with the lowest CO2 emissions will generally experience the largest associated climate impacts (Figure 3).


Figure 3: Top Frame - National average per capita CO2 emissions based on OECD/IEA 2006 national CO2 emissions (OECD/IEA, 2008)  and UNPD 2006 national population size (UNPD, 2007).  Bottom Frame: Global Climate Demography Vulnerability Index. Red corresponds to more vulnerable regions, blue to less vulnerable regions. White areas corresponds to regions with little or no population (Samson et al 2011).

Carbon - the Forgotten Fossil Fuel Subsidy

It's rather rermarkable that everyone tends to overlook this immense fossil fuel subsidy, which amounts to somewhere in the ballpark of $1 trillion per year at present, globally.  It's certainly a difficult figure to quantify with a large possible range of values, but it's also a huge cost which fossil fuel producers and consumers do not directly pay.  While the market price of fossil fuels remains artificially low, we all pick up the tab to the tune of approximately $150 per person per year, on average, though those costs are unevenly distributed.  However, Economics 101 says that the people who benefit from those emissions (fossil fuel consumers) should be the ones paying their cost through a price on carbon emissions.

Climate contrarians in particular tend to neglect this huge fossil fuel subsidy in two main ways.  First, they claim that developing nations need "cheap" energy (a favorite argument of John Christy, for example), when fossil fuel energy is not actually cheap, and in fact poorer nations tend to pay the lion's share of the associated climate costs (Figure 3).  Second, they claim that it will be cheaper to adapt to climate change than to mitigate carbon emissions (i.e. Monckton, Michaels and Cato, and the CEO of ExxonMobil have recently made this argument).  In this context, "adaptation" means continuing the economic drain of these hundreds of billions to trillions of dollars of fossil fuel subsidies every year, which is several times higher than the cost of climate mitigation.

Most importantly, until we put a price on carbon emissions (and to their credit, a few countries and regions have), fossil fuels will remain extremely heavily subidized at a time when we need to be quickly phasing out our reliance on them.

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Comments 1 to 16:

  1. Should we not also include fuel taxes in the calculations, a sort of anti-subsidy? Or is that already accounted for in the values in figure 1?
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  2. Interesting point, OPatrick. I don't think fuel taxes are accounted for in those numbers. They also don't tend to be very large though, outside of a few places like Europe.
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  3. Great post. I like to see these unaccounted externalities put into numbers. Would love to see a post comparing these adjusted fossil fuel costs vs. forms of renewable energy to understand the true economics of energy generation.
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  4. Thanks BillV. See the Cost Comparison section here for some discussion of adjusted energy costs.
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  5. dana1981 @2 not to forget Australia, which is middle of the road:

    The issue of fuel taxes is somewhat vexed because they only applies to a limited portion of CO2 emissions.
    They do not apply to fuel used in stationary energy generation, for example. In Australia, it does not apply to fuel used on farms or in mines. Because of that you need to have a measure of the emissions of CO2 by combustion of fuel on roads as a portion of all CO2 emissions to determine the value of fuel taxes as a counter subsidy.

    What is more, fuel taxes, or a portion of fuel taxes when the tax is very high, can be considered a "user pays" method of funding the road system.
    Therefore, to the extent that revenue received is less than the cost of maintaining and upgrading the national highway network, the fuel tax is not a counter subsidy on Carbon. China's fuel tax, for example, is explicitly earmarked for this purpose.

    In a similar vane, given the high death an injury rate from road transport, fuel taxes could be in part considered a user pays funding of health care for injuries received from road accidents in nations with social health systems (Europe, Australia, Canada).

    Arguably, however, all or most of these costs would exist with a fully electric transport system, in which case the revenue for these services would need to be raised in some other way. On that basis it could still be argued the full fuel tax revenue should be counted as a counter subsidy. Which approach is correct is a matter of convention. It is important to keep these conventions consistent, but it cannot be categorically asserted that one is right and the other wrong.

    In any event, the information needed to calculate the level of the "counter subsidy" is not readily available AFAIK. Therefore it would be difficult, and beyond SkS's resources to included them as a counter subsidy. For that reason Dana noted that the definition of a "subsidy" is vague, and that "these are rough estimate". I am glad that you raised the issue so that a more explicit discussion could be made as a caveat on the post.

    Having said that, this issue does not detract from the primary point of the post, ie, that the largest "subsidy" on fossil fuels is the hidden subsidy of uncompensated negative externalities.
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  6. Historians of the future (if there are any) will be fascinated at how our society paid so dearly for its own demise.
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  7. Gas taxes don't seem to be negligible: US gas taxes alone are in the $100 billion order of magnitude.

    That said, the US also spends a huge amount on foreign policy (largely military) related to oil supplies, also probably not accounted for here.

    Then another source is infrastructure spending: building roads and sewers for people moving to new oil exploitations, who would otherwise have stayed at home. That gets very tricky to account for.
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  8. Basically these roundabout subsidies are externalities, the costs of something that aren't reflected in the price, a devious distortion of the market. I've been trying to put this in terms that contrarians, obstructionists, and denialists can understand recently by explaining why they are bad for any "free market" approach; they wreck the pricing power of the market with costs that aren't priced into the product. Consumers can't make informed decisions about where to value energy if the cost is hidden behind an attractive price. Despite this entirely market-based explanation, it's very difficult to nudge people into thinking of various carbon pricing schemes as restoring balance to the market by accounting for hidden costs instead of reacting as though it were a government-imposed artificial mark-up beyond the real costs. Almost invariably, they continue to assume the latter. You can be as plain-spoken as you want but the explanation just doesn't click. That's been my experience, at least.

