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N°09/16 JULY 2016 | CLIMATE
Fossil fuel subsidies
and the new EU Climate
and Energy Governance
Mechanism
Oliver Sartor, Thomas Spencer (IDDRI)
PHASING OUT FOSSIL FUEL SUBSIDIES IS ESSENTIAL FOR
DECARBONISING EU ENERGY SYSTEMS
Providing the right price signals is essential part of the policy mix that is
needed to achieve Europe’s climate policy goals. Phasing out fossil fuel
subsidies in the EU is an important part of aligning energy prices with
the EU’s climate and energy goals. Depending on how they are measured,
combined fossil fuel subsidies in the EU range from 39 to over €200 billion
per annum (European Commission, 2014). They therefore constitute a
significant source of incoherence between the EU’s climate mitigation and
fiscal policies for energy.
THE REMOVAL OF FOSSIL FUEL SUBSIDIES HAS LARGELY STALLED IN
EUROPE
However, there has recently been mixed progress in addressing fossil
fuel subsidies in Europe. For instance, under the Europe 2020 Strategy,
Member States had committed to begin developing plans for phasing out
fossil fuel subsidies by 2020. Progress on implementing these plans was
supposed to be monitored under the European Semester. However, the
decision was taken to remove the focus on energy and fossil fuel subsidies
from the European Semester in 2015. As yet, no new system for governing
the phase-out of fossil fuel subsidies has been advanced, leaving the ques-
tion of fossil fuel subsidy reform in limbo.
THE ENERGY UNION’S “NEW GOVERNANCE MECHANISM” CAN PUT
IT BACK ON THE AGENDA
The advent of the EU’s Energy Union project creates an opportunity for
putting the phase-out of fossil fuel subsidies back on track in Europe.
This could be done by including requirements for national goal setting
on specific kinds of fossil fuel subsidies in a dedicated sub-section of the
National Climate and Energy Plans. Progress on implementation should
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also be tracked through the biennial reporting process focusing on imple-
Institut du développement durable mentation of national plans. The door to reinserting specific climate and
et des relations internationales energy issues into the European Semester should not be closed either. In
27, rue Saint-Guillaume some instances there may be a need to bring finance ministers into the
75337 Paris cedex 07 France discussion on implementation of fiscal policy for climate and energy.Copyright © 2016 IDDRI
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◖◖◖
Citation: Sartor, O., Spencer, T. (2016). Fossil
fuel subsidies and the new EU Climate and
Energy Governance Mechanism, Working Papers
N°09/2016, IDDRI, Paris, France, 20 p.
◖◖◖
This article has received financial support from
the French government in the framework of the
programme “Investissements d’avenir”, managed
by ANR (the French National Research Agency)
under the reference ANR-10-LABX-01. It also
received financial support from KR Foundation.
◖◖◖
For more information about this document, please
contact:
Oliver Sartor
oliver.sartor@iddri.org
Thomas Spencer
thomas.spencer@iddri.org
ISSN 2258-7071Fossil fuel subsidies and the new
EU Climate and Energy Governance
Mechanism
Oliver Sartor, Thomas Spencer (IDDRI)
INTRODUCTION 5
1. FOSSIL FUEL SUBSIDIES
IN THE EUROPEAN UNION TODAY 5
1.1. Defining fossil fuel subsidies 5
1.2. Fossil fuel subsidies in Europe 6
1.3. Differences in energy taxes between
Member States and ‘like’ fuels 6
1.4. Subsidies defined in terms of undertaxed
externalities 7
1.5. The impact of fossil fuel subsidies in Europe 7
2. EU GOVERNANCE OF FOSSIL FUEL
SUBSIDIES TODAY: AT A CROSSROADS 8
2.1. State aid for unprofitable coal mines 8
2.2. Harmonisation of energy taxation
(Energy Taxation Directive) 9
2.3. Environmentally harmful subsidies
under the 7th EAP and the European Semester 9
2.4. Other EU policy tools to limit fossil fuel subsidies 10
2.5. Conclusion 10
3. ENERGY UNION GOVERNANCE:
AN OPPORTUNITY FOR DEDICATED ATTENTION
TO FOSSIL FUEL SUBSIDIES? 10
3.1. The EU’s new Energy Union governance
mechanism 10
3.2. An opportunity to improve governance
of EU fiscal policy for the energy transition? 12
4. INCLUDING FOSSIL FUEL SUBSIDIES
IN THE NEW ENERGY UNION GOVERNANCE
MECHANISM: ISSUES AND OPTIONS 12
4.1. Where should fossil fuel subsidies be included
in the new governance mechanism? 12
4.2. How should fossil fuel subsidies be measured
and reported? 14
4.3. What level of detail should be provided
about fossil fuel subsidy phase-out policies? 16
4.4. Ensuring progress is made 16
5. CONCLUSION 17
BIBLIOGRAPHY 18
3Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
INTRODUCTION The purpose of this paper is therefore to explore
whether and how fossil fuel subsidy reform could
Providing the right price signals is an essential part be dealt with under the new governance mecha-
of the policy mix that is needed to achieve Europe’s nism that the EU is establishing to ensure that the
climate policy goals. To be sure, price signals goals of the Energy Union project are achieved.
