According to a recent IMF Survey Magazine article, Counting the Cost of Energy Subsidies, world-wide energy subsidies in 2015 account for $5.3 trillion or 6.5% of global GDP. The article summarises findings of an IMF working paper (see link below), which provides estimates by country, product (e.g. coal and oil) and component (e.g. global warming, local air pollution and congestion) in an Excel file
The working paper argues that energy subsidies are both larger and more pervasive than previously thought. According to the IMF Survey Magazine:
Eliminating global energy subsidies could reduce deaths related to fossil-fuel emissions by over 50 percent and fossil-fuel related carbon emissions by over 20 percent. The revenue gain from eliminating energy subsidies is projected to be $2.9 trillion (3.6 percent of global GDP) in 2015. This offers huge potential for reducing other taxes or strengthening revenue bases in countries where large informal sector constrains broader fiscal instruments.
In interpreting the findings it is important to understand how the term ‘subsidies’ is being used. According to the report, most of the $5.3 trillion “arises from countries setting energy taxes below levels that fully reflect the environmental damage associated with energy consumption.”
In other words, the term subsidy is being used whenever taxes do not fully account for the negative externalities associated with extracting and burning fossil fuels. Perhaps a better term would be ‘under-taxing’ rather than ‘subsidising’. Nevertheless the scale of not internalising externalities is huge. As Lord Nicholas Stern (author of the 2006 Stern Review on the Economics of Climate Change) says:
“The failure to reflect the real costs of fossil fuels in prices and policies means that the lives and livelihoods of billions of people around the world are being threatened by climate change and local air pollution.”
But, while not taxing external costs account for more than 80% of the underpricing of fossil fuel energy, some three-quarters of these external costs relate to local environmental damage, rather than international damage such as global warming. Thus charging for these external costs would benefit primarily the local population, as well as generating revenues, and thus provides a strong argument for governments raising energy prices through increased taxes or reduced subsidies.
So which countries are the major culprits in ‘subsidising’ fossil fuels? What specific measures does the IMF recommend to tackle the problem and what countries are addressing the problem and in what ways? The working paper and articles address these questions.
Counting the Cost of Energy Subsidies IMF Survey Magazine (17/7/15)
G20 countries pay over $1,000 per citizen in fossil fuel subsidies, says IMF The Guardian, Damian Carrington (4/8/15)
Fossil fuels subsidised by $10m a minute, says IMF The Guardian, Damian Carrington (18/5/15)
How Large Are Global Energy Subsidies? IMF Working Paper, David Coady, Ian Parry, Louis Sears, and Baoping Shang (May 2015)
- Explain how energy subsidies are defined in the IMF working paper.
- What measurement problems are there in calculating the size of the ‘subsidies’?
- Draw a diagram to show how the under taxing of fossil fuel usage leads to a greater than socially optimum level of consumption of fossil fuels.
- What specific policies are pursued by the four biggest fossil fuel subsidising countries?
- What political problems are there in persuading countries to reduce fossil fuel subsidies/increase fossil fuel taxes.
- Is there a relatively high or low income elasticity of demand for energy? What are the implications of this for different income groups of policies to hold down energy prices?
The cost of living is a contentious issue and is likely to form a key part of the political debate for the next few years. This debate has been fuelled by the latest announcement by SSE of an average rise in consumer energy bills of 8.2%, meaning that an average dual-fuel customer would see its bill rise by £106. With this increase, the expectation is that the other big energy companies will follow suit with their own price rises.
Energy prices are made up of numerous factors, including wholesale prices, investment in infrastructure and innovation, together with government green energy taxes. SSE has put their price hike down to an increase in wholesale prices, but has also passed part of the blame onto the government by suggesting that the price hikes are required to offset the government’s energy taxes. Will Morris, from SSE said:
We’re sorry we have to do this…We’ve done as much as we could to keep prices down, but the reality is that buying wholesale energy in global markets, delivering it to customers’ homes, and government-imposed levies collected through bills – endorsed by all the major parties – all cost more than they did last year.
The price hike has been met with outrage from customers and the government and has provided Ed Miliband with further ammunition against the Coalition’s policies. However, even this announcement has yet to provide the support for Labour’s plans to freeze energy prices, as discussed in the blog Miliband’s freeze. Customers with other energy companies are likely to see similar price rises in the coming months, as SSE’s announcement is only the first of many. A key question is how will the country provide the funding for much needed investment in the energy sector? The funds of the government are certainly not going to be available to provide investment, so the job must pass to the energy companies and in turn the consumers. It is this that is given as a key reason for the price rises.
