Sacred Headwaters #23: Fossil Fuel Subsidies

Fossil fuel extraction has been the most profitable industry in human history. But even today, with full knowledge of the causes of climate change, governments continue to subsidize it. Why?

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Issue #23: Fossil Fuel Subsidies

Many people still think that to give fossil fuels subsidies is a way to improve living conditions of people.

There is nothing more wrong than that. What we are doing is using taxpayers’ money – which means our money – to boost hurricanes, to spread droughts, to melt glaciers, to bleach corals. In one word – to destroy the world. 

UN Secretary-General António Guterres, May 2019.

In just the last thirty years — after governments learned about climate change, after James Hansen’s Congressional testimony, mostly after the Kyoto Protocol was signed — Exxon, Shell, Chevron, and BP have -- between the four of them -- generated $2 trillion USD of profit. Not revenue, profit. But, according to the IMF, global subsidies for the fossil fuel industry totalled $4.7 trillion in 2015 and have been rising since. (Note: the IMF definition of a subsidy is broader than what most readers would typically identify as a subsidy because it incorporates the socialized costs of fossil fuel extraction and consumption. We’ll get into that a bit below).

This is a bit puzzling. Why would governments be handing out money to the most profitable industry in human history — and even more importantly, why would they be handing out money to the industry that’s almost single-handedly responsible for the rapidly accelerating existential threat to life on Earth?

It may help to first consider why governments might apply subsidies. If you were to believe the “free market / free trade is better for everyone” narrative that dominates economic discourse, you’d be against subsidies of any kind — and in fact, many self-proclaimed “fiscal conservatives” do carry this view when pressed. But in reality, few if any governments actually subscribe to this perspective, though the narrative is often used as a weapon to drive Global South countries into exploitative economic relationships, and subsidies, tariffs, and other trade regulations are commonplace around the world.

Subsidies are traditionally used in a few ways. They can be employed to protect or support a local industry in a global market, either to allow that industry to develop to the point where it’s competitive globally or to preserve it for other reasons like security or cultural heritage. They can also be used as a “carrot” to incentivize the development of new industries, something illustrated clearly by their use in the renewable energy and electrification sectors over the last decade or two. This is far from an exhaustive list; I’m just trying to give an idea of the “good faith” reasons a government might choose to subsidize an industry.

With that in mind, let’s return to the fossil fuel industry and go through what we know. Fossil fuel extraction is incredibly profitable, and though this was a particularly bad year for fossil fuels, that profitability hadn’t changed significantly before the pandemic. Fossil fuels are also by far the largest contributor to global warming and climate change and governments have known and understood this for half a century if not longer. To top things off, most governments have been vocal about their support (subsidies, etc.) for renewable energy and “energy transition” over the last two decades…while simultaneously continuing to provide larger subsidies to the industry that directly competes with those goals.

Huh.

In this issue, we’re going to read about fossil fuel subsidies: who’s handing them out, how much are they worth, what difference would ending them make (hint: a very big one), and how exactly can we go about ending them. Similar to the last issue, it will probably make you angry. You may bang your head against the wall. You might wonder why Canada receives accolades for implementing carbon taxes…while exempting oil and gas companies from paying them. You’ll wonder why the US Democratic National Committee removed ending fossil fuel subsidies from their platform just a couple months ago. And you’ll likely wonder why so many nations have ramped up handouts to the oil and gas industry this year instead of taking the COVID-19 crisis as an opportunity to invest in a massive scale energy transition and equitable economic recovery (with policies such as the Green New Deal).

Wonder all of this in a bigger context: why are governments acting in ways that are so obviously counter to human well-being, both globally and within their own borders? Why are we spending huge amounts of money giving more money to people who already have huge amounts of money? To use Secretary-General Guterres’s words, why are we using taxpayer dollars to destroy the world? This paradox isn’t limited to the fossil fuel industry, but it provides a very clear example. Our political system — and I don’t just mean in the US; this is a global issue, driven by transnational socio-political and economic structures — is failing to fulfill its most basic mandates and the stakes couldn’t be higher.

“Fossil fuels are underpriced by a whopping $5.2 trillion” — a Look at the IMF Report (10 minutes)

The IMF has released a few bombshell reports on fossil fuel subsidies including their latest working paper on the topic which claimed that in 2017, governments around the world subsidized the fossil fuel industry with $5.2 trillion USD. These reports set off a bit of a debate about what counts as a subsidy because the IMF incorporated the socialization of costs, or what are commonly referred to as externalities, as subsidies. In short, they found ~$500 billion USD in “pre-tax subsidies” — effectively, direct transfers — and many trillions of dollars of “post-tax subsidies,” or economic costs incurred by the fossil fuel business model and paid for by taxpayers. This article explains this distinction and makes the (fairly obvious) case that while the nomenclature may confuse the issue somewhat, the “post-tax subsidies” are critically important for human well-being and the fight against climate change. I’d also quickly note that the IMF report found pre-tax or direct subsidies began increasing in 2017 after a long period of decline, and while the report doesn’t extend to 2020, we’ve seen an alarming increase in these direct payments this year. It’s also important to understand that estimates of direct subsidies are largely incomplete because of the challenges involved with identifying producer-side subsidies.

