Fossil fuel subsidies and the economics of energy transformation
The government gives the fossil fuel industry billions of pounds a year, according to a new thinktank report. With the costs of energy currently at the forefront of UK politics, the analysis has made a few headlines.
The Overseas Development Institute (ODI) suggests the UK government subsidised the fossil fuel industry to the tune of £4.3 billion in 2011 – around £7 per taxpayer. The UK ranks fifth on a global list of countries by total financial support given to carbon-intensive energy industries, the ODI says.
With the UK government legally committed to reducing greenhouse gas emissions by decarbonising the power sector, you might wonder why it is financially supporting the fossil fuel industry. But a closer look at the UK figures in the report suggests a more complicated picture.
Fossil fuel support
The ODI’s report is based on data from the Organisation of Economic Cooperation and Development (OECD). It estimates how much financial benefit fossil fuel industries – from coal power generators to oil refineries – get from a range of government energy policies.
The OECD estimates that the UK fossil fuel industry received £4.3 billion of support from government tax breaks and assistance toward infrastructure development in 2011.
The vast majority of this went to supporting the UK’s most-used fuel – gas – which got £3.6 billion. The petroleum and coal industries received support equivalent to £539 million and £85 million, respectively.
Image - UK fossil fuel support, by fuel (note)
Source: Data from OECD Inventory of Estimated Budgetary Support and Tax Expenditures For Fossil Fuels 2013, chart by Carbon Brief
The OECD calls these amounts ‘support’, rather than ‘subsidy’. It defines support as any policies that “provide a benefit or preference for fossil-fuel production or consumption, either in absolute terms or relative to other activities or products”.
In essence, that means it includes any policies which can be seen as reducing the fossil fuels industry’s costs or boosting their profits. That’s regardless of whether other industries also get this help.
If the amounts sound like a lot, it’s worth noting that over 90 per cent of the £4.3 billion figure for the UK comes from the reduced rate of VAT that domestic consumers pay for fuel and power – as the chart below illustrates.
The remainder goes toward providing tax breaks for technology improvements (such as improving pipelines) and investments in coal mines, and oil and gas fields. The chancellor has also announced a number of planned tax breaks for companies embarking on exploration for unconventional fossil fuels such as shale gas – so the number could go up marginally.
Image - breakdown fossil fuel support (note)
Source: Data from OECD Inventory of Estimated Budgetary Support and Tax Expenditures For Fossil Fuels 2013, chart by Carbon Brief
VAT on most goods is normally 20 per cent, while VAT on energy is only 5 per cent. The VAT break reduces the cost of energy for the consumer, making it relatively cheaper than goods on which the full rate of VAT is charged – so the OECD counts it as financial ‘support’.
Since about 90 per cent of the UK’s consumed energy comes from coal, gas and petroleum, you could argue the tax break mainly benefits the fossil fuel industry.
But if it seems odd that a government committed to decarbonisation to subsidise fossil fuel companies, it’s worth bearing in mind that the VAT break applies to all energy – including low carbon energy sources. In other words, most of this support doesn’t directly benefit fossil fuels at the expense of less polluting competitors.
Defining subsidies
So is giving fossil fuels tax relief the same as a giving the industry a subsidy? Views on what counts – and what doesn’t count – as a subsidy vary widely.
While the government has committed to cut the UK’s greenhouse gas emissions, it also has a responsibility to secure reliable sources of heat and electricity to the UK’s homes. The UK is still mostly fossil-fuel powered. So this can mean ensuring carbon intensive industries continue to be profitable and their products relatively affordable – even if that conflicts with other policy goals (such as reducing emissions).
Here the fossil fuel industry has an advantage, as it can reasonably argue it is less economically risky to keep an old, established industry running, than help newer, low carbon, energy technologies develop.
The way the UK supports its more established energy sector differs to other countries. Other governments give money directly to the fossil fuel industry. For instance, the US government buys petrol directly from companies for an emergency reserve, and the German government pays a subsidy to coal producers to keep the industry going in the face of declining import prices. Those approaches contrast with the UK’s largely tax relief-led approach.
The UK’s fossil fuel industry tax breaks are also a very different support mechanism to the subsidies the government offers low carbon energy sources, through feed-in tariffs and contracts for difference. Those government schemes offer low carbon energy sources clear economic benefits to help the industry develop, in deals which aren’t extended to fossil fuels.
David Steven, a policy analyst at the Center on International Cooperation (CIC) at New York University, argues that once those differences are taken into account, it’s questionable whether the UK government provides any subsidies to the fossil fuel industry at all.
He points out the the OECD’s calculation doesn’t take into account revenue raised from other taxes on the fuels – such as petrol fuel duty. So while the VAT tax break might seem pretty big, it’s partially offset by other taxes levied on the fossil fuels which the OECD doesn’t include in its estimates and which don’t apply to renewable energy sources.
On the other hand, groups such as the oil-focused campaign group, Platform, argue that the scope of what counts as a subsidy should be wider, and include things like military support for the oil and gas industry.
Policy tradeoffs
Despite the differences in the types of financial support, the question of subsidies is being reported as a ‘fossil fuels vs renewables’ story.
But the OECD figures do flag a wider issue – how governments plan to transition from being largely fossil fuel based economies to run on low carbon energy.
As governments step up their efforts to decarbonise, established ways of keeping energy systems ticking over are going to come under more pressure. The ODI’s report highlights that this doesn’t just mean revising how renewable energy is subsidised as new technologies develop – the current focus of much of the media debate – but also discussing the tricky question of what to do with the incumbent fossil fuel industry.