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© OECD/IEA 2011
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This background paper, prepared for the Asia‐Pacific Economic Cooperation (APEC) by the
International Energy Agency (IEA), estimates the cost of fossil‐fuel subsidies in APEC economies from 2007 to 2010 and models the benefits that would be realised if these subsidies were phased out by 2020.
Globally, the IEA estimates that subsidies that encourage wasteful consumption by artificially lowering end‐user prices for fossil fuels totalled $409 billion in 2010. Of that amount,
$105 billion were found in APEC economies. Of the 21 member economies, ten were identified via the price‐gap approach as having fossil‐fuel consumption subsidies. Subsidies that support fossil‐fuel production also remain in place among other APEC economies and include mechanisms such as tax breaks, credit support, direct spending and other incentives.
Phasing out inefficient fossil‐fuel subsidies, if well‐executed, can generate important economic, energy security and environmental benefits. Our analysis shows that, relative to a baseline in which subsidy rates remain unchanged, the complete phase out of fossil‐fuel subsidies in
APEC economies by 2020 would cut energy demand across the region by 2.3% in that year. Energy savings would be considerably higher in the particular countries that have subsidies. Oil demand would be lowered by 0.5 mb/d in 2020. Without reform, we estimate that the cost of fossil‐fuel
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consumption subsidies in APEC economies would reach $150 billion (in year‐2010 dollars) in
2020, or 0.3% percent of the region’s projected GDP, revenues that could be better used for other priorities. Phasing out fossil‐fuel subsidies would also help level the playing field for cleanenergy technologies and represent an important building block for tackling climate change, as expected growth in carbon‐dioxide emissions in the APEC region would be cut by 0.6 gigatonnes in 2020. Moreover, emissions of other air pollutants would be reduced, improving human health and alleviating local pollution.
One common justification for energy subsidies, in APEC economies and elsewhere, is that they are needed to help the poor gain or maintain access to energy services essential to basic living standards. We estimate that, globally, only 8% of subsidies to the consumption of fossil‐fuels reached the poorest 20% of the population. Any moves to phase‐out subsidies must be carefully designed so as not to restrict access to essential energy services or increase poverty.
Since making the commitment to rationalise and phase out inefficient fossil‐fuel subsidies in
2009, some APEC economies have moved ahead with reforms. While this is an encouraging start, continued reform is needed to realise the full extent of gains presented here and to achieve more sustainable growth.
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Summary .....................................................................................................................................
... 3
Background..................................................................................................................................
... 5
Overview of energy trends in APEC economies .............................................................................. 6
Introduction to fossil‐fuel subsidies .............................................................................................. 11
A definition...............................................................................................................................
11
Types and mechanisms .............................................................................................................
11
Rationale for their introduction ................................................................................................
5