alone cannot address all barriers to decarbonisa- Specifically, this paper aims to:
tion. Non-price barriers such as infrastructure and mm Highlight the importance of FF subsidy reform
technological path-dependency, split-incentives to the EU’s climate and energy goals.
or non-optimising behaviour of energy users, mm Give an overview of current EU governance
and challenges related to the financial risks of tools for phasing out FFS and identify potential
capital intensive technologies call for other policy gaps for the post-2020 period.
tools. Nevertheless, in market economies such as mm Explore opportunities presented by the EU’s
Europe’s, prices remain one of the main vectors by post-2020 C&E governance mechanism for im-
which production and consumption choices about proving EU oversight of FFS and accelerating
energy and GHG-intensive resources are made. their phase-out.
They are therefore crucial for putting the EU on mm Explore practical questions relating to the defi-
track to achieve its goal of an 80-95% reduction of nition of and data on FFS and what indicators
GHG emissions by 2050. could be tracked by the EU to monitor progress.
Phasing out fossil fuel subsidies (FFS) in the EU is
an important part of aligning energy prices with the
EU’s climate and energy goals. Depending on how 1. FOSSIL FUEL SUBSIDIES IN
they are measured, combined FFS in the EU range THE EUROPEAN UNION TODAY
from 39 to over €200 billion per annum (European
Commission, 2014). They therefore constitute a sig-
nificant source of incoherence between the EU’s cli- 1.1. Defining fossil fuel subsidies
mate mitigation and fiscal policies for energy.
However, there has recently been mixed pro- Generally speaking, a subsidy is any form of
gress in addressing FFS in Europe. For instance, payment or economic benefit that is granted by a
under the Europe 2020 Strategy, Member States government to an economic undertaking in order
had committed to begin developing plans for to promote an activity that may not otherwise be
phasing out FFS by 2020. Progress on implement- economically viable and which is deemed in the
ing these plans were to be monitored under the public interest. However, estimating the level of
European Semester. However, with the advent of FFS in Europe depends on which specific economic
the Energy Union, the decision was taken to re- benefits one includes in the calculation. There are
move the focus on energy and FFS from the Eu- three main methods that are used, each of which
ropean Semester in 2015. As yet, no new system has their strengths and weaknesses. These are:
for governing the phase-out of FFS has been ad- mm The “pre-tax price gap” method: This approach
vanced, leaving the question of fossil fuel subsidy compares the level of pre-tax energy prices faced
reform in limbo. by end-users to a reference price that reflects an
IDDRI WORKING PAPER 09/2016 5Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
estimate of the full cost of supply, usually based reimbursements to energy intensive industries
on international reference prices for fossil fuels, and fuel allowance policies to consumers. In
minus relevant transport and distribution costs. addition 5 billion in direct payments was given
The price gap is then multiplied by domestic to energy producers. This included items such
consumption levels of the energy source to esti- as support for coal mining in Germany, Poland,
mate the total subsidy amount. and Spain, Italian support schemes for cogenera-
mm The “after-tax price gap” method: This approach tion using fossil fuels, and other support for gas
is like the price gap method except that it also infrastructure.
includes reference tax levels to account for envi- In addition, tax deductions included 5 billion in
ronmental externalities, such as CO2, local pol- specific exceptions from VAT rates which were not
lution and health costs, in the reference price broadly applied to other products. These excep-
that is used to calculate the price gap. tions were focused in a couple of Member States.
mm The “inventory” method: This approach looks at On the other hand, almost all member states were
the set of government expenditures instead of found to provide significant reductions in excise
prices. It sums total government budget outlays tax rates (especially for diesel in the transport sec-
(direct payments) and total ‘tax expenditures’ tor), ranging from 100 million to several billions
(indirect payments, such as tax credits) to en- of Euros by Member States and summing to 28 bil-
ergy producers and consumers to arrive a figure lion in reductions in excise taxes at EU level. The
for total subsidies. majority (€33 billion) of FFS in the EU was there-
fore found to consist of tax deductions targeted
Each of these approaches has its own strengths specifically to energy, especially for excise taxes.
and weaknesses. For instance, the pre-tax method
shows how end user prices differ from a competi- 1.3. Differences in energy
tive market benchmark. However, it does not cap- taxes between Member
ture subsidies that are not reflected in end-user States and ‘like’ fuels
energy prices (such as tax reductions, which can
be a large share of subsidies). The after-tax price The above described estimation from the Commis-
gap method shows the effect of a failure to fully sion study (2014) used an excise tax benchmark
price environmental externalities and consequent- defined in terms of the recommended minimum
ly estimates tend to be higher than the other two tax rates in the EU’s Energy Taxation Directive.
