Fuel Subsidies Hurt

Submitted by John on Mon, 07/28/2008 - 1:19am. Tags:

Economics and Business

I didn't know this. Fuel subsidies in emerging economies are helping to keep world oil prices from falling. In such countries with less disposable income and more political pressure to keep gas affordable, governments have been stepping up subsidies to keep pump prices from shooting up like they have here. So, in case you were wondering why record level oil prices weren't stunting demand and bringing prices down, now you know part of the reason.

China has bumped up subsidies from $22B last year to over $40B this year to help keep prices low...as have Indonesia and Mexico and others. So while places like the US and Europe have been conserving in response to price hikes, these other countries haven't.

In fact, according to British Petroleum:

countries with subsidies accounted for 96 percent of the world’s increase in oil use last year — growth that has helped drive prices to record levels.

In most countries that do not subsidize fuel, high prices have caused oil demand to stagnate or fall, as economic theory says they should. But in countries with subsidies, demand is still rising steeply..

Well, that sucks for us. So much for the price mechanism.

Nobuo Tanaka, executive director of the International Energy Agency, said that subsidies were clearly a big factor contributing to the mismatch in supply and demand that has helped push up world oil prices. “We think the price mechanism is not working enough to make consumers more efficient,” he said.

Ha. Ya think? ;)

In case you were wondering why your gas dropped about a dime or so per gallon during the last week, China said it was upping its fuel domestic fuel prices and oil futures dropped $4 per barrel within minutes. Impressive. However, in case you were wondering why diesel is SOOOO much more expensive than gas, it's because the bulk of these subsidies are for diesel.

The big question is how long these countries can afford to continue to subsidize fuel consumption and chase their own tail in the process. Fuel subsidies may stave off public protest in the short run but the lack of reaction to real prices means consumption doesn't drop and neither do real prices...which then require higher subsidies the following year.

Malaysia was spending a whopping 7.5% of its GDP on fuel subsidies before adjusting fuel prices upward by 40%...to a great deal a public anger...so much so that the Prime Minister announced he would resign immediately and then retracted.

Sadly, economics doesn't rule the day in public policy (does it ever??), politics does. And with elections coming up in countries like India and Indonesia, cutting fuel subsidies is unlikely to get taken seriously.

And more sadly, we're not exactly the country to be telling these countries to cut back voluntarily given that we consume more oil than anyone else. But we ARE paying a more accurate price. That much can be said at least and we are conserving as a result.

Granted, these subsidies are far from the only cause for high prices. But it is one reason why prices have been slow to come down.

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Oil taxes... (#105935)

by M Aurelius on Mon, 07/28/2008 - 9:41pm

I saw that story and I thought sure, that's true as far as it goes, but on the other hand the biggest oil consumers outside the US (Europe and Japan), tax their oil consumption, highly, and have for decades.

The US consumer has been buying cheaper gas thanks to the European or Japanese consumer having to pay more, and for a very long time.

So this is a one-sided story, carefully phrased to blame foreign countries: countries with subsidies accounted for 96 percent of the world’s increase in oil use. Increase. Fact is, more fuel is taxed than subsidized. Another fact, fuel use per capita in China or Malaysia is a small fraction of that in the US or any other industrial country, so it will rise regardless.

Let's face it, we use too much of the stuff, and we are going to pay for that one way or the other. If fuel costs go up in China, all that junk in Walmart is going to be more expensive. The solution is not to play blame games, it's to change our energy technologies.

Of course not!

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well, (#105978)

by John on Tue, 07/29/2008 - 12:06am

"I saw that story and I thought sure, that's true as far as it goes,"

And I think that's all they were saying.

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Truth without context... (#106022)

by M Aurelius on Tue, 07/29/2008 - 8:56am

...is often little more than an elegant lie.

And the article entirely misses the context of the overall oil market. It has an agenda, and the agenda is that the problem lies with our stars, rather than with ourselves.

Of course not!

