End the Subsidies of Fossil Fuel

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Illustration by Bloomberg View

There may be little reason to hope the Rio+20 meeting in Brazil this week will lead to major global action against climate change. World leaders have skipped it. The draft agreement the delegates from 190 countries have written is rightly criticized as weak.

Yet it turns out that one specific climate challenge -- how to eliminate subsidies for fossil fuels such as oil, gas and coal -- is attracting extraordinary interest in Rio de Janeiro and might at least inspire countries to take small but significant steps toward reducing greenhouse-gas emissions.

These rising subsidies cost the world $409 billion in 2010, according to the International Energy Agency. If no efforts are made to curtail them, they could reach $660 billion by 2020, 0.7 percent of global gross domestic product.

What’s at least as bad is that the subsidies keep the price of fossil fuels below market rates -- so low as to discourage measures to improve energy efficiency. Getting rid of them could lower total energy demand by 4.1 percent by 2020, the IEA estimates.

Simply ending the subsidies would boost the price of power, however, and leaders naturally want to avoid a popular pushback, whether at the polls or in the streets, especially at a time of financial hardship. That is not the only option.

Our corporate colleague Michael Liebreich, the chief executive of Bloomberg New Energy Finance, has devised a way to phase out fossil-fuel subsidies and, in the process, replace them with financial support for energy-efficiency efforts and renewable power. It’s a strategy that could work in countries large and small -- without provoking backlash.

Here’s how it would work: A government would continue providing its energy subsidies for three to 10 more years, but transform them into credits. The recipients would be free to spend these, at least in part, on renewable forms of energy. Where credits could be directed to individual consumers, they could be spent on improvements such as insulation, efficient appliances and rooftop solar panels. Because the credits would not favor one kind of power over another, many renewables would be able, for the first time, to compete strongly against fossil fuels.

Wind energy, for instance, could, on a level playing field, cost as little as 6.5 cents per kilowatt-hour, BNEF estimates. That is about the same as power from new coal plants and, outside the U.S., cheaper than natural gas. Biomass, geothermal and hydro power can also be competitive with coal. And although solar power on a large scale remains relatively expensive, rooftop systems can provide cheaper-than-retail power in many markets. In the developing world, solar lanterns cost less to operate than kerosene ones.

Governments could pay out these “sunset credits,” as Liebreich calls them, in various ways. Where subsidies have been provided to consumers, they could be replaced by rebates on energy bills or by monthly or quarterly vouchers, redeemable with retailers and installers of renewable power or equipment that improves efficiency. If consumers are made aware that the credits will eventually end, they will have the incentive to invest in strategies that ultimately lower their household energy bills.

Those retailers and installers who are paid with sunset credits would in turn surrender them to a redeeming agent -- the government, perhaps, or a bank or other lending institution -- to be reimbursed the market price for their products and services.

Where subsidies are traditionally given to providers such as electric utilities, those companies would receive the credits and could either pass them along to their customers to spend on efficiency, or invest them in renewable-energy generating capacity or in their own efficiency measures.

In places where governments subsidize gasoline or diesel, credits could be spent on transportation alternatives. Delivered in the form of vouchers, debit cards or mobile-phone banking credits, they could be spent on public transportation fares, more fuel-efficient vehicles, even bicycles.

It’s easy to see, too, how sunset credits could attract investment in renewable power and in technologies that increase energy efficiency, as banks and other lenders provide upfront capital in return for the promise of credits down the line. The lenders could either redeem the credits or perhaps sell them to pension funds, life-insurance companies and other long-term asset holders, and a new credit market would be formed.

Setting up such a system would take effort and money, it’s true. And it would certainly be complicated; mechanisms would be needed to protect against fraud, for example. But such investments are worthwhile if they enable governments to stop spending public money to make fossil fuels unnaturally cheap. The draft agreement for the Rio+20 meeting only vaguely commits countries to phasing out the subsidies. Sunset credits offer a way for them to make it happen.

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