Investment in the energy infrastructure is essential for the British economy, especially given the lack of investment that we have seen over successive governments – both Labour and Conservative. Furthermore, the government’s green targets are essential and taxation is a key mechanism to meet them. Labour has been criticized for its plans to freeze energy prices, which may jeopardise these targets. The political playing field is always fraught with controversy and it seems that energy prices and thus the cost of living will remain at the centre of it for many months.
More energy price rises expected after SSE increase BBC News (10/10/13)
SSE retail boss blames government for energy price rise The Telegraph, Rebecca Clancy (10/10/13)
A better way to take the heat out of energy prices The Telegraph (11/10/13)
SSE energy price rise stokes political row Financial Times, John Aglionby and Guy Chazan (10/10/13)
Ed Miliband condemns ‘rip-off’ energy firms after SSE 8% price rise The Guardian, Terry Macalister, Angela Monaghan and Rowena Mason (28/9/12)
Coalition parties split over energy companies’ green obligations Independent, Nigel Morris (11/10/13)
Energy price rise: David Cameron defends green subsidies The Guardian, Rowena Mason (10/10/13)
‘Find better deals’ users urged as energy bills soar Daily Echo (11/10/13)
Energy Minister in row over cost of taxes Sky News (10/10/13)
SSE energy price rise ‘a bitter pill for customers’ The Guardian, Angela Monaghan (10/10/13)
Energy firm hikes prices, fuels political row Associated Press (10/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (27/10/13)
- In what market structure would you place the energy sector?
- Explain how green taxes push up energy bills? Use a diagram to support your answer.
- Consider the energy bill of an average household. Using your knowledge and the articles above, allocate the percentage of that bill that is derived from wholesale prices, green taxes, investment in infrastructure and any other factors. Which are the key factors that have risen, which has forced SSE (and others) to push up prices?
- Why is investment in energy infrastructure and new forms of fuel essential? How might such investment affect future prices?
- Why has Labour’s proposed 20-month price freeze been criticised?
- What has happened to energy prices over the past 20 years?
- Is there now a call for more government regulation in the energy sector to allay fears of rises in the cost of living adversely affecting the poorest households?
The UK economy faces a growing problem of energy supplies as energy demand continues to rise and as old power stations come to the end of their lives. In fact some 10% of the UK’s electricity generation capacity will be shut down this month.
Energy prices have risen substantially over the past few years and are set to rise further. Partly this is the result of rising global gas prices.
In 2012, the response to soaring gas prices was to cut gas’s share of generation from 39.9% per cent to 27.5%. Coal’s share of generation increased from 29.5% to 39.3%, its highest share since 1996 (see The Department of Energy and Climate Change’s Energy trends section 5: electricity). But with old coal-fired power stations closing down and with the need to produce a greater proportion of energy from renewables, this trend cannot continue.
But new renewable sources, such as wind and solar, take a time to construct. New nuclear takes much longer (see the News Item, Going nuclear). And electricity from these low-carbon sources, after taking construction costs into account, is much more expensive to produce than electricity from coal-fired power stations.
So how will the change in balance between demand and supply affect prices and the security of supply in the coming years. Will we all have to get used to paying much more for electricity? Do we increasingly run the risk of the lights going out? The following video explores these issues.
UK may face power shortages as 10% of energy supply is shut down BBC News, Joe Lynam (4/4/13)
Electricity Statistics Department of Energy & Climate Change
Quarterly energy prices Department of Energy & Climate Change
- What factors have led to a rise in electricity prices over the past few years? Distinguish between demand-side and supply-side factors and illustrate your arguments with a diagram.
- Are there likely to be power cuts in the coming years as a result of demand exceeding supply?
- What determines the price elasticity of demand for electricity?
- What measures can governments adopt to influence the demand for electricity? Will these affect the position and/or slope of the demand curve?
- Why have electricity prices fallen in the USA? Could the UK experience falling electricity prices for similar reasons in a few years’ time?
- In what ways could the government take into account the externalities from power generation and consumption in its policies towards the energy sector?
Centrica, owners of British Gas, has warned that electricity and gas prices in the UK are set to rise in the autumn. Centrica blames this on the expected rise in the costs of wholesale gas and other non-energy inputs.
One of the other ‘big six’ energy suppliers, E.On, has responded by saying that it will not raise energy prices this year. Whether it will raise prices after 1 Jan next year remains to be seen.
Last autumn, household energy prices rose substantially: between 15.4% and 18% for gas and between 4.5% and 16% for electricity. This spring, in response to lower wholesale energy prices, suppliers cut prices for either electricity or gas (but not both) by around 5%.
The government and various pressure groups are encouraging consumers to use price comparison sites to switch to a cheaper supplier. The problem with this is that supplier A may be cheaper than supplier B one month, but B cheaper than A the next. Nevertheless, switching does impose some degree of additional competitive pressure on suppliers.
