Fossil fuels are the leading driver of climate change, yet they continue to receive significant financial support from governments around the globe. Despite repeated pledges from many countries to reduce these subsidies to combat climate change, eliminating them has proven to be an exceptionally difficult challenge. As a result, fossil fuels remain relatively inexpensive, driving their consumption and contributing to the growth of greenhouse gas emissions.
Bruce Huber, a Professor of Law at the University of Notre Dame, has studied the fossil fuel sector extensively. His work reveals the deep-rooted complexities that underpin these subsidies and the formidable challenges that governments face when attempting to reduce or eliminate them. Let’s explore the mechanisms of fossil fuel subsidies, why they persist, and what the world is trying to do to reform them.
What is a subsidy?
A subsidy is essentially a financial benefit provided by a government to a particular entity or industry. Subsidies come in many forms and can range from obvious direct cash payments or tax incentives to more nuanced mechanisms like tariff protection or relaxed regulations that favour certain industries. These benefits are provided for various reasons: to stimulate economic activity, protect nascent industries, or assist established ones during times of crisis.
While some subsidies are explicit and easy to recognise, such as publicly funded crop insurance or grants for research, others are less visible. For instance, when a government fails to charge industries for the environmental damage they cause, such as air or water pollution, this is also a form of subsidy. By not requiring companies to pay for the full cost of their environmental impact, governments indirectly subsidise their activities.
Subsidies are a widespread feature of the global economy, benefiting many industries beyond fossil fuels. However, the subsidies granted to the fossil fuel sector are uniquely impactful, not only because of their economic scale but also due to their significant consequences for the planet’s climate and environment.
How are fossil fuels subsidised?
Fossil fuel subsidies can take a wide variety of forms, from consumer price support to tax incentives for producers. In many countries, fuel prices are set by the government rather than allowing market forces to dictate them.
For instance, Saudi Arabia caps gasoline prices to make energy more affordable for its citizens. To offset the cost, the government uses revenues from oil exports, which far exceed domestic energy consumption. In the United States, oil companies are allowed to deduct a significant portion of their drilling costs from their taxes. This kind of tax break makes fossil fuel production more attractive by effectively lowering the cost of doing business. In countries like Indonesia, the government sets energy prices below market levels and then compensates state-owned energy companies for the losses they incur.
This form of support ensures that energy remains affordable, particularly for low-income citizens. Some subsidies are less direct. For example, governments often underprice permits for extracting fossil fuels or fail to collect all the taxes owed by producers. The complexity of these subsidies makes it challenging to provide a precise estimate of their total value.
According to a 2022 report by the Organisation for Economic Cooperation and Development (OECD), the annual value of global fossil fuel subsidies was estimated to be around $1.5 trillion. However, the International Monetary Fund (IMF) provided a much higher estimate, placing the value closer to $7 trillion. The discrepancy between these numbers arises from different definitions of what constitutes a subsidy.
The IMF’s definition is broader, including not only direct financial support but also the environmental and social costs that are not reflected in the price of fossil fuels. For instance, the damage caused by greenhouse gas emissions, the health impacts of local air pollution, and even the economic costs associated with traffic congestion are considered implicit subsidies. In contrast, the OECD’s narrower definition includes only direct financial support, which results in a lower estimate.
Regardless of the specific figure, it is clear that subsidies for fossil fuels have a dramatic effect on the prices paid by consumers. By artificially lowering the cost of fossil fuels, these subsidies encourage their continued use and, by extension, the emissions that contribute to climate change.
Why are these subsidies hard to eliminate?
Despite the widespread recognition that fossil fuel subsidies undermine efforts to combat climate change, eliminating them has proven exceedingly difficult. Several reasons contribute to this challenge. Subsidies are politically popular. By keeping energy prices low, governments can avoid public discontent and gain support from voters.
For instance, when energy prices rise, governments often face protests and unrest. In Nigeria, for example, the removal of gasoline subsidies in 2024 led to widespread protests and even clashes with police. Such public backlash makes policymakers reluctant to cut subsidies, even when they acknowledge the environmental benefits of doing so.
Fossil fuel subsidies have a direct impact on the cost of living. Because fossil fuels are integral to nearly every sector of the economy, reducing subsidies tends to increase prices across the board. This can lead to inflationary pressure, making goods and services more expensive. For lower-income populations, these price increases can be especially painful, as they spend a larger proportion of their income on necessities like transportation and heating. The fossil fuel industry is a powerful lobby with significant influence over government policy. Many fossil fuel companies have strong financial and political connections, making it difficult for governments to reduce or eliminate subsidies.
