by Jerry Byers
The International Monetary Fund is muddying the already cloudy waters on how the world should address energy development and trade. The original report, released in May of this year, would have the casual observer believing that governments are using tax dollars to fund the energy industry to the tune of over 5 Trillion USD a year and growing. If that seems outrageous, it’s because it is. The reality of the matter is quite different.
Three Things You Should Know Regarding Subsidies
First, subsidies are not always bad. This is especially true of direct energy subsidies such as the development of nuclear energy, hydrogen fuel cells, efficient lighting, etc. Other subsidies help manage costs to consumers in order to keep utility and fuel costs affordable such as heating and electricity assistance.
Secondly, There is a distinct difference between “direct” and “indirect” subsidies and a further difference between them and unassigned externalities.
Third, the accuracy of the IMF accounting of subsidies is accurate to within 4.5 Trillion USD a year depending on what figures and estimations are used. The International Energy Agency put the value at around $500 billion USD last year and some “green” advocates place the number at almost double the IMF. Assigning a value to pollution, death, climate change damage, additional healthcare costs, etc. that arise from external factors of fossil fuels is extremely hard if not impossible. Furthermore, the IMF report would have us believe that world governments are picking up 100% of the tab for these externalities and that is not remotely accurate either.
The Report and Reactions
The original assessment was made by Benedict Clements and Vitor Gaspar and posted on their IMF blog in mid-May and titled Act Local, Solve Global: The $5.3 Trillion Energy Subsidy Problem. A subsequent release of country specific data was published in July of this year.
The articles point out that pre-tax subsidies are actually falling, but that “post-tax subsidies” have been largely underestimated. The authors call these estimates “shocking”. They make an argument for substantial reforms in global subsidies for energy ahead of the Paris Climate Conferences by “getting the prices right” for energy consumption. They are advocating for higher taxes on fossil fuels opening the door for renewables to become competitive.
Of course, the report was immediately picked up and internationally parroted by advocates of climate change prevention, renewables proponents, and the anti-fossil fuel crowd. One headline reads, “The IMF Just Destroyed the Main Argument Against Clean Energy” written by a lawyer for Sullivan and Worcester which provides representation for environmental advocacy groups and posted on the Energy Post website before it was picked up by other Green groups.
Oddly, some of the most critical reactions came from the Green crowd claiming that the IMF estimates were too small and didn’t accurately reflect the costs associated with global warming. However, several economists have been critical of the accuracy of the data used for the IMF model, which comes from the International Energy Agency (IEA), the Organization for Economic Cooperation and Development (OECD), and IMF “staff estimates”.
Subsidies, Indirect Subsidies and Externalities
The biggest problem with the IMF report is that it’s not distinguishing the huge difference between an actual “subsidy” and “externalities”. Instead, it is controversially classifying externalities as “indirect subsidies”.
A “subsidy” as defined by five online dictionaries including Merriam-Webster, Cambridge, and Investopedia all characterize a subsidy as money, tax breaks, or other special assistance given to individuals, groups, or companies for the perceived public good by a government. This is fairly straightforward and most people understand that these subsidies exist and why. For instance, a government might grant a direct subsidy to a nuclear firm for research and development on a better reactor, or subsidize/guarantee loans to a solar panel company, or give a tax break for investments into carbon capture systems that reduce CO2 emissions.
What the IMF is referring to as an “indirect subsidy”, and then incorrectly lumping together with the aforementioned real subsidies, is actually a situation called an “externality” which occurs when the market cost of a particular good doesn’t accurately reflect the true cost to society as a whole. One of the best ways to describe it is to think of the pollution created when driving cars. The consumer pays the cost of the gasoline and gains the benefit of using the gasoline, but everyone receives the negative benefit from the pollution created by the burning of the gasoline. The following graphs (Figure 1, Figure 2) illustrate the differences between an externality and a direct subsidy.
