Low oil prices are the talk of the day in environmental and energy circles. Some environmentalists probably despair over rising gasoline consumption and SUV sales in America, while others note that low prices reduce the profitability of extracting oil and gas from unconventional sources, such as as tar sands. Yet others discuss the possibly negative effects of low oil prices on clean energy.
For policymakers in emerging economies, low oil prices present an important opportunity to remove environmentally destructive and economically costly fuel subsidies. Just a week ago, The Economist advised pollicymakers to “seize the day” and use the opportunity afforded by low oil prices to rationalize the pricing of gasoline, diesel, and other fossil fuels.
It’s easy to see why this is important. According to the International Energy Agency, annual subsidies to fossil fuels now total a whopping USD 550 billion per year. These subsidies lower the price of fossil fuels and encourage over-consumption.
What is worse, these subsidies are mostly handed out by emerging and developing economies — just imagine the opportunity cost of this wasteful government expenditure. Half a trillion dollars would go a long way toward improving education, healthcare, and basic infrastructure, with real gains for the poor. Fossil fuel subsidies, on the other hand, are a regressive policy that benefits wealthy households relying on motorized transportation and consuming lots of electricity and liquid fuels. The removal of fuel subsidies is a textbook case of a genuine win-win policy.
So why are governments not acting? The removal of fuel subsidies turns out to be a political nightmare. Fuel prices are concrete and visible, and increasing them threatens to create social unrest. A government that removes fuel subsidies risks losing political power if citizens see high fuel prices without any corresponding gains. That’s why efforts to reform fuel subsidies have been so difficult.
In my work with Andrew Cheon and Maureen Lackner, we have also found that domestic institutions can be major driver of fuel subsidies. Countries with national oil companies can hide the fiscal cost of fuel subsidies in the company bottom line, as the presence of a national oil company removes the need to subsidize fuels from government expenditures in a transparent fashion. At the same time, the regulation of fuel prices is deceptively easy for the government: a national oil company can simply be told to set the price at a certain level.
Despite these challenges, some governments have already seized the opportunity and cut fuel subsidies. Encouraging and important examples include Indonesia and India (gated content), where newly elected governments have used the opportunity afforded by low oil prices to act. When oil prices are low, the pain of a price increase from subsidy removal is limited. If the government can also develop a robust strategy for using the saved expenditures in ways that benefit the people, the subsidy reform can succeed.
We don’t know what future oil prices will be, but they will probably continue to fluctuate. One of my core priorities for the future is to develop and test strategies to enact and implement fuel subsidy reforms that can weather political storms. Here’s a concrete example of a major policy problem that political scientists can solve in collaboration with governments and other practitioners. That’s a pretty exciting prospect.