Expert Speak Terra Nova
Published on Sep 10, 2022 Updated 17 Days ago
Although energy poverty is a crisis that needs to be addressed, the West should review the persistent call for phasing out energy subsidies in poor countries in light of its own indulgences.
High Energy Prices: The West joins the Rest with Subsidies and Handouts

This article is part of the series Comprehensive Energy Monitor: India and the World


Since early 2021, crude oil prices doubled, coal prices quadrupled and natural gas prices (in Europe) increased by over seven times. Between January 2020 and April 2022, the World Bank’s energy price index increased by over 76 percent and crude oil prices increased by 350 percent in nominal terms, the largest increase for any equivalent two-year period since the 1970s. In real terms, coal and European natural gas prices have reached all-time highs and remain substantially above their previous peak in 2008.

Overall energy prices are expected to increase by 50 percent on average in 2022. Coal prices, natural gas prices and crude oil prices are projected to increase in 2022 by 81 percent, 74 percent (average of the European, Japan, and U.S. benchmarks), and 42 percent, respectively. Energy prices are expected to remain higher for longer with the prices of energy commodities 46 percent higher on average in 2023 relative to January 2022 projections.

Coal prices, natural gas prices and crude oil prices are projected to increase in 2022 by 81 percent, 74 percent (average of the European, Japan, and U.S. benchmarks), and 42 percent, respectively.

As demand for energy is inelastic in the short run, high energy prices have led to significant declines in household purchasing power across the world. The impact varies considerably across households with the poorest hit the hardest. Many western governments have responded by imposing tax cuts and price caps, and by offering rebates to shield the most vulnerable households from the sharp rise in gas and electricity prices. High energy prices are not new to the rest of the world, especially in India whose citizen’s energy prices have always been high relative to average household incomes.

Subsidies of the West

In the west, energy poverty is understood as the inability to maintain household comfort. In 1991, the United Kingdom (UK) defined an energy-poor household as one that needs to spend more than 10 percent of its income on fuel to maintain an adequate level of warmth. Drawing on UK’s definition, the EU noted that poverty occurred when energy bills represent a high percentage of consumers' income, affecting their capacity to cover other expenses. According to the EU (European Union), energy poverty is a widespread problem because 50–125 million people were unable to afford proper indoor thermal comfort.

To address the exceptional rise in energy prices and the impending energy poverty in many households, which is expected to increase in winter, most of the Western world has offered emergency income support to households, state aid for companies, and targeted tax reductions for taxpayers. The European Commission (EC) has released a toolbox for EU member states to address energy poverty recommending handouts and subsidies.  These payments are far more than what an average household in the rest of the poor world can expect to earn in a year.

The US federal government is providing more than US$8.3 billion to help families and individuals with their home energy costs, including summer cooling, through the low-income home energy assistance program (LIHEAP). The British government announced a support package of GBP 15 billion that covers a rebate of  GBP 550 each for around 28 million households. All domestic energy customers in Britain are expected to receive a GBP 400 grant to help with the cost of their energy bills through the energy bill support scheme.

The US federal government is providing more than US$8.3 billion to help families and individuals with their home energy costs, including summer cooling, through the low-income home energy assistance program (LIHEAP).

France has offered an “energy cheque” worth between 48 euros and 277 euros for eligible households, according to their income and size of the household. France has also forced EDF the electricity utility to limit electricity wholesale price rises to 4 percent for a year. The country’s domestic tax on final electricity consumption has also been curbed from 22.50 euros/MWh (megawatt hour) to only 1 euro/MWh for households, and 0.50 euros/MWh for businesses.

Italy approved a new aid package worth around 17 billion euros to help shield firms and families from surging energy costs and rising consumer prices. Spain has cut value-added tax (VAT) on energy bills from 21 percent to 10 percent, whilst also cutting an existing tax on electricity from 7 percent down to 0.5 percent. Portugal and Spain have put a one-year long cap on gas prices, which ensures they remain lower than an average of 50 euros/MWh.

In the Netherlands, where the average yearly energy bill for households was expected to increase by 1,264 euros, support measures for all households including lower energy taxes and an increase in the lump sum discount on energy bill taxes was offered. On top of that, low-income households were offered an additional 800 euros of support through the municipality.  The government is also lowering VAT on energy from 21 percent to 9 percent and cutting duty on petrol and diesel by 21 percent, until the end of the year.

