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17 May 2019

IMF shows fossil fuels subsidies remain close to government hearts

A report from the Fiscal Affairs Department of the International Monetary Fund out this week shows that fossil fuel subsidies are large and still growing, and the paper calls for real pricing, where fossil fuels go unsubsidized, so that the entire global energy economy can get back to reality.

This is a critical moment in the development of renewable energy. If subsidies are raised or continued beyond their economic life, simply because it is either politically correct to do so, or because of the lobby power of fossil fuels of the consumer, then renewables can say what they like about parity with fossil fuels, but while subsidies remain, fewer deals will go the way of renewables.

The intrinsic gap between the price of renewables and the price of building coal fired power stations is undeniable right now, and anyone building fresh coal fired power stations is looking at an economic disaster – it could only be calculated as cheaper by a government if that government ignores what it already pays in subsidies to the various extractive industries for helping the industries or citizens to pay for fuel.

Local climate change activism may highlight a preference for renewables and get everyone excited, and newsletters like our may highlight intrinsic disparities in cost, but it is finance ministers inside elected governments who simply fail to change past subsidy arrangements for coal, gas and oil and blindly continued with fossil fuels. Failure to change that has a huge bearing on renewables.

The two key things that need to change is that subsidies for fossil fuels need to be cancelled and the money diverted to renewables for just one or two years. That alone would solve global warming, and also give some much needed profit relief to the renewable community. But it may get any government out of office which took that decision.

We spoke to a developer yesterday talking about wind, and when we asked if it was profitable business he said, “there is an 8% or 9% margin and it is very good business,” but then used the expression, “but it’s not oil and gas ,” where the margins are closer to 16% for exploration alone.

This is then the crisis of the moment for renewables. If the current wave of climate change activism creates any change, it needs to be these subsidies and it needs to eat into that desirable profit margin for the extractive industries, not make costs higher for the average consumer. A government may risk being accused of “deserting” its miners and energy workers, but if it was careful and instead of applied to same benefits only to renewables, and at the same time retrains the workforce which this would throw on to the market in renewables and energy conservation, it could have a “zero sum game” where for no extra costs, it meets it Paris Climate accord agreements.

The IMF paper shows that fossil fuel subsidies were at $4.7 trillion (6.3% of global GDP) back in 2015 and are likely to be $5.2 trillion (6.5% of GDP) when calculated for 2017.

The largest subsidizers were China ($1.4 trillion), USA ($649 billion), Russia ($551 billion), the European Union (with $289 billion), and India ($209 billion) – which collectively make up 66% of all global subsidies, so changing their behavior would be sufficient to solve most of the problem. Coal (44%) and Petroleum (41%) account for 85% of global subsidies. The IMF calculated that pricing the fossil fuels correctly would have lowered pollution by 28%, a massive step towards Paris agreement levels.

The paper breaks down cost into three components – first the cost of actually supplying the fuel, second the cost of air pollution, measured partly in the  cost of bringing it under control and also in the cost of higher mortality rates and health costs associated with polluted countries. Thirdly there is the tax at the point of consumption, which is often undercharged where much of the subsidy occurs. Just putting full VAT on coal, electricity and petrol might fix this, but many modern democracies have tried this, only to find voters up in arms. Usually this is because those governments fail to understand that this will fall away if the same subsidies are replaced with similar tax benefits for renewables, carried out in tandem, alongside an edict to get more electricity from renewables. Right now some democracies might find this an acceptable shift.

However when this was tried in France, it was a political disaster, with the gilets jaunes (yellow vests) protesters as vociferous as the climate change protesters elsewhere. Result stalemate. Simply because President Macron of France did not hand out the same subsidies to renewables in concert with the planned tax changes, nor take the bulk of the cost from oil and coal company profits, but instead allowed it to be passed onto consumers.

The IMF paper shows a realistic approach to rigor in the way it has worked out these costs, but there is still room for people to argue the toss about it, and suggest that all governments are doing is making life easier for their citizens although it just so happens that it also lines the pockets of the oil and coal community.

The report lists the benefits of reform, in terms of environmental gains, finance and economic welfare, and on the fiscal front reckons that savings of $3.2 trillion could be made, but admits that not all countries are willing or able to raise fuel prices.

Of course applying real world pricing and preventing the extra costs being paid for by consumer pricing, would cut a huge hole in the profits of oil and coal companies, and be vastly unpopular, but if the political climate moves further in favor of a carbon free future, that may well be the likely outcome, requiring legislation which the man in the street need not care about. Emissions trading systems have also been used, but largely without a huge effect on energy usage. The IMF may have pointed out a problem, but so far it does not show how the problem may be solved.