Should Energy be Subsidized?

The increase in international energy prices and the environmental

damage caused by excessive energy use have brought the issue of
energy subsidies into focus in recent years. While some economists
and policy makers were in favor of subsidies to the energy sector,
others were against them, considering the burden that they imposed
on government finances and the environmental impact of
indiscriminate energy use. The case discusses some of the different
aspects of energy subsidies and the impact, both positive and
negative, of withdrawing energy subsidies. The case ends with a
discussion on recent studies on energy subsidies
.

Should Energy be Subsidized?

The Dutch government will renew subsidies for green energy next year but only for
producers that can prove their energy is really green and does not deprive people of
food.1
- Jacqueline Cramer, the Environment Minister of Netherlands, in May, 2007.
Not only should global economies end energy subsidies which encourage excessive
use of energy, they should also agree on a common higher price for energy.2
- Lawrence H Summers, Former US Treasury Secretary, in April, 2007.
Encouraging reforms of subsidies that have considerable negative effects on the
environment and are incompatible with sustainable development, inter alia by
establishing a list of criteria allowing such environmentally negative subsidies to be
recorded, with a view to gradually eliminating them.3
- An action suggested in the Sixth Environment Action Program4, in
July, 2002.

Introduction
In January 2007, the US House of Representatives passed legislation seeking to cut
US$ 14 billion in oil and gas subsidies over the next ten years and instead to pass on
the amount to companies engaged in the development of renewable energy technology
and the production of renewable energy.5 However, as of June 2007, the bill was still
languishing in the US Senate, with lobbyists working hard to ensure that it did not
become law. If the bill did become law, it was expected to give a boost to the
renewable energy industry. Some analysts were, however, apprehensive that this step
might have a negative impact on the domestic oil industry in the US. A reduction in
oil subsidies was expected to lead to an increase in the domestic price of oil, forcing
the government to increase oil imports. Analysts also argued that in order to maintain
their competitiveness, US oil companies would look to cut costs, including through
layoffs, and this would have a negative impact on employment in the oil sector.
The increase in international energy prices in 2006-07 brought energy subsidies into
focus. According to economists, energy subsidies resulted in inefficient use and overconsumption of energy in addition to being a drain on the exchequer. They felt that
while it was true that subsidies allowed the poor access to energy, the government
would have to keep in mind the long-term impact of extending these subsidies on the
economy and on the environment. Even so, around the world, there were many
countries that continued with subsidies which promoted the indiscriminate use of nonrenewable energy. This not only affected the finances of these countries but also
caused harm to the environment.

3
4

Dutch Government to Renew Green Energy Subsidies in 2008, www.planetark.com,

May 7, 2007.
End Energy Subsidies by 2025, Says Summers, www.business-standard.com, April 18,
2007.
Sixth Environment Action Program, http://eur-lex.europa.eu, July 22, 2002.
The Sixth Environment Action Program (EAP) is a decision of the European Parliament
and Council. It sets out the framework for environmental policy-making in the EU for the
period 2002-12 and outlines actions that need to be taken to achieve them.
Mark Clayton, US House Takes on Big Oil, www.csmonitor.com, January 18, 2007.

217

Managerial Economics and Business Environment

In this context, proposals to shift subsidies from the non-renewable energy sector to
the renewable energy sector were gaining currency. Some analysts were of the view
that giving subsidies to develop energy from renewable sources would not only help
save the environment but also improve the finances of many oil-importing countries,
besides providing energy security. However, others felt that diverting subsidies from
the non-renewable energy sector (especially fossil fuels) was not a good idea as it
would lead to sudden increases in the price of fuel. Considering that the per unit cost
of generating energy from renewable sources was higher than the cost of generation
from non-renewable sources, the social cost of removing energy subsidies would be
high, with reduced access to energy for the poor and increase in unemployment, they
said.
On the other hand, with climate change becoming an important issue, analysts felt that
there was an urgent need to control greenhouse gas (GHG)6 emissions. It was argued
that the money that was being used to subsidize non-renewable energy could now be
effectively used to develop more efficient forms of renewable energy (Refer Exhibit I
for a brief note on renewable energy). However, even as of 2007, renewable energy
continued to be expensive vis--vis fossil fuels. Also, there were experts who felt that
renewable energy too had certain drawbacks and could not be branded as fully ecofriendly.