    The issue of externalities, esp. regarding pollution and environmental degradation, is not something people with a shallow but enthusiastically committed view of "the power of the market" or "maximal individual freedom" are prepared to deal with. On some levels it's just not a common-sense, plainly visible danger. It's an insidiously slow and spread-out effect, but that doesn't change the fact that it infringes on the freedom of everybody regardless of whether they've consented to it.

    I think this is why the vocal "capital-L Libertarians" and others who see government intervention as an unnecessary evil choose to deny or marginalize the problem, it doesn't fit with their supposedly superior platform. The alternative is to admit that some form of government regulation is both necessary and good, which they are irrationally loathe to do.
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  9. WeelsOC - yes, to this point we've always referred to carbon emissions as an economic externality, but as you note, that hasn't gained much traction amongst the self-proclaimed free marketers, perhaps because economics often isn't intuitive.

    These same folks tend to strongly oppose subsidies, so perhaps framing CO2 emissions in that light will result in a little more progress.
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  10. In my experience, a good fraction of the anti-renewable subsidies brigade are entirely unaware of all this. Use this page to make your libertarian friends aghast!
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  11. This study does not count the health costs from pollution near fossil fuel sources or the damage from acid rain. I can only eat fish I catch in the pond in my backyard twice a month because they are contaminated with mercury from fossil fuels. Fossil fuels contain many problems beyond the CO2.
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  12. I don't know what the grey color stands for in figure 1. Is it "no data available" or "no subsidies"?

    I do know that Brazil has subsidies at least for diesel and LP gas, although I don't have the numbers.
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  13. Alexandre - I'm pretty sure grey means no data available. As noted, it's difficult to determine exactly what qualifies as a subsidy, and to obtain that information from every country. The IEA wasn't even able to estimate it for most of the green countries in Figure 1.
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  14. yeah, ie Nigeria subsidises fuel alone to the tune of $8B.
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  15. Hi all. I am one of the people involved in compiling the data on support to fossil fuels in OECD countries (the green ones in the chart). Our numbers pertain cover both production- and consumption-side measures, but pertain only to budgetary expenditures and tax expenditures. The latter account for the bulk of the aggregate values. The IEA numbers pertain only to subsidies provided via policies that artificially lower domestic prices to consumers. So the numbers of the two organizations are not entirely comparable. Also, in respect of the OECD estimates we generally avoid the term "subsidy" (preferring to use the broader term, "support") because tax expenditures feature so dominantly and the reference tax systems differ markedly from one country to another. Hence, if one looks at two countries that exempt farmers from paying fuel tax on diesel, the associated tax expenditure measured in a low-taxing country will be less than that measured in the high-taxing country, even though, overall, consumers pay much higher (after-tax) prices for fuel in the higher-tax country.

    By the way, the IEA does take into account fuel taxes when deriving its estimates for consumption-related subsidies.

    Whether to equate externalized costs, including those associated with carbon emissions, with subsidies, is a decades-old debate. Clearly it is valid to speak of the externalized costs of different forms of energy, and to treat those that generate larger externalized costs (externalities) as benefiting from a bigger free ride. However, I disagree with renaming externalities "subsidies". For one, the concept of subsidy is much older than that of externality and it has come to be associated with a transfer of value that is the result of a conscious action of a government. By contrast, externalities exist generally through government INaction. Moreover, most externalities would exist even in a state of anarchy -- indeed. Should a driver of a diesel-fueled truck in Somalia be considered to be "subsidized" because he can emit with impunity?

    In response to Tom Curtis, I agree that some taxes on transport fuels are, essentially, user charges for roads. So they are not necessarily offsetting externalized costs. Also, as he points out, road accidents (and noise pollution) would exist also for electric vehicles (and those fueled by fuels made from waste materials). But my point on that would be that counting the costs of road accidents and noise pollution (as some other authors have done) as a "subsidy" to petroleum fuels is being selective: they would have to be counted for any vehicles that caused as much injury and property damage or emitted as much noise.

    One additional problem with rebranding externalities as "subsidies" is that this can confuse the public. In the late 1990s there were several well-publicized studies of environmentally harmful subsidies that included non-internalized externalities in their totals of "subsidies". They then said, "Look at all the environmental damage caused by these $2 trillion a year in subsidies!" Problem was, they were already including the cost of the environmental damage in their subsidy estimates -- i.e., they are double-counting.

    Finally, I disagree with WheelsOC who claims that Libertarians have no place in their economics for externalities. That is not true of any Libertarians that I know. Libertarians are, however, cautious when it comes to recommending government intervention -- particularly interventions that try to remedy the situation by subsidizing alternatives to polluting activities, and which invariably lead to politicians trying to pick winners (as they did with ethanol). Most Libertarians I know would agree that taxing pollution is, in theory at least, a first-best approach to addressing externalized costs.
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  16. To add to the comments of Ron @15: Considering externalities is useful but there are problems in calling them subsidies. Firstly, true subsidies are more likely to be susceptible to exact calculation, whereas externalities must necessarily be estimated. Secondly, the policy solution to each is very different. Subsidies can simply be withdrawn, while pricing externalities is more complex and requires institution of measurement and audit protocols for example.
    I'd also note that most estimates of subsidies in Australia for example incorporate tax expenditure that is a rebate on fuel excise already paid for certain qualifying uses of that fuel. So it's effectively a lower tax rate rather than a subsidy (this may or may not be a sound policy of course). Since 1 July 2012 the rebates have been lowered (i.e. tax rates raised) to include an estimate of the externality due to greenhouse gas emissions.
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