Putting the spotlight on the role of fossil fuel subsidies in exacerbating the climate crisis, a damning analysis by the International Monetary Fund (IMF) has said total fossil fuel subsidies amounted to a whopping $7 trillion in 2022 or 7.1% of global GDP.

By country, China contributed the most to total fossil fuel subsidies ($2.2 trillion) in 2022, followed by the United States ($760 billion), Russia ($420 billion), India ($350 billion), and the European Union ($310 billion).

The report, IMF Fossil Fuel Subsidies Data: 2023 Update, makes a strong case for governments across the world to undertake fossil fuel price reform.

“Fossil fuel price reform is especially timely. If global CO2 and other greenhouse gas emissions are not reduced by 25-50% below 2019 levels by 2030, this will likely put the goal of containing global warming to 1.5 to 2°C beyond reach,” the IMF said.

Explicit subsidies (undercharging for supply costs) account for 18% of the total, while implicit subsidies (undercharging for environmental costs and forgone consumption taxes) account for 82%.

The IMF report said explicit subsidies have more than doubled since its previous assessment, from $0.5 trillion in 2020 to $1.3 trillion in 2022.

Fossil fuel subsidies are considered one of the biggest financial impediments to the growth of solar, wind, and other renewable energy sources. A study by the International Institute for Sustainable Development said a mere 10-30% of fossil fuel subsidies channeled towards renewable energy sources could help faster energy transition.

Incorrect fossil fuel pricing

Fossil fuels in most countries are priced incorrectly. The optimal price would reflect the full societal costs of fuel use—their supply costs (e.g., labor, capital, raw materials); environmental costs, including CO2 emissions, local air pollution, and broader externalities associated with fuel use like road congestion; and general taxes applied to consumer goods.

“Unfortunately, current prices are routinely set at levels that do not adequately reflect environmental damages and, in some cases, not even supply costs,” the IMF said.

Source: IMF

While acknowledging raising energy prices can be politically challenging, the IMF said a portion of savings from subsidy reform could be used to make income-based transfers to vulnerable households and increase access to low-carbon alternatives.

“Energy price reform needs to be accompanied by robust assistance for households, but this should be both targeted at low-income households (to limit fiscal costs) and unrelated to energy consumption (to avoid undermining energy conservation incentives). Assistance might, therefore, take the form of means-tested transfer payments or perhaps lump-sum rebates in energy bills,” the IMF said.

Explicit subsidies are more commonly discussed among policymakers as they reflect fiscal costs —either directly in the government budget or indirectly as losses/reduced profits at state-owned enterprises. But the total (explicit plus implicit) subsidy is what matters from the perspective of getting fossil fuel prices right — environmental costs are just as real as supply costs (even if they are more uncertain).

Environmental costs

For instance, there is substantial and pervasive underpricing for the environmental costs of coal use and, to a lesser extent, natural gas. Based on a consumption-weighted average across all countries, 80% and 27% of coal and natural gas consumption, respectively, is priced below half of its efficiency.

Petroleum, natural gas, and electricity accounted for 26%, 48%, and 25% of the explicit global subsidy in 2022, while coal accounted for less than 1%.

Differences between efficient and retail prices for fossil fuels are large and pervasive across fuels, especially coal. Globally, 80% of coal consumption was priced below half its efficiency in 2022.

Impact on global warming

The IMF report said completely reforming fossil fuel prices by removing explicit fuel subsidies and imposing corrective taxes such as a carbon tax would reduce global CO2 emissions by 43% below ‘business as usual’ levels in 2030. This would be in line with keeping global warming to ‘well below’ 2 deg C and towards 1.5 deg C.

According to an International Energy Agency report, global CO2 emissions from fossil fuel combustion were expected to grow by just under 1% in 2022, thanks to the strong expansion of renewables and electric vehicles.

Complete price reform would raise revenues of $4.4 trillion, or 3.6% of global GDP, in 2030. These revenues could be used to cut more burdensome taxes, such as on those on labor, help with debt sustainability, or fund productive investments. For developing countries as a whole, revenue gains from full-price reform exceed the estimated extra spending needed to achieve the Sustainable Development Goals.

In July, a report by the United Nations Conference on Trade and Development revealed a substantial investment gap in achieving SDGs across various sectors. The current annual investment gap for these goals had surpassed $4 trillion from $2.5 trillion in 2015.

The report also estimated that fuel price reform would avert about 1.6 million premature deaths per year from local air pollution by 2030.