The amounts of these “external” costs are not factored into the price paid for the gasoline and yet people outside the transaction are negatively affected. These externalities are often difficult to quantify and we rely and trust economists to create models that can accurately reflect these costs in order to make good policy decisions.
Governments often raise taxes on these goods to help offset these negative benefits because the costs are often paid by the government and/or individuals for such as things as asthma medication for a child suffering from poor air quality. Another way to address these externalities is to try to change consumer behavior by charging “Pigouvian” style taxes that diminish the appeal of these products for consumers. For example, the prices many Europeans pay for gasoline or the cost of cigarettes in New York City or California, which are taxed heavily in order to reduce consumption. It is these types of taxes that the IMF report is advocating for.
None of this part of the equation is alarming or unusual. The part that makes it confusing is when the IMF starts using terminology such as the word “subsidy” when it tries to quantify these externalities. These externalities are not fully subsidized by the government because they don’t PAY the complete value of the externality. Often, they pay little or none of the negative benefit and individuals pick up the costs.
IMF Targets Fossil Fuel Producers
The other area the IMF report labels as a subsidy is the market prices for some commodities in resource rich countries. It asserts that countries such as Iran, Saudi Arabia and Russia are subsidizing energy export commodities because prices domestically in these countries are far cheaper than what consumers pay in many import markets. For instance, Russians pay less for their natural gas supplies than Europeans that import Russian gas. Much of the difference is explained in the pricing “netback” versus “costs plus” pricing formulas, but suffice it to say that my neighbors can buy my oranges more cheaply than people 1000 km away. I may do this voluntarily or perhaps my government mandates I sell them for less in exchange for allowing me to grow oranges on public land.
The IMF’s assertion that Russian natural gas is subsidized in this way is a huge distortion because it assumes there is a world gas market similar to that of oil. Natural gas is still limited to regional markets and most gas contracts are still bilateral agreements between producers and consumers. However, even if there was a common world market for gas, oil, coal, and electricity it would be naïve to expect producer states, especially those in the developing world, to sell domestically extracted natural resources for the same price as they would the developed world.
Using IMF logic, the reason that I pay less for a round trip ticket from St. Petersburg to Chicago than for the same flight with the same airline originating in Chicago is because of a “subsidy”. The truth is that it has more to do with the ability of the consumer to pay. The actual costs are not significantly different, but the airline knows that Americans have more money, on average, than Russians and therefore charges Americans more for the same ticket. This is more a matter of geography and not subsidies.
Schalk Cloete wrote a great article in August of 2013 discussing this very topic in the Energy Collective. He describes the situation with producer nations:
“The bulk of these subsidies are in oil-producing countries which can still extract oil from their conventional oil fields at very low prices and continue to pass these low prices on to local consumers…These nations simply prefer the economic growth provided by selling fossil fuels closer to the local cost of extraction over the increased profits resulting from selling more of their product at international market prices.”
Cloete further explains:
“Forcing the Middle East (which can still extract oil for $20/barrel or less) to sell this oil locally at $100/barrel would be similar to forcing a solar farm in Mexico to sell electricity at the same price as that required by a solar farm in Greenland.”
The following graph from the IEA’s 2014 World Energy Outlook (Figure 3) shows the countries that have the largest amounts of these types of subsidies. The report notes that the amount of subsidies in these countries is also decreasing, and it further notes that the total amount is closer to half a trillion USD, nowhere close to 5 Trillion USD as the IMF contends.
You’ll notice that nearly all the countries are developing or underdeveloped and not members of the OECD or IEA. The following quotes from the IEA report are very telling in how the OECD, IEA, and IMF view energy producing countries. The highlighted portion is my emphasis.
“Subsidies to fossil fuels, which encourage wasteful consumption, remain a big problem, despite major efforts on the part of many countries to eliminate them. […] In 2013, the global value of subsidies that artificially lower end-user prices for all forms of fossil energy totaled $548 billion – a $25 billion cut from the previous year”.