14
The case for reform ...................................................................................................................
14
Measurement of fossil‐fuel subsidies ........................................................................................... 18
The price‐gap approach ............................................................................................................
18
Estimate of fossil‐fuel consumption subsidies ..........................................................................
19
Implications of fossil‐fuel subsidy phase out ................................................................................ 26
Methodology and assumptions ................................................................................................
26
Energy demand and spending on subsidies ..............................................................................
26
CO
2 emissions ............................................................................................................................
28
Fossil‐fuel subsidies and energy poverty ...................................................................................... 29
Implementing fossil‐fuel subsidy reform ...................................................................................... 32
Recent developments in fossil‐fuel subsidies ............................................................................... 35
References ..................................................................................................................................
.. 37
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In November 2009, Asia‐Pacific Economic Cooperation (APEC) leaders took an important step toward reforming fossil‐fuel subsidies at their meeting in Singapore. Together, member economies committed to “rationalise and phase out over the medium term fossil fuel subsidies that encourage wasteful consumption, while recognising the importance of providing those in need with essential energy services”. This announcement closely followed a similar move by the
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G‐20 in September 2009. The APEC commitment was reaffirmed in its November 2010
Leaders’
Declaration in Yokohama, Japan and leaders agreed to review progress on a voluntary basis.
The commitment to fossil‐fuel subsidy reform was made in recognition that inefficient fossil‐fuel subsidies impede sustainable growth and that their phase‐out, if well‐executed, can generate economic, energy security and environmental benefits.
This background paper has been prepared by the IEA
1 to help inform APEC economies as they push ahead with efforts to identify subsidies, measure their effect and plan and execute reforms. It supports the case for reforming inefficient fossil‐fuel subsidies in APEC economies by providing quantitative data on their cost from 2007 to 2010 and the prospective benefits of their phase out by 2020. The paper covers: key energy trends in APEC economies; motivations for introducing fossil‐fuel subsidies; the case for reforming fossil‐fuel subsidies; estimates of the cost of fossil‐fuel subsidies; modelling‐based analysis of the implications of phasing‐out fossil‐fuel subsidies; fossil‐fuel subsidies and energy poverty; important considerations in implementing subsidy reform; and recent developments in fossil‐fuel subsidies.
1
This background paper, prepared by the Office of the Chief Economist at the IEA, also benefitted from input by the Asia Pacific Energy Research Centre (APERC).
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The 21 member economies of the Asia‐Pacific Economic Co‐operation (APEC), which account for about 40% of the world’s population and more than half of its economic output, make up a dynamic and diverse region that has shaped global energy markets and will continue to do so in the foreseeable future. Globally, it includes some of the largest and fastest‐growing energy consumers, from major developed economies to those that are expanding rapidly with population growth, urbanisation and industrialisation. The region also encompasses some of the world’s largest energy producers, although most member economies are net fossil‐fuel importers. Increasing prosperity among APEC economies in the previous decades has underpinned a strong expansion in global energy production and use, but the energy pathway taken by the region in the next 25 years will be a critical factor in its ability to achieve more sustainable growth. Continuing to improve energy security, by increasing end‐use efficiency and ensuring that energy supplies are available at affordable costs, and addressing the harmful environmental impacts of the energy sector are the primary challenges to securing this future.
Table 1:
Key energy indicators in APEC economies*
Unit 1990 2000 2008
2000‐
2008**
GDP (MER) $2009 billion 18 124 24 539 31 730 3.3%
GDP (PPP) $2009 billion 19 860 27 552 37 668 4.0%
Population Millions 2 278 2 544 2 700 0.7%
Primary energy demand Mtoe 4 872 5 619 6 946 2.7% share of global 55% 56% 57%
Primary energy demand per capita
Toe 2.14 2.21 2.57 1.9%
Energy intensity Toe/1 000 $ 0.25 0.20 0.18 ‐1.3%
Net oil trade*** mb/d ‐5.97 ‐13.7 ‐13.8 0.1% excluding Russia mb/d
‐11.3 ‐17.6 ‐21.1 2.3%
Net gas trade*** bcm 191 132 130 ‐0.2% excluding Russia bcm
6 ‐56 ‐79 4.4%
Energy‐related CO
2 emissions Mt 11 905 13 790 17 776 3.2%
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share of global 57% 59% 61%
CO
2 emissions intensity Mt/1 000 $ 0.60 0.50 0.47 ‐0.7%
*Includes Australia, Brunei Darussalam, Canada, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia,
Mexico,
New Zealand, the Philippines, Russia, Singapore, Thailand, the United States and Vietnam. Not included are Chile,
Papua New Guinea, Peru and Chinese Taipei. **Compound average annual growth rate. ***Negative values indicate imports.
Note: MER = market exchange rate; PPP = purchasing power parity.
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The
Current Policies Scenario provides a baseline for assessing future energy trends to 2035 if current energy and environmental policies remain unchanged.
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This gives context to key policy initiatives that are currently being considered, such as fossil‐fuel subsidy reform in APEC economies. In the Current Policies Scenario, energy demand in APEC economies increases from 6 946 million tonnes of oil equivalent (Mtoe) in 2008 to 10 000
Mtoe in 2035, with the global share declining marginally to from 57% to about 55% during that period.
Growth in energy demand averages 1.7% per year between 2008 and 2020, but slows to
1.1% per year, on average, over the remainder of the
as the pace of economic growth slows and energy use becomes more efficient. Average per‐capita energy consumption in the region was almost 60% of that in OECD countries in 2008, rising to three‐quarters in 2035. The percapita energy consumption of some APEC economies, notably those in Southeast Asia, is considerably lower than elsewhere in the region, and providing access to basic energy services, such as electricity and clean cooking facilities, remains a key imperative.
Figure 1:
Primary energy demand in APEC economies by fuel in the Current Policies
Scenario
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0
1 000
2 000
3 000
4 000
5 000
6 000
7 000
8 000
9 000
10 000
11 000
1990 2000 2010 2020 2030 2035
Mtoe
Other renewables
Hydro
Nuclear
Gas
Oil
Coal
Source: IEA databases and analysis.
The energy mix in APEC economies is dominated by fossil fuels, with oil, natural gas and coal collectively making up 85% of total demand in 2008; in the Current Policies Scenario, this share declines modestly, to about 80% in 2035 (Figure 1). Coal continues to serve as the backbone of power generation in many APEC economies, with its overall use in the region expanding by
70% over the
period. In the Current Policies Scenario, 40% of electricity generation capacity added between 2008 and 2035 is expected to be coal‐fired. There are wide disparities in the rate of growth in electricity generation needs, but overall electricity demand in the APEC region will double in the next 25 years. This will necessitate substantial investment in new generating capacity, not only to keep pace with fresh demand growth, but to replace retiring units in developed economies. Oil demand in the region increases from 44.3 million barrels per day
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2
The Current Policies Scenario takes into consideration only those policies that had been formally adopted by mid‐2010. It assumes no future measures to meet energy or climate policy targets, or commitments that have not been adopted or fully implemented. Assumptions about economic and population growth are derived from IEA, IMF, UNPD and World Bank databases.
© OECD/IEA 2011
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(mb/d) in 2008 to about 52 mb/d in 2035, with demand growth in China alone equal to the increment. Despite the notable rise in the rate of vehicle ownership in China, it is still less than half the average in OECD countries by the end of the
Oil demand in major developed economies, such as the United States, Japan and Korea, declines somewhat with efficiency improvements.
The use of natural gas in APEC economies expands from 1 670 billion cubic metres (bcm) in
2008 to 2 340 bcm in 2035, its share of the fuel mix remaining steady. Natural gas, in particular, may play a more prominent role in the region (Box 1). Nuclear power has an important role in meeting fast‐growing demand for electricity in emerging APEC economies; capacity nearly doubles in the Current Policies Scenario.
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Biomass and waste represent the largest source of renewable energy today and throughout the projection period, as they remain an important source of fuel for households in some parts of the APEC region. Non‐hydro renewables, such as wind and solar, are the fastest growing energy sources in the Current Policies Scenario, expanding on average by 5.8% per year. In general, the cost of renewable energy declines in the region, although reductions depend on specific factors such as technology, location or feedstock. Many forms of renewable energy are still not competitive with fossil‐fuels by the end of the
. Including hydropower, the share of renewable energy in the overall mix in
APEC economies rises from 9% in 2008 to 11% in 2035.
Box 1:
Is a golden age of gas in store for APEC economies?
There are powerful arguments in favour of a bright future for natural gas, globally and in
APEC
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economies. These consider the availability of additional unconventional gas supplies, particularly in North America, at relatively low cost; ambitious new policies for gas use, such as those expressed in China’s 12th Five‐Year Plan; greater use of natural gas in transport; and a potential slow‐down in the growth of nuclear capacity (IEA, 2011). Furthermore, natural gas is a lower‐carbon fossil fuel. This is not to say that a ‘Golden Age of Gas’ is inevitable. Nor should it be thought that increased use of natural gas, in itself, would be enough to put the world on a carbon emissions path consistent with limiting the average global temperature rise to no more than 2 o
C.
Ultimately, the extent of the expansion of gas use hinges on the interaction between economic and environmental factors and policy interventions in the market. In the absence of a price for
CO
2
, coal is likely to remain cheaper than gas for generating electricity in many parts of the
APEC region. However, a cost comparison alone does not necessarily reflect gas’ full range of benefits, which may prove attractive enough to spur higher gas use in a range of applications.
These benefits include reinforcing the diversity of energy supply, providing flexibility and backup capability as more variable renewable electricity generating capacity comes online and reducing local pollutants and emissions (when substituting for coal or oil).
The APEC region accounts for some of the world’s largest energy producers today, however economies’ indigenous supply will have difficulty keeping up with demand in the coming years.
This generates increased inter‐regional trade, but also leads to growing import dependence for some APEC economies. In the Current Policies Scenario, APEC economies’ total oil production is roughly the same in 2035 as in 2008, maintaining slightly more than 30 mb/d. Gas supply grows
3
These projections were produced before the events at the Fukushima Daiichi nuclear power plant in
March 2011 and do not account for any policy changes in the APEC region in its aftermath.
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by a third, reaching 1 800 bcm in 2035. Coal production expands over 50%, to 3 800 million tonnes of coal equivalent in 2035. The levels of supply in the Current Policies Scenario correspond to increasing fossil‐energy imports across the region. For oil, net imports rise from
13.8 mb/d to about 21 mb/d; gas net exports decrease from 130 bcm to about 60 bcm. If
Russia, the world’s largest oil and gas exporter is excluded, the overall oil and gas trade balance for the
APEC region shifts significantly; in 2035, net oil imports are about 28 mb/d and net gas imports are nearly 350 bcm. The combination of higher prices and expanded imports translates to growing import bill for the region, which can be a heavy burden on economic growth. We estimate that import bills as a share of GDP in 2035 for selected member economies range from
1% in Mexico to 6% (on average) for the economies of Southeast Asia (Figure 2).
Figure 2:
Share of spending on oil and gas imports in real GDP at market exchange rates in
APEC economies in the Current Policies Scenario
0%
1%
2%
3%
4%
5%
6%
7%
1990 2000 2010 2020 2030 2035
ASEAN*
China
Indonesia
Japan
Mexico
United States
Australia/
New Zealand
*ASEAN = Association of Southeast Asian Nations. It includes APEC economies Brunei Darussalam, Malaysia,
Philippines, Singapore, Thailand and Vietnam, but excludes Indonesia, which is shown separately.
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Source: IEA databases and analysis.
The projected trends in the Current Policies Scenario mean that energy‐related CO
2 emissions from APEC economies continue to increase. Having grown from 11.9 Gt in 1990 to just over
17.8 Gt in 2008, they are projected to rise to 21.7 Gt in 2020 and about 25.1 Gt in 2035, an average growth rate of 1.3% per year (Figure 3). CO
2 emissions intensity improves across the region, measured as CO
2 per unit of economic output, falling by 40%. The APEC region’s share of global CO
2 emissions declines little during the
period, from 61% to reaches 59% in
2035.
If meaningful action is to be taken to limit the increase in greenhouse‐gases and prevent the worst effects of climate change, it is clear that APEC economies will have to play a key part.
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Figure 3:
Energy‐related CO
2 emissions in APEC economies in the Current Policies Scenario
20
25
30
35
0
5
10
15
40
45
1990 2000 2010 2020 2030 2035
Gt
Gas
Oil
Coal
World
Source: IEA databases and analysis.
Energy trends and related challenges in APEC economies reflect the diverse nature of its membership. To achieve more sustainable growth, it will be important for the APEC economies to pursue policies that will enhance energy security and tackle environmental threats. In so
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doing, it will be critical to develop and deploy cleaner energy sources, while simultaneously improving energy efficiency and maintaining the current system. This will require substantial investment in clean‐energy technologies, as well as the supply of conventional fuels to meet growing demand and offset production declines or the retirement of electricity generating capacity. Access to basic energy services is not yet universal across APEC economies, having detrimental human health and social consequences, and could be improved. Phasing out inefficient fossil‐fuel subsidies is an important policy measure under consideration in APEC economies that could respond to many of these challenges and thereby pave the way for more sustainable growth.
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The IEA defines an energy subsidy as any government action directed primarily at the energy sector that lowers the cost of energy production, raises the price received by energy producers or lowers the price paid by energy consumers. Many energy subsidies are difficult to measure, so for practical reasons much narrower definitions are often adopted that include only those subsidies that can be quantified and for which data are readily available. The broad definition used by the IEA is designed to capture all of the diverse and obscure types of energy subsidy that commonly exist.
Energy subsidies are frequently differentiated according to whether they confer a benefit to producers or consumers, or whether they support traditional fossil fuels or cleaner forms of energy. In this background paper, the focus is on fossil‐fuels in APEC economies and, predominately, on consumption subsides that result from the artificial lowering of end‐use prices below international market levels. While such subsidies are now rare in advanced economies, they are still a prevalent form of subsidisation in many developing economies.
Fossil‐fuel production subsidies, which involve measures that seek to expand domestic supply, remain an important form of subsidisation in both developed and developing economies.
Many subsidies in this category have also been phased‐out with the shift towards more marketoriented
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economic and energy policies and liberalisation of international trade. Both fossil‐fuel production and consumption subsidies, by encouraging excessive production or consumption, can lead to an inefficient allocation of resources and market distortions.
Fossil‐fuel subsides may be further distinguished according to the channels through which they are administered; these include budgetary payments, regulations, tax breaks, risk transfers and trade instruments, among others (Table 2). They may be classified as either direct transfers, such as grants to expedite the deployment of fledgling technologies, or indirect transfers, such as the regulation of end‐user prices.
Subsidies to fossil‐fuel consumption are provided through several common channels: price controls intended to regulate the cost of energy to consumers, direct financial transfers, schemes designed to provide consumers with rebates on purchases of energy products and tax relief. Government interventions supporting energy consumption often involve the regulation or direct subsidization of domestic prices. However, many economies also support energy consumption through direct budgetary transfers that do not alter the observable market price for the fuels or electricity supported. In developing countries, a common form of such a transfer is a fuel voucher, which allows low‐income recipients to purchase fuel at a discounted price.
In advanced market economies, direct budgetary transfers include heating‐energy grants for lowincome households, and subsidies to help particular sectors, such as agriculture, meet the cost of fuel purchases when prices rise unexpectedly.
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Table 2:
Common types of fossil‐fuel subsidies
Type Description Examples
Trade instruments
Quotas
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Tariffs
Technical restrictions
Tariffs on imports of crude oil and petroleum products, making domestic fossil fuel production more lucrative.
Regulations
Demand guarantees
Mandated deployment
Price controls
Restrictions on market access
Preferential resource access.
Fuel prices regulated at below international market levels.
Regulations that prioritise use of domestic coal for power generation
Tax breaks
Rebates or exemption on royalties, producer levies and income taxes.
Tax credits and accelerated depreciation allowances.
Rebates, refunds or exemptions on energy duties and CO
2 taxes or for energy in general consumption taxes.
Favourable tax deductions for depletion or investments in oil and gas fields and coal deposits.
Excise exemptions for fuel used in international air, rail, or water transport.
Credit
Low‐interest or preferential rates on loans to producers.
Loan guarantees to finance energy infrastructure.
Direct financial transfer Grants to producers or consumers.
Social payment programmes
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conditioned on or earmarked for heat and electricity consumption.
Risk transfer Limitation of financial liability.
Insurance or indemnification provided to fossil fuel producers at below‐market levels.
Energy‐related services provided by government at less than full cost
Direct investment in energy infrastructure.
Public research and development.
Provision of seismic data for oil and gas exploration.
Government finance of activities relating to environmental health and safety in coal mines.
A wide array of tax breaks also target consumers. These mostly take the form of excise‐tax concessions on fuel designed to benefit particular users or areas. A survey of practices in
OECD countries suggests that these could be quite important in value terms. For example, OECD estimates that fuel tax concessions are worth some $8 billion per year to the agricultural sector in OECD countries, and at least $1.4 billion per year to the fisheries sector. Tax regimes in several advanced market economies inadvertently encourage the provision by employers of company‐owned or leased vehicles for employees, and of company‐paid fuel for those vehicles.
Governments provide support to fossil‐fuel production in a variety of ways: by intervening in markets to affect costs or prices, by transferring funds to recipients directly, by assuming part of their risk, by selectively reducing the taxes they would otherwise have to pay or by
© OECD/IEA 2011
Page | 13 undercharging for the use of government‐supplied goods or assets. Often, more than one transfer mechanism is involved. For example, a government may fund research at a national laboratory on how to convert coal into a liquid transport fuel, provide grants and loan guarantees to companies investing in synthetic fuels from coal, provide a tax credit linked to the
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production of such fuels, and exempt such producers from paying royalties on coal mined from state‐owned lands. The national government may, in turn, pay the producer a higher price for the fuel than it could have paid for an imported, petroleum‐derived fuel. Direct budgetary transfers are the most straight‐forward types of subsidies to measure, although the complexity of the task depends on how well they are reported in government budget documents.
Tax breaks relating to the production of fossil‐fuels in industrialised countries most often stem from favourable tax treatment for capital or intermediate inputs. These can encourage higher levels of production than would otherwise be demanded by the market. In the case of capital, special rules that allow businesses to deduct depreciation faster than the actual speed at which equipment becomes economically obsolete can in some cases imply large indirect subsidies.
Immediate deduction (expensing) of exploration and development costs is also a similar example, although the issue is complicated by the special nature of tax and royalty regimes targeted at natural‐resource rents. For cash‐flow based natural resource tax system where there is no deduction for interest expenditure, neutrality would require immediate deduction
(expensing) of investment outlays. Provisions for expensing or accelerated depreciation does therefore not necessarily imply subsidies, but for many countries it would be relevant to review if all the existing expensing and accelerated depreciation provisions are warranted or if some go too far. Other inputs can attract subsidies. For instance, workers in particular industries may be allowed to deduct part of their wage from their personal income‐tax base, or intermediate goods, such as raw materials may be acquired free of excise duty by refiners.
Governments also forego revenue by offering the use of scarce resources (
land or fossil‐fuel resources) under their control. This can reduce costs and thereby encourage more production than would otherwise occur. The most direct cases relate to the conditions under which governments provide access to domestic resources of fossil fuels that a private company (or
19

