Rethinking Fossil Fuel Subsidies in Energy Transition

Subsidies/Fossil Fuels/Energy Transition

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There is growing international consensus to phase out fossil fuel subsidies worldwide to mitigate climate change risks and enhance energy independence. However, the global energy crisis has hindered progress in ensuring energy affordability, accessibility, and a smooth transition to cleaner energy sources. Rising oil and gas prices have driven fossil fuel subsidies to new highs compared to historical averages in many countries [1]. This article explores the trend of fuel subsidy reform as a tool for facilitating effective energy transitions, along with the associated challenges and strategies for achieving a just transition.

FOSSIL FUEL SUBSIDIES VS CLEAN ENERGY INVESTMENTS

• $620 billion for fossil fuel subsidies

• $70 billion for clean energy were allocated globally in 2022

Governments have traditionally intervened in energy markets by regulating fuel and electricity prices to ensure energy affordability and accessibility. However, these interventions come with significant costs. In 2022, global subsidies for fossil fuel consumption exceeded $1 trillion. In 2023, governments—particularly in emerging and developing economies—continued to heavily subsidise fossil fuels, spending $620 billion, compared to just $70 billion allocated for clean energy investments [1]. While subsidies can shield the economy from energy market volatility, they also contribute to rising public debt, exacerbate social inequalities, and divert public funds from more productive uses.

Rationalising or phasing out fossil fuel subsidies has long been advocated as a means of raising fuel prices to more efficient levels. Full price reforms are expected to reduce projected fossil fuel CO2 emissions 43% below baseline levels by 2030, while generating a revenue of $4.4 trillion - equivalent to 3.6% of global GDP [2]. Countries have taken varied approaches to subsidy reform based on their unique circumstances. Some have implemented gradual subsidy reductions, introduced social safety nets, or invested in renewable energy infrastructure to mitigate the economic impacts. For example, in 2023, Canada introduced the Inefficient Fossil Fuel Subsidies Framework and Guidelines, becoming the first country to systematically evaluate and phase out inefficient fossil fuel subsidies.

Similarly, India gradually phased out subsidies on petrol and diesel (2010–2014) and introduced incremental tax increases (2010–2017), redirecting fiscal savings towards renewable energy, electric vehicles, and infrastructure development. In Indonesia, the government has shifted savings from fuel subsidies to expenditures on social inclusion and protection programs, demonstrating a focus on addressing social equity [3].

While phasing out fuel subsidies paves the way for sustainable growth, implementation poses significant challenges related to economic stability, energy security, and social equity [4]. Economically, subsidy cuts can drive inflation, raise operational costs for businesses, and strain government budgets due to the need for new social support measures to cushion the impact. In terms of energy security, countries heavily reliant on fossil fuels, such as Malaysia, face challenges to energy access as renewable alternatives remain underdeveloped, leaving their energy supply vulnerable to global price fluctuations. Socially, subsidy removal often has regressive effects, disproportionately impacting low-income households, as evidenced by welfare analysis in Nigeria following the removal of its petrol subsidy in 2023 [5].

The transition to a low-carbon economy, supported by the expansion of renewable energy capacity, can provide a positive signal for governments to phase out subsidies without compromising energy security, affordability, or fiscal stability. Further rationalising fuel subsidies and redirecting funds towards social transfer towards low-income households are key components of achieving fiscal sustainability while reducing economic distortions and aligning with decarbonization targets. The reallocation of savings through cash transfers to low-income households could efficiently promote energy equity and ensure fair access to energy support. Additionally, green financial instruments, such as transition bonds and green bonds, could be leveraged as funding mechanisms for clean energy investments. The review of fuel subsidies highlights the complexity of aligning environmental objectives with fiscal, economic, political, and social considerations.

Research Analyst: Yuan Sun

Research Editor: Zuzanna Charkowska

References:

[1] "Fossil Fuel Subsidies." International Energy Agency, n.d. https://www.iea.org/topics/fossil-fuel-subsidies.

[2] "Fossil Fuel Subsidies." International Monetary Fund, n.d. https://www.imf.org/en/Topics/climate-change/energy-subsidies.

[3] Asian Development Bank. Fossil Fuel Subsidy Reform. 2024.

[4] Oluwadele, Bolutife "Challenges of Policy-Making Failures: Impact of Fuel Subsidy Removal." The Guardian Nigeria, October 14, 2024.

[5] Okereke, C., Emenekwe, C., Onyeneke, R., Nnamani, U., and Amadi, M. Nigeria’s Fossil Fuel Subsidy Reforms: The Welfare Effects on Households. London: Overseas Development Institute, 2024.