“Ten countries account for almost three-quarters of the world total for fossil-fuel subsidies; five of them – all oil and gas exporters – are in the Middle East or North Africa. Most of the other leading subsidisers are also important hydrocarbon producers. They generally set domestic prices above the cost of production, but well below the prices those fuels could reach on the international market”.
The Negative Consequences of Economic Reports that Distort Facts
Why is this important? I took an informal poll of my colleagues and friends and made several inquiries to economists. I asked them, “What is a subsidy?” I didn’t receive a single answer that included external costs aka indirect subsidies. Not one. That is the most alarming part. If people don’t understand your language, then they won’t understand the message and the IMF report is speaking a very unique language.
Three distinct consequences from the IMF Report and those that parrot it:
- Contributes to the increasingly popular and inaccurate “fossil fuels are bad” narrative and governments are using your tax dollars to help that industry.
- Paints resource rich countries as playing unfairly, namely Russia, Iran, and Saudi Arabia but includes big consumers like the U.S. and China as culprits.
- Misleads readers into thinking that all subsidies are detrimental to combatting climate change and pollution.
Interestingly enough, my first exposure to this report came from an energy expert who incorrectly assumed that there was now proof that energy companies were getting enormous direct subsidies from individual governments and so she forwarded it on to me.
This is not even remotely accurate. Energy producers rarely depend on direct subsidies in order to remain competitive with the distinct exception of renewables, which receive exorbitant subsidies in the developed world. More accurate is the fact that economic growth and positive externalities from fossil fuels account for huge growth in developing countries and improve their citizens’ standards of living.
The IMF’s follow up article from July finishes by stating:
Your reform, your benefit
It is generally in countries’ own interest to move ahead unilaterally with energy subsidy reform. Top subsidizers in percent of GDP and in per capita subsidies stand to gain the most. The benefits will mostly accrue at the local level, by reducing local pollution and generating much needed revenues. Taxing fuels to reflect environmental costs is also straightforward administratively, as it can build off road fuel excises which are well established in most countries.
Energy subsidy reform can also contribute to carbon emissions reduction and help countries make pledges ahead of the Paris 2015 UN climate conference. To achieve significant carbon emissions cuts at the global level, it would be essential for top subsidizers in dollar terms to play a leading role.
It recognizes that the poor in these countries will be the hardest hit by these types of reforms, but suggests they’re necessary for the global good and that with energy prices at low levels it is best to act now.
The IMF report recommends that these countries raise their prices to consumers through increased taxes and suggests that it is in these countries best interests to do so. Apparently, the trade off is to pay for climate change prevention by taxing poorer consumers in developing nations.
Ironically, by their own definition, artificially raising prices on one good, such as fossil fuels, in favor of a replacement product (renewables) IS an indirect subsidy of the replacement product. The IMF report isn’t truly advocating for removal of subsidies, direct or indirect, but rather a shift in where subsidies are applied.
All these assertions being made by those that buy into the IMF and the movement to redefine externalities are at the very least, a mischaracterization, and at the most a direct attempt to control and distort the energy narrative leading up to the Paris climate change conference. Most generally people are unfamiliar with the term “externality”, but they have a rough conception of “subsidy”. Therefore, by renaming externalities in a stigmatizing fashion, institutions advocating for the elimination of all subsidies are seeking to eliminate one of the best policy tools at the disposal of governments.
Distorting the argument doesn’t help policy makers or voters in making informed decisions on the best courses of action in dealing with climate change. The vilification of the fossil fuel sector as “corporate welfare” recipients and those countries that depend on their natural resources to drive their economies doesn’t move us forward on creating solutions either. If the IMF argument is sound then it shouldn’t have to mask it with ambiguous terms or grandiose headlines.
ENERPO Journal Associate Editor – Online Edition. Graduate student of the ENERPO Program (Expected graduation date: 2016). He studied at Cornell College and received a BA in both Russian Studies and International Relations. He also holds an AAT (Associates Degree in Teaching) from Longview College.
Address for correspondence: firstname.lastname@example.org