methods. However, it is highly dependent on as- A tax level below this minimum is recorded as a
sumptions about the appropriate level of external- subsidy. However, it also provided an alternative
ity pricing for different countries and fuels. The estimate based on the highest applied excise tax rate
inventory method gives a price picture of actual among all Member States for the fuel and sector
fiscal outlays to support fossil fuel production and in question. A tax rate below this level is recorded
consumption. However, not all governments give as a subsidy. Indeed, Member States apply quite
detailed breakdowns of tax expenditures and different tax rates on energy, not only between
therefore tax benchmarks must be used to calcu- member states for the same fuel but also between
late indirect subsidy levels. Subsidy estimates may fuels that compete in the same sector. This is
therefore be higher or lower depending on the particularly true for gasoline and diesel (Figure 1),
benchmarks used. where many EU countries tax diesel significantly
less stringently than diesel, despite its higher share
1.2. Fossil fuel subsidies of consumption for transportation. Lower tax rates
in Europe on diesel compared to gasoline are thus a common
source of implicit FFS in Europe, according to this
In Europe, the most detailed studies of FFS have methodology.
made use of the inventory method. The most The approach of benchmarking tax rates to ‘best
recent study, conducted by the European Commis- in class’ described above is also imperfect. There
sion in 2014, and based on 2010 and 2011 data, may be good reasons why poorer Member States
used the recommended tax rates in the EU’s would decide lower tax rates, in absolute terms,
Energy Taxation Directive as a benchmark. This on energy sources, but which may turn out to be
methodology found that FFS totalled €39 billion equal as a share of per capita income, etc. On the
in the EU28 (in 2011 Euros). It found that direct other hand, in the EU context, there are at least
payments to fossil fuel producers and consumers two specific problems that need addressing where
were around €6 billion. Large items in this cate- a focus on differential tax rates on energy appear
gory consisted of direct support to energy users pertinent. Firstly, EU Member States tax diesel and
(€1 billion), which were mainly made up of tax gasoline at very different rates (Figure 1), although
6 WORKING PAPER 09/2016 IDDRIFossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 1. Tax rates on gasoline vs diesel in selected EU countries
1400
1200
1000
Taxes (€/toe)
800
600
400
200
Gazoline
Diesel
0
AT BE CZ DK EE FI FR DE GR HU IE IT LU NL PL PT SK SI ES SE GB
Source: IDDRI based on Enerdata (2015).
these fuels compete in the same market. This may countries with lower per capita GDP). This would
raise concerns of an overdependence on diesel therefore be a possible indicator that there were
technology. A second issue relates to industrial no FFS in the EU. (Note that the interpretation of
competitiveness, where differential tax rates on the results for very low income countries must be
energy used by energy intensive industries within interpretation with some caution.)1
the internal market may raise concerns.
1.5. The impact of fossil
1.4. Subsidies defined in terms fuel subsidies in Europe
of undertaxed externalities
Depending on how they are defined and esti-
By way of comparison, the after tax price gap mated, Europe’s FFS highlight different types of
approach conducted by the IMF in 2015 (and using problems for the EU’s climate policy goals. If FFS
2013 data) finds that the EU under-prices energy by are defined as under the inventory approach as
a total of $295 billion once environmental external- reflecting actual budgetary transfers by govern-
ities are taken into account (in 2013 dollars). This ments to energy producers and consumers, then
approach shows that, despite some outliers, the they highlight examples of policy incoherence.
median EU country under-prices after tax energy It makes no sense for the EU to be introducing
by around 1.3% of GDP and around $490 USD/ carbon pricing, subsidising loans for energy effi-
capita, once environmental externalities are taken ciency improvements, or subsidising low carbon
into account. technologies like renewable energy or electrifi-
It is worth noting that the median EU country al- cation of transport, if they are simultaneously
ready has energy taxes in place worth 1.9% of GDP. undermining these incentives by subsidising fossil
Thus, the IMF calculations suggest that the me- fuels themselves. The above measures therefore
dian EU country tends to under-tax environmen- show that, while the EU’s pre-tax FFS are perhaps
tal externalities by roughly 68% (see Figure 1). not as egregious as those of some other countries,
The source of this under-taxation appears to stem the EU still has significant room to improve policy
mainly from insufficient pricing of CO2 externali-
ties, from foregone energy tax consumption rev-
enue due to fuel tax exemptions or reduced rates, 1. Note that higher after-tax price gaps are inversely cor-
and from local pollution externalities (especially related with GDP/capita levels. This is partly due to dif-
ferences in environmental taxation levels, but it is also
from diesel and coal). due to differences in environmental performance of the
Figure 2 also suggests that, roughly speaking, energy using assets in lower income countries as well as
if the typical EU Member State ensured that fos- the fact that common externality prices were used by
the IMF and these were not adjusted to account for dif-
sil fuel energy externalities were priced appropri-
ferent levels of GDP or purchasing power parity—thus
ately, then energy tax rates would be between 2.5 lower income countries are found to have levels of ex-
and 5% of GDP (albeit with some exceptions in ternality pricing that are “too low”.
IDDRI WORKING PAPER 09/2016 7Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 2. Current energy tax level and implied subsidy using the after tax price gap approach (EU28)
10
%
9
8
7
6
5
4
3
2
1
0
Luxembourg
Denmark
Sweden
Netherlands
Ireland
Finland
Austria
Belgium
Germany
France
United Kingdom
Italy
Spain
Cyprus
Slovenia
Malta
Greece
portugal
Estonia
Slovakia
Lithuania
Latvia
Poland*
Croatia
Hungary
romania
Bulgaria*
Czech Republic
Energy taxes (%GDP) Optimal tax rate (ener)
Source: IDDRI, based on IMF and Eurostat data.