Energy Subsidies: The Whys and the Hows

Subsidies, a type of government financial assistance which could be in the form of
grants, tax breaks/exemptions, or price controls, kept prices below the market level for
consumers or kept costs down for producers. Subsidies such as grants and tax breaks
had a direct impact on price, while other forms of subsidies like governmentsponsored technology or research and development (R&D) affected prices or costs
indirectly.
In many countries, the energy sector was a beneficiary of government subsidies. Most
countries introduced energy subsidies in order to secure domestic energy supplies;
ensure that power supply was sufficient to meet demand; provide access to energy for
low-income households; maintain employment or slow down the loss of employment
in mining communities; or preserve the international competitiveness of the domestic
industry.7
Energy subsidies, though common, came in different guises. For example, some
OECD8 members gave subsidies in the form of cash transfers to producers of energy
from fossil fuels and nuclear power. Others helped provide reduced-rate loans to
energy producers while still others built infrastructure such as power grids and gas
pipelines to distribute energy. Subsidies in the form of quotas and trade restrictions
were also extended to protect the domestic energy industry from competition from
imports or to ensure energy-supply security (Refer Table I for different types of energy
subsidies).
6

7
8

218

Greenhouse gases are components of the atmosphere that contribute to the Greenhouse
effect. GHGs include water vapor, carbon dioxide, methane, nitrous oxide, and ozone.
Climate Change 2001: Mitigation, www.grida.no, 2001.
The Organization for Economic Co-operation and Development (OECD) is an
international organization of those developed countries that accept the principles of
representative democracy and a free market economy. The organization has 30 members
(as of 2007).

Should Energy be Subsidized?

Exhibit I
A Brief Note on Renewable Energy
Renewable energy comes from sources that are essentially inexhaustible such as
the sun, wind, and heat from the earth, or from replaceable fuels that are derived
from plants. During the past 150 years, modern civilization has become
increasingly dependent on fossil fuels oil, coal, and natural gas. Fossil fuels form
so slowly in comparison with the rate of energy use that they are considered finite
or limited resources.
Using renewable energy can provide many benefits, including

Making use of secure, local, and replenishable resources

Reducing dependence on non-renewable energy

Helping to keep the air clean by contributing to the reduction in the production
of carbon dioxide and other GHGs

Jobs being created in renewable energy industries.

Wind, solar, geothermal, hydel, and biomass are some examples of renewable
energies.
Wind Energy
Wind power is a significant form of renewable energy. It is converted to electricity
by a wind turbine. Over the past 10 years, the cost of generating electricity from
wind has fallen substantially. However, wind power is still not as cost-effective as
energy from conventional sources. Also, wind farms require large tracts of land,
which are getting more and more difficult to find.
In a 2006 report, the US Department of Energys Energy Information
Administration said that a wind plant entering service in 2015 could make
electricity from wind for 5.58 cents a kilowatt hour compared to 5.25 cents for
natural gas, 5.31 cents for coal, and 5.93 cents for nuclear power.9 However, with
the rapid advances in technology, experts believe that the cost of wind power
would come down further. For example, scientists are coming up with new
materials to make wind turbines, blades, etc., which could make them more
efficient.
Solar Energy
The energy released by the sun is called solar power. Humanity has been using the
power of the sun for centuries. In recent times, the development and refinement of
photovoltaic cells has led to the generation of electricity from solar power.
However, solar power accounts for a very small percentage of the total power
generated in the world. A major drawback of solar power is the high cost of
generating electricity with solar panels. At 35 cents to 45 cents per kilowatt hour
(as per IEA, in 2007), solar power is quite expensive. Also, since solar panels stop
generating electricity at night, the total energy output falls. Backup energy sources
would also be required.

The New Math of Alternative Energy, www.globalenvision.org, April 2, 2007.

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Managerial Economics and Business Environment

However, the future generation of solar plants would be able to produce electricity
at more competitive rates. The new plants would use concentrating solar power
(CSP)10 and would be able to generate hundreds of megawatts of power. These
plants would be able to generate one kilowatt hour of electricity at a cost of 9 to 12
cents. Major solar power companies in Europe such as Abengoa SA of Spain and
Enel SpA of Italy are spending billions of Euros on new solar plants that are
expected to bring down the costs even further.
Biomass Energy
Biomass is a renewable energy resource derived from several sources such as the
byproducts from the timber industry, agricultural crops, household waste, wood,
etc. As of 2007, biomass was the biggest source of renewable electricity in the US,
surpassing solar, geothermal, and wind power.
In 2007, the cost of generating power from biomass was high 5 cents to 10 cents
per kilowatt hour, without subsidies. This was because the biomass plants were
small (less than 50 megawatts in capacity). Experts were, however, optimistic
about biomass-powered plants gaining popularity because more and more
industries wanted to make electricity out of their waste. In 2007, a study by
California Biomass Collaborative concluded that there were 80 million tons of
plant materials produced in California each year that could be diverted to biomass
plants for generating electricity.
Geothermal Energy
Electricty generated from geothermal heat is called geothermal power. The
development of Enhanced Geothermal Systems (EGS) has improved the prospects
for geothermal power. A Massachusetts Institute of Technology (MIT) report
estimated that around 100 GWe (Gigawatts of electricity) could be generated
globally through EGS by 2050 more than enough to meet the energy needs of the
entire world. Geothermal power would be around for several millenia because the
Earths mantle had vast heat reserves. Geothermal energy made electricity round
the clock, unlike solar or wind power that required backup sources.
In 2007, the cost of geothermal energy was 6 cents to 10 cents per kilowatt hour,
without subsidies. In 2007, there were about 8,000 megawatts of installed
geothermal capacity globally.
Compiled from various sources.

