metadata: authors: 0: author: Larsen,Bjorn Klavdy
docna: 0: docna: World fossil fuel subsidies and global
            carbon emissions in a model with interfuel substitution
docty: Policy Research Working Paper
subtopic: Oil Refining & Gas Industry,Disability,Services & Transfers to Poor,Energy Policies & Economics,Economic Assistance,Access of Poor to Social Services,Energy Demand,Energy and Environment,Energy and Mining
teratopic: Energy
abstracts: cdata!: The author presents a simple empirical
            framework for estimating the level of world fossil fuel
            subsidies and analyzing their implications for carbon
            dioxide emissions. The author extends Larsen and Shah (1992)
            by applying a simple model with interfuel substitution,
            using a more detailed sectoral data set that includes energy
            prices and consumption for an expanded sample of countries.
            The author concludes that substantial fossil fuel subsidies
            prevail in a handful of large carbon-emitting countries. The
            fiscal implications for some countries are significant - as
            much as 10 percent of GDP in some countries. World subsidies
            are estimated to be more than $210 billion, or 20 to 25
            percent of the value of world fossil fuel consumption at
            world prices. Removing such subsidies, the author estimates,
            would reduce national carbon emissions by more than 20
            percent relative to baseline emissions in some countries. It
            would reduce global carbon emissions by 7 percent.
repnme: repnme: World fossil fuel subsidies and global
            carbon emissions in a model with interfuel substitution
display_title: World fossil fuel subsidies and
            global carbon emissions in a model with interfuel substitution
listing_relative_url: /research/1994/02/442269/world-fossil-fuel-subsidies-global-carbon-emissions-model-interfuel-substitution
topicv3: Energy and Extractives m1326595 507,Power and Electricity Sector m1327094 515,Fuel Subsidies m1327095 1628,Petroleum Industry m1583790 4710,Natural Gas m1583894 4712
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Energy
origu: Public Economics Division-575
no_of_pages: 30
author_keys: 0: author_key: 99118
model_extractions: POLICY **RESEARCH WORKING PAPER** 12S6

# **Summary findings**

Larsen presents a simple empirical fiamework for estimating the level of world fossil fuel subsidies and analyzing their implications for carbon dioxide emissions. Larsen extends Larsen and Shah (1992) by applving a simple model with interfuel substitution, using a more detailed sectoral data set that includes energy prices and consumption for an expanded sample of countries.

Larsen concludes that substantial fossil fuel subsidies prevail in a hand&ul of large carboni-emitting countries.

The fiscal implications for some countries are significant - as much as 10 percent of C,DI) in sorne countries. World subsidies are estimated to he Ilmore than $2 1 **()** billion, or 20 to 25 percent of the value of world fossil fuel consumption at world prices.

Removing such subsidies, Larsen estimates, would reduce national carbon cmissions by more than 20 percent relative to baseline emissions in some countries. It would reduce global carbon emissions by 7 percent.

This paper-a product ofthe Public Econotnics Division, Policy Research Department- is an extension of Policy Research Working Paper 1002, "World Fossil Fuel Subsidies and Global Carbon Emissions," bv Bjorn Larsen and Anwar Shah October 1992. Copies ot this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433 Please contact Carlina Jones, room N10-063, extension 37699 (24 pages). February 1994.

_The Polic)' Researcb Working Paper Se, ies disserninates the findings of ttork in progress to encourage the exchange of ideas about development issues. An objective of the serie, is to get the findings out quickly, even if the presentations are less than fully polisbed. 7he papers carry the names ofthe authors and should be used and cited accordingly. 7he findings, interpretations, and conclusions are the auti rs' otvn and should not be attributed to the World Bank, its Executive Board of Directors, oir any of its member countries._ Produced by the Policy Research Dissemination Center
# World Fossil Fuel Subsidies and Global Carbon Emissions in a Model with Interfuel Substitution

by Bjorn Larsen
# Table of Contents

# ABSTRACT

|I.<br>Introduction ............................................|1|
|---|---|
|II.<br>Existing Fossil Fuel Pricing Regimes and World Subsidies ...................|3|
|III.<br>Empirical Frcmework .........................................|13|
|IV.<br>Implications for Greenhouse Gas Emissions ...........................|16|
|V.<br>Summary and Conclusions .......................................|21|
|REFERENCES ...|3|
|List of Tables||
|Table 1:<br>Carbon Dioxide Emissions from Fossil Fuel Combustion .................|<br>4|
|Table 2:<br>Total Subsidies (mission US$) .<br>..................................|7|
|Table 3:<br>Subsidies to Coal (billion US$) ..........<br>......................|10|
|Table 4:<br>Subsidies to Natural Gas (billion US$) ............................|11|
|Table 5:<br>Subsidies to Petroleum Products (billion US$) .......................|12|
|Table 6:<br>C02 Emissions Reductions .<br>..................................|19|

*This paper is an extension of Larsen and Shah (1992c), "World Fossil Fuel Subsidies and Global Carbon Emissions," Policy Research Working Paper Series No. 1002, the World Bank, Washington, D.C., and explores ideas suggested by Lawrence H. Summners and Andrew Steer. The paper was supervised by Anwar Shah, Principal Economist, PRDPE, World Bank, and financed by a grant from the World Bank Research Commnittee, RPO 677-28. It has benefitted from discussions with Ramon Lopez and Gordon Hughes, comments by Anthony A. Churchill, Mahan Monasinghe and Robert P. Taylor, and able research assistance from Isidro Soloaga.
# WORLD FOSSIL FUEL SUBSIDIES ANN GLOBAL CARBON EMISSIONS

# IN A MODEL WITH INTERFUEL SUBSTITUTION

I. Introduction: The last few years have witnessed a dramatic growth in worldwide concern over global climate change. Increases in atmospheric temperatures are expected to take place as a result of accumulation of so called greenhouse gases. The magnitude of temperature increases and the environmental and economic costs are still highly uncertain and are likely to differ substantially across regions. The main greenhouse gases are carbon dioxide (C02), methane, CFCs and nitrogen oxides, of which carbon dioxide accounts for as much as 80 percent of the total warming potential on a global scale when adjusting the instantaneous warming potential by the atmospheric lifetime of the gases (Nordhaus 1991)'.