*Poland’s and Bulgaria’s optimal tax rates under the IMF methodology are above 10% of GDP
effectiveness and cut back on budgetary waste 2. EU GOVERNANCE OF FOSSIL FUEL
from FFS. SUBSIDIES TODAY: AT A CROSSROADS
Alternatively, if Europe’s FFS are defined using
the after tax price gap approach then they can be From a governance perspective, some might be
interpreted as sending a different policy message. tempted to argue that FFS are not a legitimate
Namely, they highlight the extent to which the area of European competency. Subsidies and taxes
EU’s energy and environmental taxation regime are, after all, instances of fiscal policy, and the
is inconsistent with the goals of the EU’s low-car- details of fiscal policy is generally acknowledged
bon transition (and environmentally sound fiscal as an area of jealously guarded national compe-
policy more generally). This measure is, of course, tence by EU Member States. However, in practice,
imperfect, since it includes all environmental ex- FFS overlap with a number of areas of long-estab-
ternalities and the “right” pricing of these exter- lished EU competency, such as state aid decisions
nalities is a theoretical abstraction to some extent. in relation to coal mines, value added taxation on
Nevertheless, this indicator gives a meaningful in- consumption, environmental policy, trade agree-
dication of the extent to which incentives created ments, the internal market, and the Stability and
by fiscal policy to shift away from fossil fuels are Growth Pact relating to national fiscal policy. The
low or high compared to one useful set of econom- EU therefore has a number of existing tools that
ic criteria. By this measure, the above data shows it has deployed to varying degrees to monitor
that the EU is still a long way from having a suffi- and coordinate Member State action on the main
ciently incentivising fiscal policy regime to reduce economic vectors of FFS. A brief survey of recent
fossil fuel consumption in line with climate goals. experience with these tools will be helpful to iden-
The challenge remains in terms of defining the ap- tify what gaps in the EU’s governance system for
propriate indicator: either in terms of externality phasing out FFS after 2020.
pricing or the ‘right’ level of energy taxation (if it
is not the minimum defined in the EU Energy Tax 2.1. State aid for
Directive, what should it be?). unprofitable coal mines
This discussion suggests that, ideally, the EU
should be monitoring both approaches to measur- Under Council Decision 2010/787/EU, Member
ing FFS, as each can tell a useful part of the story States agreed to prohibit the allocation of
about the adequacy and coherence of fiscal poli- continued subsidies (which were allowed for
cies to climate goals. This issue is taken up in the under former Regulation 1407/2002) to uncom-
next section, which looks at the existing govern- petitive coal mines and established conditions for
ance arrangements in the EU for monitoring and the phase-out these subsidies. With the justifica-
phasing out FFS. tion of easing the social impacts of their closure,
8 WORKING PAPER 09/2016 IDDRIFossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
the Decision stated that Member States can only renewables (for instance, diesel is taxed less than
provide aid to uncompetitive coal mines until 2018 biodiesel and coal is the least taxed fuel among all
and only under certain conditions (such as that fuels).3
they must be closed by 2018 and have a dedicated An ambitious attempt to address these weak-
closure plan). The Decision effectively means that nesses via a reform this Directive in 2011 ultimately
mines currently receiving operating subsidies proved unsuccessful due to strong opposition from
should be closed by 2018. Central and Eastern European Member States. The
However, in practice, there has been strong lack of an alternative reform proposal means that
political opposition to closure of uncompetitive the EU currently has no coordinated strategy for
mines in both Spain and Poland, and it is possible creating more coherent taxation of energy and
that the end of 2018 deadline may be extended. CO2 in sectors not covered by its emissions trading
Recent experience in countries such as Poland or scheme. As these sectors account for 55% of gross
even discussions around the phase-out of coal- European CO2 emissions (EEA, 2014), this repre-
fired power plant in Germany, also make it very sents a significant gap in the set of fiscal incen-
conceivable that additional mines that are cur- tives that the EU needs to create to drive its energy
rently not subject to a phase-out plan will need to transition.
be closed after 2018 and that the same arguments
for subsidisation (managing social impacts) with 2.3. Environmentally harmful
need to be addressed beyond 2018.2 Thus contin- subsidies under the 7th EAP
ued monitoring of the implementation of national and the European Semester
mining closure plans and related fiscal policies are
likely to be needed beyond 2020. Another important policy lever that the EU has
pursued in order to remove FFS and better align
2.2. Harmonisation of fiscal policy with energy and climate objectives
energy taxation (Energy has been via the European Semester. In 2010, the
Taxation Directive) Europe 2020 Strategy for Smart Sustainable and
Inclusive Growth called for the phasing out of
However, as noted in the preceding section, direct environmental harmful subsidies, building on the
subsidies to fossil fuel production such as coal conclusions of the G20 in 2009 to phase out FFS
mining, while significant, still represent only a by 2020. This lead to the 7th Environmental Action
small piece of the total EU fossil fuel subsidy pie. Program (EAP) of the EU of 2013, which set the
The majority of subsidies under the inventory phasing out of environmentally harmful subsi-
method is composed of reductions in excess and dies as a priority objective and called on Member
VAT taxation; while the majority of post-tax subsi- States to develop plans for their phase-out by
dies came from inefficient pricing of environmental 2020 (EU, 2013a). This process began by focusing
externalities. In principle, these forms of subsidies explicitly on FFS, with were defined using the
are treated under the EU’s Energy Taxation Direc- inventory method described above. Thus, they did
tive and the European Semester, although this has not include an evaluation of inadequate pricing of
changed in the case of the latter recently. environmental externalities.
