Fossil fuel subsidies – let’s at least agree on how to measure them!

At OpenOil we’re researching fossil fuel subsidies because we want to join the global debate on how to end them. They will cost about $600 billion this year, are a massive drag on the development of green energy and mostly serve the rich. There really is very little to be said for them.

But it came as something of a shock to find out, in this great global debate, that there is no standard way to measure energy subsidies! The IMF, IEA, EIA, OECD, UNEP, you name it – use either different methodologies or different assumptions or both and routinely come up with wildly different estimates for the same country in the same year.

Not only are the data swilling around the public domain confusing – I might expect that – but the methodologies and assumptions on which it is based are incoherent most of the time. And what is particularly striking – there is no consensus on how to measure the subsidies. How could that be, given their huge impact on carbon emissions and government budgets? And what is the consequence.

At this point we issue a geek alert, but read on, because the devil in this detail is truly astonishing.
To begin at the beginning. On the surface, there is consensus on a broad definition of energy subsidies. According to the International Energy Agency (IEA) they entail “any government action that concerns primarily 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.” So far so good.

The trouble is there is a long catalog of what such government actions might be. A joint report by the OECD, IEA, World Bank and OPEC lists, for instance, up to 30 different types of subsidies in a so-called matrix of transfers and in a recent study the OECD even identifies up to 250 mechanisms across 34 member. Broadly speaking those types of subsidies can be divided into producer and consumer subsides and entail everything from direct financial transfers as grants to consumer and producers, tax credits, trade restrictions and direct price controls.

So to determine the exact level of fossil fuel subsidies in a country, the best way would be to have a look at each single different type of subsidy transfer off this list within that country – if you can find it. At each of national, state, provincial and local levels of government of course. And remember that different agencies at each of these levels of government might deploy a similar subsidy mechanism on the same product at the same time, but calling it different names.

And it doesn’t end there. In countries with less transparent governance, accurate information is hard to get as government officials, and all kinds of middle men may want to hide the level of benefits they draw from these subsidies. The best example is Nigeria where last year an ad-hoc committee of the federal House of Representatives realized that about $7 billion had disappeared into private pockets out of the subsidy program.

Exactly because of these difficulties there are some methodologies which are supposed to make estimating energy subsidies easier. But what I have found out, especially when reading a brilliant paper by Doug Koplow, is that not only do major organizations often use different methodologies, they may use different underlying assumptions to arrive at radically different results even with the same methodology. For instance, according to estimates by the IEA the total amount of subsidies on oil products in Egypt amounted to $9.2 billion in 2007. The IMF, however, estimates a figure of $3.8 billion, for the same year using the same methodology! That is a difference of about 58 percent! What a statistical margin of error. For Nigeria that difference accounts to up to 31 percent. How can that be explained? And with such an explosive issue politically, how can we expect policy planners to put their careers on the line and address the subsuidy question when they know they are acting a bunch of conflicting best guesses, usually produced by foreign experts who may be well-intentioned but who don’t have skin in the game like they do?

Both these institutions used something called the “price-gap approach”, also used by the OECD and World Bank. One could say, it is THE main approach to measure energy subsidies on a large scale and tries to capture the amount of money that is lost by selling fuel not in a subsidy-free market (for some economic geeks this often also refers to the opportunity cost concept). It does so by calculating the difference between a so-called ‘reference price’ and a domestic ‘end-user price’ or retail price.  Most of these big institutions above agree more or less on the end-user price by taking the domestic retail price as it is – except the World Bank subtracts any taxes imposed at the retail level. But there is no agreement on reference prices, time frames, and a whole bunch of other assumptions. For instance, the OECD suggests that the reference price for large fuel exporters should be the cost of production, while the IEA, IMF and World Bank usually take world prices of different fuel products and adjust them to a border price which is world market price minus the cost of transporting fuel to export markets (for exporters) and the cost of moving fuel products to consumers in import countries.

Also, taking world prices as a reference sounds like it makes sense. But they don´t actually exist for all fuel products. There are, for instance, no world prices for natural gas and liquified gas because it sells more regionally or locally, and many parts of the world lack any transport and conversion facilities. So, what is used sometimes in such cases is a so-called “long-run marginal cost” proxy, the cost of bringing a unit of that energy product onto the market.

And yet none of these proxies, adjustments and assumptions are standardized and most organizations are not very transparent about their exact methodologies, even if they are public service institutions. Yes, the IEA has published a short summary of its methodology for a global estimation of energy subsidies. But it only scratches the surface of a large labyrinth of data, and as you see with the comparison of estimates above, leads to huge margins of error.
There are, however, also other problems with the price-gap approach and the way it has been used. A major one is that it leaves out a large chunk of subsidies that do not affect end-consumer prices but are harmful for government budget and the environment.  This includes foremost producer subsidies that protect domestic energy industries which are outdated, harm the environment and entail a large budget burden, such as domestic coal industries.

To make that more clear, let’s try a direct comparison between price gap methodologies and another more detailed technique used to try and capture these other subsidies. These are, for instance, the the producer subsidy equivalent (PSE) and the Consumer Subsidy Estimates (CSE) used by the OECD. They are probably the most detailed measurement of subsidies as they sum up each single subsidy benefit transferred to consumers and producers. The OECD just recently published estimates of subsidies for 34 countries using this methodology.  I just use some older estimates, here, to show you what difference the methodological approach makes and how much the price-gap approach leaves out. For instance, in the UK coal subsidies according to the PSE amounted to $3.4 per tonne in 1996, but only to $2.2 per tonne under a price-gap approach. For Japan, the difference is incredible with $2.2  subsidies per tonne of coal in 1996 according the price-gap approach and $149 per tonne according to the PSE.

So, how can we come up with a global fossil fuel subsidy initiative if we can’t even agree on the level of subsidies in each country? And maybe even more importantly, if you we underestimate the level of harmful energy subsidies in any given country? My answer is, you probably can’t or at least you shouldn’t.

This does not necessarily mean we should try and re-invent the wheel and devise a better methodology than the price-gap approach. But as Koplow suggests, the price-gap approach should be complemented by other methodologies where possible, such as the PSE or CSE.

But, more importantly, all this confusion does mean is that the basis of different methodologies have to become more transparent and organizations should agree upon a common approach to analyse the problem. Consider this blog an invitation to join us in convening the right group of people to figure it out.

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