Energy subsidies - Environmental Audit Committee Contents


1  Introduction

1.  Globally, government subsidies for the use of resources—water, energy, steel and food—run at $1.1 trillion a year.[1] The largest part of that figure is accounted for by fossil fuels subsidies. The International Energy Agency (IEA) identified global subsidies to fossil fuel producers alone at $523bn in 2011.[2] The OECD estimates that its member countries spend $55-90bn a year on such subsidies.[3] The IEA calculate that subsidies for fossil fuels are six times higher than for renewables.[4]

2.  Such fossil fuel subsidies are inconsistent with the global effort to tackle climate change. By encouraging consumption they increase emissions and remove incentives to be more energy efficient. As Shelagh Whitley of the Overseas Development Institute puts it:

If their aim is to avoid dangerous climate change, governments are shooting themselves in both feet. They are subsidising the very activities that are pushing the world towards dangerous climate change, and creating barriers to investment in low-carbon development and subsidy incentives that encourage investment in carbon-intensive energy.[5]

In 2011 the IEA estimated that completely eliminating fossil fuel subsidies would cut global energy demand by 4%, and emissions by nearly 5%, by 2020. A similar OECD analysis envisaged a 6% reduction in emissions by 2050.[6] More recently, the IEA estimated that even a partial withdrawal of fossil fuel subsidies by 2020 could reduce CO2 emissions by 360m tonnes, or 12% of the reduction needed to keep global average temperature rise to the 2oC limit set by the UN Climate Change Convention.[7]

3.  In June 2012, the UN 'Rio+20' Earth Summit resolved:

... to phase out harmful and inefficient fossil fuel subsidies that encourage wasteful consumption and undermine sustainable development. We invite others to consider rationalising inefficient fossil fuel subsidies by removing market distortions, including restructuring taxation and phasing out harmful subsidies, where they exist, to reflect their environmental impacts.[8]

This followed a commitment by the G20 in 2009 (restated in 2012) to:

phase out and rationalise over the medium term inefficient fossil fuel subsidies while providing targeted support for the poorest. Inefficient fossil fuel subsidies encourage wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change.[9]

Collectively, the G20 countries accounted for 78% of global carbon emissions from fuel combustion in 2010.[10] But of the G20 countries, half (including the UK) claim to have no 'inefficient' fossil fuel subsidies (paragraph 66).[11] This contrasts with assessments of the extent of fossil fuel subsidies in the UK, without the Rio+20 and G20 differentiation of 'harmful' or 'inefficient' subsidies, of $6.8bn a year by the OECD and $10.9bn by the IMF.[12]

Definitions

4.  Because there is no single globally agreed definition of energy subsidy,[13] we commissioned Dr William Blyth of Oxford Energy Associates to set out the theory and practice of energy subsidies and to review how the various definitions that are available apply to the UK.[14]

5.  He identified a difference between 'direct' and 'indirect' subsidies. He noted that the subsidies definition used by the World Trade Organisation ("any financial contribution by a government ... that confers a benefit on its recipient"[15]) focuses mainly on measuring direct subsidies, including the transfer of funds, taxes foregone and government guarantees. Such guarantees transfer risk from producers to government, reducing the cost of capital for the producer which constitutes a tangible reduction in cost. Dr Blyth noted that the OECD, on the other hand, also include as subsidy the impact of "all forms of market price support involving transfers between consumers and producers created as a result of policy such as government interventions on tariffs", which includes applying tax rates which are lower than those 'normally' applied.[16] Like the WTO definition, the OECD definition uses the notion of 'conferring benefit'.[17]

6.  Rather than the OECD's bottom-up 'effective rate of assistance' approach, which relies on identifying different aspects of subsidy in some detail,[18] the International Energy Agency uses a 'price gap' approach. Its definition covers "any government action that concerns primarily the energy sector that lowers the cost of energy production, raises the price received by energy producers or lowers the price paid by energy consumers".[19] It considers the difference between the subsidy-produced price and the price in the absence of subsidy.[20] The latter 'reference price' requires a judgement about what taxes are 'normal', because taxes are essentially negative subsidies. The International Monetary Fund (IMF) have a narrow ('before tax') and a broader ('after tax') measure, which uses a 'price gap' approach to compare the price paid for energy in a country with the international price available.[21] The IMF has included reduced VAT rates within its definition of subsidies.[22] Under the IEA methodology, however, lower rates of VAT on electricity generation are not treated as being a subsidy, on the basis that the electricity sector is often regarded as an "intermediate energy transformation process rather than a final consumer" and therefore not normally taxed.[23]