These companies argue that subsidies are necessary for maintaining energy security, preserving jobs, and ensuring economic stability. Energy security is another key factor that complicates subsidy reform. Governments are wary of being overly dependent on foreign energy sources, particularly in times of geopolitical tension.
By subsidising domestic fossil fuel production, countries can reduce their reliance on imported energy, thereby improving their energy security. This consideration often outweighs environmental concerns when governments make policy decisions.
The cost of inaction
The persistence of fossil fuel subsidies has serious implications for the environment and human health. Fossil fuels are the leading source of greenhouse gas emissions, which are the primary driver of global warming. By keeping fossil fuel prices artificially low, subsidies encourage overconsumption and wasteful use, which in turn exacerbates climate change.
The cost of inaction is too great to be overlooked by the global community. In addition to their climate impact, fossil fuel subsidies have significant economic costs. By diverting public funds to support fossil fuel industries, governments have less money to invest in other areas, such as education, healthcare, and renewable energy. This opportunity cost is particularly problematic in developing countries, where resources are limited and the need for public investment is high.
Redirecting funds from fossil fuel subsidies to education and health could dramatically improve the quality of life in developing countries. Currently, vast public resources are spent maintaining artificially low fuel prices, which primarily benefit wealthier consumers and industries.
By redirecting these funds to education, governments could improve literacy, increase school attendance, and equip the next generation with the skills necessary for economic growth. Investment in healthcare could ensure better access to medical services, reduce child mortality, and increase life expectancy.
These changes would create a healthier, more educated population capable of contributing to a diversified and resilient economy. Such investments would break the cycle of poverty, empowering individuals to pursue opportunities beyond survival. By addressing basic human needs, countries can move toward a more sustainable and equitable development path, improving overall well-being and prospects for millions of people.
Global efforts to reform subsidies
Recognising the need to address fossil fuel subsidies, global leaders have made several commitments to reform them. In 2009, the G20, which includes many of the world’s largest economies, pledged to “rationalise and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption.” The Asia-Pacific Economic Cooperation (APEC) forum made a similar commitment later that year.
In 2010, the Friends of Fossil Fuel Subsidy Reform group was formed by 10 countries, including the Netherlands and New Zealand. The group’s goal is to build political consensus on the importance of fossil fuel subsidy reform. Despite these pledges, progress has been limited. A major study of 157 countries found that between 2003 and 2015, governments made little or no progress toward reducing subsidies.
The recent spike in fossil fuel subsidies in 2021 and 2022 highlights the challenges of reform. Following Russia’s invasion of Ukraine, energy prices surged throughout Europe. In response, European governments provided substantial financial support to offset the impact on consumers. This led to the largest fossil fuel subsidies in Europe’s history, as leaders prioritised affordable energy over climate goals.
Economists argue that increasing the price of fossil fuels can lower demand, thereby reducing emissions and mitigating the impacts of climate change. This principle was evident during the recent energy price surge: higher prices led to reduced consumption and a temporary decline in emissions.
The IMF has suggested that periods of high energy prices provide an ideal opportunity for reform. When energy prices are already elevated, governments can phase out subsidies without causing additional price shocks for consumers. By locking in higher prices, governments can encourage the adoption of cleaner energy sources and reduce their reliance on fossil fuels.
Another potential avenue for reform is the use of targeted subsidies to support low-income households during the transition. By providing direct financial assistance to those who are most affected by rising energy prices, governments can mitigate the regressive impacts of subsidy reform. This approach can help build public support for reform while ensuring that vulnerable populations are protected.
There is no doubt that by continuing to subsidise fossil fuels, governments are not only undermining efforts to combat climate change but also missing out on opportunities to invest in cleaner, more sustainable energy sources.
While the path to reform is challenging, it is not impossible. With the right combination of political will, public support, and targeted assistance, it is possible to phase out fossil fuel subsidies and pave the way for a cleaner, more sustainable future.
The recent surge in energy prices offers a unique opportunity to make meaningful progress on subsidy reform. By taking advantage of this moment, governments can reduce their reliance on fossil fuels, support the transition to renewable energy, and help mitigate the impacts of climate change. The stakes are high, but the potential rewards—for the environment, the economy, and future generations—are even higher.