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I think the context was simply (#106045)

by John on Tue, 07/29/2008 - 11:02am

to consider the role of prices: demand rises and/or supply does not keep up, Prices shoot up and demand eventually reacts by flattening or shrinking and/or supplies increase...which brings prices back down.

There's no agenda there. The article is simply saying that subsidies in the emerging economies are keeping this process from functioning as normally as they otherwise would. No need to draw conclusions based on what wasn't said. The US being the largest oil consumer is not a secret nor is it the point here.

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Why doesn't the price mechanism work here? (#105912)

by Jordan on Mon, 07/28/2008 - 9:16pm

These governments are basically buying the fuel, or co-buying it, and price increases hurt their bottom line just as it would consumers. Malaysia sounds like a perfect example.

What difference IOW, if the consumer is a government or a person? If price pressure goes up, governments look for ways to conserve/improve efficiency just like people.

Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH

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do they really? (#105977)

by John on Tue, 07/29/2008 - 12:04am

I think that's part of the point. Apparently it's not working that way. Consumers want, consumers buy. The government isn't controlling or rationing the gas market...they're merely subsidizing it.

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Price controls absolutely affect government decisions. (#106095)

by Jordan on Tue, 07/29/2008 - 2:08pm

And that's the point. These governments providing subsidies don't have unlimited budgets, and the rise in fuel (and food) prices are hurting them. Granted, as decisionmakers they aren't nearly as volatile as individual consumers, but demand is slowly curbing for them as well.

As Manish points out, there's redistribution going on here too. The wealthiest members of a society will curb their demand for gasoline only at much higher cost than the poorest members. When subsidies are involved, those two demand points are averaged. That's all.

Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH

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John, subsidies keep people alive in the developing world. (#106007)

by mmghosh on Tue, 07/29/2008 - 8:28am

Unfortunate though that might seem.

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you seem to think such a statement (#106047)

by John on Tue, 07/29/2008 - 11:09am

is warranted. Psychologically, that's more interting than the blog topic itself.

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Possibly! I tend to feel that keeping people fed (#106050)

by mmghosh on Tue, 07/29/2008 - 11:23am

tends to trump all else. Thats the kind of view we tend to get here.

Subsidies are a part of the redistributive process. Hard as it might be to swallow, a process of redistribution is a large and essential part of a modern society. Just as a social service network is a necessary part of it all.

I don't deny the presence of corruption and venality in the process, either, and I also think you are legitimate in you attempt to criticise structural problems in a redistributive system that perpetuates central price control.

And yes, subsidies abroad (as in farming subsidies in the west) hurt us here too. But we also understand the necessity for them.

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Mexico is arguably a special case, John: (#105819)

by JKC on Mon, 07/28/2008 - 5:58pm

One assumes that they're free to price their own oil resources as they see fit internally.

That, by the way, is the argument many in the GOP are using in favor of offshore and ANWR drilling: that because it will be our oil, we can price it as cheap as we'd like. Bring that Hummer out of mothballs!

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I don't see how that's possible here (#105841)

by John on Mon, 07/28/2008 - 6:46pm

oil companies are privately owned. The govt would have to pay the oil co. 's the difference for what they would get at market prices. Is that really the answer? I don't think so.

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I agree... (#105842)

by JKC on Mon, 07/28/2008 - 6:55pm

We need to consume less oil.

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That helps. (#105852)

by John on Mon, 07/28/2008 - 7:29pm

personally, I want this phase that we are in terms of fuel prices to be the period that our grandchildren (well, mine at least...I'm in my mid 30s) read about as the period that pushed us to the advent of an xyz-based energy economy. We'll see.

But somehow suspect prices may not stay this high for long. Just a hunch. And then voluntary conversation will stop.

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You may be right. (#105858)

by JKC on Mon, 07/28/2008 - 7:36pm

Oil is like any other commodity, in that price will drop with demand. At some point, though, the oil will start to become scarce, and if we don't have a replacement of some sort on deck, then we're in serious trouble. To that end, I'd support a gas tax that keeps the price of unleaded regular at $4 a gallon.

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