Budget 2021 should end the subsidising of fossil fuels

Posted on Friday, 2 October 2020

There has, for some time now, been a consensus among the environmentally-focused scientific community that for humanity to avoid climate disaster, the vast majority of existing coal, oil and gas reserves must remain in the ground. With this in mind, most developed economies have begun a process of de-carbonisation which involves the removal of costly Fossil Fuel Subsidies (FFSs).

The term “Fossil Fuel Subsidy” may not be widely known, but environmental lobbyists are increasingly focused on eliminating such subsidies as they are an indirect or clandestine way of encouraging the burning of harmful fossil fuels that, under other circumstances, might not be economically viable. For this puprpose, 'subsidy' is defined as anything that:

  • lowers the cost of fossil fuel exploration or production;
  • lowers the price paid by energy consumers; or
  • subsidises the activities or profits of energy producers.

FFSs include things like tax breaks on fossil fuel exploration and government spending on fuel-poverty alleviation policies that use fossil fuels.

The IMF gives two definitions of “subsidy” relating to fossil fuels:

  • Where consumer prices are below the opportunity cost of supplying energy;
  • A broader definition, based on “the true cost” of energy consumption, accounting for undercharging for environmental costs – carbon emissions, local air pollution, traffic congestion, and so on – and the failure to fully apply standard rates of consumption tax.

Based on the first definition, global energy subsidies are estimated at about $500 billion. However, under the second broader definition, subsidies are estimated at more than $5 trillion (or about 6.5 per cent of global GDP, pre-Covid). The bulk of these subsidies are due to under-pricing of energy, setting energy taxes below levels that fully reflect the environmental damage associated with energy consumption. Interestingly (and perhaps worryingly), that figure of 6.5 per cent of global GDP has been more or less steady for this decade, suggesting that the value of such subsidies is deeply structural and depends heavily on the economic cycle.

Despite commitments from most governments to phase out FFSs, progress has been limited. The EU had committed to phasing out FFSs by 2020, and the governments of the G7 countries have committed to 2025, but many have already broken from this pledge. For example, between 2013 and 2015 the European Investment Bank (EIB) provided approximately €7 billion in funding for fossil fuel-related projects. The European Bank for Reconstruction and Development (EBRD) made investments of up to €5 billion in fossil fuel exploration over the same period. Both banks are arms of the EU.

A case study on capacity markets in the United Kingdom (though no longer an EU member) shows that over €800m was set to be channelled to coal and diesel investments between 2014 and 2018.

A major project that will have a significant impact on whether the EU meets its professed targets is the Southern Gas Corridor; a 3,500km chain of gas pipelines from Azerbaijan to Italy, expected to start pumping gas to Europe in the next few years. Such a large infrastructure project would lock in gas dependency for decades to come.

Publicly funding this project goes against EU’s international commitment under the 2015 Paris Agreement and defies the European Commission’s own projections that the demand for gas in Europe is dropping. The total cost of the project is estimated to be $45 billion. The EIB and EBRD contributions for the sections through Greece and Albania are expected to be the biggest single loans in the history of each of the banks (up to €3 billion and €1.5 billion respectively).

The International Energy Agency has estimated that four-fifths of the total energy-related CO2 emissions permissible by 2035 were already “locked-in” by existing capital stock (e.g. power plants and factories, buildings etc.) and that if stringent new action was not forthcoming soon, the energy-related infrastructure in place by then would generate all the CO2 emissions allowed up to 2035.

This would leave no room for additional power plants, factories and other infrastructure that were not zero-carbon; something which would be extremely costly. It concluded, therefore, that delaying action was a false economy, as for every $1 of investment avoided in the power sector pre-2020, an additional $4.30 would need to be spent afterwards to compensate.

Closer to home, things are no better. The Central Statistics Office (CSO) last year published a report that highlighted some of the ways that Ireland directly and indirectly provides support for fossil fuel extraction and consumption, as well as other actions that are potentially damaging to the environment. The numbers do not make for encouraging reading.

The CSO estimates that in 2016, the total amount in direct subsidies and revenue foregone due to preferential tax treatment supporting fossil fuel activities in Ireland was €2.5 billion, while a further €1.6 billion supported other potentially environmentally damaging activities. That's a total amount for potentially environmentally damaging subsidies of €4.1 billion in one year. Supports to fossil fuel activities increased on a year by year basis from 2012 to 2016 from €2.3 billion in 2012 to €2.5 billion in 2016.

More than half a billion euros (€534 million) was spent on direct supports for fossil fuel use in 2016. The Public Service Obligation levy – commonly known as the PSO, a levy Social Justice Ireland has campaigned for the abolishment of for years – to support peat-powered electricity and welfare programmes like the fuel allowance accounted for approximately 93 per cent of this spend. However, as has recently been pointed out by the Nevin Economic Research Institute (NERI), the larger part of government supports for fossil fuel use – and implicit subsidisation – occurred through exemptions in the tax code. The government levies lower excise on Auto-diesel, Marked Gas Oil, Kerosene, Aviation fuel and fuel oil than it does on unleaded petrol. If the state had levied the same excise on these fuels in 2016, an additional €2 billion extra in tax could have been collected. This is over 3 per cent of the total tax take in 2016. If rates of excise reflected the amount of carbon in these fuels, additional revenue would have been higher.

The EU and Ireland may like to view themselves as leading voices in advocating for strong climate action. However, evidence suggests both are way off track to achieve those goals, and that public funding is out of sync with the Paris Agreement. A significant increase in current policy ambition and a major shift in investment trends by all governments is required, and soon.