Fuel subsidies an inefficient means of supporting the poor

The issue will be discussed during the World Economic Forum (WEF) on East Asia 2013 in Myanmar this week. 

The following is his view: 

Developments in energy pricing will be a critical driver of future energy trends by affecting the amount and type of energy that is consumed and the effort that is put into improving energy efficiency and developing cleaner-energy technologies. A key issue in this respect is how quickly fossil-fuel subsidies, which still remain substantial and commonplace in many countries, will be phased out.

The International Energy Agency (IEA) has been focusing attention on fossil fuel subsidies for well over a decade in the context of its World Energy Outlook publication. The work is primarily aimed at raising awareness about the magnitude and incidence of fossil-fuel use and its impact, an essential step in building momentum for global fossil-fuel subsidy reforms.

The IEA’s latest estimates indicate that fossil-fuel consumption subsidies worldwide amounted to US$523 billion (Bt15.9 trillion) in 2011, up almost 30 per cent from 2010 and six times more than the subsidies to renewables. These subsidies were most prevalent in the Middle East, amounting to 34 per cent of the global total. The estimates capture the value of subsidies that reduce end-user prices below those that would prevail in an open and competitive market. Such subsidisation occurs whether energy is imported at world prices and then sold domestically at lower, regulated prices, or, in the case of countries that are net exporters of a given product, where domestic energy is priced below international market levels.

In many cases, fossil-fuel subsidies were introduced with the well-intentioned objective of improving access to modern energy services for the poor. While making electricity and clean cooking facilities available to the poor is of vital importance, studies have found that fossil-fuel subsidies as presently constituted tend to be regressive, disproportionately benefiting higher-income groups that can afford higher levels of fuel consumption. Indeed, recent analysis in the World Energy Outlook indicates that only 8 per cent of fossil-fuel subsidies typically reach the poorest income group (the bottom quintile). This finding reflects the fact that poor households may not have access to subsidised energy directly, since they may lack a connection to electricity or natural gas and own no vehicle. It also demonstrates that subsidies are an inefficient means of assisting the poor; other direct forms of welfare support would cost much less. 

Although low-income households only benefit from a small proportion of energy subsidies, they are still likely to be disproportionately affected by their removal as they spend a higher percentage of their household income on energy. Therefore, any moves to phase out subsidies must be carefully designed so as not to restrict access to essential energy services or increase poverty. In undertaking major changes, assessments should be made regarding the extent to which the economy and society can absorb the impacts of reforms. Financial support for economic restructuring or poverty alleviation will often be essential. In most successful cases of energy-subsidy reform, support has been well targeted, temporary and transparent.

As has been seen in, for example, Myanmar, subsidy reform is difficult as the short-term costs imposed on certain groups of society can be very burdensome and induce fierce opposition. Nonetheless, globally we are seeing some encouraging signs of progress. G20 and Asia-Pacific Economic Cooperation member economies have made commitments in recent years to phase out inefficient fossil-fuel subsidies and many are now moving ahead with implementation, including China, India, Russia and Indonesia, to name just a few. Many countries outside these groupings have also committed to subsidy reform. In net-importing countries, reforms have been closely linked to persistently high-energy prices, which have made subsidies an unsustainable financial burden. Even some net-exporting countries have taken steps as they have realised that artificially low prices are eroding export availability and reducing foreign currency earnings. 

While these efforts indicate growing momentum to phase out subsidies, the reality is that energy resources are still significantly underpriced in many parts of the world. The countries involved face a momentous choice between pursuing the hard but necessary reforms and continuing with the status quo. If they make the right decision, I am convinced they will reap long-term benefits for their own economies, while also making an important contribution towards putting the global energy system on a more sustainable path.