Expert Speak Terra Nova
Published on Jun 29, 2024

In India, fossil fuel subsidies dominate over support for renewable energy, creating complexities despite varying subsidy definitions

Subsidies to fossil fuels in India: Too much?


In the context of climate change, the dominant narrative on energy subsidies in India is that fossil fuel subsidies far exceed subsidies for non-fossil fuels, particularly renewable energy (RE) sources and if fossil fuel subsidies are transferred to RE, it will accelerate the energy transition. Studies based on this narrative use a broad definition of the term ‘subsidy’ to arrive at figures that are several times higher than subsidies for RE. However, a precise definition of what counts as “fossil fuel” is not explicitly stated upfront. Consequently, complementary services like electricity transmission are included in subsidy accounting for fossil fuels. The use of gross rather than net subsidies allocated to fossil fuels inflates the figure for fossil fuel subsidies. Most importantly, the use of aggregate values of subsidies rather than subsidies per unit of energy delivered disproportionately increases the value of fossil fuel subsidies. Implicit subsidies that include the cost of externalities such as greenhouse gas (GHG) emission and local air pollution, that are not internalised in consumer price for energy is considered a subsidy and added to other explicit subsidies for fossil fuels.

Defining and measuring subsidies

Internationally, there is no systematic definition of energy subsidies. However, definitions by the International Energy Agency (IEA) and International Monetary Fund (IMF) are widely used in papers on energy subsidies. Estimates for energy subsidies conveyed in papers from academic institutions and think tanks vary widely and span three orders of magnitude. The wide variation in estimates for energy subsidies is attributed to conflicting definitions of what constitutes a subsidy. As per the IMF, consumer subsidies are said to arise when the price paid by consumers is below a benchmark price. For pre-tax consumer subsidies, the benchmark price is taken as the supply cost. Producer subsidies are said to be present when producers receive either direct or indirect support that increases profitability above what it otherwise would be. The IMF argued in 2010 that when the G20 nations agreed to eliminate subsidies to fossil fuels, that primary energy demand at the global level would fall by 5.8 percent, and energy-related carbon-dioxide emissions would fall by 6.9 percent, compared with a baseline in which subsidy rates remain unchanged if fossil fuel subsidies were phased out by 2020. The Organisation for Economic Cooperation and Development (OECD), by contrast, follows the inventory approach and defines energy subsidies (based on World Trade Organisation as a result of a government action that confers an advantage on consumers or producers in order to supplement their income or lower their costs.

The price-gap approach is the most common method used to estimate fossil fuel subsidies, though the method has a number of shortcomings. Under this approach, end-user prices are compared with reference prices. The reference prices consist of supply costs inclusive of shipping costs and margins, as well as any value-added tax. The full gap between efficient prices—the sum of supply, environmental, and other costs—and retail prices, multiplied by consumption, is treated as fossil fuel subsidy. According to the IMF’s last update issued in 2023, total fossil fuel subsidies amounted to US$7 trillion in 2022, equivalent to nearly 7.1 percent of global GDP. Explicit subsidies (undercharging for supply costs) accounted for 18 percent of the total, while implicit subsidies (undercharging for environmental costs and forgone consumption taxes) accounted for 82 percent. China contributed the most to total subsidies (US$2.2 trillion) in 2022, followed by the United States (US$760 billion), Russia (US$420 billion), India (US$350 billion), and the European Union (US$310 billion).

The IMF offers a long list of negative externalities of energy subsidies such as, environmental damage, premature deaths through local air pollution, congestion and other adverse side effects of vehicle use, increases in atmospheric GHG concentrations, large fiscal costs financed by some combination of higher public debt, higher tax burdens, crowding out of potentially productive public spending on health, education, infrastructure, lower investments in energy efficiency, renewables, and energy infrastructure, and increase in vulnerability of countries to volatile international energy prices.

Empirical evidence suggest that subsidising access to modern cooking fuels such as LPG (liquified petroleum gas) and electricity (often coal based) increase health outcomes at the household level and also contribute to better economic and educational prospects for women. The IMF counters this argument, citing the finding that energy subsidies are inefficient, as most of the benefits from energy subsidies are typically captured by rich households. The IMF assumes that the solution to this problem is to eliminate energy subsidies rather than design policies in such a way that only households that are energy-poor and economically-poor receive subsidies.

