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Will China’s Fuel Subsidies Save the World from Climate Change?

October 22, 2009

Conventional wisdom points to cutting subsidies to fossil fuels as a path to climate salvation.  In particular, subsidising consumers at the pump is a target.

The thinking is that subsidies keep fuel prices artificially low, do not reflect real resource scarcity, and do not send real market signals to consumers.  Without subsidies, world prices would be higher, which should both suppress demand, and spur investment into alternative fuel sources and energy efficiency.

However, I just re-read an article from the Economist – ‘Petrol Prices in China – Driving in the Right Direction’  – which seems to suggest that this is not necessarily the case.

It includes the intriguing line

Last year, when crude-oil prices soared, Western economists heavily criticised China for holding petrol prices below market rates. Artificially cheap prices, they said, encouraged households and firms to guzzle more oil, pushing global prices higher. (my accentuation)

It infers that, when the subsidy is for a large enough market segment, it stokes aggregate global demand artificially, thus causing fuel price escalation in other regions/segments. 

If the subsidy in China weren’t in place, then it is conceivable that demand would decline in China, depressing global prices, thus marginally reducing invesment in mitigation and behavioural change  in other markets.

While the subsidy therefore does not create the appropriate market signals and associated response in that market, it is conceivable that, in aggregate, the resulting global fuel price escalation (ex-China) would provide for a larger response than would otherwise occur.  Some modelling of this would be of great interest.

In considering the mechanics of the outcome of this potential, it is worth thinking about the composition of the response to prices. 

To reduce greenhouse gas emissions, we must invest in abatement which are both short term, but also structural.

A temporary reduction in fuel use in China may generate (substantial) short-term abatement, but not necessarily the investment in R&D, and commercialisation, and innovation required for longer-term structural change.

A marginal global oil price increase resulting from the China subsidy would signficantly affect the gas-guzzling United States. 

The US is No. 4 in the most innovative countries in the world according to the Economist Intelligence Unit, while China doesn’t make it into the top 25. 

According to IEA statistics the US has consistently accounted for over one third of all OECD public energy research and development investment (Australia accounts for about 1%).  Investment in alternative energy correlates strongly with energy prices (brent crude).

It therefore seems likely that the long-term structural adjustment impacts and climate mitigation effects of a marginal elevation of fuel price in the United States would be greater than that with the short-term effects of a marginal global price reduction concurrent with a response to a decline in Chinese demand were the subsidy removed.

Whether the real-world reflects this theory or not is another issue. 

Since the mid-1990s US Federal R&D in energy accounted for only 1% of all Federal R&D.  PNNL, in a review of US Federal Energy R&D expenditure between 1961-2008, provides some interesting points on the response of public R&D to the 1973-1976 oil price embargo, driven by ‘Oil Independence’ programme launched by Nixon in 1973.

 Federal investments in energy R&D more than doubled in real terms in the short interval between 1973-1976 and nearly doubled again between 1976-1980. Federal investments in energy R&D rose from $2.45 billion in 1974 to $7.47 billion in 1980 (in constant, inflation adjusted 2005 US$). 


 (….) Federal spending on renewable energy grew 42 fold in real terms from $32 million in 1974 to $1.36 billion in 1979. 

(….) it was not until 1974 that there were any outlays for a dedicated federal energy efficiency R&D program (OMB, 2006). This federal energy efficiency R&D program started out with a modest $29 million in 1974 and quickly expanded to $511 million in 1979 (in constant inflation adjusted 2005 US$). 

 The oil intensity of GDP of IEA member countries dropped between 1973 and 1985 by an average of 20 percent.


In a 2005 paper, Nemet and Kammen state that overall energy R&D (public and private) dropped from US$ 5,833 billion in 1994 to US$ 4,506 billion in 2003 across all energy technology categories at the same time as overall R&D expenditures (i.e. across all sectors) during the same period increased by 6 percent. The reduction in the funds allocated to energy R&D has been primarily caused by reduced private commitments. The share of private to overall energy R&D used to be roughly 50 percent. Yet, by 2003 it had dropped to less than a quarter.  They blame the incoherence of Federal public investment and end-market programmes for the reduced private sector investment.

In a 2008 issues paper, Will Blyth points establishes the requirement for linked technology R&D and end-markets (e.g. emissions trading, but could also apply to new market caused by high fuel prices) to enable cost reductions in abatement as an outcome. 

This infers that alongside the creation or perpetuation of higher emissions prices (or energy prices as a proxy), the continuation of high levels of public basic energy science research funding needs to continue, but higher levels of public funding for ‘proof of concept’ and demonstration programmes are also required, in order to leverage private sector investment.

A perception in the OECD  (in particular the US, which has high levels of innovation, high expenditure of GDP on energy, high levels of public energy R&D investment, and increasing dependence on imported oil) of a long-term continued thirst in China for energy, exacerbated by subsidy, which will cause continued elevation of fuel prices, may actually be the spur to induce both substantial and continued public and private investment in R&D that is required to meet the greenhouse gas mitigation challenge.

3 Comments leave one →
  1. sukruth permalink
    February 6, 2010 7:33 pm

    If all over the world people could take public transport it could revolutionize the way oil market works here is the new innovative “Bus day” started by BMTC and public transport cooperation of Bangalore


  1. Subsidies don’t influence fuel consumption in China « commercial climate's Blog
  2. Fossil Fuel Subsidies: Greenhouse Gas Emissions Benefits Offset by OECD Growth « commercial climate's Blog

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