Economic Cost of Global Fuel Subsidies

Prof. Lucas Davis of UN Berkeley has this nice paper where he estimates the cost of global fuel subsidies. It is a nice paper which can be used to explain the concepts of social costs, external costs. private costs to students with some real world analysis.

He estimates the global subsidy bill at $11o bn:

By 2015, global oil consumption will reach 90 million barrels per day. In part, this high level of consumption re ects the fact that many countries provide subsidies for gasoline and diesel. This paper examines global fuel subsidies using the latest available data from the World Bank, finding that road-sector subsidies for gasoline and diesel totaled $110 billion in 2012.Pricing fuels below cost is inecient because it leads to overconsumption. Under baseline assumptions about supply and demand elasticities, the total annual deadweight loss worldwide is $44 billion. Incorporating external costs increases the economic costs substantially.

The paper has some nice graphs showing the price and consumption of gasoline, countries with highest subsidies and so on.

Figure 1 plots road-sector gasoline consumption per capita and gasoline prices for 128 countries. A plot of diesel consumption and prices is available in the online appendix. Prices are domestic consumer prices including taxes and come from a survey administered November 2012. The size of the circles is proportional to country population.

The figure reveals an enormous amount of variation in gasoline prices. Gasoline prices average $5.26 per gallon, but range from $.09 per gallon in Venezuela to above $9.00 in Turkey and Norway. Diesel prices tend to be a bit lower, averaging $4.12 per gallon, with a range from $.04 to above $7.00.

This wide variation in prices is somewhat surprising because crude oil and refi ned products are widely traded internationally, so the opportunity cost of fuels is similar everywhere. Although there are diff erences in transportation, refi ning, and distribution costs, they can explain only a small part of the observed variation in prices.

He says the more important question is to ask why taxes and subsidies differ widely:

Instead, the more important explanation for the wide variation in fuel prices is that taxes and subsidies di er widely. Among OECD countries, gasoline taxes per gallon range from an average of $0.49 in the United States, to above $4.00 in Germany and the Netherlands (Knittel, 2012). Outside the OECD the range is even larger, and there are dozens of countries that subsidize gasoline and diesel, selling it for below its price in international markets. Many of these countries are in the Middle East, though Asia (Malaysia, Indonesia), Africa (Egypt, Nigeria, Algeria) and South America (Venezuela, Ecuador, Bolivia) are also represented. 

Gasoline consumption tends to be high in countries where gasoline is subsidized. Saudi Arabia, for example, has experienced a nine-fold increase in fuels consumption since 1971 and is now the sixth largest oil consumer in the world (Gately et al., 2012). Venezuela is another particularly illustrative example. Gasoline consumption per capita in Venezuela is 40% higher than in any other country in Latin America, and more than three times the regional average

It looks at fuel subsidies across both petrol and diesel. Saudi Arabia runs the highest subsidy at nearly USD 25 billion divided 50-50 between petrol and diesel. This is followed by Iran (higher % for diesel) and Indonesia (higher for petrol).

The deadweight costs from subsidies is highest in Saudi followed by Venezuela.

However, if one includes the external costs as well like pollution etc. we get different numbers:

Eliminating subsidies for gasoline and diesel would, with a -0.6 demand elasticity, decrease global fuel consumption by 29 billion gallons per year. At $1.11 per gallon this excess consumption imposes external costs worth $32 billion annually. Combined with the estimated deadweight loss ($44 billion), the total economic cost of fuel subsidies is $76 billion annually. The global market for gasoline and diesel was $1.7 trillion in 2012, so this is 4% of the market.

This is the economic cost of pricing fuels below private cost. An alternative calculation would be to measure the deadweight loss relative to the full social cost of fuels consumption. This would include the deadweight loss ($44 billion) and external cost ($32 billion) from pricing below private cost, but also the additional welfare loss from units transacted for which willingness-to-pay is above private cost but below social cost. Deadweight loss under this counterfactual is $92 billion.

Much of the increased deadweight loss in this alternative calculation comes from the United States, where gasoline and diesel prices are above  private cost but below social cost. When ranked by country, the United States appears in spot number four, behind only Saudi Arabia, Venezuela, and Iran.

India ranks 9th in this overall deadweight cost list.

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