Analysis: Ukraine crisis could boost rising fossil fuel subsidies

FILE PHOTO: A 3D printed oil pump jack is seen in front of the stock diagram shown in this illustration image, April 14, 2020. REUTERS/Dado Ruvic/Illustration

March 8, 2022

By Noah Browning and Stephanie Kelly

LONDON (Reuters) – Soaring oil prices as a result of a possible Russian oil import ban could force governments to pour more money into fossil fuel subsidies to protect consumers from rising energy bills, rather than using the money to fight climate change.

Even before Russia invaded Ukraine, rising energy costs had triggered a wave of subsidies, although the countries at the COP26 climate conference in November declared their willingness to curb them.

“The last thing governments want to do is increase subsidies for fossil fuel use, but they have to be sensitive to the price shock,” said Ben Cahill, senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS).

“It’s an economic issue that we have to deal with today.”

Oil has risen to around $140 a barrel as the United States and Europe weigh a Russian ban on oil imports as part of measures against Russia over the Ukraine crisis.

Oil had already risen sharply over the past year as demand rebounded from a pandemic slump and supply remained relatively tight, exacerbating decades of high inflation.

Coal and natural gas are also near all-time highs.

Governments are using tax breaks, price caps and other measures to help consumers cope with soaring energy prices.

During the pandemic, lockdowns reduced demand for fossil fuels in 2020 and sent consumption subsidies worldwide to an all-time low of $180 billion — down nearly half from the year before, the International Energy Agency said.

But as demand and prices rose again, so did the subsidies.

The Paris-based agency predicted in November that subsidies would rise by the highest annual rate ever to $440 billion in 2021, with the ultimate figure certainly higher, it told Reuters.

The IEA said renewable energy is expected to receive $42 billion in global government spending for economic recovery, mostly for solar and offshore wind.

Fearful of upsetting a cash-strapped electorate, politicians have largely resorted to dumping government money in the form of subsidies on the problem of higher energy prices.

“Most politicians don’t think beyond the next election cycle,” said Elchin Mammadov, vice president of ESG research at global equity index giant MSCI.

“So they’d rather kick the can out and prioritize winning votes by subsidizing fossil fuels over climate action, where the benefits are more long-term.”

Japan increased its gasoline subsidies to oil traders as part of an emergency program to reimburse oil wholesalers for their costs.

Sweden wants to cut taxes on gasoline and diesel, cut gas station prices by about 5 cents a liter and reduce tax revenue by about $257 million in 2022.

The UK, France, Germany, Italy, Spain and a number of other countries have introduced caps on electricity price increases.

DIFFICULT JOURNEY

“The continued proliferation of taxes and regulated prices that favor fossil fuels make the path to a sustainable energy future significantly more difficult,” the IEA said in its annual World Energy Outlook, saying they hurt clean investments.

In emerging markets, subsidies are often used to drive down fuel prices to avoid public anger over rising energy bills.

Nigeria’s government, which faces elections next year, backtracked last month on its promise to end fuel subsidies despite a widening budget deficit. Indonesia allocated 83.79 trillion rupiah ($5.9 billion) for fuel and canisters for home cooking last year, an increase of over 75% from 2020.

“The current increase in fossil energy prices is likely to lead to an increase in fossil fuel subsidies,” said Lourdes Sanchez, senior policy adviser at the Geneva-based International Institute for Sustainable Development.

“2020 presented an opportunity to reform many subsidies. Some, like India, have — but very few countries have embraced it, supporting the fossil fuel industry instead.”

India has reduced fuel subsidies since 2017, levied higher fuel taxes and allowed market-based pricing, but in November the government asked state-owned oil companies to freeze fuel prices.

“STICK IT TO CONSUMERS”

Washington has so far refrained from direct sanctions on Russian oil, with the White House saying such a move is on the table but could end up raising gas prices for Americans.

Leaders in the White House and Congressional Democrats began considering a pause in federal taxes on gasoline last month to help offset already rising prices.

Michael Zehr, federal affairs adviser to the Consumer Energy Alliance, said policymakers have “few good options” to deal with buoyant demand that has yet to be met by cleaner fuels and that higher fuel bills are not leading to a switch to renewables energies led.

“Just forcing it on consumers who don’t have options hasn’t resulted in a shift to less carbon-intensive sources,” Zehr said. “This prompted a switch to more carbon-intensive sources,” citing high gasoline and electricity prices and a surge in US coal-fired power generation in 2021.

However, some analysts argue that the price hike could be a catalyst for the phase-out of fossil fuels over the long term.

“Over time, higher demand would encourage governments and businesses to invest in low-carbon products, which in turn would make consumers less dependent on fossil fuels and their price volatility,” said economist and ESG director Tu Nguyen of the Tax and Economics Bureau Accounting firm RSM Canada.

(Additional reporting by Yuka Obayashi in Tokyo and Fransiska Nagoy in Jakarta; Editing by Jane Merriman)