The long goodbye to fossil fuel subsidies

Ben Goldsmith, partner at sustainable investment group WHEB, outlines three reasons why global fossil fuel subsidies will not last a generation.

Fossil fuel subsidies are a familiar topic in environmental circles. But, even so, an annual increase in global hydrocarbon subsidies of 30% to $523 billion went relatively unremarked when it was announced by the International Energy Agency in late 2012.

Combined with the scale of subsidy is the sheer complexity of the support. The Organisation for Economic Co-operation and Development (OECD) has counted over 250 separate mechanisms, ranging from direct consumer subsidies, for example by keeping retail fuel prices artificially low when compared with an international reference price, to producer support, ranging from underwriting risk, selectively reducing, rebating or removing taxes that would otherwise be paid or transferring funds directly to producers.

In spite of the scale of these subsidies and the complexity in their provision, there are fundamental factors at work which ultimately will make fossil fuel subsidies unsustainable and will lead to their decline and allow other forms of energy to compete more easily.

First, in the last 10 years or so the prices of many soft and hard commodities have increased and become more volatile. According to a report written by consultants MJ Bradley & Associates for a US taskforce on natural gas markets, “global commodity prices on the whole appear to be getting more volatile, having shifted from a fairly calm 15-year period from 1990 to 2004 to an upward trend from 2004 to 2010”.

Clearly the advent of cheaper shale gas has altered the trend in the US, but even here price volatility is still expected to remain an issue. As James Rogers, CEO of Duke Energy, put it, “Ben Franklin said there are two certainties in life: death and taxes. To that, I would add the price volatility of natural gas.”

Add global geopolitics and the strategic vulnerabilities in energy supply chains – an issue not lost on groups determined to antagonise the west – and continued price volatility is inescapable.

This volatility, combined with price increases in many parts of the world, exposes governments to a subsidy gap that is both unpredictable and, most likely, widening. Renewable energy by contrast invites a narrowing cost gap – because of declining equipment costs, ostensibly zero fuel costs, and little dependence on unstable supply chains.

Secondly, pressure is building for greater transparency and accountability in the fossil fuel industry. Reforming subsidies is politically difficult due to voters’ dependence on expensive forms of hydrocarbon energy and is, in the words of the OECD, “not easy due to the vested interests of those that benefit from them and the limited available data”. However, more transparency is being delivered by projects such as the 2013 OECD Inventory of Support to Fossil Fuel Production or Use.

The energy industry also moved down the Edelman Trust Barometer in 2012, enjoying the trust of only 53% of those surveyed. An increasingly unpopular industry, defending expensive subsidies, is clearly not well-placed to escape the moving frontier of better governance and accountability which has already swept many industries before it.

Finally, energy users can be expected to become increasingly autonomous in their consumption of energy. Reduced demand for electricity plays a part.

The chairman and CEO of the US utility Xcel believes energy efficiency is dampening demand in the US by 0.7% per annum. In 2012, most major European countries also saw reductions in energy demand, with a significant part due to governmental energy efficiency initiatives.

At the same time, energy users are increasingly producing their own electricity. In Germany, where renewables are furthest advanced, 37% of renewable energy generation infrastructure is owned by households. Utilities and financial investors are second with 25%, with farmers at 20% and industry at 16%.

In the UK, over a third of UK businesses are also considering generating renewable energy on their premises, the principal reason being a desire to control energy costs more effectively. These shifts won’t happen across Europe overnight, but they are progressively weakening public support for fossil fuel subsidy paid for by taxpayers.

Subsidies for fossil fuels have existed for as long as the industry. It is perhaps no surprise that, in spite of calls by the OECD and the G20 to phase out harmful fossil fuel subsidies and echoed in person by Barack Obama, the reality has proved extremely hard to deliver.

Indeed, when new forms of fossil fuel are discovered, such as the recent shale gas finds under Blackpool in the UK, they are immediately welcomed with the announcement of new tax breaks.

The question is: are such tax breaks merely delaying our inevitable energy transition? I would argue they are, and that accelerating rather than delaying the advent of a level playing field for different energy sources is in the greater collective long-term interest.

Ben Goldsmith is a partner at WHEB. This article originally appeared in the second issue of WHEB’s magazine, WHEB Quarterly, which is published every three months.

Further reading:

Inquiry launched to ‘get to the bottom’ of UK energy subsidies

Governments are throwing ‘green money after brown’

Ditch energy subsides for a better world, says IMF report

The real energy subsidy scandal

What have subsidies ever done for us