Table I: Types of Energy Subsidies

Government
intervention
Direct
financial
transfer
Preferential
tax treatment

10

220

Example
Grants to producer
Grants to consumer
Low interest or
preferential loans
to producer
Rebates or
exemptions on
royalties, duties,
producer levies and
tariffs

How the subsidy usually works

Lowers cost
Raises
Lowers
of
cost of
price to
production
production
consumers

Concentrating Solar Power (CSP) uses semiconductor chips to convert sunlight into
electricity. CSP plants use huge arrays of mirrors or solar dishes to track the sun and
collect its heat to make electricity.

Should Energy be Subsidized?

Trade
restrictions
Energy
related
services
provided
directly by
government
at less than
full cost
Regulation
of the energy
sector

Tax credit
Accelerated
depreciation
allowances on
energy supply
equipment
Quotas, technical
restrictions, and
trade embargoes
Direct investment
in energy
infrastructure
Public research and
development

Demand guarantees

and mandated
deployment rates
Price controls

Market access

restrictions
Source: Reforming Energy Subsidies, www.uneptie.org, 2002.

Although it was not possible to accurately determine the total quantum of subsidies
extended to the energy sector globally, some estimates were available. For example, a
study carried out by the World Bank (WB)11 in 1992 estimated the global annual
fossil-fuel consumption subsidies12 to be at around US$ 230 billion. Very few studies
have been carried out since then to assess the extent of global energy subsidies.
Although some governments moved to reduce their levels in the late 1990s and the
early 2000s, energy subsidies continued to be high.
Several regional studies indicate that subsidies continued to be extended to the energy
sector. In 1997, the WB estimated annual fossil fuel subsidies at US$ 10 billion in the
OECD and US$ 48 billion in twenty of the largest countries outside the OECD.13 In
1999, an International Energy Agency (IEA)14 study estimated the total value of
energy subsidies in eight of the largest developing countries at around US$ 95
billion.15 In 2001, energy subsidies in the EU were estimated to be around 6.3 billion
to the coal sector, 8.7 billion to the oil and gas sector, and 2.2 billion to the nuclear
11

12

13
14

15

The World Bank is a group of five international organizations responsible for providing
finance and advice to countries for the purposes of economic development and poverty
elimination.
Governments give consumption subsidies on some commodities so as to keep their prices
low and affordable to more consumers.
Focus on Energy Subsidies, www.iisd.org, November, 2006.
The International Energy Agency (IEA) is a Paris-based intergovernmental organization
founded by the OECD in 1974 in the wake of the oil crisis. The IEA is dedicated to
preventing disruptions in the supply of oil, as well as acting as an information source for
statistics on the international oil market and other energy sectors. (Source:
www.en.wikipedia.org)
Focus on Energy Subsidies, www.iisd.org, November, 2006.

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Managerial Economics and Business Environment

sector. According to the IEA, consumption subsidies in non-OECD countries were
running at an annual rate of approximately US$ 250 billion and the largest subsidies
existed in Russia US$ 40 billion (based on 2005 data).16 The US government too
extended subsidies to its energy sector (Refer Exhibit II for US energy subsidies in
2007).

Exhibit II
US Energy Subsidies in 2007
(in Billion US$)
Mixed
Conservation,
resources, 3
2
Other
renewables, 6
Ethanol, 6

Oil/Gas, 39
Nuclear, 9

Mixed fossil
fuels, 2
Coal, 8

Source: www.csmonitor.com.

Subsidies, Rising Energy Prices, and the Environment

With rising energy prices, the issue of energy subsidies became important to policy
makers. Some environmentalists too began raising the issue due to the damage to the
environment caused by faulty energy policies. There were arguments both for and
against energy subsidies.