individuals) then exploits for their own use or for sale. This sometimes takes the form of a royalty exemption for a particular type of coal or a project to extract oil and gas. But many governments also provide access to intermediate inputs, like water or electricity at below market prices and access to government land for the construction of roads or buildings.
Transfers of risk to governments are much less transparent and, as such, hard to gauge even in the case of industrialised countries. They include measures related to capital like concessional loans but also security guarantees as in the case of government‐funded oil stockpiling.
Equally important are the transfers of environmental and health liabilities from producers to the public, which often result in governments acting as insurers of last resort. An example would be the amounts disbursed by governments to compensate residents affected by subsidence associated with abandoned coal mines.
Another area of government involvement in energy production is investment in research and development (R&D). In 2008, IEA data suggest that total government expenditure on R&D related to fossil fuels amounted to almost $1.7 billion. Included under this category of expenditure is R&D related to enhanced oil and gas production; unconventional oil and gas production; refining, transport and storage of oil and gas; oil, gas and coal combustion; and oil, coal and gas conversion.
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The rationale for introducing of fossil‐fuel subsidies has often been to advance particular political, economic, social and environmental objectives, or to address problems in the way markets operate. In practice, however, fossil‐fuel subsidies have rarely proven to be a successful or efficient means of achieving their stated objectives. The most common justifications for their introduction include:
Consumption subsidies have been used to improve the
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living conditions of the poor by making cleaner, more efficient, fuels affordable and accessible. For example, liquefied petroleum gas (LPG) in place of traditional biomass.
Production subsidies have been used to support indigenous fuel production in a bid to reduce import dependency. They have also been used at times to support a country’s foreign and strategic economic policies by helping the overseas activities of national energy companies.
Fossil‐fuel subsidies to industrial users are a source of competitive advantage. They are sometimes used to encourage investment in energy‐intensive industries, such as aluminium smelting, which would otherwise not be profitable. Further, production subsidies, usually in the form of tariffs or trade restrictions, are often used to maintain regional employment, especially in periods of economic downturn or transition.
In major energy‐producing countries, consumption subsidies that artificially lower energy prices are often seen as a means of sharing the value of indigenous natural resources. They are also used in an effort to encourage economic diversification and employment by improving the competitiveness of energy‐intensive industries, such as petrochemicals and aluminium.
In recent years, momentum to phase out certain types of fossil‐fuel subsidies has increased as many lead to an economically inefficient allocation of resources and distort markets, while often failing to meet their intended objectives (Figure 4). Fossil‐fuel subsidies encourage wasteful consumption, exacerbate energy‐price volatility by blurring market signals, incentivise fuel adulteration and smuggling, and undermine the competitiveness of renewables and more efficient energy technologies. For importing countries, subsidies often impose a significant fiscal burden on state budgets, while for producers they quicken the depletion of resources and can thereby erode export availability and earnings over the long term. Below are the key unintended effects of fossil‐fuel subsidies that have been drivers of reform in recent years:
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Create a fiscal burden on state budgets:
In some cases, high energy prices have imposed unsupportable financial burdens on countries that import energy at world prices and sell it domestically at lower, regulated prices. As a share of GDP at market exchange rates, spending on oil and gas imports in many economies spiked in 2008, reaching levels well above those seen during the first and second oil shocks. Some countries seized the opportunity presented by the fall in prices after mid‐2008 to reduce subsidies without having a major impact on inflation
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(since the fall in world prices cushioned consumers from the upward pressure on prices resulting from subsidy removal) and without provoking consumer wrath. However, higher prices have returned in 2010 and 2011 and governments that have not closed price gaps for fossil‐fuel products are again facing strong fiscal pressure because of expanding import bills.
Encourage wasteful consumption:
Subsidies can encourage wasteful consumption, thereby leading to faster depletion of finite resources, and can also discourage rationalisation and efficiency improvements in energy‐intensive industries. Eliminating subsidies would provide consumers with an incentive to conserve energy by improving proper price signals. For example, a power company burning oil to produce electricity may not have the choice of switching to a less costly alternative overnight, but could decide to build new, non‐oil capacity if it expects higher input prices to persist as a permanent feature of the market. Similarly, a rise in the price of gasoline might encourage a motorist to alter their driving habits or buy a more fuel‐efficient car when their existing vehicle is traded or scrapped.
Figure 4:
Rationale for and potential unintended effects of fossil‐fuel subsidies
Exacerbate energy price‐volatility:
The price controls that give rise to fossil‐fuel subsidies exacerbate energy price‐volatility on global markets by dampening normal demand
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responses to changes in international prices. Many analysts were surprised by the robustness of global oil demand, despite the dramatic increases in crude‐oil prices, during the first half of 2008. This has now been attributed in part to artificially low energy prices in many countries, which blunted market signals. A survey of 131 countries carried out by the International Monetary Fund
(IMF) found that in 2008 around two‐thirds of countries failed to fully pass through the sharp rise in international prices for gasoline and half failed to pass through the full increase in the cost of diesel (Coady
, 2010). Cutting subsidies, by shifting the burden of high prices from government budgets to individual consumers, would lead to a much faster and stronger demand response to future changes in energy prices and free up government revenues for other urgent needs.
Distort markets
: Subsidies for fossil‐fuel production can hinder competition and create market distortions by propping up less efficient producers. For example, several countries still retain subsidies for hard coal mining. In some cases, a significant share of the subsidy is directed at covering the cost of closing down mines and compensating workers who had lost their jobs as a
© OECD/IEA 2011
Page | 16 result of earlier rationalisation of the industry, so is unlikely to alter demand and supply patterns. In other cases, subsidies maintain production that would otherwise be uneconomic, for example, by enabling high‐cost local coal producers to compete against imports.
Furthermore, by propping up less efficient producers, subsidies can create barriers to the introduction of cleaner technologies and fuels and discourage the uptake of more efficient production practices.
Countries also offer subsidies for oil and gas production through reduced royalties for leases in certain areas. Removing these production subsidies would typically have the effect of making domestic production less competitive compared with imports and would, therefore, tend to lower indigenous production. The extent to which investment and production would be
23