Under the EU’s Energy Taxation Directive (EU, Progress in implementing these phase-out plans
2003), the EU has sought to harmonise energy were to be monitored under the European Se-
taxation rules by setting common rules for which mester, with Member States required to report on
fuels should be taxed, and setting minimum rates specific policies in their annual National Reform
for taxation. However, the Directive, which has Programs. The Commission thus began to use the
not been successfully revised since 2003, contains Annual Growth Survey to highlight progress and
a number of weaknesses. Minimum tax levels identify further scope for action (EU, 2013b) and
have not been adjusted since 2003, which means using dedicated indicators to track progress un-
that inflation has reduced their real value. These der Alert Mechanism Report. Under this process,
levels are also based on the volume of fuel rather some Member States, such as Belgium and France,
than energy or CO2 content, which means that the began to make include reforms to FFS (e.g. by re-
most CO2 intensive fuels are often taxed less than ducing tax rate exemptions on fossil fuels) in the
National Reform Programs.
However, the inclusion of FFS within the frame-
2. Since the 2010 Council Decision, Polish coal mining work of the European Semester proved a politically
has suffered from further falls in coal prices. It has thus
more recently approached the EU to request state aid
approval for a restructuring of its 4 major coal mining 3. http://europa.eu/rapid/press- release_ MEMO-11-238_
companies. en. htm?locale=en
IDDRI WORKING PAPER 09/2016 9Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
contentious issue with Member States. A desire to However, these tools are limited in their scope
reduce the scope of country-specific recommenda- and normativity, are likely to have limited impact
tions in the Semester to a maximum of 5 key issues, in reducing existing subsidies and are unable by
plus the decision to create a dedicated EU govern- themselves to drive an economy-wide phase-out of
ance mechanism for the goals of the European FFS in Member States.
Energy Union in February 2015, has led to the re-
moval of energy-related issues, including FFS and 2.5. Conclusion
taxation, from the European Semester in 2015. This
means that there is currently no dedicated mecha- Taken as whole, the discussion in this section
nism at the EU level for tracking the implementa- suggests that there is currently a major gap in EU
tion of the goals of the 7th EAP and reviewing the energy policy on the issue of fossil fuel subsidy
adequacy of energy taxation more generally. reform. In particular, in the wake of the removal
of energy from the European Semester, there
2.4. Other EU policy tools to is now no dedicated process to track the extent
limit fossil fuel subsidies of FFS, nor to ensure that Member States phase
them out. This situation is inconsistent with the
The above examples are the main policy tools EU’s stated decarbonisation and energy efficiency
that the EU has pursued to date to phase out FFS. dimensions5 under the Energy Union. It also
However, some additional but more limited tools stands at odds with the objective of increasing
also exist. These include: European energy and climate policy coherence,
mm The State Aid Guidelines for Environment and which is at the heart of the Energy Union project.
Energy of 2014, which provided some limita- In the wake of the decision to remove FFS from
tions on the extent to which energy industries the European Semester process and the failure of
could receive exemptions from environmental the revision of the Energy Taxation Directive, the
taxation (European Commission, 2014a).4 EU is therefore in need of an alternative process
mm The EU’s revised Regional Aid Guidelines of for tracking and ensuring the phase-out of FFS by
2014, which strengthen the conditions under the Member States.
which aid can be granted to companies invest-
ing into economically and socially disadvan-
taged regions and thus make it more difficult for 3. ENERGY UNION GOVERNANCE:
aid to fossil fuels producing projects to be given AN OPPORTUNITY FOR
(European Commission, 2014b).
mm The EU’s 2014 State Aid Guidelines for Important DEDICATED ATTENTION TO
Projects of Common European Interest, which FOSSIL FUEL SUBSIDIES?
require that such projects, which are eligible for
EU funding on advantageous terms in the pur- 3.1. The EU’s new Energy Union
suit of important EU goals, “must respect the governance mechanism
principle of phasing out environmentally harm-
ful subsidies” (European Commission, 2014c). One possible alternative to the European
mm The recently proposed revision of the EU Emis- Semester to governing FFS in the EU from 2018
sions Trading Scheme Directive, which seeks to onwards is the new governance mechanism that
place stricter rules on the use of auctioning rev- is being set up as part of the new Energy Union
enues in the new Member States for power plant project. As noted above, a core goal of the Energy
modernisation (European Commission, 2015). Union is to provide for a more coherent and
mm Various statistical and analytical reports on en- comprehensive approach to European energy
ergy market prices and taxes, including quar- and climate policy.