Most OECD countries have already comrmitted to stabilize C02 emissions at 1990 levels by year 2000, and some western European countries to further reduce emissions 20% by year 20052. Non-OECD countries are reluctant to reduce emissions on global enviromnental 'The instantaneous warming potential of a gas is defined as the increase in atmospheric concentration of a gas times the instantaneous or current radiative impact of that gas. The total warming potential of a gas is the sum of the instantaneous warming potential over each time period for the life time of the gas. For instance, in terns of instantaneous warning potential, carbon dioxide accounts for about 53% and methane for 17 %. But in terms of total warming potential, they account for 80% and 2% respectively because of significantly longer life of carbon dioxide in the atmosphere.

2The Framework Convention on Climate Change, signed at the "Earth Summit" in Rio de Janeiro last summer, aims at stabilizing atmospheric concentrations of greenhouse gases in the long .erm, which would require a reduction in annual global emissions of approximately _50%_ below current emissions. A shorter term target is a return to 1990 annual emissions levels by year 2000 in industrial countries, while no binding constraints are imposed on developing countries. Although few time specific targets are included in the treaty, mechanisms for deciding on stronger measures in the future, if warranted, were set up (see Steer (1992) for a brief report on the conference in Rio).
considerations because of more urgent development objectives and the fact that the current stock of atmosph nissions is primarily a "responsibility" of the OECD countries<sup>3</sup> . Nevertheless, non-OECDs, and particularly the states of the forrrer Soviet Uniop and eastern Europe, may achieve substantial reductions relative to "busiress as usual" over the next 10 to 20 years by policies that mak,e econominc and local environmental sense. Such policies include removal of substantial subsidies on fossil fuels and fossil fuel generated electricity, removal of non-price barriers to e-nergy efficiency, a "moderate" tax on fossil fuels based on local environmental considerations, and a reorientation of the fiscal tax structure to reduce disincentives to invest in productive capital and increase incentives to reduce use of inputs and production factors that pollute locally and globally (see Larsen and Shah 1992a, 1992c and Shah and Larsen 1992a, 19925).

The removal of fossil fuel subsidies has been advocated as the first order of priority in instituting economic policies to protect local and global environments (see Summers, 1991, Churchill and Saunders, 1991, Larsen and S"-h, 1992a, 1992b, 1992c and Shah and Larsen, 1992a, 1992b). Elimination of fossil fuel subsidies can be a politically sensitive issue, in particular when prices are only a small fraction of world prices. But many developing countries do price fossil fuel at or above world prices, suggesting that fossil fuel pricing reforms can be done if introduced gradually. In this context, it would be helpful to quantify the magnitude of existing subsidies and potential environmental benefits associated with the elimination of such subsidies. A number of recent studies have reflected upon various aspects of this question. For 3For instance, contribution to atmospheric C02 concentration increases (1800-1988) from fossil fuel combustion by OECD countries is 65 % of world total, while current annual emissions (1988) are "only" 45% (Grubler and Nakicenovic 1992).

2
exampL, Kosmo (1989) estimates the level of subsidies for a large sample of developing countries primariiy for petroleum products and electricity. Sterner (1989) presents a time series of domestic petroleum product prices relative to world prices for Latin American countries. Burgess (1990) evaluates potential carbon dioxide emission reductions from efficient electricity pricing in a sample of countries including the United States, China and India. Larsen and Shah (1992c) present an estimate of world fossil fuel subsidies and the impact of subsidy removal on global carbon dioxide emissions, but ignore interfuel substitutior.. This paper attempts to account for interfuel substitution from subsidy removal using a more detailed data set, in most cases from end of 1991, on fuel prices covering a larger country sample.

Section II reviews existing fossil fuel pricing regimes and estimates the level of world fossil fuel subsidies. Section III develops a simple framework for estimating the impact of subsidy removal on national and global carbon emissions. Estimates of carbon emission reductions are presented in section IV. Section V presents a summary and conclusions.

.I. Existing fossil fuel pricing regimes and world subsidies: Getting fossil fuel prices right would prima facie represent first order of priority in any economic policy response to curtail greenhouse gas emissions. This section explores this potential by analyzing fossil fuel pricing practices around the world. It is interesting to note that while a complete inventory of fossil fuel subsidies in the world is a formidable task and beyond the scope of current work, yet it is possible to reach reasonable estimate of the overall level of subsidies by studying only a few countries. For exam *e, 90% of the world coal is consumed by 15 countries; almost 80% of world petroleum pr'<sup>1</sup> ucts by 28 countries and almost 90% of the world natural gas by 18 countries (Table 1). These few countries emit a total of 85 % of global carbon f.oom fossil fuels, 3
TABLE 1 CAWON DIOXIDE EHISSIONS PROM FOSSIL FUEL COMBUSTION

