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MONEY to BURN? the High Costs of Energy Subsidies

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MONEY to BURN? the High Costs of Energy Subsidies MONEY TO BURN? The High Costs of Energy Subsidies In \Kirk W () R LD RE S O U R C li S INSTITUT L MONEY TO BURN? The High Costs of Energy Suhsidies Mark Kosmo WORLD RESOURCES INSTITUTE A Center for Policy Research October 1987 Kathleen Courrier Publications Director Hyacinth Billings Production Supervisor American Petroleum Institute Cover Photo Each World Resources Institute Report represents a timely, scientific treatment of a subject of public concern. WRI takes responsibility for choosing the study topics and guaranteeing its authors and researchers freedom of inquiry. It also solicits and responds to the guidance of advisory panels and expert reviewers. Unless otherwise stated, however, all the interpretation and findings set forth in WRI publications are those of the authors. Copyright © 1987 World Resources Institute. All rights reserved. Library of Congress Catalog Card Number 87-51349 ISBN 0-915825-26-0 ISSN 0880-2582 Contents I. Introduction 1 Government Revenues and Petroleum Subsidies 34 II. Energy Pricing Policy: What is at Stake 3 V. Microeconomic Effects of Energy Economic Efficiency and Energy Subsidies 37 Pricing 3 How Petroleum Subsidies Redistribute Objectives of Energy Pricing Policy 6 Income 37 How Petroleum Subsidies Affect Consumer Decisions 38 III. Current Fuel-Pricing Trends 11 Economic Efficiency and Equity in Petroleum Product Pricing 11 Electricity Pricing 40 Electricity Pricing 12 Do Producer Subsidies Promote Energy Natural Gas Pricing 13 Self-Sufficiency? 43 Coal Pricing in India and China 15 Increasing Natural Gas Supplies 45 Environmental Benefits of Rationalized IV. Macroeconomic Effects of Energy Energy Pricing 46 Subsidies 19 Conceptual Framework 19 VI. Conclusion and Policy Economic Growth 22 Recommendations 49 Balance of Trade 24 Inflation 27 Notes 53 Energy Efficiency 29 References 65 Acknowledgments any people contributed substantially Afsaneh Mashayekhi, Robert Williams, Gus to this report. Robert Repetto con- Speth, and Jose Goldemberg. I would also like M ceived the study and provided help- to thank Mohinder Goswami of the World ful guidance throughout. Randall Fiertz provided Bank who provided oil price data. Finally, first-rate research assistance and helped pre- Robert Kwartin and Beverlyann Austin of WRI pare the tables and graphs. Raechelle Desai, were always there when I needed computer Katherine Harrington, and Rose Valraie all had help. a hand in typing numerous drafts. Kathleen Courrier did an excellent editing job, and Case studies prepared by Russell deLucia Hyacinth Billings supervised the production of and the Technical Economic Research Council the report. in Beijing, China were especially useful in the preparation of this report. In addition, I would Thanks are also due to many people who like to acknowledge the help of Craig Thomas, commented on early drafts, including William David Pekelney, Alison Jones-Webb, Tinling Magrath, Andrew Maguire, Corazon Siddayao, Choong, and Tina Swieczkowski. Mohamed El-Ashry, James Mackenzie, William Baumol, Jessica T. Mathews, Irving Mintzer, MX m Foreword o tomorrow's energy historians, the Although many countries have reduced early 1980s will almost certainly seem petroleum subsidies substantially since 1981 or T anomalous—a blip on a trend line of so, such subsidies still persist, especially in the half a century or more of stable or increasing oil-exporting countries. Moreover, subsidies to oil prices. Although the declining prices of the electricity, natural gas, and coal are even more early 1980s brought welcome relief to oil- pervasive. As for both microeconomic and importing countries, the reprieve now appears macroeconomic effects, Kosmo shows that the to be ending. putative benefits of subsidies—economic stimu- lation, enhanced trade performance, and infla- While oil is only one (albeit large) component tion control—aren't the true effects. Indeed, of the energy picture, it amply illustrates the subsidies tend to increase unemployment (as need for national governments to shelve poli- energy is substituted for labor) and encourage cies that impede efforts to adjust to changes in over-investment in energy-intensive industries energy prices and availability. In Money to at the expense of other sectors. At the same Burn? The High Costs of Energy Subsidies, time, they have little impact on overall trade economist Mark Kosmo promotes this long- balances, inflation, or the lot of the poor. overdue exorcism by demonstrating how public Energy subsidies also translate into foregone subsidies of energy production and consump- revenues and the inefficient use of energy. tion drain government coffers, encourage resource depletion, and dampen prospects