terly gas and electricity market reports, reports The goal of this new governance mechanism is
on retail electricity and gas prices, and a one off to do three things. Firstly, it seeks to strike a new
report on energy prices and costs in Europe, in- balance in EU climate and energy policy between
cluding an assessment of taxes and levies (Euro- “top-down” and “bottom-up” approaches to Euro-
pean Commission, 2014). pean climate and energy policy. Secondly, it seeks
to develop a more integrated system of planning,
4. Note, however, this issue is not a clear-cut case of limit-
ing environmentally harmful subsidies, since competi- 5. The Energy Union has five dimensions: energy efficien-
tiveness concerns may sometimes need to be addressed cy and moderation of demand, decarbonisation, energy
to gain political support for raising the overall level of security, completing the internal energy market, and in-
environmental taxation. novation and competitiveness.
10 WORKING PAPER 09/2016 IDDRIFossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 3. Overview of key elements of the new governance mechanism
Process Who 2016 2017 2018 2019 2020 2021 2022 2023
UNFCCC
Stocktake New NDCs Stocktake
UNFCCC
of NDCs submitted of NDCs
Revision of Scheduled
NECPs for 2020-2030 NECPs
MS ambition for review of
developed Finalised
NDC??? NECPs
Regional
Regions/ Stakeh/r
EU NECPs
Stakeholders Consulta-
tion NECPs
Reviews
NECPs /
Commission
recommen-
dations
Policy Policy Policy
Biennial Biennial
MS reforms if reforms if reforms if
Reporting Reporting
needed needed needed
Monitoring implementation
SotEU SotEU SotEU
SotEU SotEU SotEU SotEU SotEU
Commission Detailed Detailed
Indicators Indicators Indicators Indicators Indicators
Indicators Review Review
Detailed Detailed
Recommen- Recommen- Recommen- Recommen- Recommen-
Commisson to MS Recommen- Recommen-
dations dations dations dations dations
dations dations
Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue
MS Commission
on policy on policy on policy on policy on policy on policy on policy on policy
Parliament
agenda agenda agenda agenda agenda agenda agenda agenda
reporting, dialogue and policy-making for govern- EU and/or specific Member States are off track in
ing increasingly interrelated challenges. Thirdly, terms of implementing the core goals of the Ener-
the new governance system seeks to establish a gy Union and some related sub-objectives. In some
process that can give more political attention to cases, where deviations from intended trajectories
energy and climate policy, both at the EU and na- towards these goals as outlined in national plans
tional level. This is a response in part to concerns is significant, the indicators could also be used to
that follow up on the implementation of EU policy trigger a deeper review of a Member States’ under-
goals is sometimes lacking (Client Earth, 2014) lying policies.
due to the absence of a dedicated process. The indicators will in turn be used to feed into
To implement this new governance mechanism, an annual assessment of progress and room for
the Commission has proposed a number of new improvement under the State of the Energy Union
dedicated governance tools. One of these tools will Communication, the first of which was released
be new National Climate and Energy Plans, which in November 2015 (European Commission, 2015).
are intended to describe Member States climate The State of the Energy Union’s role will be not
and energy strategies out to 2030 for all five di- only to provide an overview of general progress
mensions of the Energy Union. These plans are to towards EU goals, but also to set and motivate the
be prepared by 2018 in dialogue with the Commis- EU policy agenda for the coming year.
sion and regional partners and will be reviewed The second way in which the implementation of
every 5 years. the plans will be tracked is via a biennial reporting
Member States will have the implementation of cycle. The Commission will use this cycle to ensure
their plans tracked in two ways. Firstly, the Com- that policies and measures are being implemented
mission has proposed a set of key indicators that as required by EU sectoral legislation (such as for
will be collected by the Commission and moni- Energy Efficiency, Transport, Renewable Energy,
tored annually. These indicators are intended to Electricity Markets, etc.) and also to double check
reflect progress on the 2030 Framework targets in that Member States policies place them on track to
particular, but also on all five dimensions of the achieving their 2030 and potentially longer-term
Energy Union. Their role will be to signal when the goals. The Commission will have the option to
IDDRI WORKING PAPER 09/2016 11Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism provide recommendations to Member States should At the same time, the movement of the treat- the biennial review reveal deficiencies in the imple- ment of FFS and related fiscal policy incentives mentation of either binding sectoral legislation or out of the European Semester also comes with that a Member State is off track with respect to its risks. In particular, one may ask whether eliminat- targets. ing FFS requires the dedicated attention of finance To a significant extent, the non-legislative as- ministers that comes with the process of scrutiny pects of this governance mechanism have been under the European Semester. Further, the Com- modelled on the European Semester itself. There mission faces a significant political challenge in are, for instance, some similarities between the setting up the new governance mechanism for the State of the Energy Union Communication and Energy Union in the present political climate. This the Annual Growth Survey under the Semester; could also mean that its appetite for include politi- between the Alert Mechanism Report and the role cally sensitive policy details in the new governance of key indicators; and between the national cli- mechanism may be limited, at least in the short mate and energy plans and the National Reform term. This may call for some “porosity” between Programs. The Commission has indicated that it the new Energy Union governance process and the would like to create a dedicated process for dia- European Semester to ensure that FFS do not “slip loguing with Member States on an annual basis on between the cracks” of both mechanisms. the progress of the Energy Union in order to build the policy agenda with Member States (and prob- ably also the Parliament). However, it has not yet 4. INCLUDING FOSSIL FUEL been defined what this process would look like. SUBSIDIES IN THE NEW ENERGY Figure 3 provides an overview of what different parts of the process might look like, based on cur- UNION GOVERNANCE MECHANISM: rent knowledge of the Commission’s proposal. ISSUES AND OPTIONS 3.2. An opportunity to improve 4.1. Where should fossil fuel governance of EU fiscal policy subsidies be included in the for the energy transition? new governance mechanism? Including the issue of FFS within the EU’s new As noted above there are several different pieces Energy Union governance mechanism has a couple to the new Energy Union governance mechanism. of advantages. Firstly, an important purpose of the This raises the question of where exactly the issue Climate and Energy Plans is to highlight inconsist- of FFS should be treated. For instance, should they encies and promote greater coherence between be tracked only by the “key indicators”, included various climate and energy policies by bringing in the planning template, or reported on via the them to light in a common strategy. In this sense, biennial reporting mechanism, or all of the above? this a process well suited to interrogating the We would suggest that FFS should be included acceptability and legitimacy of current FFS in in a dedicated sub-section of the National Climate Europe. and Energy Plans with progress on implementa- Secondly, as noted above, fossil fuel subsidy tion tracked via both the key indicators and the reform is currently given little attention in Euro- biennial reporting process. However, we would not pean climate governance discussions. A potential include it directly as a key indicator in the govern- strength of the new Energy Union governance ance mechanism. mechanism is that, by creating an annual process Removing FFS and reforming energy taxation for assessing the state of the EU energy transition are effectively the policy means to achieve specific via the State of the Energy Union, and stocktake of goals (decarbonisation, energy efficiency) under policy frameworks, it creates the political space to the Energy Union. Thus, it makes sense to treat shed light on missing parts of energy and climate them as such. Following the design of the national governance picture. planning template as currently being contemplat- Thirdly, it is expected that the NECP process ed by the Commission, a discussion of the role of will also call on Member States to detail their key fiscal policy is required in the chapter of the plans policies and measures to implement their national dedicated to describing the “policies and meas- climate and energy strategies. This allows for a ures” that will be used to implement the Energy broader approach to the governance question, Union goals. After all, fiscal policies are essential focusing on the adequacy of fiscal policies more to achieving national targets and objectives cost generally for supporting the low carbon transition, effectively. In this context, it is reasonable to ask rather than the narrower terminology of FFS. Member States to include a brief discussion of the 12 WORKING PAPER 09/2016 IDDRI
Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 4. Where would fossil fuel subsidies go in the NECPs?
NECP
1. Energy Efficiency 2030
2. Decarbonisation High level summary National 2050 decarbonisation
Policy Strategy
3. Internal Energy Market Targets, objectives, and key Roadmap
Key policies and measures and
4. Security of supply indicators (Non-binding and exploratory)
sectoral details
5. R&D, Innovation
Fossil fuel subsidiy
reform included here
under ficsal policies
status and contribution of the removal of FFS to If this reveals that FFS are contributing to this fail-
achieving their targets. ure (e.g. by preventing the retirement of coal-fired
The annual review of key indicators which track power plants), then the Commission would have
the progress towards achieving core goals of the a reasonable grounds for asking Member States
Energy Union also enables the negative impacts of to take further policy measures to tackle this issue
fossil fuels subsidies to be identified and addressed as it relates specifically to their decarbonisation
indirectly, but from a position that fits comfortably strategy.
within the mandate of the new governance mecha- Further, the biennial reporting process is the
nism. For instance, if Member States are failing to process by which Member States should report (in
achieve their goals as reflected by the key indica- detail) on their progress in implementing their na-
tors (say the share of renewable energy target), tional plans, the specific policies they contain and
then this would be a reasonable basis for the Com- their impact on medium to longer-term projections
mission to make a further investigation into why. of key indicators. This is therefore the appropriate
Figure 5. Places were fossil fuel subsidies could be treated in the Energy Union governance mechanism
Process Who 2016 2017 2018 2019 2020 2021 2022 2023
UNFCCC
Stocktake New NDCs Stocktake
UNFCCC
of NDCs submitted of NDCs
MS NECPs for 2020-2030 NECPs Revision of Scheduled
developed Finalised ambition for review of
NDC??? NECPs
I M P L E M E N TAT I O N
Regional
EU NECPs
Regions/ Stakeh/r
R E G I O N A L I N I T I AT I V E S P U R S U E C O O P E R AT I O N
Stakeholders Consulta-
tion NECPs
Reviews
NECPs /
Commission
recommen-
dations
Policy Policy Policy
Biennial Biennial
MS reforms if reforms if reforms if
Reporting Reporting
needed needed needed
Monitoring implementation
SotEU SotEU
SotEU SotEU SotEU SotEU SotEU SotEU
Commission Detailed Detailed
Indicators Indicators Indicators Indicators Indicators Indicators
Review Review
Detailed Detailed
Recommen- Recommen- Recommen- Recommen- Recommen-
Commisson to MS Recommen- Recommen-
dations dations dations dations dations
dations dations
Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue Dialogue
MS Commission
on policy on policy on policy on policy on policy on policy on policy on policy
Parliament
agenda agenda agenda agenda agenda agenda agenda agenda
IDDRI WORKING PAPER 09/2016 13Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 6. Ratio of diesel to motor gasoline taxes in EU Member States 2015
1400
1200
1000
Taxes (€/toe)
800
600
400
200
Gazoline
Diesel
0
AT BE CZ DK EE FI FR DE GR HU IE IT LU NL PL PT SK SI ES SE GB
Source: IDDRI, based on data from Enerdata.
