Reforming Fossil Fuel Subsides for a Cleaner Future

Phasing out fossil fuel subsidies remains a major global challenge, two years after the adoption of the Paris Agreement at COP21.

These subsidies contribute significantly to global warming. At a time when countries are trying to put the brakes on burning fossil fuels, an estimated 13% of global CO2 emissions has been linked to the use of subsidized fossil fuels for consumption, according the International Energy Agency (IEA).

The IEA also found that in 2015, about $325 billion was spent on energy subsidies globally - more than double the value of subsidies for renewables.

Not only are subsidies holding the world back from a low-carbon future, but their intended beneficiaries – the poor – gain significantly less from these subsidies than the wealthy who generally consume more energy. Subsidizing fossil fuels can also reduce the amount of public money available for schools, hospitals, and social programs to help poor and vulnerable populations.

The good news is that over the past decade, many countries have managed to reform their subsidies successfully.

For example, in 2015, Saudi Arabia, announced a 5-year plan to raise fuel prices. India removed price controls on diesel and gasoline, and it has launched a successful campaign to get wealthier consumers to voluntarily give up subsidized liquefied petroleum gas (LPG). 

The Paris Agreement provided a further impetus for reform for at least 11 countries—Egypt, Ethiopia, Ghana, India, Iran, Kuwait, Morocco, Rwanda, Togo, the United Arab Emirates, and Vietnam— that included fossil fuel subsidy reforms in their Nationally Determined Contributions (NDCs).

A few countries have made progress with the help of the World Bank and its Energy Sector Management Assistance Program (ESMAP):

• Through analysis, technical assistance, and capacity building ESMAP helped Egypt to halve the fiscal cost of subsidies and bring average electricity tariffs closer to cost recovery. The country was able to increase spending on education and health with the fiscal savings. These reforms have catalyzed demand for energy efficient appliances and reduced peak load.
• Ukraine increased residential gas tariffs by 470% and district heating tariffs by nearly 200% amid a fiscal crisis. It also raised the number of households covered by the social protection system from 1 million to almost 7 million to ensure that the most vulnerable were protected from the price increases. With ESMAP support, the World Bank is now assisting the country to set up the Ukraine Energy Efficiency Fund to finance retrofits of multi-apartment buildings to reduce heating bills.

Reforming subsidies is a complex and politically difficult process. While the fall in oil prices in 2015 has facilitated many of these reforms, lessons are emerging about how to sustain them, even if oil prices start rising again.

Experience from countries across the world shows that careful policy design is not enough for successful reforms. Political will is what drives the process, often stemming from strong fiscal pressures, and supported by key champions for reform and an informed public.

It is also evident that subsidy reform is less a technical challenge than a political one.  Communications must be clear and take place before reforms are implemented.  Success requires that people understand why reforms are necessary and what they can receive in exchange for higher fuel prices. For example, in Egypt and Ukraine, the governments committed to strengthen social safety nets with budget allocations.  Similarly, in Indonesia, the government committed to divert the money saved to public infrastructure investments.

Reforms are not just about prices.  In every case of successful reform, it has been about the social compact between government and citizens. In Angola, Egypt, Honduras and Ukraine, subsidy reform strengthened broader social policy. For example, in Ukraine, one element that helped increase the acceptability of the reform was to allow people to apply for social assistance by mail, so asking for help was less public.

These and other lessons were discussed at a November 15 event on fossil fuel subsidy reform at COP23 in Bonn, Germany, organized jointly by ESMAP; the German Federal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety; and the German Federal Ministry of Economy and Energy. The event brought together representatives of Germany, Indonesia, and Mexico and from the OECD, the World Bank, and IISD’s Global Subsidies Initiative to share knowledge in implementing reform and to call for further action.

A preview of ESMAP’s energy subsidy reform assessment framework was also presented. The framework is a comprehensive guide to help counties navigate through the complex landscape of reform.  It offers tools to help identify subsidies and outlines approaches to diagnose their impacts. It helps to better understand political contexts and provides guidance on how to consult and communicate with the public to address concerns. It also includes a rapid diagnostic analysis tool to guide the process without prescribing policy recommendations, as there can be no one-size-fits-all approach to subsidy reform.

(Originally appeared on the ESMAP website.)