7.  The imposition of carbon prices, Dr Blyth told us, acts to correct a market failure. In the OECD model, therefore, they should in theory be considered as "a correction to a sub-optimal prevailing market price signal ... In that sense, the absence of a carbon price in energy markets constitutes a subsidy since in a market without carbon prices, polluters are not paying their full production costs."[24] Renewable UK (one of our witnesses) supported this approach.[25] The IEA methodology, however, "excluded environmental externalities from their calculations of subsidies on the basis that carbon pricing is not yet 'normal' practice within its member countries".[26] The IMF has actually included as subsidy any lack of taxes designed to internalise the cost of environmental damage, including a $25/tCO2 benchmark for emissions from fossil fuels.[27] This shifts the focus of the energy subsidy debate. Since most countries do not tax carbon at this level (if at all), Dr Blyth pointed out that this under-pricing of externalities, combined with tax breaks, "swings the total level of energy subsidies from being dominated by developing country producers (as suggested by the IEA price-gap approach) to being dominated by the major energy users".[28]

8.  A definition put forward by the Global Subsidies Initiative (who gave evidence to our inquiry), largely based on the WTO's definition, covers all forms of support—financial or otherwise—provided to consumers or producers. The GSI considers benefits to be a subsidy if they confer a considerable advantage to groups of market participants, even if some other groups may receive equal treatment (e.g. accelerated depreciation allowance is not specific to the oil and gas industry, but the GSI would still consider it a subsidy).[29]

9.  A definition of subsidy is also implicit in EU state aid rules, which identify several tests which all must be met for state aid to be present: that is, whether state resources are being provided, whether they confer an advantage on the recipient which favours certain commercial undertakings or the production of certain goods, and whether that distorts competition and affects trade.[30] Platform, who also gave evidence to our inquiry, take a wider view than most others of what comprises subsidy, by including "diplomatic subsidies and military subsidies" as well as export credit support (paragraph 34).[31]

10.  Some subsidies involve transfers between consumers and producers, or between different types of producers, or between different types of consumers. The UK feed-in tariff for residential solar PV power, for example, provides subsidies to those with solar panels on their roofs which electricity supply companies have to pay, but which they then effectively pass on to all residential electricity customers. The WTO definition of subsidy (paragraph 5) excludes such transfers because they do not involve government money.[32] Other subsidies are paid for by government, however. Dr Blyth explained how for such subsidies the benefit is shared between consumers and suppliers—irrespective of whether the subsidy is directed at one rather than the other—depending on the elasticity of demand for that energy.[33] The size of the benefit each receives then depends on the change in the quantity of energy produced and consumed, as well as the change in the price, resulting from the subsidising scheme. So, for example, Cold Weather Payments to pensioners in the UK are not subsidy, Dr Blyth told us, because although pensioners receive extra money there is no link to the quantity of energy they consume—they can spend the money on other things.[34]

11.  There is no single internationally agreed definition of what constitutes energy subsidy. Methodologies differ widely, as do the nature of transactions and support mechanisms that might be subsumed in a measurement of subsidy. It is regrettable that this, as we note later in this Report (paragraph 65), has provided a way for the Government to reject—erroneously, in our view—the proposition in some areas that it provides energy subsidies.

Our inquiry

12.  Dr William Blyth's paper described the nature of energy subsidies, from first principles. He explained how 'perfect markets' might achieve 'maximum social welfare', and thereby how subsidies (like taxes) might represent a distortion from that ideal. But he also noted that perfect markets are in practice difficult to find because competition can be limited, because fixed costs present barriers to market entry, or because 'externalities' such as environmental damage (paragraph 7) are not reflected in prices.[35] He concluded that "the market model still provides a very important benchmark, but this should not be used as the basis for a dogmatic rejection of interventions that seek to redress some of the more obvious failings".[36] He identifies three main arguments that have been put forward as rationale for subsidies:

  • to allow 'infant industries' and new technologies to be developed and be able to operate economies of scale;
  • as part of 'pro-poor' policies (the most cited reason for subsidies at a global level); and
  • protection from foreign competition.