## C02 emissiona from petroleum products (1969) C02 emissions from coal (1989)

# C02 emissions from natural gas (1989)

||000<br>*<br>|of<br>world<br>cum<br>|mulative<br>||000|t of<br>world<br>|cuffmilative||000<br>|%of<br>world<br>cum|mulative|
|---|---|---|---|---|---|---|---|---|---|---|---|
||tons|emissaons|%||tons|emissions|I||tons|emissions|I|
|I UNITED STATES<br>2 USSR|2075685<br>1237842|23.42t<br>1|23.42%<br>|1CHINA<br>|1964032<br>|22.41%<br>|22.41*<br>|1 USSR|1129996|32.60%|32.60%|
|<br>3 JAPAN|<br>|3.97%<br>|37.39%<br>|2 UNITED STATES<br>|1826149<br>|20.84%<br>|43.25t|2 UNITED STATES|924735|26.681|59.28%|
|<br>**4**CHINA|603157<br>292699|6.S1%<br>|44.192<br>|3 USSR<br>|132885<br>|15.16%<br>|SS.41t<br>|3 CANADA|128130|3.70%|62.90%|
|<br>S G<br>|<br>|3.30t<br>|47.49%<br>|4 INDIA<br>|461803<br>|5.27%|63.681|4 UNITED KINGDOM|104710|3.02%|66.00%|
|ermany,<br>Went<br>6 ITALY|247478<br>|2.791<br>|50.28%<br>|5 POLAND<br>|370005<br>|4.22%|67.90%|5 Germany,<br>West|96568|2.79%|68.70%|
|<br>7 MEXICO|241938<br>|2.73%<br>|53.01%<br>|6 JAPAN<br> <br>|303995<br>|3.47%|71.37t|6 JAPAN|92616|2.66%|71.46s|
|<br>|234624<br>|2.65%<br>|55.66%<br>|7 Germany,<br>West<br> <br>|283623<br>|3.24%|74.60%|7 ITALY|76926|2.22%|73.68%|
|8 FRANCE<br>9 CANADA|214613<br>|2.42%<br>|56.09%<br>|8 Germany.<br>East<br>|65000<br>|3.02%|77.63%|8 ROHANIA|66165|1.91%|75.59%|
|<br>10 UNITED|209303<br>|2.36%<br>|60.451<br>|9 UNITED KIGDO4M<br>|251277<br>|2.87%|80.49%|9 NETHERLIUDS|64105|1.85%|77.44%|
|KINGDOM<br>11 BRAZIL|201560<br>|2.27%<br>|62.72%<br>|10 SOUTHAFRICA<br>|239362<br>|2.73%|83.23%|10 FRANCE|55964|1.611|79.05%|
|<br>12<br>|146816<br>|1.66%<br>|64.381<br>|11 CZECHOSLOVAKIA<br>|156136|1.78%|85.01t|11 SAUDI ARABIA|51270|1.48%|60.53%|
|<br>INDIA<br>13 SAUDIARMABIA|143929<br>110261|1.62%<br>|66.00%<br>|12 AUSTRALIA<br> <br>|141932<br>|1.62%|86.63%<br>|12<br>UIcIO|49255|1.42%|61.951|
|<br>14 IRAN|<br>|1.24%<br>|67.25%<br>|13 North<br>KOREA<br>|136946<br>|1.56%|88.19%|13ARGENTINIA|42050|1.24%|83.191|
|<br>15 SPAIN|110191<br>121|1.24%<br>|68.49%<br>|14CANADA<br> <br>|107352<br>|1.22%|89.41%|14 IRAN|42590|1.23%|84.42%|
|<br>16 Sth<br>KOREA|073<br>|1.21%<br>|69.70%<br>|15 South<br>KOREA|97037|1.11%|90.52%|15 VENEZUELA|38945|1.12%|.<br>.54'|
|ou<br> <br>1|103466<br>|1.17%<br>|70.67%<br>|||||16UNIT.ARAB EMIR|31210|0.90%<br>Os.44%||
|7 AUSTRALIA<br>19 INDONESIA|81746<br>|0.92%<br>|71.79%<br>|WORLD|8764288|||17 AUSTRALIA|3055S|0.86s|87.321|
|<br>19|61722<br>|0.92%<br>|72.711<br>|||||18CHINA|298317|0.13%|88.16%|
|ARGENTINA<br>20 EGYPT ARAB|62834<br>|0.71%<br>|73.42%<br>|||||||||
|, REP<br>21 TURKEY|59349<br>|0.67%<br>|74.09%<br>|||||WORID|3466144|||
|<br>22 ROMNIA|56118<br>|0.66%<br>|74.75%<br>|||||||||
|a<br>23<br>IRA|52439<br>|0.59%<br>|75.34%<br>|||||||||
|<br>Q<br>|50794<br>|0.57%<br>|75.91%<br>|||||||||
|24 THAILAND<br> <br>|50604<br>|0.572<br>|76.486<br>|||||||||
|25 Germany,<br>East<br>|47000<br>|0.53%<br>|77.01%<br>|||||||||
|26 VENEZUELA<br>|46042<br>|0.52%<br>|71.53%<br>|||||||||
|27 CZECHOSU)VAEIA<br>|44979<br>|0.51t<br>|78.04%<br>|||||||||
|28 POLAND<br>WORLD|43939<br>6863216|0.50%|78.53%|||||||||