shifted to other parts of the world, and the extent to which prices would rise or fall as a result, would depend on the shape of the global supply curve. In practice, the effect of one country no longer subsidising fossil fuels on world energy prices and consumption is likely to be small.
However, when many countries engage in similar policies, world prices are likely to be higher than otherwise.
Cause adverse environmental impacts:
Fossil‐fuel subsidies generally have detrimental environmental effects. Those that enable poor communities to switch from the traditional use of biomass to modern fuels can minimise deforestation and reduce household air pollution.
However, the vast majority of fossil‐fuel subsides are counterproductive in reaching local and global environmental goals. Subsidised energy prices dampen incentives for consumers to use energy more efficiently, resulting in higher consumption and greenhouse‐gas emissions than would otherwise occur. Furthermore, fossil‐fuel subsidies undermine the development and commercialisation of renewable energy and other technologies that could become more economically attractive.
Encourage fuel adulteration:
Fossil‐fuel subsidies can encourage fuel adulteration, and the substitution of subsidised fuels for more expensive fuels. In some countries, subsidised kerosene intended for household cooking and lighting is diverted for unauthorised use as diesel fuel due to wide price differentials. Smuggling can also arise, since an incentive is created to sell subsidised products in neighbouring countries where prices are unsubsidised and, therefore, higher. This has been an issue for years in many parts of the world, particularly in Southeast
Asia among those economies in the APEC region. The effect in subsidising countries is a substantial financial transfer to smugglers, while recipient countries experience losses from uncollected taxes and excise duties, due to reduced sales in the legitimate market. Removing subsidies would eliminate incentives both to adulterate fuels and to smuggle them across borders.
Disproportionally benefit the middle class and the rich:
Although fossil‐fuel subsidies are
24

often intended to help redistribute income to the poor, the greatest benefit typically goes to those who consume the most energy,
who can afford to own motor vehicles, electrical appliances, etc. Poor households may not have access to subsidised energy directly, lacking a connection to electricity or natural gas and owning no vehicle. Numerous studies have found that fossil‐fuel subsidies as presently constituted tend to be regressive. The Co‐ordinating Ministry of
Economic
Affairs of Indonesia, for example, reported that the top 40% of high‐income families absorb
70% of energy subsidies, while the bottom 40% of low‐income families reap only 15% of the benefits
(IEA, 2008). Without precise targeting, fossil‐fuel subsidies are often an inefficient means of assisting the poor.
Threaten investment in energy infrastructure:
Subsidies can have an adverse impact on investment resources. Where fossil‐fuel consumption is subsidised through consumer price
© OECD/IEA 2011
Page | 17 controls, the effect – in the absence of offsetting compensation payments to companies – is to reduce energy companies’ revenues. This limits their ability to invest in, maintain and expand energy infrastructure. For example, many state‐owned electricity companies are obliged to provide electricity at heavily subsidised rates (or, in certain cases, for free) to certain sections of the community. This weakens their financial position, harming their capacity to invest in building new generating plants and in maintaining and extending the transmission and distribution network. Although this problem is particularly prevalent within the electricity sector, it also exists in the oil, natural gas and coal sectors.
Hasten the decline of exports:
Several energy‐rich exporting countries have also moved to phase out subsidies, or have expressed interest in doing so, concerned not only by the high cost of the subsidies but also the resulting low efficiency in domestic energy use. Over time, such
25

subsidies may even threaten to curtail exports that earn vital state revenue streams. This would also have implications for global energy security. A few major oil exporters rely on imports of refined petroleum products, partly because low regulated prices preserve artificially high demand and undermine investment in adequate refining capacity. This problem is particularly acute if refiners are not reimbursed by governments for their losses.
The gains from phasing out fossil‐fuel subsidies can be enhanced if combined with broader energy taxation reforms. Rising world market prices have greatly enhanced the profits from fossil‐fuel production and in some cases, the royalty and tax regimes for natural resource rents may warrant review to assess if they are well balanced. Some middle‐income countries have also found higher excise taxes on energy consumption to be an attractive route in a context of difficulties controlling income tax evasion. Wider reforms can therefore raise considerable revenues that can help financing the measures needed to ensure a social balance when fossilfuel subsidies are phased out and, as emphasised by OECD work on Tax and Development, contribute to state building and administrative development.
© OECD/IEA 2011
Page | 18
The IEA estimates subsidies to fossil‐fuels that are consumed directly by end‐users or consumed as inputs to electricity generation. The price‐gap approach, the most commonly applied methodology for quantifying consumption subsidies, is used for this analysis.
4
It compares average end‐user prices paid by consumers with reference prices that correspond to the full cost of supply. The price gap is the amount that an end‐user price differs below a reference price, and its existence indicates the presence of a subsidy (Figure 5).
The methodology is particularly sensitive to the calculation of reference prices, which reflect the price of energy traded in a competitive international market. For net‐importing countries, reference prices for oil products, natural gas and coal, are the sum of the market price from the nearest international hub, adjusted for quality differences where applicable, the costs of
26

freight and insurance and internal distribution, and any value‐added tax (VAT). VAT is added to the reference price where the tax is levied on final energy sales, as a proxy for a normal level of taxation on economic activities. Other taxes, including excise duties, are not included in the reference price. Reference prices for tradable energy goods in net‐exporting countries are calculated similarly, but subtract out the costs of freight and insurance to obtain an FOB price at the border of the exporting country before adding internal distribution and VAT.
Figure 5:
Illustration of the price‐gap methodology, comparing the reference and retail prices of oil products
0 0.2 0.4 0.6 0.8 1.0
Gasoline
Diesel
LPG
Dollars per litre
International price
Freight and insurance
Internal distribution
Value-added tax
End-use price
Price gap
(subsidy)
Note: The height of each bar indicates the total reference price. Gasoline and diesel prices are for the transport sector. Kerosene and LPG prices are for households.
Unlike oil, gas and coal, electricity is not extensively traded over national borders, so there is no reliable international benchmark price. The reference price is calculated in this analysis to reflect its short‐run average cost, but no other costs, such as for investment. Electricity reference prices are based on the average annual cost of production, which depends on the
4
Kosmo (1987), Larsen and Shah (1992) and Coady et al.
(2010), among others, have used this approach.
© OECD/IEA 2011
Page | 19 make up of generating capacity, the unsubsidised cost of fossil‐fuel inputs, and transmission and distribution costs.
27

