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The Harmful Impact Of Subsidies On The Oil Industry

Energy subsidies combined with price control can reduce supply when producers do not have a profit incentive to increase supply.

Fuel subsidies and price controls can reduce supply

Venezuela has a nationalized oil company that is legally required to supply gasoline priced at extremely low levels but despite abundant crude oil reserves cannot profitably refine and distribute sufficient gasoline to meet domestic demand. Chinese price controls have caused fuel rationing and shortages in the past. The United States created the Federal Energy Administration in 1974 after the OPEC oil embargo to implement federal oil allocation and pricing regulations. The unhappy result was long lines at gasoline stations and limited supply throughout most of the United States.

India’s oil demand increases after fuel subsidies were eliminated

Oil demand in India has expanded sharply in the last several years despite the removal of oil product subsidies. The increased demand surprised analysts because excise duties were simultaneously imposed on product sales which did not allow as great a price decline as had been anticipated by the drop in the global price oil that began in late 2014.

Related: Saudi Policy Tied to Weak Economy

Fuel Subsidies may hinder low income families climbing the energy ladder

While not precisely and directly correlated, rising income levels generally allow households to climb the energy ladder by increasing use of energy generally, and cleaner energy specifically. However, fuel subsidies as described by the International Institute for Sustainable Development (IISD) Global Subsidies Initiative, exhibit what economist Gordon Tullock has called the “transitional gains trap” which can lock consumers into a particular spot on the energy ladder that limits opportunities for advancement to a healthier lifestyle. The IISD describes the related political phenomenon that parallels the lock in: “Subsidies themselves create a pool of money out of which recipients can influence the very political process than channels money to them in the first place. In many instances subsidies redistribute wealth from a large number of unknowing contributors to a smaller number of beneficiaries. The latter lobby vigorously to defend their handouts; the former seldom bother, or are empowered, to prevent them.”

Related: Oil Falls As Saudi Arabia Questions Freeze Deal

In their paper “Energy Subsidies in the Arab World” published by the United Nations Development Programme in 2012, Bassam Fattough & Laura El-Katiri argue that “Energy subsidies distort price signals, with serious implications on efficiency and the optimal allocation of resources. Energy subsidies also tend to be regressive, with high-income households and industries benefiting proportionately most from low energy prices.”

Conclusion – fuel subsidies and price controls can hurt the people most meant to help

According to the International Monetary Fund, energy subsidies cost the world almost a half a trillion U.S. dollars in 2011. The IMF noted that these subsidies “aggravate fiscal imbalances, crowd-out priority public spending, and depress private investment”. Inevitably these market distortions create disincentive for producing energy that cannot be profitably sold while redirecting previous resources away from households who need to move from using dung and biomass for cooking and heating to cleaner hydrocarbon fuels while also robbing the free market transportation sector from the fuel needed to create and sustain global economic growth.

By Tom Morgan via DrillingInfo

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