Source: World Resources Institute (1992)
of which roughly a half of the coal and natural gas consumers and a third of the petroleum product consumers are OECD countries with relatively insignirlcant subsidies<sup>4</sup> . We define subsidies on fossil fuels as the difference between domesJic fossil fuel prices a-id their (private) opportunity cost evaluated at end-user prices. When fuels are traded internationally border prices serve as opportunity cost, which is the case for petroleum products for all sample countries. Opportunity cost at end-user level would be border prices plus a mark-up for distribution. U.S. pre-tax end-user prices of petroleum products by sector are used as proxies for opportunity cost at end-user level, although unit distribution costs may lo some extent vary across countries. Natural gas and coal are traded less frequently than oil/petroleum products and natural gas markets are primarily regional in character. Border prices plus distribution costs are used if these fuels are imported or there exist export markets as for the formner Soviet Union in the case of natural gas and to a lesser extent coal<sup>5</sup> . In the case of China, an approximation to the opportunity cost of coal is the unit price for the proportion of coal traded in the free domestic market. In the remainder of the paper opportunity cost is referred to as world pricA for sake of convenience. Official exchange rates reported in IMF's International Financial Statistics have been used to convert domestic prices into dollars. Implicit subsidies stemming from overvalued exchange rates are ignored and subsidies are thus underestimated relative to an 4The Environment Directorate (OECD) is currently undertaking a study on producer and consumer subsidies and other "supports" to the energy sector. There are significant producer coal subsidies in Germany, but end-user prices of coal in Germany are well above border pric-s due to import restrictions on coal.

5It is recognized that border prices plus distribution costs as defined here are not likely to be equivalent to the opportunity cost of energy, but are used in the estimations of subsidies because data on marginal cost of energy and domestic distribution cost are rather scarce. Given that the United States have the lowest pre-tax energy prices of the OECD countries, subsidies as calculated are likely understated rather than overstated. _5_
equilibrium exchange _rate._ Implicit subsidies are for some countries larger than the subsidies estimated by applying the official exchange rates, and estimated carbon emission reductions may in these cases be significantly understated. Total subsidies Sk for country k evaluated at the official exchange rate is:

# _Sk_ = El Ej (pWjj-plje)qO

vwhere **pU** is domestic end-user price of fossil fuel i in sector j, **pwl** is opportunity cost of fuel i in sector j in US dollars, e is the exchange rate in units of US dollars to domestic<sup>currency, and</sup> qij is domestic consumption of fuel i in sector j<sup>6</sup> . Total subsidies is thus the price<sup>differential</sup> r.iultplied by quantity consumed at subsildized prices. Price elasticity of demand<sup>need not be</sup> applied to calculate subsidies. This is apparent from the definition<sup>of efficiency cost of</sup> subsidies, defined as the difference between increase in consumer surplus<sup>and total subsidies.</sup> If total subsidies were to be calculated based on consumption at non-subsidized<sup>prices, total</sup> subsidies would be less than increase in consumer surplus and welfare thus<sup>higher with a</sup> subsidy.

Total subsidies by fuel and country are presented in Table 2 for 1991.<sup>It is important</sup> to note that some countries, such as China and Indonesia have increased<sup>their energy prices</sup> significantly since 1991. Other countries, in particular the states of the former<sup>Soviet Union,</sup> are attempting to increase prices to international levels but with less<sup>success because of high</sup> levels of inflation. The former Soviet Union accounted (and still accounts)<sup>for more than two-</sup> 6Sectors include electricity generation, industry, transport, agriculture, residential, commercial and a residual sector. Subsidies on outputs, such as electricity,<sup>or complement</sup> inputs to fossil fuels in any of .hese sectors would act as "implicit" subisides<sup>on fossil fuels</sup> because more energy would be used than at efficient input and output prices. We do not attempt to account for such inefficiencies.

6
# **Table 2. Total Subsidies (miuHons U.S.$)**

||**Coal**|Gias|**Petroleum**|**Total**|<br>T )tal/|
|---|---|---|---|---|---|
|Former USSR|17000|63000|65000|14500C|<br>10-13%'|
|China|3300||4600|7900|1.8%|
|Poland|66n0|1,O||6730|10.0%|
|Czechoslovakia|2100|460|380|2940|6.0%|
|Brazil||50|900|950|0.2%|
|Venezuela||1750|3600|5350|10.6%|
|Mexico|90|600|1550|2150|1.0%|
|India|2550||4250|6800|2.3%|
|Indonesia|||5100|5100|5.0%|
|Saudi Arabia|||5000|5000|4.8%|
|South Korea|1650||1100|2750|1.2%|
|South Africa|_1550_|||_1550_||
|Egypt||_350_|3000|3350|10.7%|
|Iran||2300|9100|11400|8.u%|
|Romania|600|800||1400|3.7%|
|Bulgaria|750||_450_|1200|6.0%|
|Total|36190|69440|104030|209660||

Source: Author's calculations.

tAssuming per capita income in the range of US $4000-5000.
thirds of the total worla subsidies, about US $145 billion. This is not unexpected given the low domestic prices relative to world prices, and the fact that the former Soviet Union consumes approximately 20% of world fossil fuel consumption. Iran follows wita the second highest level of energy su,sidies, about US $11 billion (in 1993). These subsidies are estimated based on an exchange rate after recent substantial devaluations that were brought about to correct for a significantly overvalued currency. China follows with the third highest level of subsidies of about US $8 billion, although diminishing. Subsidies in China are difficult to estimate because of a multiple pricing system. Coal subsidies in China were significantly higher a fe." years ago (Bates and Moore 1992) before the two-tier pricing system was introduced that permits a large proportion of coal to be traded at market prices. Subsidies on petroleum products, in total US dollars, were still significant in 1991. .r:ces of gasoline and diesel to the transport sector have for several years been above world prices, but diesel is subsidized to agricuilture and fuel oils in particular to the industrial sector. However, both coal and petroleum product subsidies in China are rapidly being reduced and our estimate of US $8 billion in subsidies could well be significantly lower at this time in 1993. After China follows India, Poland, Venezuela, Indonesia and Saudi Arabia' with subsidies in the range of US $5-7 billion, although Indonesia has by now significantly reduced subsidies.

