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Fossil Fuel Subsidy Removal: Greenhouse Gas Emissions Benefits Offset by OECD Growth

April 21, 2011

Source: OECD

In a working paper released by the OECD two weeks ago, researchers examine the environmental benefits of global fossil fuel subsidy removal focussed on emerging markets.  They conclude that aggregate global emissions benefits resulting from subsidy removals are less than those forecast by the previous G20 estimates should no emissions caps be in place for OECD nations. 

Subsidy removal would in such a scenario yield a benefit of an 8.2% emissions reduction in 2050, rather than 9.8% reduction should OECD caps be in place.

Removal of fossil fuel subsidies has been a major focus of the G20 over the past few years.

The authors of the paper (Mitigation Potential of Removing Fossil Fuel Subsidies:  A General Equilibrium Assessment) finger the principal cause of this marginal change to be a rebound effect (or carbon leakage as they call it) whereby OECD economies benefit from lower world energy prices, thereby increasing economic output and energy consumption rates.

The report states:

The resulting drop of emissions of CO2 is quite substantial in some countries/regions, amounting to more than 25% in Russia and 45% in the oil-exporting countries. While CO2 emissions fall by 16% in non- Annex 1 countries in 2050, they remain almost unchanged in Annex 1 countries. This is because reductions in Russia and non-EU Eastern European countries are offset by emission increases in other Annex 1 countries. As consumption of fossil fuels in non-OECD countries fall as a result of the subsidy removal, international fossil fuel prices drop inducing an increase of the fossil fuel consumption in countries that do not subsidize their energy demand or do not remove their existing fossil fuel subsidies, a phenomenon usually referred to as a carbon leakage. This leakage is particularly pronounced in the EU and EFTA countries where CO2 emissions increase by 12% in 2050 relative to the baseline. Of the 6.1 GtCO2 emission reduction achieved by removing energy subsidies in non-OECD countries in 2050 (corresponding to a reduction of their emissions by 16%), around 17% is offset by an increase of emissions in OECD countries. With binding emission caps in OECD countries, carbon leakages would be contained, and the environmental benefits from subsidy removal would be larger.

The analysis concludes that a multilateral fossil fuel subsidy removal would lower crude oil and natural gas prices by 8% and 13% respectively in 2050, and coal by 1%.

At this blog, last year we contemplated the proposition that non-OECD subsidy removal would engender an energy price rebound effect.  It appears that this GEM analysis supports this theory.  However, we advanced a concept of an additional marginal structural offset created through reduced energy innovation as a consequence in OECD.

Back to the OECD paper: In both Unilateral and Multilateral scenarios of fossil fuel subsidy removal, most nations and regions benefit from income and welfare gains, with aggregate global real income increasing by 0.3% in 2050.  However, Russia and Canada in particular are seen to be major losers in a multilateral scenario, with incomes reducing by 5.8% and 2.5% respectively, while non-EU Eastern Europe suffering a negative impact of close to 10%.  Australia and New Zealand suffer a negative real income impact of 0.5%.

The report also notes that these global models do not contemplate the domestic social impacts of the implied redistribution of costs of subsidy removal, rather these are dealt with in country studies.

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