Making sense of fossil fuel subsidies

Blog - July 10, 2014 - By Amin Asadollahi

In 2009, Canada made a promise. Along with the other member states of the G20, we committed to phasing out fossil fuel subsidies, recognizing that they “encourage wasteful consumption, distort markets, impede investment in clean energy sources and undermine efforts to deal with climate change.”

Canada made that promise for good reasons. Government financial support for the oil sector is largely inefficient, unnecessary and wasteful. But five years later, Canadian taxpayers continue to subsidize a sector that is both profitable and well established. This is especially concerning at a time of cutbacks to government programs and reductions in environmental protection.

As Pembina’s latest report explains, the financial support Canada gives the oil sector is unnecessary given the favourable economic reality that sector currently faces. Fossil fuel subsidies — both explicit and implicit — are also counterproductive when it comes to reducing the risks of climate change, enabling investments in clean energy and building the economy of the future.

Action means more than words

The federal government has made some progress in phasing out fossil fuel subsidies. For example, prior to 2009, Canada announced plans to phase out four major subsidies with a combined value of $879 million.

Oil pumpBut there’s plenty of room for improvement. If we use the definition of subsidies provided by the World Trade Organization, the oil sector still benefits from a number of support measures at the federal level, including the Canadian Development Expense (CDE) and the Canadian Exploration Expense (CEE).

The value of these two remaining subsidies for the oil sector was estimated at $711 million in 2008. (Due to the difficulty of estimating tax expenditure subsidies, more recent estimates of the CDE and CEE do not exist.) And that’s even not the full picture of how much these explicit and implicit subsidies cost Canadians.

A growing number of oil companies recognize that social and environmental pressures will lead to more stringent regulatory requirements in the future, particularly around carbon pollution.  As a result, a number of companies have adopted internal “shadow” prices on carbon.

While those shadow prices are factored into the industry’s cost of doing business, Canada doesn’t actually collect those dollars. The absence of a carbon price means that the federal government is effectively foregoing between $4 and $18 billion a year in revenues that could otherwise have been collected without changing oil and gas investment decisions.

Benefits versus costs

The argument that the economic benefits of the oil sector justify the subsidies we give to it resides on three foundational errors:

First, any economic benefits from subsidies in the short-to-medium term are countered by the sector’s long-term environmental impacts. Those are very real costs that we, as Canadians, are passing on to generations to come. This is particularly concerning because the sector — and its environmental impact — continues to grow at a rapid pace.

Second, although the sector provides economic benefits, they’re often overstated. It does not drive Canada’s economy, as economists have explained and Pembina showed in our analysis of the economic implications of Canadian oilsands development. As of 2013, unconventional oil and gas — the subsector that includes the rapidly growing oilsands — accounts for just two per cent of Canada’s GDP.

That raises questions about the value of the current subsidies. The combined value of the CDE and CEE subsidy programs for the oil sector alone (not counting gas) was $711 million in 2008, and the total value of subsidies and other federal support measures has risen since then.

Oil drumMeanwhile, the combined oil and gas sector paid $1.3 billion in federal corporate income taxes in 2012. So it’s possible that the amount of revenue the government foregoes through these subsidies, plus the direct support measures it provides, now exceeds the federal income taxes being paid by the sector.

Finally, the sector doesn’t really need the help. Subsidies are usually justified when there are imperfect markets, or for industries that are either new or going through difficult times. None of those justifications apply for the oil sector.

For example, governments often subsidize exploration activities because of the risk they carry — that’s the logic behind the CEE. But Canada’s oil sector is highly profitable and well positioned to carry a larger portion of that risk, rather than to take subsidies for such activities.

Solutions that make sense

Canada should deliver on its fossil fuel subsidies promise. To reduce the environmental and financial cost of the oil sector, the government should phase out the CDE. It should also reclassify eligible expenses for the CEE, so that it applies only to unsuccessful exploration expenses — that is, we should only provide the subsidy for projects that need it.

It’s also high time for Canada to introduce federal emissions regulations for the oil and gas sector with enough stringency to put Canada on track to meet our 2020 emissions reduction target. Together, these steps would maximize the benefit Canadians receive from the development of our oil and gas sector.

Moreover, as countries around the world shift to the low-carbon economy of the future, Canada must capitalize on those new opportunities. Part of that transition involves shifting our support away from the oil sector — which doesn’t need subsidies — and toward the development and uptake of clean energy technologies.

Canada should keep its word on fossil fuel subsidies, and get on track for a cleaner energy system.

 Follow Amin on Twitter @aminpost.

Amin Asadollahi

Amin is director of the Pembina Institute’s oilsands program. He is a former senior policy advisor at Natural Resources Canada, and is based in Calgary.


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