In terms of subsidies by fuel for the world as a whole, petroleum products are heaviest 7In the case of Saudi Arabia, one may argue that the opportunity cost of domestically consumed petroleum products is not world prices if annual exports are constrained (OPEC) and if exports at world prices contain a large rent element. On the other hand, selling petroleum products at lower than world prices may still be considered a subsidy because domestically consumed petroleum products could alternatively be exported at world prices in the future. Thus there are intertemporal inefficiencies unless world prices are to decline significantly in the future.

8
subsidized accounting for more than 50% of total subsidies, followed by natural gas (33%) and coal (17%). Among petroleum products fuel oils receive the largest subsidies in dollar value. Gasoline is often tzxed even in countries with substantial subsidies on other petroleum products. The largest coal subsidizers are the former Soviet Union, P3and, China, India, Czechoslovakia, South Korea and South Africa (Table 3). More than one half of total coal subsidies are to coal to the power sector. The largest natural gas subsidizers are the former Soviet Union, Iran and Venezuela (Table 4). The largest petroleum product subsidizers are the former Soviet Union, Iran, Indonesia, Saudi Arabia, China, India, Venezuela and Egypt (Table 5). All petroleum products (i.e. gasoline, kerosene, diesel, heavy and light fuel oils) are subsidized in the former Soviet Union, Indonesia (not gasoline in 1993), Venezuela, Saudi Arabia, Iran and Egypt, while gasoline prices are siginificantly above world prices in India, Czechoslovakia, Brazil and South Korea. About 60% of petroleum product subsidies in India, about 35% in Indonesia and 33% in Egypt are to kerosene. In total, world fossil fuel subsidies are about US $210 billion, and possibly US $10 billion more from the countries for which no data were obtained. This leaves us with subsidies in the range of US $210-220 billion, which corresponds to 20-25 % of the value of world fossil fuel consumption at current world prices. Such large fossil fuel subsidies have significant fiscal implications in many of the larger subsidizing countries and are thus important in a macroeconomic context. Fossil fuel subsidies are higher than 10% of GDP in the former Soviet Union, Egypt, Venezuela and Poland, while "only" 2.3% and 1.8% of GDP in India and China respectively (Table 2).

Estimates of total world subsidies are 5-10% lower than estimated in Larsen and Shah (1992c). This is primarily because estimated subsidies in the former Soviet Union are 15% 9
# **Table 3. Subsidies to Coal (billion US $)**

|Sectors:|Power|Industry|Trans|Agr|Conum|Res|Total|**Pd/pw**|
|---|---|---|---|---|---|---|---|---|
|Former USSR<br>Chi|6.0<br>|4.0<br>|0.2<br>|**0.4**|6.42||17.0|0.45|
|na<br>Pld|0.7<br>|1.6<br>|0.1<br>|0.1<br>||0.8|3.3|0.82|
|oan<br>Chlki|5.0<br>|1.3<br>|0.1|0.1||0.1|6.6|0.34|
|zecosovaa<br>Idi|1.0<br>|0.3<br>||||0.8|2.1|0.25|
|na<br>Sth K|1.9|0.5||||**0.15**|2.55|0.62|
|ou orea<br>Sth Afi||||||1.65|1.65|0.403|
|ou rca<br>Ri|0.9<br>|0.4<br>|||0.1|**0.15**|1.55|0.48|
|omana<br>Bl i|0.25<br>|0.15<br>||||0.2|0.6|0.79|
|u -ara|0.5|0.1||||0.15|0.75|0.45|
|Total<br>Source: Author's calc|16.25<br>ulations.|8.35|0.4|0.6|||36.1||

I/Ratio of weighted average domestic prices to world prices.

2/Commercial and residential.

3/Residential sector.
# Table 4. Subsidies to Natural Gas (billion US $)

|Sectors:|Power|Industry|Trans|Agr|Comm|Res|Total|Pd/p"I|
|---|---|---|---|---|---|---|---|---|
|Former USSR<br>Chlki|20.0|21.0|1.0|1.0|7.0|13.0|63.0|0.12|
|zecosovaa<br>Vl|||||0.35|0.11|0.46|0.85|
|enezuea<br>Mi|0.4|1.0<br>||||0.35|1.75|0.15|
|exco<br>E||0.3||||0.3|0.6|0.85|
|gypt<br>I|0.35<br>||||||0.35|0.48|
|ran<br>Ri|0.7<br>|0.6<br>||||1.0|2.3|0.05|
|omana|0.2|0.2||||0.4|0.8|0.84|
|Total<br>Source: Author's calc|21.65<br>ulations.|23.1|1.0|1.0|7.35|15.16|69.26||