More powerful pressure could be applied by ‘collective switching’. This is where a lot of people switch via an intermediary company, which sources a deal from an energy supplier. This collective buying is a form of countervailing power to offset the oligopoly power of the suppliers. Such schemes are being encouraged by the Energy Minister, Ed Davey.
The other approach, apart from doing nothing, is for Ofgem, the energy regulator, to impose tough conditions on pricing. But at present, Ofgem’s approach has been to try to make the market more competitive (see also), rather than regulating prices.
British Gas owner Centrica warns of higher energy bills BBC News (11/5/12)
E.ON to keep residential energy prices unchanged in 2012 Reuters, Adveith Nair (14/5/12)
E.ON promises to hold energy prices for 5million customers in 2012 This is Money, Tara Evans (14/5/12)
British Gas owner Centrica feels cold blast from critics ShareCast, John Harrington (11/5/12)
Gas and electricity price battle lines drawn BBC News (14/5/12)
Taking on the energy giants: The co-operative insurgency gains ground Left Foot Forward, Daniel Elton (11/5/12)
Group Energy Buying hits the UK Headlines Spend Matters UK/Europe, Peter Smith (11/5/12)
Think tank calls for competition to break Big Six rip-off Energy Live News, Tom Gibson (30/4/12)
Collective switching will not fix the UK’s broken energy market Guardian, Reg Platt (27/4/12)
Make your own small switch for cheaper energy The Telegraph, Rosie Murray-West (14/5/12)
- What are the barriers to entry in the electricity supply market?
- How competitive is the retail energy market at present?
- To what extent do price comparison sites put pressure on energy companies to reeduce prices or limit price increases?
- What scope is there for collective buying of gas and electricity from the six energy suppliers by (a) households; (b) firms?
- Assess Ofgem’s package of proposals for a simpler and more competitive energy market.
Following a 38% increase in profit margins made by energy companies towards the end of 2010, Ofgem (the energy and gas regulator) began an investigation into the activities of energy companies. The review by Ofgem was aimed at determining whether or not consumers should be better protected from the powerful energy companies, many of whom had previously raised prices, forcing some consumers to pay an extra £138 per year. At the time, it was believed that Ofgem might request support from the Competition Commission, but it seems as though the big size energy companies have had a lucky escape. They will not be referred to the Competition Commission, even though critics, in particular First Utility – Britain’s largest independent energy supplier – suggest that Ofgem’s proposals are unlikely to be effective. It seems that the big six have shown sufficient co-operation with Ofgem.
A key reform that Ofgem hope to implement will try to reduce the power of this oligopoly by making it easier for new entrants to gain market share. One such proposal would see the big six auctioning off up to a fifth of the electricity they generate. As the owners of Britain’s power stations, new companies cannot buy gas and electricity on the open market and this reform aims to change that. However, there are concerns that this will be ineffective, as the big six may simply outbid the smaller companies or even just buy and sell electricity from each other, thereby keeping their dominant positions in the market. Although the big six have received constant criticism from all sides, the lack of government support for a Competition Commission inquiry may be related to the need for these companies to invest £200bn in Britain by 2020 to help create and build new energy sources, including wind farms and nuclear power. Without this investment, Britain’s energy supply could be in jeopardy. The following articles consider this energetic debate.
Ofgem may be blown away by the power of the ‘Big Six’ energy companies Telegraph, Rowena Mason (23/6/11)
Ofgem pledges to get tough with ‘big six’ energy companies Guardian, Miles Brignall (22/6/11)
Scottish power investigated over ‘misleading’ marketing campaign Independent, Sarah Arnott (23/6/11)
Ofgem and ‘Big Six’ need to put some energy into cleaning up their acts Telegraph, Richard Fletcher (23/6/11)
In search of a coherent energy policy Independent, David Prosser (23/6/11)
UK suppliers face tough power auction reforms Reuters (22/6/11)
Ofgem: ‘We are watching energy companies closely’ BBC News (22/6/11)
Energy price statistics Department of Energy & Climate Change
Energy statistics publications Department of Energy & Climate Change
- What is the role of Ofgem? How does it relate to the Competition Commission?
- What factors have contributed to the investigation by Ofgem into the ‘big six’ energy companies?
- How much power does Ofgem actually have to implement reforms?
- What are the characteristics of an oligopoly? To what extent does the energy market fit into this market structure?
- What are the main barriers to entry that prevent new companies from competing with the ‘big six’? Are the reforms likely to help them?
- What other proposals have been suggested by parties other than Ofgem in bid to help new competitors and customers? Are any likely to be more effective than those proposed by Ofgem?