Energy Subsidies are Useful

The supporters of energy subsidies argued that since energy was essential for all
economic activities, it needed to be subsidized so that everyone could afford it. In
developing countries, it was common for governments to provide subsidized kerosene,
LPG, and/or electricity to make them affordable to even poor households.
Energy subsidies had a direct impact on inflation. A reduction in energy subsidies was
expected to increase energy prices, which in turn would increase the direct energy
expenditures of households. Higher energy prices would also increase the production
cost of most goods and services, which would contribute further to inflation (Refer
Exhibit III for the inflationary effect of reducing energy subsidies in Iran in 2000).
16

222

Doug Koplow, Ten Most Distortionary Energy Subsidies, www.eoearth.org, January 26,
2007.

Should Energy be Subsidized?

Exhibit III
The Inflationary Effect of Reducing Subsidies in Iran in 2000
Sales prices
(Rials/Unit)
Unit

1999

2000

Change
19992000(%)

Kerosene

Liter

100

110

10.0

0.14

Fuel oil

Liter

50

55

10.0

0.07

Gasoline

Liter

350

385

10.0

0.29

Gas oil

Liter

100

110

10.0

0.43

Inflation
ary effect
(%)

Electricity

KWh

80.3

88.5

10.2

0.18

Natural gas

Cubic Meter

47.2

53.8

14.0

0.05

Total

1.15
17

On December 31, 1999, 1 US Dollar was equal to 1,741.25 Iranian Rial.

Source: Energy Subsidies: Lessons Learned in Assessing their Impact and Designing
Policy Reforms, www.greenleaf-publishing.com, February 2004.
Therefore, in many countries, the domestic prices of petrol and other fossil fuels were
contained with the help of energy subsidies. The impact of increases in international
oil prices was also cushioned through subsidies.
Politics, both regional and international, played an important role in the continuation
of energy subsidies. Energy subsidies in the developing world were usually intended
to benefit the poor, who also usually formed the largest vote banks. And as
governments did not want to be seen as anti-poor, they continued with the subsidies.
Subsidies on cooking and heating fuels were considered necessary to improve the
living standards of the populace, especially the poor. For example, providing
affordable LPG to the rural poor meant that women and children did not have to spend
time gathering firewood. It also reduced air pollution, as evidenced in Senegal when
the government there started providing subsidized LPG to the poor. With fewer trees
being cut for cooking and heating, the pressure on forests in rural areas also went
down.
Some countries preferred cross-subsidies to government subsidies. For example,
commercial customers of Korea Electric Power Corporation (KEPCO), a state-owned
monopoly electricity company, paid 34% more than the cost of service. On the other
hand, the industrial sector paid 96% of total costs and the agricultural sector paid only
48% of total cost. Some analysts favored such cross-subsidization as it reduced the
financial burden18 on the government. In this case, KEPCO earned enough from its
commercial customers to build grid extensions to supply electricity to remote areas.19
However, the OECD was not in favor of KEPCO continuing with cross-subsidies as
the energy prices that different sections of the population paid were not marketdetermined.

17
18
19

As of mid-2007, 1 USD = 9,307 Iranian Rial.

The annual subsidy to agriculture and to remote areas was approximately US$ 113 million.
Energy Subsidies: Lessons Learned in Assessing their Impact and Designing Policy
Reforms, www.greenleaf-publishing.com, February 2004.

223

Managerial Economics and Business Environment

Energy Subsidies are Wasteful

Energy subsidies came in for criticism from many economists. It was argued that
subsidies made energy, especially fossil fuels such as petroleum, coal, and natural gas,
cheaper, leading to their increased consumption. Further, it was believed that energy
subsidies, especially in the developed world, led to irresponsible usage of energy. For
example in the US, the relatively low gasoline price encouraged the use of Sports
Utility Vehicles, which were also referred to as gas-guzzlers. Energy subsidies,
therefore, contributed to the faster depletion of fossil fuels, a finite resource, and to
increased GHG emissions.
It was also charged that energy subsidies distorted the costs and prices. Analysts
argued that by removing energy subsidies, the true cost of production of energy from
non-renewable sources could be ascertained.
The nuclear energy sector was a major recipient of energy subsidies in many
countries. Nuclear power was believed to be one of the most uneconomical energy
sources and critics said that it was only because of subsidies that energy generated
from nuclear power was viable. For example, the mandatory insurance coverage for
damage caused by a nuclear accident was miniscule in comparison to the potential
damage from a nuclear accident. In other words, the mandated insurance coverage
levels were usually too low to effectively address the potential loss. In the US, the
Price-Anderson Act20 specified the coverage requirements21. Here too, the total third
party liability coverage was lower than the coverage that US companies usually took
to insure against damages caused by natural events.
Analysts pointed out that most nuclear power companies did not include nuclear waste
disposal costs in their price structure. This too contributed to the distortion of costs in
the nuclear sector. In many countries, the government took the responsibility for
managing nuclear waste for a small fee. In the US, surcharges on nuclear power were
too low to cover anticipated disposal costs. Nuclear companies paid the US
government a one-time fee for using storage areas, which were built and managed by
the government. If insurance and capital costs were properly included, then the true
price of electricity sourced from nuclear plants could be correctly calculated. Though
the subsidies extended to the nuclear industry could not be assessed accurately, it was
estimated that on a global level, they could be around US$ 10 billion per year.22
Electricity generation from fossil fuels caused substantial environmental damage, but
most costs associated with such damage were not included in the pricing system. This
kind of subsidy was referred to as the allowance of external cost23. In the EU, cost of
20

