FALLING OIL PRICES AND FOSSIL-FUEL SUBSIDIES: FUEL FOR REFORM

The price of crude oil went from a peak of about US$115 a barrel in June 2014 to below US$50 in January 2015. The decline has continued ever since and crude oil now costs less than US$30 a barrel, falling more than 70 per cent since the second half of 2014. The environmental implications of this sharp drop in oil prices are far from straightforward. On the one hand, low oil prices encourage the overconsumption of carbon-intensive fuels and reduce the incentives for energy conservation. Low oil prices could also make renewables relatively even more expensive and hence scare off much-needed investment in the renewable energy sector (Cheon and Urpelainen 2012). On the other hand, falling oil prices presents an invaluable opportunity to phase out FFSs (Coady etal. 2015; IEA 2015a; World Bank 2015). The major challenge is how to maximize the opportunities and mitigate the challenges.

There is a broad consensus in the literature that the main barriers to FFS reform are political. Subsidy reforms face strong opposition both from vested interests and from the public at large. The primary opposition to subsidy reform comes from specific interest groups that benefit from the status quo (Overland 2010). Subsidy reforms create ‘winners’ and ‘losers’, like most other policy reforms. The political economy of reforms suggests that reforms become extremely difficult to implement when the ‘losers’ are more powerful or better able to organize themselves than the ‘winners’ (Haggard and Webb 1994). This is particularly the case for FFSs. Different studies show that subsidy benefits tend to be highly concentrated in the hands of specific groups

(with higher levels of energy consumption), while the costs are widely spread across the general population. Those who benefit from the status quo obviously stand to lose from the removal of subsidies. And hence they have strong incentives to lobby for the retention of subsidies. In contrast, members of the general public have much less incentive,[1] as well as less information, to lobby for subsidy reform. This lack of countervailing lobbying for subsidy reform strengthens the vested interests’ chance of successfully blocking subsidy reforms. The drop in oil prices, however, reduces the incentives for such lobbying. Under the current low oil prices, the change in fuel prices after the removal of subsidies would not be as dramatic as it would have been under high oil prices. By limiting the price increase from subsidy removal, low oil prices mitigate the cost of subsidy reforms for those groups that benefit from subsidies (Benes etal. 2015).

Another source of resistance to subsidy reform comes from the general public. In theory, one may expect the poor, in whose name FFSs are usually justified but who benefits very little from subsidies, to support rather than protest against subsidy reforms. In practice, however, public resistance is often the cause of FFS reform reversal in many countries (Cheon 2015; Victor 2009). Perhaps this is down to the lack of information about the costs of FFSs (and the benefits of their reform) among the general public and the fact that unlike their long-term economic and environmental benefits, the short-term impacts of FFS reforms (e.g., increase in fuel prices and general inflation) are more visible and easier to detect for the general public. Some countries have implemented compensatory measures such as direct cash transfers to poor households to offset the increase in fuel prices from subsidy reforms. Such targeted subsidies are, however, complex and difficult to implement, especially for countries with limited institutional capacity (Fattouh and El-Katiri 2012). Here, again, low oil prices reduce the risk of public resistance to subsidy reforms and the need for compensatory measures. Low oil prices means that the removal of subsidies is unlikely to cause a significant increase in fuel prices.

  • [1] This is because the cost of subsidies is likely to be much smaller in per capita terms than thebenefit to vested interests (Morgan 2007).
 
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