Denmark is offering a cash handout to the elderly and other measures totalling 417 million euros, including a cut to a levy on power prices. A "heat cheque" worth 269 million euros will be paid to over 400,000 households hit hard by rising energy bills.

Germany also approved two relief packages for a total of 30 billion euros to help its citizens with rising energy prices this year.

Germany has pledged to lower VAT on natural gas from 19 percent to 7 percent until the end of March 2024. Germany also approved two relief packages for a total of 30 billion euros to help its citizens with rising energy prices this year. The German government will offer a one-off energy price flat rate of 300 euros to all taxpayers with poor families getting more. Similar hand-outs, tax rebates, and subsidies are being offered by all member countries of the EU.

Subsidies of the Rest

The justification for government intervention in the energy markets of the West is that of market failure to prevent sudden disruptions to energy supply that can increase energy prices. Energy prices have a disproportionate impact on the economy and society because energy is an essential input in all goods and services, and also is part of every household's budget. Spikes in energy prices will reduce consumer demand, discouraging businesses from hiring and investing all of which will have detrimental effect on the economy.

For the rest of the developing world where energy poverty is simply the lack of access to modern energy sources, the justification of energy subsidies is that it provides access to energy to the poor. Though this is true to some extent, it comes at the cost of wider social spending.  India, where energy subsidies and handouts have been a part of social spending for over five decades, offers an interesting case study.  India has used market distorting price interventions in the past to limit energy price increases, especially for petroleum products, and to ease access to electricity and liquid petroleum gas (LPG). But product specific price discounts have largely been phased out. Currently there are no net subsidy pay-outs in the petroleum sector as tax-take on petroleum products is an order of magnitude larger.

India has used market distorting price interventions in the past to limit energy price increases, especially for petroleum products, and to ease access to electricity and liquid petroleum gas (LPG).

However, political parties continue to offer free or low tariff for electricity and free LPG connections through programmes such as Ujjawala yojana just before regional or central elections. An empirical study of energy subsidies in 109 low-and middle-income countries showed that high energy subsidies and low social spending emerge as an equilibrium outcome in the political game between the elite and middle classes, the poor and the politician. Support handouts for the poor such as free electricity and LPG connections because they are small but certain immediate benefit to consumption, whereas the delivery of public goods such as soft and hard infrastructure for education and healthcare is highly uncertain. The poor who outnumber the rich in India reward the politician with favourable electoral outcomes. The elite and middle classes welcome energy handouts and subsidies because they consume much more energy than the poor and consequently appropriate most of the price subsidies.  More importantly, they are in favour of low social spending for the poor which could erode the financial status of the economy affecting their investments. The study quoted above found that public expenditures in education and health were on average lower by 0.6 percentage point of GDP (gross domestic product) in countries where energy subsidies were 1 percentage point of GDP higher. The study also found that crowding-out of social spending was stronger in the presence of weak domestic institutions, narrow fiscal space, and amongst the net oil importers. India unfortunately qualifies on all counts. But India’s hand-outs and subsidies have enabled it to attain much higher electrification rates and also facilitated a faster shift away from biomass to LPG compared to countries with comparable per-person incomes.

The key takeaway for the West is that its persistent call for phasing out energy subsidies in poor countries should be reviewed in the light of its own indulgence in subsidies. The takeaway for the rest is that subsidies and handouts are not a substitute for development, income generation and overall improvement in quality of life.

Source: Breugel
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Authors

Vinod Kumar Tomar

Vinod Kumar Tomar

Vinod Kumar, Assistant Manager, Energy and Climate Change Content Development of the Energy News Monitor Energy and Climate Change. Member of the Energy News Monitor production ...

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Lydia Powell

Lydia Powell

Ms Powell has been with the ORF Centre for Resources Management for over eight years working on policy issues in Energy and Climate Change. Her ...

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Akhilesh Sati

Akhilesh Sati

Akhilesh Sati is a Programme Manager working under ORFs Energy Initiative for more than fifteen years. With Statistics as academic background his core area of ...

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