Trade in a 2030 Agenda-era: Fossil fuel subsidies and the WTO

19 July 2016

The elimination of fossil fuel subsidies presents a challenge but also a substantial opportunity to enhance climate action and move to a low carbon economy.
 

Although the international trade and climate agendas are perceived by some to be in conflict, there is in fact a symbiosis between the two, for both trade and climate are closely intertwined with sustainable development. This is particularly clear in the context of fossil-fuel subsidies, which run contrary to both economic and environmental objectives. Fossil-fuel subsidies are a challenge for climate change mitigation, as they operate to incentivise the use of greenhouse-gas drivers such as coal, oil and gas, and can be a drag on government budgets. Conversely, abolition of such support represents an opportunity to bolster competitiveness by removing market-distortions, and render public spending supportive of the shift towards a low carbon economy.

The need to eliminate fossil fuel subsidies has been recognised by the G-20 as well as former Director General of the WTO Pascal Lamy, who in 2013 referred to the institution’s failure to address fossil fuel subsidies as a “missed opportunity.” In addition, former Deputy Director-General Harsha Vardhana in 2010 said, “[r]eflections on the link between trade and climate change, and on the eventual role of the WTO rulebook on an issue such as fossil-fuel subsidies, must take place.”

Much academic literature has been devoted to exploring ways in which the international trade system can support the scale up of renewable energy including, for instance, discussions on the scope of the general exception clause in Article XX of the General Agreement on Tariffs and Trade (GATT).[1] However, the issue of fossil fuel subsidies is perhaps both more urgent and more easily solvable, as their abolition is less controversial in theory than the promulgation of renewable energy subsidies.

Although the world arrived at a new post-2020 climate change agreement (the Paris Agreement) at the Twenty-first Conference of the Parties to the UN Framework Convention on Climate Change last December (UNFCCC COP 21), the negotiations did not focus on fossil fuel subsidies to any significant extent. It is thus clear that in a world signed up to a set of integrated Sustainable Development Goals (SDGs), which balance environmental, economic, and social aims, the time is right for trade to rise to the occasion.
 

Fossil fuel subsidies: A challenge and an opportunity

The International Energy Agency (IEA) estimated in late 2014 that fossil fuel subsidies amounted to US$548 billion per year. The IEA also found that in the Middle East alone, two million barrels per day of oil are used to generate electricity, “when, in the absence of subsidies, the main renewable energy technologies would be competitive with oil-fired power plants.” The International Monetary Fund (IMF) reports that pre-tax subsidies to fossil fuels account for 0.7 percent of global GDP, or 2 percent of total government revenues.

From a climate change perspective, there is a pressing need to remove fossil fuel subsidies, as estimates suggest that up to 80 percent of all fossil fuel reserves must be kept underground to avoid the most catastrophic effects of climate change. Research indicates that removing fossil fuel subsidies in 20 countries between now and the end of the decade would reduce their national emissions by an average of 11 percent.

In terms of trade there are various reasons why fossil-fuel subsidies should be abolished, which may overlap.[2] First, they impair the relative cost competitiveness of renewable energy by reducing the cost of fossil fuel-based alternatives, thereby creating an artificial cost advantage. The IEA has shown that where resources are good, hydro, geothermal, on-shore wind and solar photovoltaic technologies are cost competitive with new fossil plants, even without generation-based subsidies. Some fossil-fuel subsidies go as far as to support the use of coal reserves that would otherwise not have been economically profitable. Secondly, since many electricity systems are based on fossil-fuel generation, fossil-fuel subsidies often act to lock in and reinforce incumbent generation technologies, thereby imposing barriers for new entrants attempting to develop renewable technologies. They reduce the fiscal space available for investment in other, more productive energy sub-sectors, crowding out investment and distorting investment decisions. This is especially concerning because new electricity generating plants resulting from fossil-fuel subsidy incentives will exist for decades, locking in the problem. Furthermore, fossil-fuel subsidies serve to contribute to an under-pricing of environmental and social externalities, meaning that energy prices do not reflect its true cost.