21

22

23

224

The Price-Anderson Act, originally enacted by the US Congress in 1957, limits the
liability of the nuclear industry in the event of a nuclear accident in the United States. The
main purpose of the Price-Anderson Act is to ensure the availability of funds ($10 billion
in 2007) to provide compensation to members of the public who incur damages in a
nuclear incident.
As per the Price Anderson Act, revised in August 1998, the assessments came to around
US$ 10 million per reactor per year. (Source: www.nei.org)
Doug Koplow, Ten Most Distortionary Energy Subsidies, www.eoearth.org, January 26,
2007.
External costs are tangible costs incurred by society in relation to health and the
environment. However, these costs are not built into the price of energy as paid by the end
consumer and therefore are borne by society at large. (Source: Energy subsidies and
external costs, www.uic.com.au, February, 2007)

Should Energy be Subsidized?

electricity generation on an average was 4 cents/kWh; if external costs were included,
the price of electricity from coal would double and that from gas would increase by
around 30%.
Around the world, the ethanol and bio-diesel sector received a large amount of
subsidies. In the US, the Volumetric Ethanol Excise Tax Credit (VEETC)24 indicated
the magnitude of the subsidy (Refer Exhibit IV for US support for ethanol and biodiesel). Agricultural subsidies combined with energy subsidies distorted the real costs
incurred by ethanol producers to make ethanol.
Exhibit IV
US support to Ethanol and Bio-diesel
Ethanol
(Low)

Ethanol
(High)

Biodiesel
(Low)

Bio-diesel
(High)

Total support
(Annualized estimate,
2006-2012)

$ billions

6.3

8.7

1.7

2.3

Subsidy per gallon

gasoline equivalent
(GGE) or gallon diesel
equivalent (GDE)
(Annualized estimate.
2006-2012)

$/GGE
or
$/GDE

1.44

1.96

1.24

1.70

Source: Ronald Steenbilk, Born Subsidized: Biofuel Production in the USA,

www.gem.sciences-po.fr, January 2007.
In many countries, consumers were provided with subsidized electricity. For example,
farms in California paid very little for using electricity for irrigation.25 Russia too
extended subsidies on electricity to consumers. In India in 2000-2001, the average
price of electricity was 212 Paise (around 5 US cents) per/kWh, which was 30%
below the average cost. In the same year, the average price paid by the consumers in
the agricultural sector was 28 Paise/kWh, and the average household price was 174
Paise/kWh. Since the State Electricity Boards (SEBs) in India could not cover their
costs, they faced financial problems and were unable to invest in new power stations
and distribution networks to improve the reliability and quality of their service.
Some analysts were of the view that if subsidies on non-renewable energy were
removed, renewable energy would become cost competitive and this could promote its
use. Reduction in the use of non-renewable energy would also lead to considerable
reduction in GHG emissions. Analysts cited Chinas efforts to eliminate fossil fuel
subsidies and their impact on consumption of renewable energy. Between 1990 and
1997, China reduced its annual fossil fuel subsidies from US$ 24.5 billion to US$ 10
billion. It cut its coal subsidies from US$ 750 million in 1993 to US$ 240 million in
24

25

The American Jobs Creation Act of 2004 (Public Law 108-357) established the Volumetric
Ethanol Excise Tax Credit (VEETC), which provides ethanol blenders/retailers with $ 0.51
per pure gallon of ethanol blended or $ 0.0051 per percentage point of ethanol blended.
The incentive is available until 2010. VEETC was a production-linked subsidy without any
linkage to the price of the fuels ethanol is supposed to compete with (Source:
http://www.ethanolrfa.org/resource/veetc/)
According to a study released on May 30, 2007, by the Environmental Working Group, the
amount of the subsidy was US$ 100 million in each year (Source: Calif. Farms Get
Electricity Subsidy, www.topix.net, May 30, 2007).