Reforming fossil fuel subsidies: drivers, barriers and the state of progress (20 minutes)

Sections 1, 2, 3, and 8.

This 2016 paper gives an overview of the global landscape of fossil fuel subsidies, prospective benefits of subsidy reform, and the hallmarks of successful and failed attempts at implementing subsidy reform. The introduction lists a few pretty dramatic statistics from other papers: one study found that 36% of global emissions from 1980-2010 could be attributed directly to fossil fuel subsidies. Others found that if implemented by 2020 (oops), subsidy reform could reduce cumulative emissions through 2050 by 6.4%-18% depending on how it is implemented. The authors go on to explore other impacts of fossil fuel subsidies, what the risks to reform are, and how best to mitigate those risks. In particular, they point out that while subsidies are often justified as providing consumption-level support for poor populations, they are actually regressive in most cases, meaning the majority of their impact flows to the wealthy. Much of this paper deals with consumer subsidies (as opposed to producer subsidies); the absolute dollar amounts of these are higher and they have been the primary focus of reform, but producer subsidies remain high in developed countries and the next paper we’ll read looks at the disproportionate impact they carry.

Figure 5, Reforming fossil fuel subsidies: drivers, barriers and the state of progress, Jun Rentschler & Morgan Bazilian.

Why fossil fuel producer subsidies matter (10 minutes)

This short response to another paper makes an argument that is particularly important for those of us living in countries like the USA and Canada: wealthy countries that are oil and gas exporters and have low tax rates on oil and gas. Both countries provide huge producer subsidies to the oil and gas industry in ways that are driving rapid expansion of fossil fuel infrastructure. In my opinion, these types of subsidies are the most obviously outrageous. This subsidization has accelerated in the wake of COVID-19 and is skewing investment decisions in an otherwise low-price, dwindling capital environment. The authors of this paper argue that the impact of producer subsidies has been underestimated because previous studies have failed to account for these investment-level effects. The subsidies cause infrastructure to be built that wouldn’t be otherwise, which “locks in” future emissions. They also suggest that the additional funds may allow fossil fuel companies to amplify a feedback loop where they spend money on political activities, blocking attempts to regulate emissions and lobbying for additional subsidies. This should not sound surprising to you if you read the last issue of this newsletter.

Here’s another paper by some of the same authors that looks specifically at how today’s subsidies will affect US oil extraction (and in turn, our exceedance of the “carbon budget”) over the next three decades.

The Politics of Fossil-Fuel Subsidies (25 minutes)

I was going to suggest reading most of this paper, but it’s quite long (over an hour). If you have time, by all means read the whole thing, otherwise, stick to the Executive Summary, Introduction, and Conclusions for Reformers. The next section I’d read after that is “III. The Supply of Subsidies.”

There are a few important things to keep in mind as you read this given that it was written in October 2009. First, the author (and most analysts at the time) was under the impression that oil prices would remain high ad infinitum. That turned out not to be the case; oil prices have been incredibly low this year, but were already low prior to the COVID-19 pandemic. Second, the amounts discussed are lower than estimates today both because of variable definitions (as discussed above) and because of substantial work done in the last decade to identify hidden, “covert” subsidies.

This paper is a dive into the political factors that cause governments to adopt subsidies and make it challenging to achieve subsidy reform, despite fairly widespread agreement that eliminating fossil fuel subsidies would be “win-win.” It’s written from the perspective of political economic analysis with the basic assumption government decision-making is motivated by a desire to stay in power. The author explores how interest groups are able to convince governments to create subsidy programs, how those subsidies entrench themselves as the interest groups invest in capital infrastructure based on their presence, and how the world might create conditions that allow reform to be possible. The short answer, of course, is that it’s very hard, something we’re seeing quite clearly. One notable takeaway for me came from this quote:

In the extreme form, the capitalization of subsidies in the form of investments and political organization creates a “trap” that is hard to escape. Where those traps exist, reform may be impossible without massive resources or a shock from external factors that force a re-pricing of capital assets.

Much of the world is in this extreme trap. Readers in the US and Canada should be quite familiar with it, though it exists across the globe. But this year — because of COVID-19 and the pre-existing weak conditions in the oil market — is a unique opportunity for us to make change. Removing subsidies would be inexpensive for consumers because of the low price of oil and we’re in the midst of a massive adjustment in the valuation of oil and gas assets. So far, progress has been depressingly limited, but we may never see another opportunity like this again. If you’re in a position to make political noise of any kind, now is the time to fight fossil fuel subsidies.

Book Recommendation: Fossil Fuel Subsidy Reforms, Jun Rentschler

This book, written in 2018 by the author of “Reforming fossil fuel subsidies: drivers, barriers and the state of progress” (above), looks at how we can approach fossil fuel subsidy reform globally. Rentschler looks at who is involved, who exercises decision-making power, what the impacts of reform would be, and how to mitigate negative impacts and use reform to drive sustainable development. Despite my rhetorical tone in the introduction, subsidy reform — especially on the consumption side and in the developing world — is a delicate issue and while it needs to be done urgently, it also needs to be done carefully. And it can’t be done at all without a good understanding of the political economy involved.

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