UK Fossil Fuel Subsidies

July 2017: Firstly an apology – I wrote this post about 3 years ago and thought I had published it, but hadn’t! So sorry it’s a bit out of date . . . some more up-to-date posts coming soon.

There has been much discussion in the press and blogosphere recently about an OECD report on the ‘levels of subsidy’ enjoyed by fossil fuels worldwide, broken down by country.

The report, which counts tax breaks as a form of subsidy, calculates subsidies to fossil fuels in the UK at around £3.6 billion in 2010. Most of this ‘subsidy’ comes from a preferential VAT rate of 5% on domestic energy supplies, as opposed to the normal 20% for goods. Other tax breaks include relief on certain ‘economically marginal’ North Sea fields. North Sea oil and gas is heavily taxed and raises a large income for the Treasury. This is justifiable as the oil and gas are UK national resources and belong to the UK rather than to the oil and gas extraction companies. The Treasury’s policy has been to adjust the tax regime so that extraction remains profitable whilst maximising income to the Treasury.

The Guardian has calculated the level of subsidy for renewable energy at £1.4 billion for that year. Renewable energy subsidies are not largely a result of tax breaks, but a result of an obligation on energy companies to invest in renewable energy through various schemes such as the Renewables Obligation and the Feed In Tariff. As they do not come from the public purse, renewables subsidies can be regarded as an additional tax on energy companies. This impacts on profits but some have argued that the cost is automatically passed onto the customer. The profit regime of energy companies however remains opaque.

Energy companies are not necessarily oil companies, but for the sake of argument let’s say this leaves a net difference of around £2.2 billion in subsidy for fossil fuel industries.

Some commentators argue that this calculation is not correct as tax relief on an already very high tax regime cannot be counted as a true subsidy. Normally this reasoning would be correct, but in this case fails to take into account that North Sea oil and gas reserves are property of the UK and not property of the oil and gas companies. Failure to recognise this fact would be to provide a subsidy to the oil and gas companies of free oil and gas, both very valuable exhaustible resources. In contrast, wind and sun (and wave and tidal energy) actually are free, and inexhaustible.

This difference is key. The costs of renewable energy are the equipment used to harvest these free fuels (i.e. wind turbines and solar panels), and research and development. These costs are likely to naturally fall over time, and indeed have been doing so, even as efficiency rises. Conversely, as the finite reserves of fossil fuels become depleted, the market price of energy derived from fossil fuels will rise, as it is indeed doing, along with the costs of extracting them as the ever more difficult resource deposits are tackled. Tax relief given by the Treasury is based on the costs of extraction of ‘difficult’ fields – the Treasury however has no control over international oil and gas prices, which remain at record highs despite worldwide economic recession. In theory, the rising market price itself will eventually make economically marginal oil and gas fields viable. So why does the Treasury need to give additional tax relief? Simply, to bring the exploitation of these fields forward in time. The subsidy is being paid by the future UK economy for the benefit of the current government.

The same will apply to the “generous” tax regime that the Chancellor has said he will put in place for the exploitation of ‘shale gas’.

Wind and sun however will continue to be free into the foreseeable future. Subsidies given now to improve and bring down the cost of the harvesting technologies will result in permanently lower energy prices.

Green’ groups have seized on these figures as evidence that fossil fuels have an unfair market advantage, even without considering the contribution of additional carbon dioxide emissions to the increasing amounts of heat energy being held in the Earth’s atmosphere, resulting in a more energised biosphere and resultant climate impacts, as forecast by climate scientists.

Of course, climate science is in its relative infancy and it is notoriously difficult to predict localised weather, so the amount of environmental and economic damage resulting from the burning of fossil fuels is difficult to quantify. Lord Stern estimated in his review that the world could lose around 10% of GDP through the effects of climate change, with a 50C rise in global temperatures (currently predicted by the World Bank, amongst others) – around £243 billion annually if translated to the UK. If correct, this economic cost represents a subsidy to the fossil fuel industry as the industry does not have to pay to rectify the environmental damage its pollution causes. Of course, this figure for the UK is the cost of global emissions, not just UK emissions. UK emissions are about 1.75% of the world total, so we would be responsible for around £4.2 billion of that annual loss.

One indicator of whether or not climate change is actually having an economic impact is the reinsurance industry. In many US states, insurers must disclose to financial regulators their exposure to climate change related risks. Here in the UK, the government is currently in difficult negotiations with insurers to try to retain insurance for domestic homes at risk of flooding. 2012 has been one of the worst years in living memory for flooding.

So whilst statistics about individual storms, droughts etc are debateable and contentious, the insurance industry whose business it is to know about risk and put a price on it, is raising costs. These higher insurance costs also represent a subsidy to the fossil fuel industry.

Support for the fossil fuel industry could be a risky investment for the UK, according to the Bank of England. Tax breaks now to encourage the development of marginal oil and gas fields could be wasted if the future value of these resources disappears. Oil companies can write off the cost of establishing production from an oil field against tax immediately rather than over the lifetime of the field.

Back in November 2009, Andrew Mitchell MP gave a passionate speech to the Overseas Development Institute pledging to end the Labour Party’s support for fossil fuel projects across the globe, citing support amounting to three quarters of a billion pounds. He was absolutely clear that climate change is one of the major risks to humanity. Yet here in 2013, on the website of the UK Export Credits Guarantee Department, is listed support of $1 billion for Petrobras offshore oil and gas projects.

If the tax revenue from oil and gas was being used by the Treasury to reduce demand for energy through a programme of energy efficiency, then that would be a justification for continuing to develop fossil fuels. However, even the revenue from carbon taxes such as the CRC Energy Efficiency Scheme is not spent on improving energy security for the UK.

So it does seem clear that UK fossil fuel companies do receive significant subsidies which are not afforded to renewable energy, for extremely questionable benefits, except the short term financial interests of the current government and the oil and gas companies themselves.

Whilst renewable energy does not generate an income for the Treasury except for normal corporation tax (which, after tax breaks, is often all oil and gas companies end up paying on the marginal fields which are left to exploit), it increases UK energy security whilst ensuring long-term lower energy prices for consumers, as well as giving the UK the opportunity to become a world leader in the development of efficient technologies.

By contrast, the fossil fuel extraction industry has a finite lifetime which is increasingly beset by rising costs, technical difficulties and environmental risks, not to mention the obvious geopolitical destabilisation that political reliance on fossil fuel producing countries brings.

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