Sunday, August 17, 2008

Government Subsidies Keep Oil Demand Inflated in Emerging Markets

By Andrzej Zwaniecki

There is good and bad news about developments triggered by high oil prices. Petroleum consumption has fallen across the developed world. In the United States, it is expected record the sharpest decline in 25 years in 2008 as Americans drive less. This is good news. (See "Americans Shocked by Fuel Prices into New Lifestyles")

The bad news is that these fuel savings are more than offset by a consumption surge in the developing world.

Between the first quarter of 2007 and the same period of 2008, oil demand in industrialized countries of the Organisation for Economic Co-operation and Development (OECD) dropped by 1 million barrels per day, while in the rest of the world it rose by 1.1 million barrels, according to the International Monetary Fund (IMF).

Much of the rise in demand for petroleum is driven by rapidly expanding emerging economies in Asia and elsewhere. But governments in almost 50 countries boost demand additionally through oil subsidies -- tax breaks and allowances that help oil companies and refineries close or reduce the gap between the global market prices and lower prices targeted by the government. According to the oil company BP, countries with oil subsidies accounted for 96 percent of the global increase in oil use in 2007.

Economists say that subsidies distort the global petroleum market by obscuring price signals. When businesses and consumers do not have to face rising prices of fuel, they have no incentive to save it.

Michelle Foss, the head of the Center for Energy Economics at the University of Texas at Austin, calls subsidies "the Number 1 risk" to the oil market.

"If you cannot balance the market, nothing is going to work," she told

Developing countries defend oil subsidies as a measure designed to help propel industrialization and shield poorer segments of the population from high global oil prices. But most economists say those supports benefit mostly well-off consumers and, more important, often hurt development by diverting money away from more productive uses and preventing the economy from becoming more energy-efficient.

With rising petroleum prices, subsidies are ravaging national treasuries. The IMF projects that, for example, Egypt and Indonesia will spend around 5 percent of their gross domestic products on fuel subsidies in 2008.

Faced with mounting costs, some nations and areas -- including China, India, Taiwan, Malaysia and Indonesia -- have cut their energy subsidies. Although these steps were too timid to dampen demand significantly, they nevertheless have been met by political backlash and protests. Some governments concerned about more repercussions and a potential surge in inflation have refrained from further action.

Under Secretary of Treasury David McCormick said countries need to develop a plan to eliminate subsidies over time.

Foss said he believes that credible plans to do so by governments of major countries that subsidize energy could dampen oil prices. But she and other experts say the United States and other developed countries do not have much sway over those governments.

Other experts believe the United States is hardly in a position to tell other countries what to do. Although it does not subsidize fuels, it is the largest consumer of oil in the world.


Americans until recently had been among the most profligate users of petroleum. While the European Union increased fuel taxes and discouraged driving in other ways, U.S. administrations and lawmakers for a long time were unwilling to "confront" American drivers and automakers about their dependence on cheap fuel, said Steve Andrews, an energy specialist based in Denver.

Congress toughened auto fuel-economy standards in 2007 after no changes for many years.

In China, auto sales have risen rapidly, with fuel-guzzling sport utility vehicles in the lead, and India has ambitious plans to expand its own auto fleet. But both countries, which are projected to drive up demand for oil in the future, have introduced fuel economy standards tougher than those in the United States, according to John Deutch, an energy specialist at the Massachusetts Institute of Technology.

"China over time will change its capital stock to be more comparable in energy efficiency to OECD countries," he told

The United States has engaged China and other developing countries through the Asia-Pacific Partnership on Clean Development and Climate, a private-public partnership. The partnership already has produced many concrete energy-efficiency projects.

But the United States may not be able to persuade China or other nations to change their ways unless it leads. The United States must show the way forward, said Dan Rosen of the Peterson Institute for International Economics, by investing more in innovative auto technologies.

"Getting the [average] auto fleet [fuel economy] up to 50 miles per gallon ... is entirely doable," Rosen told The current U.S. mandate calls for 35 miles per gallon by 2020.

McCormick is optimistic about America's ability to rise to the challenge.

"Americans must do what we have always done -- adapt, innovate, persevere and prevail," he said.

The full text of McCormick's remarks ( ) is available on the Treasury Department Web site.