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Managerial Economics and Business Environment

1995. It also imposed a tax on high-sulfur coals. The combination of subsidy
reductions and the imposition of tax on high sulfur coal contributed to Chinas coal
consumption falling by 14% (or 411 million short tons26) between 1996 and 2000.
With coal becoming dearer, producers and consumers in China started using more
renewable energy. The direct impact of this was that carbon dioxide emissions fell by
17% (between 1997 and 2000).27
In 1995, Chile too removed subsidies on coal. While the macroeconomic effect of
removing the coal subsidy in Chile was negligible, it generated several positive
environmental effects such as a drop in carbon monoxide (CO)28 emissions (by nearly
8% in 1996).
Analysts argued that removing subsidies would help save the environment. The
environmental damage caused by the use of petroleum and other fossil fuels had been
well documented. Environmentalists blamed the excessive use of fossil fuels for
climate change. The air pollution caused by burning fossil fuels was believed to
contribute to several respiratory illnesses among the general population. Nuclear
power too had many adverse environmental effects such as radiation and soil
contamination.
Energy subsidies, as they distorted the costs of non-renewable energy, discouraged
research on new technologies. Despite the renewable energy sector receiving
subsidies, on a per unit basis, subsidized fossil fuels were cheaper than renewable
energy. Analysts argued that as long as subsidies were extended to oil companies,
producers of renewable energy would find it difficult to find a ready market. As a
result, R&D in the renewable energy sector did not move at the pace that it should.
One of the arguments in favor of energy subsidies was that removing them would
seriously affect the underprivileged. However, in response to this argument, analysts
suggested redirecting the money previously spent on energy subsidies to income
support, health, environment, education, or regional development programs so as to
minimize the impact.
Energy subsidies were believed to place a heavy burden on government finances.
With the increase in world energy prices, the fiscal cost of keeping domestic fuel
prices low also increased. It was also argued that countries that had negligible reserves
of fossil fuels had to meet a large proportion of their total energy needs through
imports. But by extending subsidies to fossil fuels, the governments were implicitly
encouraging their consumption. With increase in consumption, the countrys fuel
imports too increased, which would worsen its fiscal situation. Subsidies in the form
of tax exemptions reduced tax revenues, which contributed to increasing budget
deficits.
International criticism against energy subsidies was also growing. In 1997, the Kyoto
Protocol29 suggested the phasing out of fiscal exemptions and of subsidies on GHG
emitting sectors. In September 2002, at the United Nations World Summit on
26
27

28

29

226

A short ton is a unit of mass equal to 907.184 Kilo grams or 2000 pounds.
A Case Study of Chinas Policy to Eliminate Harmful Fossil Fuel Subsidies,
www.geni.org.
Carbon monoxide (CO) is a colorless, odorless, and poisonous gas. It is produced by the
incomplete burning of solid, liquid, and gaseous fuels. (Source: www.cpsc.gov)
The Kyoto Protocol of United Nations Framework Convention on Climate Change is an
amendment to the international treaty on climate change, assigning mandatory emission
limits for the reduction of GHG emissions to the signatory nations. The treaty was
negotiated in Kyoto, Japan, in December 1997. (Source: www.greenhouse.gov.au)

Should Energy be Subsidized?

Sustainable Development (WSSD), held in Johannesburg, South Africa, the Plan of
Implementation (PoI) suggested action, where appropriate, to phase out [energy]
subsidies...that inhibit sustainable development, taking fully into account the specific
conditions and different levels of development of individual countries and considering
their adverse effect, particularly on developing countries.30

Renewable Energy Subsidies

Renewable energy was considered to be the solution to the problem of growing GHG
emissions. Also, countries which were dependent on oil imports could ensure energy
security by investing in renewable energy. The renewable energy sector could also
generate employment and foreign exchange for the economy. For example, the
renewable energy sector in countries like Denmark, Australia, Japan, etc., earned
foreign exchange revenue by selling renewable energy technology and products.
Some analysts were in favor of energy subsidies to the renewable energy sector. They
argued that providing subsidies to clean, renewable energy would save billions of
dollars through reduced health care costs, and pollution and waste cleanup costs
(Refer Exhibit V for environmental impact of different sources of electricity).