Fossil fuel subsidies

A simple estimate of fossil fuel subsidies in India may be obtained from budgetary provisions for fossil fuels (coal, petroleum and natural gas).  As with most estimates for fossil fuel subsidies, some assumptions will have to be made. The key assumption would be that allocation of public funds to ministries in charge of coal, petroleum & natural gas meets total ‘subsidy’ outgo for fossil fuels. Only allocations for primary fossil fuels are considered. Allocations for secondary sources of energy or energy carriers, such as electricity that are obtained from conversion of fossil fuels or RE, and for the transmission and transport of fuels and energy carriers are not included. The subsidy is calculated net of revenue from the fossil fuels in the form of taxes and other levies and allocated on a per unit of energy equivalent basis.

As per figures in the budget document, the allocation to the Ministry of Coal was INR4.463 billion under various heads,  and the revenue contributed by the coal sector to the central and state governments through various taxes and levies was INR792.71 billion in 2022-23. Therefore, the net subsidy to coal was negative in 2022-23. In 2023 (calendar year), coal contributed 21.9 exajoules of energy to primary energy consumption in India. This translates into about INR 0.2 billion per exajoule gross subsidy to coal.

The total subsidy and under-recovery for petroleum products and natural gas in 2022-23 was INR 303.96 billion. Out of this about INR 220 billion was under recovery in the retail price of LPG. From 2016-17 to 2021-22 and in 2023-24, there was no allocation for under recovery on LPG, which makes the large allocation in 2022-23 a deviation from the norm. The revenue contribution of the petroleum sector through taxes and levies to the central and state government was over INR 7.487 trillion in 2022-23. This means that that there was no net subsidy to the petroleum sector despite the one-time allocation of over INR 220 billion as a subsidy for LPG.  In 2023 (calendar year), petroleum products and natural gas contributed 12.95 exajoules of energy to India’s primary energy consumption. This translates into a gross subsidy of about INR 23.45 billion per exajoule of energy derived from petroleum and natural gas.

In 2022-23, the budgetary allocation for RE was just over INR 69 billion. In 2023, RE contributed about 2.25 exajoules of energy to India’s primary energy consumption. This translates into over INR 30.6 billion gross subsidy per exajoule of energy derived from RE. Although these are indicative values, they illustrate the key fact that there are no net subsidies to coal and petroleum in India and the gross subsidy per unit of energy derived from RE is higher than that offered to coal or petroleum.

Issues for thought

Defining and measuring energy subsidies is not merely a technical matter, but a deeply political one, and the disagreement over what should be counted as subsidy is inherently value-laden. Conclusions of a study that developed five scenarios to simulate national energy policies through the elimination of energy subsidies, followed by the re-allocation of the budget using the recursive dynamic Computable General Equilibrium (CGE) model, are nuanced. It was found that energy reform (subsidy elimination) does reduce energy consumption and carbon emission but if subsidy reform is not followed by a significant compensation/reallocation policy, it may harm the economy as a whole. The study concluded that subsidy elimination followed by a re-allocation through increased government spending was not able to compensate for the negative impacts caused by the energy subsidy reform.  The study also found that subsidy removal and investment policy are not enough in achieving the desired energy mix target, even in a scenario where half of the subsidy is re-allocated to RE investment. The study identified lack of political support for fossil fuel subsidy removal as a key challenge. Energy affordability is critical to energy policymaking in India, given that energy consumption per person is lower than world average per person energy consumption, and its GDP (gross domestic product) per person is lower than the per person GDP of lower middle-income countries of the world.

The economic case against subsidies for energy production or consumption is understood, but policy makers need to be cautious in interpreting numbers put out by various studies. Quantifying the extent of subsidies is extremely difficult, and institutions are using unpriced externalities that do not actually measure the underlying social welfare cost as fossil fuel subsidies. The use of indirect or notional concepts to define subsidies inflates numbers to such an extent that they become meaningless and potentially misleading.

Source: International Energy Agency

Lydia Powell is a Distinguished Fellow at the Observer Research Foundation.

Akhilesh Sati is a Program Manager at the Observer Research Foundation.

Vinod Kumar Tomar is a Assistant Manager at the Observer Research Foundation.

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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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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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