Estimates using the price‐gap approach capture only interventions that result in final prices to end‐users below those that would prevail in a competitive market. While such consumption subsidies account for the vast majority of subsidies to fossil fuels, there are numerous others that are not captured by the price‐gap approach (Koplow, 2009). It does not, for example, capture subsidised research and development or supply‐oriented subsidies that do not result in a lower price to end‐users or power generators (because of the difficulty in identifying and measuring them). Energy production subsidies have been conservatively estimated to be at least $100 billion per year (GSI, 2010). Our estimates for APEC economies, which cover only consumption subsidies, should therefore be considered a lower bound for the total economic cost of fossil‐fuel subsidies and their impact on energy markets.
For countries that export a given fossil‐energy product but charge less for it in the domestic markets, the domestic subsidies are implicit; they have no direct budgetary impact so as long as the price covers the cost of production. The subsidy, in this case, is the opportunity cost of pricing domestic energy below international market levels,
the rent that could be recovered if consumers paid world prices, adjusting for differences in variables such as transportation costs. For importers, subsidies measured via the price‐gap approach may be explicit, representing budget expenditures arising from the domestic sale of imported energy at subsidised prices, or may sometimes be implicit. Many countries, Indonesia for example, rely extensively on domestically produced fuels, but supplement domestic supply by importing the remainder. In such cases, subsidy estimates represent a combination of opportunity costs and direct expenditures.
5
The price‐gap approach has been utilised to carry out a global survey of fossil‐fuel consumption subsidies. It identifies subsidies in 37 countries that collectively accounted for more than half of global fossil‐fuel consumption in 2010 and estimates their cost; this group of countries includes all of the largest subsidisers (by total economic cost) of end‐user prices. This set covers all
28

APEC economies for which data were available.
Worldwide, the economic cost of fossil‐fuel consumption subsidies is estimated to have totalled
$409 billion in 2010 – about $100 billion higher than in 2009. This amount was still well below the total in 2008, when global subsidies reached more than $550 billion. Among APEC economies, we estimate fossil‐fuel subsidies in 2010 were $105 billion, or roughly a quarter of the global total (Figure 6). Of the 21 member economies, ten were identified via the price‐gap approach as having end‐use prices that are supported by some form of subsidy. This group does not reflect fully the APEC economies that have fossil‐fuel subsidies, as subsidies to support fossil‐fuel production also exist but were not quantified. The total cost of fossil‐fuel consumption subsidies in APEC economies in 2010 rose by almost 40% year‐on‐year, largely following global trends. Of fuels consumed directly by end‐users, oil products attracted the largest subsidies, totalling $35 billion, or a third of the total in APEC economies. The cost of subsidies to natural gas followed at $19 billion; subsidies to coal end‐use consumption were
5
Some governments include allocations for subsidies in their budgets. Our estimates will not necessarily match because of differences in the definition of subsidies, data availability and assumption needed to carry out the price‐gap approach.
© OECD/IEA 2011
Page | 20 comparatively small at only $2 billion. We estimate that subsidies resulting from the underpricing of electricity generated by fossil‐fuel inputs were significant, reaching $49 billion in 2010
(Figure
7
).
Figure 6:
Economic cost of fossil‐fuel consumption subsidies globally
0
25
50
75
100
29

125
150
0
100
200
300
400
500
600
2007 2008 2009 2010
Dollars per barrel
Billion dollars
Rest o f world
APEC economies
IEA average crude oil import price
(right axis)
Changes in international fuel prices are chiefly responsible for differences in the cost of fossilfuel subsidies from year to year, although they can also fluctuate according to changes in policy, exchange rates and demand patterns. The increase in the cost of subsidies in 2010, both globally and in APEC economies, closely tracked the sharp rise in international fuel prices, as the average IEA crude‐oil import price increased by 29% between 2009 and 2010, while natural gas import prices rose modestly. Higher international prices in 2010 negated or reversed the gains,
closing price gaps, which would have occurred from upward price adjustments in some economies. The estimate of fossil‐fuel consumption subsidies in 2010 would have been higher in the absence of efforts to raise end‐user prices towards more competitive levels, thereby limiting the increase in the price gaps for some products. The series of estimates from 2007 to 2010 demonstrates clearly the large economic liability represented by regulated energy prices, as international energy markets can be subject to unpredictable fluctuations. For net‐importing
30

countries, fossil‐fuel consumption subsidies become particularly difficult to reduce during periods of rising prices, high inflation, uncertain economic growth prospects and fiscal tightening – just when the burden is becoming insupportable.
© OECD/IEA 2011
Page | 21
Figure 7:
Economic cost of fossil‐fuel consumption subsidies in APEC economies by fuel
40
50
60
70
0
10
20
30
80
2007 2008 2009 2010
Billion dollars
Oil
Natural gas
Electricity
Coal
The total costs of fossil‐fuel subsidies for individual APEC economies were generally spread across the range of countries that were surveyed globally, according to their respective rates of subsidisation (subsidies as a proportion of the total reference fossil‐energy bill) and the amount of subsidised fossil‐energy that each consumes (Figure 8). Subsidies in the Middle East, having many net‐exporters of fossil fuels, were considerably higher than in APEC economies, amounting to nearly $170 billion, or about 40% of the global total in 2010. Globally, the largest subsidies were measured in major net‐exporting countries – Iran, Saudi Arabia and Russia – which tend to subsidise energy at a higher rate than net‐importing countries because losses from subsidies, as opportunity costs, are easier to absorb than budget shortfalls in the shortterm.
At about $80 billion, fossil‐fuel subsidies in Iran were the highest in the world, although that figure is expected to fall significantly in the coming years if the sweeping energy‐pricing
31

reforms that commenced in late 2010 are implemented successfully and prove durable.
Russian subsidies to consumers of natural gas and electricity remain large, at almost $40 billion, despite ongoing efforts to raise end‐use prices.
Among APEC economies, Russia’s subsidies to fossil‐fuel consumption were the highest in terms of total cost in 2010. China’s subsidies totalled $21 billion. While the rate at which fossil‐energy products are subsidised in China is relatively low, the large amount consumption from a huge population drives up the total cost of subsidies. The cost of subsidies can be more completely understood when also viewed by other measures, for example as a percentage of gross domestic product (GDP) or as subsidies per capita (Figure 9). On these bases, subsidies to fossilfuel consumption in China are comparatively lower, at 0.4% of GDP and about $16 per person.
Subsidies in Indonesia reached $16 billion in 2010, primarily directed toward various oil products (for which it is a net‐importer) and electricity. By alternative measures, the cost of
Indonesia’s subsidies was equivalent to 2.3% of GDP and $66 per person. Even though
Indonesia has actively pursued reform, rising international fuel prices and concerns about inflation have made it difficult to phase out its subsidies.
© OECD/IEA 2011
Page | 22
Figure 8:
Economic cost of fossil‐fuel consumption subsidies in 2010
0 10 20 30 40 50 60 70 80 90
Iran
Saudi Arabia
Russia
India
China
Egypt
Venezuela
UAE
Indonesia
32

Vietnam
Nigeria
South Africa
El Salvador
Angola
Philippines
Azerbaijan
Taipei
Sri Lanka
Colombia
Brunei
Billion dollars
APEC economies
Other economies
Uzbekistan
Iraq
Algeria
Mexico
Thailand
Ukraine
Kuwait
Pakistan
Argentina
Malaysia
Bangladesh
Turkmenistan
Kazakhstan
Libya
Qatar
Ecuador
© OECD/IEA 2011
Page | 23
Figure 9:
Fossil‐fuel consumption subsidies per capita and as a percentage of GDP in selected economies in 2010
33

Iran
Saudi Arabia
Venezuela
UAE
Iraq
Kuwait
Turkmenistan
Qatar
Libya
Egypt
Algeria
Brunei
Pakistan
Ecuador
0
500
1 000
1 500
2 000
2 500
3 000
0% 5% 10% 15% 20% 25%
Subsidies per capita (dollars per capita)
Subsidies as a share of GDP (MER)
See below
Scale (billion $)
40
10
Russia
China India
Indonesia
Argentina
Malaysia
Thailand
Mexico
Kazakhstan
Vietnam
Philippines
34