Exhibit V
Environmental Impact of Various Energy Sources
Environmental
Impact^

Solar

Geothermal

Wind

Nuclear

Coal

Natural
gas

Global warming

None

None

None

None

Yes

Yes

Air pollution

None

None

None

None

Yes

Limited

Mercury

None

None

None

None

Yes

None

Mining/ extraction

None

None

None

Yes

Yes

Yes

Waste

None

None

None

Yes

Yes

None

Habitat impacts

None

None

Yes

Yes

Yes

Yes

^ At the electricity generation stage

Compiled from various sources.
Subsidies for renewable energy had increased in response to environmental concerns.
In some cases, governments subsidized these technologies to provide access to
electricity in remote areas. These subsidies generally took the form of favorable tax
treatment, grants and soft loans, regulations that favored a particular technology, and
R&D grants.
In Germany, there was a feed-in tariff31 arrangement which guaranteed renewable
energy producers up to 90% of the retail domestic electricity price. In 2001 in the EU,
the energy subsidy to the renewable energy sector was 5.3 billion. In Norway, the
government subsidized wind energy with a 25% investment grant and a production
support of NOK32 0.12 per kWh.33 China gave financial subsidies and tax incentives
for the development of sources of renewable energy.
30
31

32

www.globalsubsidies.org.
Feed-in tariff is the price per unit of electricity that an electricity company has to pay for
renewable electricity from private generators. The government regulates the tariff rate
(Source: www.glossary.eea.europa.eu).
NOK or Norwegian Krone is the official currency of Norway. As of July 29, 2007, 1 USD
= 5.80 NOK.

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Managerial Economics and Business Environment

In the US, wind energy project owners received tax credits only for the energy
produced, thus encouraging them to use better technology to harvest the maximum
energy possible from each wind turbine. Spain had a fixed tariff of 0.063/kWh for
wind energy. The US and many European countries gave subsidies for solar energy.
In Australia, there were subsidies of up to AUD 0.05/kWh for energy retailers to
source specific quantities of power from new renewables (Refer Exhibit VI for
information on direct support extended to renewable electricity supply).

Exhibit VI
Direct Support for Renewable Electricity Supply

Country

Subsidy
(Million per year)

Subsidy /KWh

2001

2010
(projected)

2001

2010
(projected)

Austria*

122

702

0.025

0.041

Belgium

27

55

0.027

0.027

Denmark*

273

499

0.042

0.039

France*

112

814

0.031

0.031

Germany*

1047

3326

0.062

0.066

Italy

1067

2493

0.063

0.059

59

679

0.019

0.057

Spain*

323

1537

0.028

0.027

Sweden

100

220

0.019

0.013

96

547

0.027

0.015

The Netherlands

UK

* Using feed-in tariff

Source: Energy Subsidies and External Costs, www.world-nuclear.org, February
2007.
In the Netherlands, the bio-fuel sector was supported with grants for R&D. In 2006, a
tax relief system was introduced. The Netherlands also gave production subsidy or
MEP34 on electricity from renewable energy sources35.
Despite general support for renewable energy, subsidies to the renewable energy
sector too came in for criticism from some quarters. It was pointed out that the capital
costs of establishing renewable energy plants was prohibitive and sometimes not
justified, considering the fact that they eventually did not produce much energy
(compared to fossil fuel power plants). Some analysts argued that some renewable
sources of energy might even have adverse environmental consequences. For
example, the dams built for hydro-electric power plants were believed to have
disturbed regional eco-systems in some areas. Regarding ethanol and other bio-fuels,
33
34

35

228

Energy Subsidies and External Costs, www.world-nuclear.org, February 2007.

MEP (Milieukwaliteit van de Elektriciteitsproductie) or Environmental Quality of
Electricity production is a production subsidy per KWh paid to domestic producers in The
Netherlands.
However, in August 2006, this subsidy program was suspended for all new renewable
energy projects as the country was expected to successfully achieve the 2009 target of
generating 9% of its energy from renewable sources.

Should Energy be Subsidized?

there was a view that their production was a major threat to the worlds remaining
rainforests, especially in Brazil. It was pointed out that policy makers rarely took into
account the negative impact of ethanol and other bio-fuels in the form of land erosion
and water pollution when they decided to give subsidies. Moreover, the subsidies
were the same even if the ethanol plant relied on coal rather than on cleaner energy
sources to convert the corn/sugar into fuel. However, supporters of ethanol argued that
air quality has improved in every city, county, and state that has switched from
straight gasoline use to ethanol-blended fuel.36

Future Outlook
A study by the OECD indicated that if all subsidies on fossil fuels used in industry
and the power sector were removed everywhere in the world, then global carbondioxide emissions would fall by more than 6%, and real income would increase by
0.1% in OECD countries and by 1.6% in non-OECD countries by 2010.37
A report released by the Intergovernmental Panel on Climate Change (IPCC)38 in May
2007, listed reduction of fossil fuel subsidies, imposition of taxes or carbon charges on
fossil fuels, and extension of producer subsidies and feed-in tariffs for renewable
energy technologies as effective policy measures to help control environmental
damage.39 The authors of the report argued that if renewable energy would get
subsidies in the form of financial contributions or tax credits from national
governments, it had the potential to meet a significant proportion of the energy needs
of the world. According to a report by the American Solar Energy Society, renewable
energy had the potential to provide 40% of the US electric needs projected for 2030.
With efforts to improve efficiency of renewable energy sources, they could one day
provide 50% of USs energy needs by 2030.40
In the late 1990s itself, Greenpeace had demanded that the EU and European
governments immediately remove subsidies on fossil fuel and nuclear energy
industries; transfer these funds to programs that accelerated the commercialization of
solar renewable energy technologies and the uptake of energy conservation; and
ensure full public disclosure of all direct and indirect energy subsidies41. However,
governments were unwilling to phase out fossil fuel subsidies fearing economic
recession. Even as of 2007, the trade-offs between the economic and environmental
benefits of removing energy subsidies and the short-term social costs of higher fuel
prices or of higher unemployment in local energy industries remained.