I/Ratio of weighted average domestic prices to world prices.
**Table** **_5._ Subsidies to Petroleum Products (billion US. $)'**

||Gasoline|Kerosene|Diesel|HFO*|<br>LFO*|<br>Total|
|---|---|---|---|---|---|---|
|Former USSR|19.0<br>(0.54)|1.0<br>(0.40)|30.0<br>(0.30)|5.0<br>(0.68)|10.0<br>(0.23)|65.0|
|China|||1.5-<br>(0.70)|0.6<br>(070)|2.5<br> <br>(0.79)|4.6|
|Czechoslovakia|(2.34)||(1.88)|(1.05)|0.38<br>(0.74)|0.38|
|Brazil|(1.95)|0.1<br>(0.74)|0.4<br>(0.94)|(1 41)|0.4<br>(0.71)|0.9|
|Venezuela|2.3<br>(0.25)|0.2<br>(0.47)|0.6<br>(0.18)|0.1<br>_(0.55)_|0.4<br>(0.19)|3.6|
|Mexico|(1.06)|0.2<br>(0.72)|0.85<br>(0.71)|0.4<br>(0.84)|0.1<br>(0.75)|1.55|
|India|(2.09)|2.55<br>(0.33)|1.3<br>(0.79)|(1.60)|0.4<br>(0.61)|4.25|
|Indonesia|0.6<br>(0.65)|1.8<br>(0.28)|1.3<br>(0.39)|(1.00)|1.4<br>(0.36)|5.1|
|Saudi Arabia|1.1<br>(0.65)|0.1<br>(0.22)|0.8<br>(0.13)|0.5<br>(0.47)|2.5<br>(0.12)|_5.0_|
|South Korea|(1.84)|0.3<br>(0.74)|0.3<br>(0.83)|(1.05)|_0.5_<br>(0.68)|1.1|
|Egypt|0.6<br>(0.34)|1.0<br>(0.05)|0.2<br>(0.05)|0.1<br>(0.95)|1.1<br>(0.40)|3.0|
|Iran|1.7<br>(0.29)||3.8<br>(0.05)|1.5<br>(0.07)|2.1<br>(0.04)|9.1|
|Bugaria|(1.29)|0.15<br>(0.60)|0.1<br>(0.90)|(1.80)|0.2<br>(0.75)|0.45|
|Total|25.3|7.4|41.2|8.3|22.0|104.1|

# Source: Author's calculations.

* Heavy Fuel Oils and Light Fuel Oils respectively.

** Primarily to agriculture (no diesel subsidies to transport).

I/Figures in parentheses are ratio of domestic prices to world prices.
lower than previously estimated. The main reason.is that exchange rate and price data used in this paper on the former Soviet Union is from 1989, rather than 1992, to avoid the problem of high inflation and associated exchange rate uncertainty in recent years. In any case total subsidies in the former Soviet Union are in the range of US $145-172 billion. Estimates of total subsidies are for some countries significantly different than estimated in Larsen and Shah (1992c) primarily due to exchange rate fluctuations, domestic price changes and a more detailed data set used in this paper. Estimates in this study of subsidies on petroleum products in Brazil and Mexico and on coal in Czechoslovakia are significantly lower than the previous estimate. Subsidies in Argentina are now virtually non-existent due to the recent introduction of a new currency. Subsidies on petroleum products are estimated to be significantly higher in Indonesia, Saudi Arabia and Egypt, and on coal and petroleum products in India relative to the previous estimates. Estimates for China, Poland and South Africa are almost identical to previous estimates. Finally, estimates for South Korea, Iran, Romania and Bulgaria are included in this study.

# III. EmRirical framework:

The approach taken here is in partial equilibrium assuming factor prices, other than energy prices, and level of aggregate output in the economy are constant. This may be an acceptable approximation for small changes in energy prices. For large changes in energy prices however, as is evaluated in this paper, a country specific general equilibrium analysis is of course preferable but beyond the scope of this study given that the analysis extends to 16 countries. At best, estimated emission reductions from fossil fuel subsidy elimination alert to 13
the priority subsidy elimination should take in any strategy to reduce national and global greenhouse gases.

The quantity of energy demanded is considered derived demand, i.e., energy is an input in the production of goods and services. We assume there exists a twice differentiable aggregate production function, where Q is gross output, K is capital stock. L is labor input, E is energy input, M is material input, and t is technical change. Assuming exogenously given input prices, output level and cost minimizing behavior, the theory of duality implies existence of a unique twice differentiable cost function, where C is total cost and Pi's are the respective input price indices. If the cost function is weakly separable in its aggregate inputs, then an energy function can be written as,

# E = E(qc, q0 , qp) (3)

where qi's are the primary energies (here fossil fuels) coal, natural gas, and petroleum products respectively. Assuming that E is homothetic with respect to q, for i=C, G, P, we have the energy cost function, PE = P(PC, PG, PP) (4) where Pc, PG, and Pp are prices of coal, natural gas and petroleum products respectively.

Estimation of the impact of subsidy removal on fossil fuel demand is carried out in two stages. First, we hold aggregate energy constant, apply Shephard's lemma to each fossil fuel and differentiate each fuel input with respect to each fuel price. This gives the price elasticities 14
S = Sjeji for all i, j _(5)_ of fuel demand, ejj, for fuel i and fuel price j such.that, and Ej =0 for all i (6) where Sij are the fuel cost shares in total energy cost. (5) results from the symmetry of the Hessian matrix of second order derivatives of the energy cost function and (6) from the linear homogeneity of the cost function. Second, we allow aggregate energy E (as well as K, L and M) to adjust to energy price changes while output is still held constant. This gives the price elasticities, where **eEE** is the own price elasticity of aggregate energy.

In order to estimate the impact of fossil fuel subsidy removal, we will assume values for the own price elasticity of aggregate energy and the own price elasticity for each fuel holding aggregate energy constant. Since we are considering fossil fuels only, of which there are three, the elasticities from (7) is a three-by-three matrix of which three of **the,** entries will be assumed.

