Low Oil Prices: An Opportunity for Fuel Subsidy Reform
The decline in oil prices that began in the middle of 2014 presents an opportunity for governments to reform their fuel subsidies. Fossil fuel subsidies that artificially lower consumer prices are estimated to cost governments around the globe approximately $500 billion per year. These subsidies have a host of negative effects on an economy—encouraging wasteful consumption, creating a large fiscal burden on developing country budgets, disproportionately benefiting wealthier households, and increasing the health and environmental costs associated with fossil fuel use. Therefore, reforms to these subsidies can be good for the economy and the environment. Recent reforms by Indonesia and Malaysia illustrate that governments can capitalize on lower prices and act swiftly to remove fuel subsidies. While these governments have changed the regulated prices of fuels before, some of their recent reforms have removed fuel subsidy mechanisms altogether.
In a new paper for the Center on Global Energy Policy, Dr. Johannes Urpelainen, Associate Professor of Political Science at Columbia University and a Faculty Affiliate at the Center, and his co-authors examine the impact of low oil prices on global fuel subsidies across a number of dimensions. First, the paper explains the benefits of fuel subsidy removal and how low oil prices can enable action. Second, it summarizes key lessons about political obstacles to reform based on original research and the existing literature. Finally, it offers action-oriented recommendations for national and international policymakers, as well as social scientists. The key findings of the paper are below and the full study is available here (PDF).
- The main barriers to fuel subsidy reform are generally political. A move to eliminate subsidies can face popular resistance as well as resistance from vested interests. Efforts can also be complicated by a country’s low institutional capacity. In a lower oil price environment, the risk of a sharp short-term increase in energy costs from subsidy removal is drastically reduced. This can decrease the intensity of popular opposition as well as from vested interests to reform.
- Countries with lower institutional capacities can struggle to pay for alternative, targeted social welfare spending that compensates for the impact of higher fuel prices on their populations when subsidies are removed. Cheaper fuel prices effectively lower the amount of spending that would initially need to go into such programs.
- One potential downside of low oil prices is that it may undermine the political will for a government to undertake reforms. While a lower price environment supports taking action, lower prices also reduce the cost of the subsidies and, therefore, reduce the fiscal pressure on oil-importing countries to reform subsidies.
- For international and civil society organizations, the development of best practices and information-sharing mechanisms is an important area to continue to strengthen. The recent decrease in global oil prices took the international community by surprise, and the long-run effect of this change in the world economy on fuel subsidies remains to be seen. If governments that have already had success with their reforms are willing to share information about their strategies and experiences—an action that would bring reputational benefits to these governments by highlighting their reforms— then international organizations and civil society groups can help disseminate this information to others.
- Academic researchers will have a role to play in the international effort to abolish fuel subsidies. As governments consider reforms, they worry about short-run costs and popular opposition. Systematic data collection and rigorous analysis can be useful for estimating the magnitude of these costs and the extent of opposition in different circumstances. Such estimations can help governments decide whether the time is ripe for reform, and if so, how extensive. The most important research priority is the creation of a comprehensive database of events and processes related to fuel subsidies in key countries.