A short search for the dictionary definition of subsidy provides the following insight – "A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low". The word has longevity (late 14th century), effectively derived from Anglo-Norman French subsidie or Latin subsidium, implying assistance.

In today's context, subsidies continue to be used widely in order to encourage consumption of goods and services with positive benefits, particularly when part of that benefit accrues to society. At the simplest level, subsidies alter the supply & demand dynamics of a free market. The laws of economics state that, ceteris paribus, subsidising the cost of a good typically leads to an increase in consumption of that good.

A fossil fuel subsidy is any government action that lowers the cost of fossil fuel energy production, raises the price received by energy producers, or lowers the price paid by energy consumers. Fossil fuel subsidies can also come in many different forms, which can lead to significant discrepancies in their estimates. For example, the International Energy Agency (IEA) focuses largely on subsidies that have a direct impact on the consumer, whereas the International Monetary Fund (IMF) includes those aimed at producers, such as tax relief and the cost of carbon. That said, the majority of subsidies in emerging countries relates to consumption rather than exploration & production. Regardless, fossil fuels account for the majority of our total energy consumption, and hardly represent a fledgling industry in need of support.

In emerging nations, fossil fuel subsidies have proven to be one of the most difficult challenges to address by policymakers. Historically, fuel subsidies have been part of policy intervention mechanisms designed to protect the lower-income part of the population from highly volatile commodity prices. Perhaps surprisingly, IMF research suggests such policies on fossil fuel subsidies actually widen the gap between high and low income populations. Furthermore, IEA analysis indicates that only 8% of the subsidy typically granted reaches the poorest income populations (IEA, 2011). A recent World Bank paper agrees – "in low and middle-income countries, the richest 20% received six times as much from fossil fuel subsidies as the poorest 20%." A fair conclusion is that as a social welfare tool, it is clearly failing.

The IEA's latest estimates (for consumption) indicate that fossil fuel consumption subsidies worldwide, amounted to $548 billion – see graph opposite. This is the equivalent to four times the value of subsidies to renewable energy and more than four times the amount invested globally in energy efficiency improvements.

But there are greater distortions, as a study by the IEA in the South-East Asia (ASEAN) region in 2013 found that the payback period for energy efficiency measures doubled due to the presence of energy price subsidies. Such a distorted production and consumption pattern for resources has significant negative environmental and social impacts. In terms of estimated footprint, the IMF has calculated that global carbon emissions would have been 4.5billion tonnes (13%) lower without these subsidies. The impact on carbon emissions is heightened by the fact that these subsidies stall the growth of cleaner fuels and new energy technology. Taking these into account, the global cost of subsidies has been estimated by the IEA at $1.3 trillion in 2011 – or 2.5% of global GDP.

Clearly, the pervasiveness of fossil fuel subsidies brings about inefficient energy use leading to excessive carbon emissions. This costs governments dearly, in terms of exacerbating fiscal deficits, but the social and chronic health issues resulting from the increased air pollution can be even more damaging.

On the positive side, there is potential for re-allocating the funding of these damaging policies to more productive, sustainable policies such as improving energy efficiency. The recent changes of government in Indonesia and India, have led to positive changes aided by the fall in oil price. Indonesia's decision to remove its extensive transport fuel subsidies is expected to save up to $8bn a year. Further progress on closing down expensive oil-based power plants would be well received. In India, the new Modi Government took positive steps to eliminate state controls on diesel prices, while introducing a new scheme to alleviate poverty through better administration of the LPG subsidy programmes. Spending on fossilfuels in India is reportedly $42.8bn or c.2.3% of GDP according to a 2012 IEA paper – double the public expenditure on health, estimated by the World Bank at 1.2%-1.3% of GDP.

In summary, reallocating state funding away from these damaging subsidies towards sustainable sources will, in our view, be more beneficial for both society and the economy in the future. In terms of stock specific exposure, companies that offer productive energy efficiency solutions, such as Daikin, have a strong opportunity to capture a portion of this reallocated budget.


http://www.economicshelp.org/micro-economic-essays/marketfailure/subsidypositive-ext – subsidies – positive externalities

Source: IEA

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