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There are 800 different programs around the world that subsidize fossil fuels, according to a new report from the OECD. The OECD released the report ahead of the international climate change negotiations set to take place in Paris in December, where the world has a "moral imperative to reach an ambitious and actionable agreement."
Tackling climate change will be a monumental task, but key to the effort will be scrapping "lose-lose" fossil fuel subsidies, as the OECD calls them. Subsidizing oil, natural gas, and coal leads to distortions in prices, contributes to overconsumption of energy, and saps developing countries of revenues that could be used for much better investments in education and infrastructure.
They also lead to environmental fallout, with capital flowing to pollution-heavy industry and energy extraction. These investments, once made, can last for decades, essentially "locking in" pollution for a long time to come. That is one of the glaring downsides to subsidizing fossil fuels. "Because they change the stream of income investors expect to receive for holding a particular asset, those subsidies influence investment choices and change the allocation of capital across sectors. In the case of certain fossil-fuel subsidies, there is therefore the risk that investors end up favouring sectors that produce fossil fuels or use them intensively, at the expense of cleaner forms of energy and other economic activities more generally," the OECD wrote.
The report only surveyed the OECD member countries (consisting of Western Europe, Japan, Korea, North America, and a few other rich countries), plus Brazil, China, India, Indonesia, Russia, and South Africa. All told, the OECD concluded that the world subsidized fossil fuels to the tune of $160 billion to $200 billion per year between 2010 and 2014, across 800 subsidy programs. That is much more than the $121 billion that renewable energy receives each year.
The programs are varied, but a few examples include: drilling incentives such as the percentage depletion allowance for natural gas in the United States; favorable tax treatment for major upstream fossil fuel development, such as Russia's Yamal LNG project; and consumer subsidies to purchase petroleum products and electricity in Indonesia, India, and many other developing countries (some of which has recently been scrapped).
Reducing subsidies to fossil fuels would, logically, reverse the costs. Governments would have more cash to use for other priorities, capital would flow to cleaner sources of energy, and greenhouse gas emissions would decline. By removing consumer subsidies alone, for example, global greenhouse gas emissions could decline by 3 percent by 2020 compared to the baseline scenario, the OECD says.
There has been quite a bit of progress more recently, however. The total level of fossil fuel subsidies appears to have peaked, in both 2008 and 2011-2012. One of the larger sources of reduction came from Mexico, which not only scrapped gasoline and diesel subsidies, but also slapped on a fuel tax. Combined, Mexico managed to reduce subsidies from $18.5 billion in 2012 to just $2.5 billion in 2014. Since then, the tax flows have flipped -- Mexico is now taking in net taxation on fossil fuels.
Of course, it is important to note that paring back support for oil, gas, and coal has been massively easier because of the collapse in commodity prices. Some countries even have supports in place that automatically fall when oil prices fall, for example. And governments, having long known that subsidies drain their budget, are taking advantage of this low-oil-price environment to scrap fuel incentives, something that has been politically difficult in years past when oil prices were high. China, Indonesia, Malaysia, and India are just a few of the countries that have removed support for fuel purchases since last year. There is a question about the stability of such moves -- if oil prices spike again in the future, will the governments once again put subsidies into place?
For oil and gas companies, a global shift to remove subsidies, however minimal or fleeting it may be, comes as a double whammy. Low oil prices are already hitting producers hard. Removing subsidies takes away another source of revenue -- either through direct support upstream, or by reducing demand as consumers have less of a reason to consume.
But if the world is to avoid the most dangerous effects of climate change, that is exactly the point.
By Nick Cunningham of Oilprice.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.