Shelagh Whitley of the Overseas Development Institute, one of our inquiry witnesses, identified other factors which are often found as the cause for initiating and then failing to curtail fossil fuel subsidies, including the "national patrimony" of fossil fuel producing countries seeking to share the benefit of production across their societies, buffering against price shocks, the power of special interest groups (eg farmers in India), lack of information on the extent of subsidies, and a lack of other available policy levers in countries with weak government institutions.[37]

13.  Against that background, we explore in this Report the rationale for energy subsidies—pro-poor policies in Part 2 and supporting infant and low-carbon industries in Part 3—and the extent to which the UK uses such subsidies. In Part 4 we consider the extent to which UK subsidies are 'harmful' or 'inefficient' and the extent of transparency in respect of energy subsidies in the UK.

14.  In addition to discussing the paper we commissioned from Dr William Blyth of Oxford Energy Associates,[38] we took oral evidence from others who have studied the extent of subsidies; representatives of different energy sectors; DfID, UK Export Finance and DECC officials; and the Energy Minister Rt Hon Michael Fallon MP. Our aim has been to produce our Report ahead of the Autumn Statement, which could provide the Government with a timely opportunity for addressing our recommendations.



1   ODI, Time to change the game: Fossil fuel subsidies and climate (November 2013)  Back

2   IEA, World energy outlook 2012 (2012)  Back

3   OECD, Inventory of estimated budgetary support and tax expenditures for fossil fuels (2012) (From an analysis of 34 countries (Q48)) Back

4   IEA, Redrawing the energy-climate map (2013)  Back

5   Time to change the game: Fossil fuel subsidies and climate, op cit. Back

6   IEA, OPEC, OECD & World Bank, An update of the G20 Pittsburgh and Toronto Commitments (2011), Section 1.3  Back

7   Redrawing the energy-climate map, op cit. Back

8   UN, The Future We Want (June 2012), para 225 Back

9   G20, Summary of Progress Reports to G-20 Leaders on the Commitment to Rationalize and Phase Out Inefficient Fossil Fuel Subsidies (2012) Back

10   Time to change the game: Fossil fuel subsidies and climate, op cit. Back

11   ibid, Table 1; Summary of Progress Reports to G-20 Leaders on the Commitment to Rationalize and Phase Out Inefficient Fossil Fuel Subsidies, op cit Back

12   Inventory of estimated budgetary support and tax expenditures for fossil fuels, op cit; IMF, Energy subsidy reform: Lessons and implications (2013); Time to change the game: Fossil fuel subsidies and climate, op cit, Table 1 Back

13   Time to change the game: Fossil fuel subsidies and climate, op cit. Back

14   Ev 64 Back

15   WTO, Uruguay round agreement: Agreement on subsidies and countervailing measures (1994), Article 1.9 (p44)  Back

16   Ev 64; Inventory of estimated budgetary support and tax expenditures for fossil fuels, op cit. Back

17   OECD, Analysing energy subsidies in the countries of eastern Europe (2013) Back

18   Ev 64, para 1.2.2 Back

19   Analysing energy subsidies in the countries of eastern Europe, op cit; IEA, Taxing and Subsidising Energy (2006) Back

20   Ev 64, para 1.2.1 Back

21   Energy subsidy reform: Lessons and implications, op cit; Time to change the game: Fossil fuel subsidies and climate, op cit, Section 2.1.3  Back

22   Ev 64 Back

23   ibid Back

24   Ev 64, paras 1.1.5, 1.2.2 and 2.1 Back

25   Q137 Back

26   Ev 64, para 1.2.1 Back

27   Ev 64, para 1.2.4 Back

28   ibid Back

29   Analysing energy subsidies in the countries of eastern Europe, op cit Back

30   ibid  Back

31   Q137 Back

32   Analysing energy subsidies in the countries of eastern Europe, op cit Back

33   Ev 64, Figure 1 Back

34   Ev 64, para 2.2 Back

35   Ev 64, paras 1.1.1 - 1.1.2  Back

36   Ev 64, para 1.1.3 Back

37   Time to change the game: Fossil fuel subsidies and climate, op cit.  Back

38   Ev 64 Back


 
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© Parliamentary copyright 2013
Prepared 2 December 2013