Sifting through shifting support for energy subsidies

by Tanya Bodell, Energyzt

The energy industry is filled with government support, usually in the form of tax credits or subsidies. Although economists tend to abhor such government intervention in otherwise competitive markets, there are many conditions under which such programs can be justified economically. The strength of those justifications often ebb and flow with the underlying economics created by status quo conditions.

Support for Fossil Fuels

Fossil fuels such as oil, natural gas and coal have enjoyed immense government support. Globally traded, domestic and international subsidies affect the price of these energy sources. A report by the International Monetary Fund (IMF) issued earlier this year calculates that fossil fuel subsidies worldwide total $1.9 trillion, or about 8 percent of all government revenues.

The IMF estimates include direct subsidies and indirect tax credit support to oil and natural gas producers. Most of the estimated support, however, is composed of costs associated with 1) subsidies to complements such as transportation infrastructure and military support; and 2) failure to price externalities such as environmental quality, health, safety and congestion. Although most fossil fuel subsidies occur in emerging economies and developing countries, the IMF report estimates the United States spends roughly $502 billion in fossil fuel support, of which subsidies and tax credits range from some $10 billion to $52 billion annually. The Obama administration has proposed to eliminate $4 billion of this support without success.

Support for Renewable Energy

Renewable energy advocates argue that global government support of fossil fuels creates an unfair playing field that requires implementation of the equivalent support for alternative energy. To the frustration of alternative energy advocates, government support for renewable energy shifts with the political winds. President Jimmy Carter installed solar panels on the White House; President Ronald Reagan removed them. The production tax credit (PTC), a 20-year-old pillar that supports the economics of the renewable energy industry, has been allowed to lapse before being extended another one to five years. The lack of long-term certainty forces the industry to grow in fits and starts, gaining momentum when lucrative programs are in place and screeching to a stop as the industry waits for Congress to pass the next set of incentives. Relative energy prices, warped by fossil fuel subsidies, are a critical factor.

Collective Action

The IMF study argues that eliminating fossil fuel subsidies worldwide would reduce greenhouse gas emissions 13 percent and unlock trillions of dollars that could be redirected toward infrastructure investment and social support. Such a proposal will be difficult to implement because it creates a textbook collective action problem. If all but one country removed the subsidies, the sole country with subsidies would benefit from worldwide environmental improvement, as well as a more competitive position in energy markets. Each country acting in its self-interest is likely to maintain fossil fuel subsidies, resulting in a worse position collectively than if all subsidies were removed.

A collective action problem challenges worldwide adoption of carbon tax and global support for renewable resources. Any jurisdiction that supports renewables through subsidies or carbon limits imposes an additional cost on itself that can create a competitive disadvantage. This has been recognized by global leaders such as Germany and Spain, which spent billions of dollars in support of alternative energy programs before pulling back in response to economic strain. In the U.S., California’s Little Hoover Commission has called for “greater clarity on the aggregated costs and consequences of the energy policies being implemented in California.” As a result of status quo conditions and collective action problems, it will be difficult to realize worldwide support for renewables and elimination of fossil fuel subsidies. Yet in a world without fossil fuel subsidies, alternative resources will be more economic. An exercise to overhaul energy policy reflecting unadulterated economics is in order. Even if such a world of pure economics does not exist, the results will inform a contentious debate colored by current market conditions.

Author

Tanya Bodell is executive director of Energyzt, a collaboration of energy experts intent on understanding the impacts of energy integration. Reach her at 617-416-0651 or tanya.bodell@energyzt.com.

“When we give a subsidy, the benefits to the public ought to exceed the benefits to the company. When it doesnt, thats our definition of corporate welfare.”

—Ohio Gov. John Kasich

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