Government funding at odds with climate ambitions, warns Allianz, outlining need for holistic ‘just transition’ policies.
While fossil fuel subsidies have been declining at the global level, the trend is not nearly sufficient to reach climate ambitions, according to a study by Allianz and credit insurance subsidiary Euler Hermes. As of 2019, the total value of fossil fuel subsidies in 81 countries studied was US$468 billion, outpacing renewable energy subsidies in most countries with the exception of the EU 28 and the US.
As noted by Allianz, the International Renewable Energy Agency (IRENA) estimates that the world’s total, direct energy sector subsidies, including fossil fuels, renewables and nuclear power, stood at least US$634 billion in 2017. Fossil fuel subsidies accounted for 70% of the figure while subsidies to renewable power generation technologies accounted for around 20% (US$128 billion), biofuels 6% (US$38 billion) and nuclear power around 3% (US$21 billion).
IRENA estimates that fossil fuel subsidies will have to fall below US$139 billion by 2050 for a 1.5°C-compatible energy transition pathway.
Fossil fuel subsidies account for 0.5% of global GDP, “almost exactly the size of the funding gap needed to comply with the Paris Accord”, stated the Allianz study. It warned, however, that abolishing such subsidies would come with steep costs for consumers, particularly the poorest households.
Poor households are strongly affected in relative terms as their energy-related expenditures consume almost twice the share of their household incomes (nearly 7%), compared to that of the richest quartile of households, according to the study. Policy-makers and investors are increasing aware of the social impact of the transition to net-zero emissions and ensuring an equitable transition to a low-carbon economy. Initiatives include the UK’s Financing a Just Transition Alliance, launched in November 2020.
The Allianz study reported that the most likely determinant of higher fossil fuel subsidies vis a vis renewable subsidies is the presence of a large domestic fossil fuel industry – “exceptionally high” subsidies are present in the Middle East and North Africa, Australia and Venezuela. The total subsidy of fossil fuels as a percentage of GDP in Venezuela is more than 16%, with Libya ranked second at just under 14%.
“The persistence of subsidies for fossil fuels stems from the political and lobbying power of the sector in many economies, along with the slower pace of energy transition that we expect in emerging economies,” said the study. “Subsidies persist for several reasons: lack of disclosed information regarding their amount, distribution and effects; weak institutions unable to better target them; lack of confidence in the government’s use of fiscal revenues from abolishing them (especially in countries prone to corruption); concerns over the harmful impact on the poor and the general economic impact (inflation, competitiveness) or weak macroeconomic conditions.”
Political sensitivities around the abolition of fossil fuel subsidies is politically sensitive require governments to take a holistic approach. Allianz cited examples of phasing-in and sequenced price increases to enable consumers to smoothly adjust. This has to be accompanied by targeted cash transfers to poor households, such as safety net programs, temporarily maintained universal subsidies on commodities used by poor households or increased spending on programs benefiting primarily the poor (targeted health, education or infrastructure expenditures).
Such measures have already been taken in Egypt, Ukraine, the Philippines, Indonesia, Ghana and Morocco. Countries that have tried to implement reforms without taking a holistic approach have faced significant popular protests, including France, where the Yellow Vest movement was sparked by a fuel tax increase.
The study warned that in situations where measures to abolish subsidies are met with popular protests, governments are often tempted to backpedal, rather than pursue reform efforts.