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Energy subsidies

Tracking the impact of fossil-fuel subsidies

The IEA has been measuring fossil-fuel consumption subsidies in a systematic way for more than a decade. The analysis performed by the World Energy Outlook is aimed at demonstrating the impact of fossil-fuel subsidy removal for energy markets, climate change and government budgets.

Tracking fossil-fuel subsidies

The value of fossil-fuel subsidies increased in 2018

Higher average oil prices in 2018 pushed the value of global fossil fuel consumption subsidies back up toward levels last seen in 2014, underscoring the incomplete nature of the pricing reforms undertaken in recent years. The new data for 2018 show a one-third increase in the estimated value of these subsidies, to more than $400 billion. The estimates for oil, gas and fossil-fuelled electricity have all increased significantly, reflecting the higher price for fuels (which, in the presence of an artificially low end-user price, increases the estimated value of the subsidy). The 2018 data sees oil return as the most heavily subsidised energy carrier, expanding its share in the total to more than 40%. In 2016, electricity briefly became the sector with the largest subsidy bill.
Methodology and assumptions

久草影院The IEA estimates subsidies to fossil fuels that are consumed directly by end-users or consumed as inputs to electricity generation. The price-gap approach, the most commonly applied methodology for quantifying consumption subsidies, is used for this analysis. It compares average end-user prices paid by consumers with reference prices that correspond to the full cost of supply. The price gap is the amount by which an end-use price falls short of the reference price and its existence indicates the presence of a subsidy. In a given economy, the basic calculation of subsidies for a product is:

Subsidy = (Reference price - End-user price) × Units consumed

久草影院The data required for the price-gap calculations are extensive. End-user price and consumption data are drawn from IEA data and, where necessary, from government sources and other reports. Furthermore, the estimate is sensitive to reference prices, which are calculated for fuels on the basis of international prices. Electricity reference prices are derived from annual average-cost pricing (see below for further explanation of how reference prices are calculated).

For economies that export a given fossil-energy product but charge less for it in the domestic markets, the domestic subsidies are implicit; they have no direct budgetary impact so as long as the price covers the cost of production. The subsidy, in this case, is the opportunity cost of pricing domestic energy below international market levels, i.e. the rent that could be recovered if consumers paid world prices, adjusting for differences in variables such as transportation costs. For net importers, subsidies measured via the price-gap approach may be explicit, representing budget expenditures arising from the domestic sale of imported energy at subsidised prices, or may sometimes be implicit. Many economies, Indonesia for example, rely extensively on domestically produced fuels, but supplement domestic supply by importing the remainder. In such cases, subsidy estimates represent a combination of opportunity costs and direct expenditures.

久草影院Estimates using the price-gap approach capture only interventions that result in final prices to end-users below those that would prevail in a competitive market. While such subsidies account for the majority of subsidies to fossil fuels, there are numerous others that are not captured by the price-gap approach. It does not, for example, capture subsidised research and development or subsidies for fossil fuel production. Estimated based on the price-gap approach therefore understate total fossil-fuel subsidies as well as their impact on economic efficiency and trade. Despite these limitations, the method is a valuable tool for estimating subsides and for undertaking comparative analysis of subsidy levels across economies to support policy development. 

For net importers, reference prices are based on the import parity price: the price of a product at the nearest international hub, adjusted for quality differences if necessary, plus the cost of freight and insurance to the net importer, plus the cost of internal distribution and marketing and any value-added tax (VAT). VAT was added to the reference price where the tax is levied on final energy sales, as a proxy for the tax on economic activities levied across an economy. Other taxes, including excise duties, are not included in the reference price. For net exporters, reference prices were based on the export parity price: the price of a product at the nearest international hub, adjusted for quality differences if necessary, minus the cost of freight and insurance back to the net exporter, plus the cost of internal distribution and marketing and any VAT. All calculations are carried out using local prices and the results are converted to US dollars at market exchange rates.

Assumed costs for transporting oil products vary according to the distance of the country from its nearest hub; these are taken from average costs as reported in industry data. Average internal distribution and marketing costs for oil products in all economies are assumed to be equal to costs in the United States. For natural gas and coal, transport and internal distribution costs are estimated on the basis of available shipping data.
Reference prices are adjusted for quality differences, which affect the market value of a fuel. Reference prices are assumed to be below observed import prices in some cases, such as steam coal in India, which relies heavily on low-quality domestic coal but imports small volumes of higher quality coal.

久草影院Unlike oil, gas and coal, electricity is not extensively traded over national borders, so there is no reliable international reference price. Therefore, electricity reference prices were based on annual average-cost pricing for electricity in each country (weighted according to output levels from each generating option). In other words, electricity reference prices were set to account for the cost of production, transmission and distribution, but no other costs, such as allowances for building new capacity. They were determined using reference prices for fossil fuels and annual average fuel efficiencies for power generation. An allowance of $15/MWh and $40/MWh was added to account for transmission and distribution costs for industrial and residential uses, respectively. To avoid over-estimation, electricity reference prices were capped at the levelised cost of a combined-cycle gas turbine (CCGT) plant.

Some authorities regard the above method of determining reference prices as inappropriate. In particular, a number of energy resource-rich economies are of the opinion that the reference price in their markets should be based on their cost of production, rather than prices on international markets as applied within this analysis. The basis for their view typically is that natural resources are being used to promote their general economic development, and that this approach more than offsets the notional loss of value by selling the resource domestically at a price below the international price. The counter-argument is that such an approach results in an economically inefficient allocation of resources and reduces economic growth in the longer term.

End-user prices data are from IEA World Energy Prices database, 2019

Our work

In September 2009, G20 leaders took a key step towards reforming energy subsidies at their summit in Pittsburgh, United States. Together, they committed to “rationalize and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption”. This move was closely mirrored by Asia-Pacific Economic Cooperation (APEC) leaders in November 2009. These commitments were made in recognition that inefficient fossil-fuel subsidies distort markets, impede investment in clean energy sources and undermine efforts to deal with climate change.

During the Pittsburgh Summit, the G20 requested the IEA, OECD, World Bank and OPEC to prepare a Joint Report on the scope of energy subsidies and suggestions for the implementation of their phase-out initiative. The Joint Report was presented to the G20 Toronto Summit in June 2010, during which country-specific implementation strategies and timetables were tabled.  

The IEA, OECD, and World Bank were subsequently requested to prepare a second report for the November 2010 G20 summit meeting to be held in Seoul, Republic of Korea. This work extends the analysis presented in Toronto in June 2010, in particular by updating the quantitative findings to include data for the year 2009 and providing a road map for phasing out fossil fuel subsidies.