Analysis: Ukraine crisis could boost ballooning fossil fuel subsidies

© Reuters. FILE PHOTO: A 3D-printed oil pump jack is seen in front of displayed stock graph in this illustration picture, April 14, 2020. REUTERS/Dado Ruvic/Illustration

By Noah Browning and Stephanie Kelly

LONDON (Reuters) - Sky-high oil prices resulting from a potential Russian oil import ban could force governments to pour more cash into fossil fuel subsidies to shield consumers from rising energy bills, rather than use the money to fight climate change.

Even before Russia's invasion of Ukraine, rising energy costs had triggered a wave of subsidies despite countries agreeing to rein them in at the COP26 climate conference in November.

"The last thing that governments want to do is increase any subsidies for fossil fuel use but they have to be sensitive to the price shock," said Ben Cahill, a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS).

"It's an economic problem we have to deal with today."

Oil has soared to around $140 a barrel as the United States and Europe weigh a Russian oil import ban as part of measures against Russia over the Ukraine crisis.

Oil had already surged last year as demand rebounded from a pandemic slump and supply remained relatively tight, exacerbating multi-decade high inflation.

Coal and natural gas are also near all-time highs.

Governments are using tax breaks, price caps and other measures aim to help consumers to cope with the huge jump in energy prices.

During the pandemic, lockdowns cut demand for fossil fuel in 2020, sending consumption subsidies worldwide to an all-time low of $180 billion - down by nearly half compared with the year before, the International Energy Agency said.

But when demand and prices yo-yoed back up, so did the subsidies.

The Paris-based agency projected in November that subsidies soared by the highest annual rate ever in 2021 to $440 billion, with the final figure certainly higher than that, it told Reuters.

The IEA said renewables are expected to receive $42 billion in government economic recovery spending worldwide, mostly dedicated to solar energy and offshore wind.

Wary of angering a cash-strapped electorate, politicians have largely resorted to throwing governnment money at the problem of higher energy prices in the form of subsidies.

"Most politicians don't think beyond the next election cycle," said Elchin Mammadov, Vice President of ESG Research at global equity index giant MSCI.

"Therefore, they'd rather kick the can down the road and prioritise winning votes by subsidising fossil fuels over climate action, where the benefits are more long term."

Japan hiked its gasoline subsidy for oil distributors as part of an emergency programme to compensate oil wholesalers for their costs.

Sweden seeks to cut taxes on petrol and diesel, cutting pump prices by around around 5 cents per litre, reducing tax income in 2022 by around $257 million.

Britain, France, Germany, Italy, Spain and a number of other countries have introduced caps on electicity price increases.

DIFFICULT JOURNEY

"The continued prevalence of taxes and regulated prices that favour fossil fuels makes the journey towards a sustainable energy future considerably more difficult," the IEA said in its annual World Energy Outlook, saying they hurt clean investment.

For emerging market countries, subsidies to dampen fuel prices are frequently used to avoid public anger over rising energy bills.

Nigeria's government, facing elections next year, last month rowed back on a pledge to end petrol subsidies despite a widening budget deficit. Indonesia last year allotted 83.79 trillion rupiah ($5.9 billion) toward fuel and home cooking canisters, up over 75% from 2020.

"Current increases in fossil energy prices are likely to trigger an increase in fossil fuel subsidies," said Lourdes Sanchez, Senior Policy Adviser at the International Institute for Sustainable Development based in Geneva.

"There was an opportunity in 2020 to reform a lot of subsidies. Some, such as India did - but very few countries took it and instead they supported the fossil fuel industry."

India has reduced fuel subsidies since 2017, imposing higher fuel taxes and allowing market-linked prices, but in November the government asked state run oil companies to freeze fuel prices.

'STICKING IT TO CONSUMERS'

Washington has so far held off on direct sanctions on Russian oil, with the White House saying such a move was on the table but could end up raising gas prices for Americans.

The White House and Democratic congressional leaders began weighing last month a pause on federal taxes on gasoline to help offset already rising prices.

Michael Zehr, federal affairs adviser for Consumer Energy Alliance, said policymakers had "few good options" to address buoyant demand that has yet to be met by cleaner fuels and that higher fuel bills have not driven a shift to renewable energy.

"Just sticking it to consumers that don't have options hasn't resulted in shifting to less-carbon intensive sources," Zehr said. "It resulted to moving to more carbon-intensive sources," citing high gasoline and power prices and a rise in U.S. coal-fired electricity generation in 2021.

Some analysts argue, however, that in the long run the price spike could be a catalyst to dump fossil fuels.

"Over time, higher demand would incentivise governments and businesses to invest in low-carbon products, which in turn make consumers less dependent on fossil fuels and their price fluctuations," said economist and ESG director Tu Nguyen with tax and audit firm RSM Canada.