One example of a fossil-fuel subsidy is a dual pricing scheme, where governments set a lower price for domestic consumption of fossil fuels, compared with the price charged for exported fuel. This is problematic from both an environmental and trade perspective, as it encourages overconsumption of fossil fuels, and provides domestic industries with cheaper energy inputs relative to the prices paid by competitors.[3]

However, things do not have to be this way. Right now, governments across the world have the opportunity to abolish fossil fuel subsidies. The conclusion of the Paris Agreement gives governments a clear mandate to do so, and low oil prices provide an additional economic incentive. This reform would likely reduce fiscal burden, improve macroeconomic stability, encourage energy conservation and efficiency, reduce depletion of resources, and reduce pollution and GHG emissions.[4]
 

Subsidies and the WTO framework

The multilateral trading system has not yet stepped up to the challenge of fossil fuel subsidy reform. This framework could nevertheless be a powerful mechanism to reduce fossil fuel subsidies. The main instrument governing subsidies in the WTO is the Agreement on Subsidies and Countervailing Measures(SCM). It defines a subsidy, broadly speaking, as a financial contribution by a government or public body which confers a benefit. The concept of “financial contribution” includes direct transfers of funds, such as grants, loans, and equity infusions; potential direct transfers of funds or liabilities, such as loan guarantees; relief from tax or other government revenue; the provision by a government of goods or services other than general infrastructure; the purchase by a government of goods; and government payments to a funding mechanism or through a private body.

However, while the SCM Agreement is the most obvious candidate for a multilateral tool to help support the reduction of fossil-fuel subsidies, existing rules have so far not been used in this manner. The agreement restricts subsidies that are either considered to be inherently trade distorting, or that are shown to have “adverse effects” on other WTO members. Subsidies are prohibited if they are contingent upon either export performance or the use of domestic over imported goods. These subsidies are prohibited because they have a direct impact on trade. Even if they are not prohibited, subsidies can still be “actionable” if they are “specific” to an enterprise, industry, or region and cause adverse effects on the interests of other members of the organisation. However, while either of these classes might apply to fossil-fuel subsidies depending on their formulation, proving adverse effects or specificity in the broader sense of a given nation’s economic production and consumption patterns appears difficult. In addition, governments have periodically argued that the residual case of “non-actionable” subsidies applies to dual pricing schemes, but these arguments have not gained significant traction.

Under the SCM Agreement, WTO members must disclose their subsidies in detail, but rates of reporting have been low as the mechanism lacks effective implementation or sanctions. Political dynamics are a key driving factor, especially as producer states oppose new WTO disciplines on energy subsidies, and are reluctant to disclose existing subsidies.

The WTO would be an appropriate negotiating forum in which to address the issue of fossil-fuel subsidies because it has a broad membership; can cater to the needs of developing countries through differential provisions; already contains reporting mechanisms; and has an effective enforcement mechanism in the Dispute Settlement Body. The SCM Agreement could provide a legal framework to address fossil-fuel subsidies without significant structural changes, which is important due to the political factors previously mentioned.
 

Solutions, actors, and incentives

This section presents options for reform to trade rules. The clear objective here is the removal of subsidies on fossil fuels, because it is the “first best” solution to correcting the market distortion that they cause, “so that the cost of power is fully reflective of the costs associated with each generation type.”[5]

There are several challenges which would need to be overcome, however, in order to bring fossil fuel subsidies into the SCM Agreement. It must be shown that fossil fuel subsidies are specific and that they cause one of the three types of adverse trade effects listed in Article 5. Ultimately, the category of prohibited subsidies may have to be extended, a proposal that has been suggested by players such as the EU and the US.
 

At present the disclosure and transparency framework under the SCM Agreement is fundamentally limited due to its lack of effective enforcement. Many writers attribute this to the lack of sanctions for non-compliance or inaccurate or incomplete reporting, encouraging convergence toward the lowest minimum standard.[6] An obvious solution would be to implement a sanction mechanism in cases where disclosure obligations are not adequately fulfilled; however, such an option does not appear to be politically feasible.

As Lang et al. note, there is a precedent for a sectoral approach when it comes to subsidies, in respect to both the agriculture and fisheries negotiations.[7] The fisheries negotiating mandate, in particular, could provide a good basis for taking a holistic approach to the harmful effects of subsidies. Fossil fuel subsidy regulation would, however, likely involve more complex challenges than fisheries subsidies.