That leaves six unknowns, which are determined by the system of six equations in six unknowns given by (5) and (6). Thus the off-diagonal entries in the elasticity matrix, i.e. the cross-price . elasticities, are uniquely determined from the own price elasticities<sup>8</sup> We have not assumed any particular technology in (1) and therefore not a specific form for the energy function. We approximate the energy demand function in the relevant region by 8Note that this is not the case if we have more than three fuels.

15
a Cobb-Douglas function, i.e. the price elasticity of demand for fuel i, ej, is constant in the relevant region. Taking partial derivatives with respect to energy prices of the Cobb-Douglas function in logaritmic form would give the estimated changes in energy demand from a price change. But the derivative is a linear approximation, while we will estimate changes in energy demand from subsidy removal by **a** movement along the demand curve. The change in energy demanded from subsidy removal is thus, where qi is domestic consumption of fossil fuel i, pj is the domestic price of fuel j before subsidy removal, pjw is the world price of fuel j. The impact on carbon emissions is calculated from (8) by multiplying the change in fuel i by the respective carbon emission coefficients. It should be noted that an implicit assumption is that the energy markets are in equilibirum for the energy prices used in this study, i.e., that energy consumption has fully adjusted to past energy price changes. This may of course not be the case for countries with recent domestic energy price adjustments. In case domestic energy prices have recently been adjusted upwards, reductions in consumption may not yet be realized, as in the case of China, and our estimates understates the new equilibirum energy consumption after subsidy removal.

IV. Implications for greenhouse gas emissions: Removal of fossil fuel subsidies would be expected to induce reductions in fossil fuel consumption and therefore carbon emissions in subsidizing countries. If domestic prices are below world prices because of price ceilings effective for producers as well as consumers, then removal of such price ceilings may have 16
positive supply effects. In the case of non-traded energy products, in particular electricity, demand may be supply constraint. Removing subsidies, or price ceilings, may therefore increase consumption. We do not take this into account, but recognize the importance of this fact.

Reductions in fossil fuel demand in subsidizing countries may also reduce world prices and thus result in increased consumption in non-subsidizing countries. We will estimate carbon reductions assuming no change in world prices, although this assumption may be unrealistic if all fossil fuel subsidies were removed simultaneously.

The removal of subsidies will not immidiately translate into reductions in fossil fuel consumption. Consumers will respond to higher prices over time, and we have thus estimated reductions as below projected baseline emissions in year 2010, i.e. below projected emissions if subsidies were not removed (table 6). Projected baseline emissions for the world as a whole is estimated to be about 50% higher in 2010 than in 1989. OECD emissions are assumed to be constant given that most OECD countries have committed to stabilize emissions at 1990 levels by year 2000 and some to further reduce emissions to 80% of 1990 emission levels by year 2005. Baseline emission projections in the former Soviet Union and eastern Europe are based on Baron (1992). His estimates incorporate the impacts of restructuring, i.e. compositional changes in aggregate output. Baseline emissioni projections for all other non-OECD countries are based on GDP projections less _0.5-1.0%_ annual autonomous energy efficiency improvements that may arise from less energy intensive capital, appliances and transport equipment, and compositional changes in aggregate output.

The magnitude of carbon reductions realized by removal of fossil fuel subsidies clearly depends on the price elasticities of demand. Bohi (1981) presents a comprehensive survey of 17
price elasticities of energy demand. Long run own price elasticities are in the range of -0.5 to - 1.0 for natural gas, -0.7 to _-1.5_ for petroleum products, -0.5 to -1.0 for coal and -0.5 to -1.0 for electricity. Hoeller and Wallin (1991) estimates the long-run price elasticity of carbon demand to -1.04 in a cross sectional study of the OECD countries. These elasticity estimates woulvd be valid for marginal changes in prices only. In cases of high levels of subsidies, as in for example the former Soviet Union, elasticity estimates for marginal price changes can not be applied to arrive at emission reductions but instead much smaller values of elasticities must be considered. Therefore own price elasticities of demand used are in the range of -0.15 to -0.25 in most of these cases and -0.6 in cases of low levels of subsidies. The analysis attempts to include estimation of interfuel substitution and cross price elasticities are determined within the model. Estimates of emission reductions from the removal of subsidies can also be in serious error for countries where supply is completely inelastic with excess demand at low prices as may be the case in particular for natural gas. In Poland, natural gas may be considered supply constrained and therefore an increase in natural gas prices within a certain range may not have any significant effect on natural gas consumption. Excluding emission reductions from Poland on account of natural gas would lead only to a minor revision in the overall estimate for reductions in global carbon emissions. In the case of Soviet Union, the share of natural gas in total energy consumption is as large as that of petroleum products and coal and it is therefore perhaps realistic to assume that price increases of natural gas will lead to reduced natural gas consumption.