36

37
38

39

40

41

ACE Responds to Stanford University Report on Ethanol Emissions, www.ethanol.org,

April 29, 2007.
Energy, www.globalsubsidies.org.
The Intergovernmental Panel on Climate Change (IPCC) was established by the United
Nations Environmental Program (UNEP) and the World Meteorological Organization
(WMO) in 1988 to assess the scientific, technical and socio-economic information relevant
for the understanding of human-induced climate change, its potential impacts and options
for mitigation and adaptation. (Source: en.wikipedia.org)
IPCC, Climate Change 2007: Mitigation, Contribution of Working Group III to the
Fourth Assessment of the Intergovernmental Panel on Climate Change, Cambridge
University Press, www.ipcc.ch, May, 2007.
Renewable Energy can Curb Global Warming, www.greenfuture.blogspot.com,
February 9, 2007.
The Subsidy Scandal, www.archive.greenpeace.org, 1997.

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Managerial Economics and Business Environment

It was estimated that as of 2006, subsidies to the non-renewable energy sector (nuclear
power/fossil fuel) consumed US$ 250 billion-US$ 300 billion of government money
globally. Analysts felt that energy subsidy reform required strong determination to
take decisions that benefited society as a whole and in the long term. While society
might have to initially pay a price in terms of loss of employment in the conventional
energy industry and increase in the price of fuel, redirecting the money previously
spent on subsidies to income support, health, environment, education, or regional
development programs could minimize the impact of the move on the poorer sections
of society.

Additional Readings & References:

1. Dutch Government to Renew Green Energy Subsidies in 2008,
www.planetark.com, May 7, 2007.
2. Michael Hopkin, Tackling Greenhouse Gases Looks to be Affordable,
www.nature.com, May 4, 2007.
3. ACE Responds to Stanford University Report on Ethanol Emissions,
www.ethanol.org, April 29, 2007.
4. End Energy Subsidies by 2025, Says Summer, www.business-standard.com,
April 18, 2007.
5. The New Math of Alternative Energy, www.globalenvision.org, April 2, 2007.
6. Energy Subsidies and External Costs, www.world-nuclear.org, February 2007.
7. Doug Koplow, Ten Most Distortionary Energy Subsidies, www.eoearth.org,
January 26, 2007.
8. Jerry Taylor and Peter Van Doren, Oil Subsidies in the Dock, www.cato.org,
January 19, 2007.
9. Mark Clayton, US House Takes on Big Oil, www.csmonitor.com, January 18,
2007.
10. Ronald Steenbilk, Born Subsidized: Biofuel Production in the USA,
http://gem.sciences-po.fr, January 2007.
11. Wind Energy and U.S. Energy Subsidies, www.awea.org. January 2007.
12. Bettina Meyer, Subsidies to Energy Consumption with Special Focus on
Energy Intensive Industries in Germany, www.ec.europa.eu, December,
2006.
13. Focus on Energy Subsidies, www.iisd.org, November, 2006.
14. Highlights from Greenhouse Gas (GHG) Emissions Data for 1990-2004 for
Annex I Parties, www.unfcc.int, 2006.
15. Indonesias Oil Subsidy Dilemma, www.radioaustralia.net.au, September 20,
2005.
16. Energy Subsidies: Lessons Learned in Assessing their Impact and Designing
Policy Reforms, www.greenleaf-publishing.com, February 2004.
17. Reforming Energy Subsidies, www.uneptie.org,2002.
18. Climate Change 2001: Mitigation, www.grida.no,2001.
19. Intervention and Subsidy Basics, www.earthtrack.net.
20. A Case Study of Chinas Policy to Eliminate Harmful Fossil Fuel Subsidies,
www.geni.org.
21. http://www.epa.qld.gov.au/register/p00401aa.pdf.
22. www.awea.org.
23. www.globalsubsidies.org.
24. www.ucusa.org.
25. www.geni.org.
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