Furthermore, in addition to the WTO and the UNFCCC, many other international organisations are connected to the area of energy subsidies. The IEA and the OECD both have “strong research capacities to identify, measure and analyse the impacts of fossil-fuel subsidies.” The World Bank and the IMF have experience providing support to developing countries to help them reform subsidies and introduce more effective poverty alleviation measures. The UN Environment Programme (UNEP) also has completed substantial policy research on the key issues, benefits, and challenges of fossil-fuel subsidy reform.

The overall attitudes of WTO members are a key determinant of whether, and when, fossil-fuel subsidy reform will occur. Although admittedly it is not presently at the top of the now rather unidentifiable multilateral trade agenda, the incentives for addressing fossil-fuel subsidies may increase as energy security and climate change become higher national priorities, although conversely it is also arguable that energy security concerns have a role in the continuation of fossil-fuel subsidies. That the G-20, as noted in the introduction, have repeatedly spoken out on fossil-fuel subsidies is a promising sign as to the political mood. Further promising signs are the conclusion of the Paris Agreement, and statements made by ministers at COP21 regarding the need to phase out fossil fuels.

Lang et al. argue that “the efforts of a range of diverse institutions will be required in the short and medium term” to form international cooperation on reducing fossil-fuel subsidies, because there must be a strategic vision, careful planning, and deployment of scarce research and political resources, as well as a long-term commitment and political will.
 

The time is now

There are pressing reasons to abolish fossil-fuel subsidies, from both a trade perspective, and from that of climate change. At present the WTO system, and in particular the SCM Agreement, presents the most promising theoretical option for a multilateral platform to help countries undertake the necessary reforms. Options include bringing fossil-fuel subsidies expressly within the ambit of the SCM Agreement, or alternatively, forming a new sectoral agreement on energy subsidies. Tightening the reporting and disclosure requirements to include effective implementation and enforcement procedures would also assist by increasing transparency around fossil fuel subsidies.

The realistic prospects of the success of any reform depend ultimately on political will among WTO members. This political incentive may well increase over time as climate change and energy security become ever more important concerns to states. Governments should make fossil-fuel subsidy reform a priority for strong trade and environmental reasons. This would be a particularly helpful contribution from the trade community to fulfilling the world’s new 2030 Agenda and its SDGs.

This article was selected as part of the TDS Bridges Writing Competition.  For more information please see the following link:  http://tds.ictsd.org/tds-bridges-writing-competition.

 

Author: Natalie Jones, LLM student in international law, University of Cambridge.

[Picture in Passerelles vol. 17, issue 1]




[1] See for example Leal-Arcas, Rafael. “Trade Proposals for Climate Action.” Trade, Law and Development 6.1 (2014): 11, 13.

[2] Bridle, Richard and Kitson, Lucy. The Impact of Fossil-Fuel Subsidies on Renewable Electricity Generation. Winnipeg/Geneva: IISD/GSI, December 2014.

[3] Meyer, Timothy. “Energy Subsidies and the World Trade Organization.” ASIL Insights 17.22 (2013): 11.

[4] Beaton, Christopher, Gerasimchuk, Ivetta, Laan, Tara, Lang, Kerryn, Vis-Dunbar, Damon and Wooders, Peter. A guidebook to fossil-fuel subsidy reform for policy-makers in Southeast Asia. Winnipeg/Geneva: IISD/GSI, 2013.

[5] Bridle, Richard and Kitson, Lucy. “The Impact of Fossil-Fuel Subsidies on Renewable Electricity Generation”. Winnipeg/Geneva: IISD/GSI, December 2014.

[6] Bigdeli, Sadeq Z. “Will the friends of climate emerge in the WTO? The prospects of applying the fisheries subsidies model to energy subsidies.” CCLR 1 (2013) 78–88. Steenblik, Ron and Simón, Juan. A new template for notifying subsidies to the WTO. Winnipeg: IISD, 2006.

[7] Lang, Kerryn, Wooders, Peter and Kulovesi, Kati. Increasing the Momentum of Fossil-Fuel Subsidy Reform: A Roadmap for international cooperation. Winnipeg: IISD, June 2010: 21.

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