Nigeria
Azerbaijan
South Africa
0
50
100
150
200
250
300
0% 1% 2% 3% 4%
Subsidies per capita (dollars per capita)
Subsidies as a share of GDP (MER)
APEC
Other
Chinese
Taipei
Note: MER = market exchange rate. Circle sizes are proportional to the total cost of the subsidy.
© OECD/IEA 2011
Page | 24
Subsidies to fossil‐fuel consumption were also identified in Mexico, where the gradual schedule of price increase for oil products such as gasoline and diesel had not kept pace with rise of fuel prices in international markets. Mexico’s subsidies were estimated at $10 billion in 2010, otherwise comprising 0.9% of GDP or $84 per person. Thailand and Malaysia were other
APEC economies for which sizeable fossil‐fuel consumption subsidies were found in 2010, with their total costs being $8 billion (2.7% of GDP) and $6 billion (2.4% of GDP), respectively. Subsidies in
Malaysia were higher on a per‐capita basis than in most other APEC economies, at $200 per person. However, these were not as high as in Brunei (a net‐exporter), which at $840 per person is estimated to have had the most expensive subsidies per capita among APEC economies.
Figure 10:
Fossil‐fuel consumption subsidies in APEC economies in 2010
0
35

10
20
30
40
50
Billion dollars
Electricity
Coal
Gas
Oil
Fossil‐fuel consumption subsidies tend to be more prevalent in net‐exporting countries, where they largely represent opportunity costs. For net exporters of oil and gas in APEC economies, subsidies to those fuels totalled $74 billion in 2010, compared with $31 billion in net‐importing countries (Figure 11). Since 2007, 70% of the estimated subsidies, on average, have occurred in net exporters of oil and gas. When international fuel prices have dropped, as between 2008 and
2009, subsidies declined by more in percentage terms in net‐importing countries. Many subsidies in net‐importing countries are either reduced substantially or eliminated as the gap between reference prices and regulated domestic prices is closed. In some cases, governments seized this opportunity to liberalise prices or raise prices closer to international market levels as lower costs were easier to pass through to consumers. As end‐user prices in net‐exporting countries are sometimes only enough to cover production costs, falling international prices do not have as large an impact in shrinking the price gap. Rising international fuel prices exert fiscal pressure on net‐importing countries that absorb the higher cost of subsidies in their budget, offering strong incentive for reform. In net‐exporting countries, however, this incentive is not as strong as they simultaneously have the benefit of higher export revenues.
© OECD/IEA 2011
Page | 25
Figure 11:
Fossil‐fuel consumption subsidies by net importer and net exporter of oil and
36

natural gas in APEC economies
0
20
40
60
80
100
120
2007 2008 2009 2010
Billion dollars
Exporter
Importer
Box 2:
Subsidies that support fossil‐fuel production in OECD countries
While this background paper does not attempt to estimate subsidies that support fossil‐fuel production, work has been undertaken by the Organisation for Economic Cooperation and
Development (OECD) to identify and estimate support for both fossil‐fuel consumption and production in member countries.
6
In OECD countries, measures that directly or indirectly support the production of fossil fuels vary significantly, depending on the fuels that benefit from such measures. Not all OECD countries are significant fossil‐fuel producers. Among those that are, some extract crude oil and natural gas, while others mine coal. The variety of situations is reflected in the equally diverse array of policies in place in OECD countries.
Support to the production of coal is the most visible form of support in OECD countries, and the largest. The OECD estimates that coal attracted close to 39% of total fossil‐fuel producer support in the year 2010. The importance of coal in total support is largely explained by the need in Europe to use budgetary transfers and price support to allow a gradual restructuring of the coal‐mining industry in a socially acceptable manner. Coal also attracts support in other countries, such as Australia, Canada, Korea or the United States, but at a lower level. It is provided most notably through tax expenditures and funding for research and development.
Crude oil and natural gas production are supported mainly by tax breaks, typically in the form of advantageous income‐tax deductions, such as depletion allowances and the accelerated depreciation of capital expenses. Royalty reductions or credits are also commonly used to encourage extraction at high‐cost or marginal wells. These features of countries’ tax and royalty regimes are often complex and less transparent than direct expenditures, making
37

country comparisons difficult since tax expenditures associated with these policies have to be estimated by reference to country‐specific baselines. Some measures relate to aspects of the tax regime that are specific to the resource sector, making the extent of support obscure.
6
For more information on the OECD work on support to fossil‐fuel producers and consumers, see: http://www.oecd.org/document/57/0,3746,en_2649_34361_45233017_1_1_1_1,00.html.
© OECD/IEA 2011
Page | 26
Fossil‐fuel consumption subsidies induce consumers and producers to trade energy products at prices below their true opportunity cost, thereby encouraging additional and often wasteful consumption of finite resources with adverse economic and environmental consequences.
This section provides modelling results that quantify the economic and environmental gains that could be obtained from removing subsidies in APEC economies: energy savings, lower carbondioxide emissions and reduced fiscal burdens.
7
The analysis is based on simulations using the IEA’s World Energy Model (WEM), assuming the phase‐out of all fossil‐energy subsidies in APEC economies over the period 2012 to 2020 by decreasing gradually the respective rates of subsidisation (subsidies as a proportion of the total reference fossil‐energy bill). Because the economic value of subsidies fluctuates from year‐toyear, initial subsidisation rates are averaged over the most recent three‐year period (2008 to
2010). Savings from eliminating subsidies are presented in 2020 and 2035 relative to a baseline case in which average subsidy rates from 2008 to 2010 remain unchanged. The analysis is intended to illustrate the potential gains and should not be interpreted as a prediction.
The assumption of
subsidy phase‐out across APEC economies by 2020 may be optimistic given uncertainties about the various economic, political and social hurdles that could
38

arise for member economies during that time. Furthermore, some well‐targeted subsidies may serve important roles by providing access to basic energy services for the poor and may not be categorized as inefficient by member economies. Generally, it can be expected that phase‐out programmes will progress more rapidly in net‐importing countries than in net‐exporting countries, as direct fiscal costs are usually a more urgent motive for action than forgone revenue. Several economies have already announced plans that, if fully implemented, would eliminate or reduce their subsidies well before 2020.
The modelling takes into account inter‐fuel substitution. For instance, phasing‐out subsides for natural gas in a certain market may lead to an increase in the use of coal. Energy‐related carbon‐dioxide (CO
2
) savings linked to the abolition of subsidies are then determined based on the CO
2 emission factor. This calculation is performed for each fuel and the results added to determine the total change. With the reduction in energy demand that would result from a phase‐out programme, lower world prices for fossil fuels may induce a “rebound‐effect”, which refers to the increase in the demand for energy services that occurs when the overall cost of the service declines. In this modelling analysis, the rebound effect is assumed to be negligible as a result of subsidy phase out in APEC economies.
Relative to a baseline in which current rates of subsidisation remain unchanged, the IEA estimates that the complete phase out of fossil‐fuel subsidies in APEC economies by 2020 would cut energy demand in the region by 2.3%, or 200 million tonnes oil equivalent (Mtoe) in that
7
Although beyond the scope of this analysis, social and equity impacts resulting from energy subsidy removal also need to be a central consideration in the design of any phase‐out programme (see, for example, IEA/ OECD/OPEC/World Bank, 2010).
© OECD/IEA 2011
Page | 27 year. By 2035, energy demand is reduced by 3.0% or 310 Mtoe (Figure 12). Energy savings would be considerably higher in the particular APEC economies that have subsidies. Energy savings are the product of higher prices, which follow subsidy removal and incentivise
39

greater energy conservation and efficiency. The responsiveness of demand to higher prices varies by country, according to subsidisation levels and the price elasticity of demand.
8
Energy intensity, an important measure of the economic efficiency of energy consumption, improves steadily across APEC economies with the rationalisation of energy prices.
Figure 12:
Impact of fossil‐fuel consumption subsidy phase‐out on energy demand in APEC economies, 2012‐2035
- 400
- 300
- 200
- 100
0
2012 2015 2020 2035
Mtoe
Gas
Coal
Oil
Note: Energy savings are from the progressive phase‐out of all subsidies by 2020 compared with a baseline in which subsidy rates remain unchanged.
Subsidy phase out would trim global oil demand in APEC economies by about 0.5 million barrels per day (mb/d) in 2020 and 0.6 mb/d in 2035. Oil demand savings in 2020 are roughly equal to the present oil consumption of Chile and New Zealand combined. These cuts stem predominately from the transport sector. Demand for transport fuels is relatively inelastic in the short term, but higher prices (and expectations of such) contribute to greater conservation and the uptake of more efficient vehicles long after the phase‐out of subsidies has been completed.
The elimination of subsidised electricity prices is the main source of coal savings in APEC economies, which amount to 3.6% in 2020 and grow to 5.3% in 2035. Natural gas demand would be cut by 3.4% in 2020 and 3.8% in 2035, with the savings evenly distributed between industry, buildings and the power sector.
Curbing the growth in energy demand via fossil‐fuel subsidy reform has several important
40