for Of course, the ill effects of energy subsidies economic growth. cannot be rooted out overnight without trau- matizing a nation's economy, even if politics Taking as his touchstone the economist's permitted. But Money to Burn? does point the definition of efficient energy pricing, Kosmo way to a politically and economically acceptable examines the many ways energy prices are transition to the next energy era, one based on kept artificially low by government actions. He sharp increases in energy efficiency in rich and also examines the effects of these policies on poor countries alike. government revenues, energy price stability, industrial development, environmental protec- Money to Burn? fits squarely into two of tion, income redistribution, balance of trade, World Resources Institute's programs. First, inflation and supply. On all scores, the news is it is the third in a series of studies examining sobering. economic policies and practices that discourage sound resource use and sustainable growth. onment and Development and to the Rocke- (Earlier works in this series cover water feller Brothers Fund for their support for this resources and pesticide use.) Second, this study, study complements two recent WRI releases on the global energy picture—Energy for a Sus- tainable World and Energy for Development. James Gustave Speth World Resources Institute expresses its ap- President preciation to the World Commission on Envir- World Resources Institute I. Introduction or the past 15 years, world attention this study, while petroleum consumption is has been riveted on the importance of still subsidized in the oil-exporting developing F energy in the global economy. Oil price nations. shocks in 1973 and 1979 and subsequent price fluctuations have painfully demonstrated the By removing such energy subsidies, govern- economic implications of unstable energy ments can encourage energy efficiency, cut the prices—high inflation rates, world recession, costs of producing and using energy, reduce and mounting debt burdens. costly energy imports (or, in the oil-exporting countries, increase oil exports), minimize en- Now, with world oil prices again on the rise vironmental damages and risks, and reduce and the world economy experiencing sluggish their own fiscal burdens. Such improvements, growth, many fear continued stagnation and which further both environmental and resource possibly future oil price shocks unless action is conservation and development objectives, are taken. Indeed, it is an opportune time for critical for sustainable economic growth and governments to reassess their domestic energy development. Options include removing price policies, cushion themselves against any future controls, selectively imposing energy taxes, and price shocks and their destabilizing effects, and more effectively targetting politically unavoid- promote a more stable energy future. Specif- able subsidies to needy groups. ically needed are effective demand-manage- ment policies, especially pricing policies that The time is right for such policies since few encourage energy conservation. analysts expect world energy prices to fall. Moreover, the political and economic costs of This paper examines commercial1 energy sub- pricing policy reform are likely to be greater sidies and energy pricing policies in over 30 during the 1990s when world oil prices should countries. Many countries have recently raised be higher. Policy-makers should seize the exist- domestic energy prices to reflect true costs ing opportunity since they do not face the more fully, but energy subsidies are still wide- usual number of difficult tradeoffs, but can spread. Electricity, natural gas, and coal are instead promote fiscal, economic, and environ- subsidized in all of the countries covered in mental goals simultaneously. II. Energy Pricing Policy: What is at Stake? ill the energy crises that plagued the for oil may even exceed 1973 levels. (See Figure world during the 1970s return? In part, 1.) Clearly, oil conservation is needed in the W the answer depends on whether short run to minimize the possibility of recur- pricing policies that provide better incentives rent oil price shocks. for energy conservation are adopted. Without these incentives, the 1990s might find us in a In the next century, natural gas, electricity, and bind remarkably similar to that of the 1970s. coal will become substantially more important, as will pricing policies for these fuels. But this During the past year, oil imports have increased trend doesn't make petroleum pricing policies in several countries, including the United States, and oil conservation any less important since and worldwide dependence on Middle Eastern oil production in the non-OPEC countries will and OPEC oil has deepened. Increasing depen- decline. Furthermore, since 63 percent of the
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