Estimates of carbon emission reductions from subsidiy removal are presented by country in Table 6. Removal of subsidies are estimated to result in almost 7% reduction in world carbon 8
Table 6. C02 **Emissions** Reductions

||C02<br>emissions<br>1989<br>(mill tons)<br>(1)|Baseline C02<br>emissons<br>2010<br>(mill tons)<br>(2)|C02<br>emissions<br>2010 w/o<br>subsidies<br>(3)|%<br>reduction<br>relative to<br>baseline<br>(4)|C02<br>emissions<br>2010 relative<br>to 1989<br>(3)/(l)|
|---|---|---|---|---|---|
|World|21093|32784|30480|7.0%|_1.5_|
|OECD|9717|9717|9717||1.0|
|Non-OECD|11376|23067|20763|10.0%|1.8|
|Non-OECD w/o<br>China|9090|16698|14681|12.1%|1.6|
|Former USSR|3697|_5065_|3798|25.0%|1.03|
|China|2286|6369|6082|4.5%|2.7|
|Poland|433|_511_|389|24.0%|0.9|
|India|_632_|1815|1652|9.0%|2.5|
|South Africa|274|_510_|439|14.0%|1.6|
|Czechoslovakia|221|221|168|24.0%|0.8|
|Mexico|304|693|669|3.5%|2.2|
|Brazil|193|439|428|2.5%|2.2|
|South Korea|206|700|672|4.0%|3.3|
|Venezuela|86|159|124|22.0%|1.4|
|Indonesia|106|326|304|7.0%|2.9|
|Saudi Arabia|162|271|239|12.0%|_1.5_|
|Egypt|75|208|175|16.0%|2.3|
|Iran|157|358|272|24.0%|1.7|
|Roniania|205|246|192|22.0%|0.9|
|Bulgaria|104|125|111|11.0%|1.1|

(2) Projected emissions if fossil fuel subsidies are not removed.

(3) Projected emissions if fossil fuel subsidies are removed.
dioxide emissions from fossil fuel consumption, of which 56% are from coal, 30% from gas and 14% from petroleum products. In terms of potential reductions in national carton emissions, reductions are estimated to be larger than 20% in the former Soviet Union, Poland, Czechoslovakia, Iran, Romania and Venezuela. Such large reductions may appear unrealistically high, but even after such reductions carbon intensity (tons of carbon to GDP) in these countries would still be significantly higher than in OECD countries or other middle income countries.

Perhaps interesting, total carbon dioxide emission reductions from reductions in consumption of petroleum r)roducts are significa1ltly lower than for coal and natural gas, primarily because percentage change in domestic petroleum product end-user prices from subsidy removal is smaller than for coal and gas prices, although total value of subsidies to petroleum products is far higher than to coal and gas. Total value of subsidies to petroleum products is higher in large part because subsidies per unit of carbon content is higher on petroleum products due to higher world prices and non-subsidized end-user prices of petroleum products per unit of carbon content relative to coal and to some extent gas. Emission reductions from gas is also higher than from petroleum products because domestic prices of gas relative to world prices are lower than for petroleum products in the former Soviet Union, from where the largest reductions in emissions from gas are estimated to occur. In terms of total world emission reductions, estimates in this study are lower than the previous emstimates primarily because of lower estimates of reductions from petroleum products in the former Soviet Union. Although estimated emission reductions from petroleum products are as high as 18% of petroleum product emissions, total emission reductions are only 2% because of the large share of coal in total emissions.

20
In terms of the other countries, estimated emission reductions in Mexico are substantially lower than estimated in Larsen and Shah (1992c) even subsidies, although small in total value, to coal and gas are now included. The reason is that petroleum product subsidies, estimated at official exchange rate, are significantly reduced resulting in an estimated slight increase in petroleum product consumption from interfuel sLbstitution. Emission reductions in Brazil are also substantially lower due to signifiLantly lower estimates of petroleum product<sup>subsidies.</sup> Estimated reductions in Indonesia are also substantially lower, although estimated total subsidies to petroleum prodeucts are now higher. Reductions are lower because estimates suggest relatively large increase in coal and gas consumption from removal of petroleum product subsidies. Estimated reductions in Saudi Arabia and Egypt are signi:icantly higher according to this study because of substantially larger estimated subsidies. Estimated reductions in Czechoslovakia are now larger primarily due to larger estimated reductions in coal conumption and inclusion of subsidies to gas. Estimated reductions in Venezuela are now larger because significant subsidies to gas are included. Estimated total reductions in India, Poland and South Africa are relatively close to previous estimates. Finally, this study includes estimates for South Korea, Iran. Rom.'nia and Bulgaria, which were not included in Larsen and Shah (1992c).

V. Summarv and conclusions: Substantial energy subsidies prevail in a handful of large carbon emitting countries. Total world subsidies are estimated to be in excess of US $210 billion, or 20-25% of the value of world fossil fuel consumption at world prices. Removal of such subsidies are estimated to reduce national carbon emissions in some countries by more<sup>than 20%</sup> and reduce global carbon emissions by almost 7% assuming no change in world prices of fossil fuels. If all subsidies are eliminated simultaneously, world prices of fossil fuels may he 21
expected to decline relative to the price path of no subsidy removal. A decline in world prices could stimualate demand in non-subsidizing countries and partially offset estimated reductions in carbon emissions. On the outer hand, a decline in world prices would only have a minor effect on most national emission reductions in subsidizing countries estimated in this paper (see Larsen and Shah 1992c).

It should be noted that subsidy removal would not be sufficient to stabilize aggregate carbon emissions at 1989 levels in non-OECD countries. In particular, the share of world emissions from China will increase from about i0% _in_ 1989 to 20% in 2010 even if fossil fuel subsidies are removed. Stronger economic p',licy responses would be required to achieve stabilization, although emission reductions in some individual countries from subsidy removal would be significant.

The paper does point to the fact that substantial fossil fuel subsidies exist in a handful of large carbon emitting countries, although subsidies are being phased out, or being attempted, in some of these coutries. Further research should include the electricity sector with explicit consideration to supply constraints, a more country specific model, broader energy strategy options for China and India given their current share of global carbon emissions and rapidly increasing share in the future, and the impact of energy subsidy removal on world prices.

22