energy‐security implications. In net‐importing countries, lower energy demand reduces import dependence and thereby spending on imports while, for net‐exporting countries, removing subsidies allows for maintenance of export availability and earnings. Enhanced consumer
8
The price elasticity of demand is the principal determinant of energy and emissions savings from subsidy reform, reflecting the extent to which consumption is responsive to higher prices. Elasticities vary according to the specific region, fuel and uses analysed, but generally increase over time as consumers have opportunities to purchase more energy‐efficient equipment and change behaviour.
© OECD/IEA 2011
Page | 28 responsiveness to prices changes may also help alleviate upward pressure on international energy prices and contribute to less volatile energy markets. Furthermore, fossil‐fuel subsidy removal serves to improve the competitiveness of renewable‐energy technologies, which diversify the energy mix and are critical to achieving more sustainable growth.
High and volatile international energy prices in recent years, and the expectation that these conditions will persist, have forced many governments to reconsider the affordability of fossilfuel subsidies. Without further reform, we estimate that the cost of fossil‐fuel consumption subsidies in APEC economies would reach $150 billion (in year‐2010 dollars) in 2020 (0.3% percent of the region’s projected GDP), up about 40% from the average level of subsidies observed in the region over the period 2007 to 2010. As in the case of the historical estimates, this figure represents a mix of implicit and explicit subsidies to fossil‐fuel consumption.
2
By encouraging higher levels of consumption and waste, subsidies exacerbate the harmful environmental effects of fossil‐fuel use and impede development of cleaner energy technologies. Potential CO
2 savings in APEC economies from subsidy phase‐out directly reflect the fossil‐energy savings. We estimate that energy‐related CO
2 emissions in APEC economies would be cut by 0.6 gigatonnes (Gt), or 2.8%, in 2020 and 1 Gt, or 3.7%, in 2035, relative to unchanged rates of subsidisation (Figure 13). Cumulative CO
2 emissions over the analysed period would be lower by 14 Gt. Although not modelled here, other environmental co‐benefits would arise from subsidy phase‐out. In particular, slower demand growth for fossil‐fuels would
41

reduce emissions of other air pollutants, such as sulphur dioxide (SO
2
), nitrogen oxides (NO
X
) and particulates that cause human health and environmental problems.
Figure 13:
Impact of fossil‐fuel consumption subsidy phase‐out on CO
2 emissions in APEC economies, 2012‐2035
12
22
24
26
28
14
16
18
20
2000 2005 2010 2015 2020 2025 2030 2035
Gt
Subsidy removal
No subsidy removal
© OECD/IEA 2011
Page | 29
The IEA’s
estimated that, worldwide, 1.4 billion people (over
20% of the global population) lack access to electricity and 2.7 billion people (some 40% of the global population) rely on the traditional use of biomass for cooking. One common justification for fossil‐fuel subsidies, in APEC economies and elsewhere, is that they are needed to help the poor gain or maintain access to energy services essential to basic living standards. While making electricity and clean cooking facilities available to the poor is of vital importance, numerous studies have found that energy subsidies as presently constituted tend to be regressive, disproportionately benefitting higher income groups that can afford higher levels of fuel consumption (Arze del Granado, 2010). Poor households may not have access to subsidised energy directly, lacking a connection to electricity or natural gas and owning no vehicle.
42

Lowincome households in any case generally spend less in absolute terms on energy than their higher‐income counterparts. Without precise targeting, energy subsidies are often an inefficient means of assisting the poor.
In APEC economies where fossil‐fuel consumption subsidies have been identified, the electrification rate and share of the population with access to modern fuels has been estimated for China, Indonesia, the Philippines, Thailand and Vietnam (Table 3). The analysis indicates the presence of subsidies for fuels that are typically directed toward increasing access to basic energy services for the poor, such as electricity, LPG and kerosene. In 2010, subsidies to these fuels in APEC economies ranged from 21% of total subsidies in the Philippines to 83% of total subsidies in China. Even where the share of subsidies to these fuels is high, efficiency of delivery to targeted groups that need assistance is not guaranteed.
Table 3:
Subsidies in the residential sector for electricity, LPG and kerosene in APEC economies with low levels of modern energy access, 2010
Energy poverty indicators Subsidies in the residential sector Electricity, LPG & kerosene subsidies as share of total
Electrification rate
Modern fuels access
Electricity LPG Kerosene
China 99% 68% yes yes no 83%
Indonesia 65% 46% yes yes yes 56%
Philippines 90% 53% no yes no 21%
Thailand 99% 65% yes yes no 46%
Vietnam 98% 41% yes no no 58%
In practice, the poor capture only a small share of all the subsidies to fossil fuels. We estimate that out of the $409 billion spent globally on fossil‐fuel consumption subsidies in 2010, only
$35 billion, or 8% of the total, reached the poorest income quintile (the bottom 20%). This
43

finding is based on a survey of 11 of the 37 countries identified as having fossil‐fuel consumption subsidies (including five of the ten APEC economies identified) and does not take into account subsidies specifically provided to extend access to basic energy services. In the
11 countries, which were selected on the basis of data availability and have an aggregate population of 3.4 billion, the share of total fossil‐fuel consumption subsidies reaching the
© OECD/IEA 2011
Page | 30 poorest income quintile ranged from about 2% to 11% (Figure 14). Among the APEC economies surveyed, the share was lowest for the Philippines.
Figure 14:
Share of fossil‐fuel subsidies received by the lowest income quintile in selected countries in 2010
0% 20% 40% 60% 80% 100%
South Africa
Sri Lanka
Philippines
India
Bangladesh
Angola
Indonesia
Thailand
Vietnam
China
Pakistan Lowest 20%
Remaining population
Compared to other fuels, subsidies to kerosene tend to be best targeted on the poor, despite its tendency to be sold in the black market. In 2010, nearly 15% of the kerosene subsidies in the countries analysed reached the lowest income quintile; subsidies to LPG, gasoline and diesel benefited the poor least, with only 5% to 6% going to the lowest quintile (Figure 15). Despite the utility of LPG as a clean cooking fuel for the poor, the up‐front cost for infrastructure connections and the practice of selling LPG in larger quantities than kerosene make this fuel less affordable for the poor, elevating the barrier to their gaining initial access (Shenoy, 2010).
44

Subsidies to electricity and natural gas were in the middle of the range, with shares of 9% and
10% disbursed to the lowest quintile. These results demonstrate that subsidising fossil fuels is, in practice, an inefficient method of providing assistance to the poor. They also highlight the opportunity for subsidy reform, as the same level of financial support could be distributed more efficiently to low‐income households at a lower cost. In general, social welfare programmes are a more effective and less distortionary way of helping the poor than energy subsidies.
© OECD/IEA 2011
Page | 31
Figure 15:
Share of fossil‐fuel subsidies received by the lowest income quintile by fuel in surveyed countries, 2010
6%
Gasoline
5%
LPG
6%
Diesel
15%
Kerosene
10%
Natural Gas
9%
Electricity
Although low‐income households only benefit from a small proportion of energy subsidies they are still likely to be disproportionately affected by their removal, as they spend a higher percentage of their household income on energy. Similarly, subsidies can bring considerable benefits to the poor when they encourage switching to cleaner and more efficient fuels or enhance access to electricity. Therefore, any moves to phase‐out subsidies must be carefully designed so as not to restrict access to essential energy services or increase poverty.
Providing financial support for economic restructuring or poverty alleviation is essential to smoothing the path for fossil‐fuel subsidy reform. In most successful cases of energy‐subsidy reform,
45

support has been well‐targeted, temporary and transparent.
9
In undertaking major changes, assessments should be made regarding the extent to which the economy and society can absorb the impacts of the reform. Furthermore, the phase‐out of fossil‐fuel subsidies should be considered as a package, particularly if broader structural reforms are underway or being contemplated. Pre‐announcing a strategy and timeframe for phasing in subsidy reform can help households and businesses to adjust to these reforms (UNEP, 2008).
9
See, for example, Laan (2010), and IMF (2008).
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Governments face difficult challenges in reforming inefficient fossil‐fuel subsidies. Each country must consider its specific circumstances, the types of subsidies that need reform and their intended purpose and effectiveness pursuing economic, political or social goals. Past reforms have had varying levels of success. Many have achieved positive and lasting change; but some have been planned and implemented poorly, or have succumbed to back‐sliding,
governments successfully institute reforms only to reintroduce subsidies later. The risk of adverse consequences if subsidy reform is not carefully planned for and executed is real.
Previous experiences have illustrated several barriers to implementing fossil‐fuels subsidy reform and strategies that can help guide future efforts (Figure 16).
Inadequate information about existing subsidies is frequently an impediment to reform.
Before taking a decision about reform, governments must precisely identify energy subsidies, including their beneficiaries, and quantify their costs and benefits, in order to determine which subsidies are wasteful or inefficient. If subsidies are failing to serve their defined objectives or are leading to unintended adverse consequences (for example, fuel adulteration and smuggling), the need for remedial action will be clear. Nonetheless, removing subsidies without understanding
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and providing for the consequences may hurt vulnerable low‐income groups that depend on subsidies for access to basic energy services. Making more information on fossil‐fuel subsidies available to the general public can help build support for reform. Disclosure may include data on overall costs and benefits as well as on price levels, price composition and price changes
(Wagner, 2010).
Figure 16:
Summary of common barriers to fossil‐fuel subsidy reform and strategies for successful implementation
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Box 3:
Recent experiences implementing subsidy reform
implemented sweeping reforms to energy subsidies in December 2010 in a bid to lessen the burden on its central budget and reverse deep inefficiencies in its energy sector and the larger economy. Prior to the reform, energy prices were often subsidised by over 90%.
Under the reform programme, the prices of regular gasoline increased by 300%, premium gasoline by 230% and diesel and gas oil by 840%. To date, these higher prices have been maintained, despite the population having been previously accustomed to low energy prices and the limited success (with the exception of its use of smart cards for gasoline rationing) of previous reform attempts. To counter the public sense of entitlement to low energy prices and build a case for reform, subsidies were identified and their onerous costs publicised before changes were made. Although details were lacking, the intent to undertake a five‐year programme to phase out energy subsidies (that included compensation to consumers) was communicated frequently. To encourage public acceptance and diminish the economic impact of price increases for households, cash payments were made to every citizen prior to the effective date and nearly 90% of the population continue to receive monthly payments. Furthermore, key capabilities were developed to facilitate reform, such as establishing bank accounts for heads of households to receive government compensation payments. Time will tell whether the reforms will be permanent, and certain aspects of the programme can be criticised (for example, the lack of discrimination in compensation payments), but its experience thus far reflects serious intent.
In
, the price of LPG cylinders was previously subsidised, benefitting consumers
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who could afford to buy larger quantities rather than low‐income families. The government raised the price of LPG cylinders to market levels in 2011 and began to provide offsetting payments to the poor through electricity bills. This is an interesting example of targeting assistance to the poor by linking to another household service; the delivery method is not perfect as it fails to offer payments to multiple families on a single connection or those without a connection to the electricity grid.
Inequitable distribution of subsidies and the scale of the associated financial liabilities, particularly as international oil prices have risen, provided a strong impetus for reform in
(Tumiwa
, 2011). The government accordingly announced in its
Medium‐Term
Plan in 2010 that it would reduce spending on energy subsidies by 40% by 2013 and eliminate subsidies by 2014. Actual implementation measures have been slowed by macro‐economic concerns and lack of public acceptance. Fuel subsidies to private vehicles were to have been phased out, but the programme was postponed in early‐2011 because of worries about rising inflation. It will be important for the government to actively continue to communicate the potential benefits to both individuals and the economy (such as improved competitiveness and freeing government revenues for capital investment and social assistance programmes).
The politics of reforming subsidies are challenging. Subsidies create entrenched interests among domestic industries advantaged by cheap energy inputs and those income groups that are accustomed to receiving this form of economic support. Such stakeholders can be expected to resist subsidy phase out, particularly in the absence of clear plans to compensate losers or make the transition gradual. Resistance to fossil‐fuel subsidy reform can be particularly strong in major fossil‐fuel‐exporting countries, where people may feel entitled to benefit directly from their nation’s resource wealth. Although not always necessary, subsidy reform has a better
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While the removal of fossil‐fuel subsidies generally improves long‐term economic competitiveness and fiscal balances, fears of negative economic consequences in the short term can be expected. The phase‐out of subsidies must be carried out in a way that allows both
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energy and other industries time to adjust, so as to safeguard the communities affected.
Energy‐price controls are often an important tool for controlling inflation and their removal must be accompanied by other macroeconomic policies to reduce inflationary pressures.
Once reforms have been implemented, mounting pressure from short‐term economic concerns has sometimes led to back‐sliding. This risk can be mitigated if governments dissociate themselves from price‐setting, such as when energy prices are liberalised or automatic pricing mechanisms are established.
Even where there is interest in pursuing subsidy reform, certain institutional and administrative capacity, and even physical infrastructure, is required for governments to act effectively. It is important to have institutions that are capable of accurate and timely data collection of data about the existing subsidies, their distribution and the need for compensation (where necessary) following reform. Governments are well‐placed to gather this far‐reaching information, although other organisations may have integral technical expertise that can aid in this effort. Targeted compensation is typically more effective where the necessary administrative capacity exists to reach the intended groups and distribute benefits reliably and without fraud. Where subsidies are re‐targeted to the poor via direct financial transfers, those eligible to receive support may not be registered with the government or may lack the means for receiving support, such as having a bank account. Creating new infrastructure may sometimes be an important element in subsidy reform. For example, the availability of public transportation reduces the need for personal vehicles and lessens the burden of the rising cost of transport fuels, although its provision is usually only readily practicable in population centres.
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The economic burden of fossil‐fuel subsidies in APEC and other economies has provided a
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strong motive for reform, but progress to phase them out has been uncertain. Falling prices during the 2008‐2009 recession offered a window of opportunity to align regulated domestic prices and international prices. This was seized by several governments, however obstacles to reform have mounted with the return of higher prices in 2010 and 2011. Of the ten APEC economies that the IEA has identified as having fossil‐fuel consumption subsidies in 2010, at least half have taken steps toward reform. Some have already implemented new measures to bring prices closer to international market levels, even if this has not yet led to expected reductions in price gaps (Table 4).
Table 4:
Recent policy changes in APEC and other economies affecting fossil‐fuel subsidies
China Oil product prices were indexed to a weighted basket of international crude prices in 2008. Natural gas prices increased by 25% in May 2010. China has started removing preferential power tariffs for energy‐intensive industries.
India Plans to eliminate cooking gas and kerosene subsidies in a phased manner beginning in 2012, replacing with direct cash support to the poor. Raised prices for gasoil, LPG and kerosene (by 9%, 14% and 20%) in June 2011.
Indonesia Plans to reduce spending on energy subsidies by 40% by 2013 and fully eliminate fuel subsidies by 2014, but postponed the restriction of subsidised fuel for private cars in February 2011 because of inflation concerns.
Iran Significantly reduced subsidies in December 2010 as the start of a 5‐year programme to bring the prices of oil products, natural gas and electricity in line with international market‐levels.
Malaysia Reduced subsidies to gasoline, diesel and LPG in July 2010 as part of a gradual reform programme. However, total subsidy bill is expected to rise in 2011.
Mexico Intends to eliminate subsidies to gasoline and diesel, but international prices have risen more quickly than scheduled increases; also plans to close the price gap for LPG.
Pakistan Raised gasoline, diesel and electricity prices in 2011, but price increases have not kept pace with international prices. Plans are to reduce the power subsidy by 20% this year and gradually phase it out.
Russia Fully liberalised wholesale electricity prices in January 2011; electricity tariffs to households remain regulated. Natural gas prices for industrial users are to continue increasing toward international levels through 2014 based on the balancing of revenues from domestic and export sales.
South Africa Raising electricity tariffs by approximately 25% per year over 2010 to 2013.
Thailand Announced in April 2011 that a cap on domestic diesel fuel prices will be
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maintained by drawing on the state Oil Fund.
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Globally, there are recent examples of progress, but reform has been a struggle since the return of higher energy prices. While this has reminded governments of the heavy economic liability associated with subsidised prices, many have not been able even to keep domestic price increasing in line with the rise in international prices. The cost of subsidies is expected to grow in 2011 in Pakistan, Qatar and the UAE, despite their having raised oil product prices to some extent. Argentina, Morocco, Nigeria, Thailand and Venezuela have frozen prices at times in order to shield citizens from higher prices, thereby increasing subsidies. Recent political instability has made subsidy reform more challenging across the Middle East and North
Africa and, since late 2010, strikes, protests and demonstrations have persuaded several governments to reverse efforts to reduce fuel subsidies or expand current subsidy programs.
In any case, the international commitments by APEC economies (as well as those in the
G‐20) generally reflect the growing recognition that fossil‐fuel subsidies are unsustainable. This is an encouraging start, and continued reform efforts will be needed to realise the full extent of gains from subsidy removal and achieve more sustainable growth.
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International Energy Agency
9 rue de la Fédération, 75739 Paris Cedex 15, France
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