point for asking Member States to describe pro- First, in the definition of the national plans them-
gress made on the relevant fiscal policy aspects of selves. Second, in annual review of the indicators,
their strategies to implement their NECPs (and by state of the energy union, country recommenda-
extension fossil fuel subsidy reform). If Member tions and policy agenda setting process. Thirdly, in
States were found to be unable to achieve their the biennial review of the implementation of the
medium-term targets due to the presence of FFS, policies and measures in the plans and the related
or if the proposed policies in the NECPs were not recommendations that could flow from those.
being implemented as intended with potentially
detrimental consequences for the achievement of 4.2. How should fossil fuel
the EU’s Energy Union goals, then Commission subsidies be measured
could use its biennial review of implementation to and reported?
address this. This could come either in the form of
country specific recommendations or by feeding If FFS are to be included as a necessary require-
the issue into its State of the Union Communication ment of the NECPs (and biennial reports), then
and policy agenda for the coming year. what should these requirements look like in the
Although it is tempting to do so, we would sug- respective templates?
gest that FFS are not included in the set of “key As discussed in Section 1, there are different ways
indicators” for tracking progress on the Energy Un- of defining FFS, each of which effectively measures
ion. This is because there is a risk of overwhelming different things (direct subsidies, direct and indirect
the “key indictors” part of the governance mecha- fiscal transfers, pricing of externalities) and each of
nism. The purpose of the key indicators should be which with its own strengths and weaknesses. Each
to help Member States to set targets for specific, of these three issues is also relevant to Europe’s col-
high level outcomes for the transformation of the lective effort to decarbonise its economy. We would
energy system and economy and to track progress to- suggest including one high level measure of total
wards these high level outcomes. Given the already FFS relating to each of three methodologies, to-
significant number of these outcomes that need to gether with one complementary measure captur-
defined and tracked (i.e. for all 5 dimensions of the ing the level of CO2 taxation throughout the energy
Energy Union), the indicators part of the govern- system. Thus, the planning and reporting template
ance mechanism already risks being overburdened. in the new governance mechanism could ask Mem-
Experience with the European Semester and the ber States to provide information on the current
Europe 2020 Strategy itself suggests that an exces- status of and proposed reforms to:
sive number of goals can lead to a watering down mm Direct subsidies to fossil fuel production and
of the level of attention given to each. Figure 5 consumption.
once again summarises the governance process mm Indirect subsidies stemming from exemptions
and highlights with red circles the points at which and tax rate differentials between substitutable
FFS could potentially be relevant to the process. fuels in the transport sector.
14 WORKING PAPER 09/2016 IDDRIFossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
Figure 7. Energy taxes as a share of GDP in EU
3,5
3
2,5
% of GDP
2
1,5
1
0,5
0
European Union
Euro area
Belgium
Bulgaria
Czech Republic
Denmark
Germany
Estonia
Ireland
Greece
Spain
France
Croatia
Italy
Cyprus
Latvia
Lithuania
Luxembourg
Hungary
Malta
Netherlands
-Austria
Poland
Portugal
Romania
Slovenia
Slovakia
Finland
Sweden
United Kingdom
Source: IDDRI, based on Eurostat data.
mm Energy tax revenues as a share of GDP. an implied cost of more than a given de minimis
mm CO2 taxation / CO2 emissions from energy use. threshold.
The third measure would then capture an overall
In practice, the first measure would largely cap- picture of the extent to which Member States are
ture policies relating to the EU’s requirement to pricing energy externalities in a way that is consist-
phase out subsidies to uncompetitive coal mines ent with decarbonisation, energy efficiency and an
and some oil and gas extractive activities. overall greening of the tax base. It would measure
The second measure would capture exemptions the share of energy taxation in GDP. The IMF study
from excise and VAT of fossil fuels, relating in par- cited earlier suggested that most Member States in
ticular to exemptions for diesel in the transport the EU should generally pay at least 2.5% of energy
sector. This is not a complete measure of all of the taxes in GDP if they were pricing energy consist-
different kinds of indirect FFS that can occur un- ently with the cost of fossil fuel externalities, high-
der this measure—for instance, indirect subsidies er in some cases. However, most Member States
to energy intensive industry are ignored. How- are currently well under this level (Figure 7).
ever, as argued above, full rate exemptions in the This 2.5% is of course an imperfect measure,
transport sector is quantitatively the most impor- since it depends on where the incidence of the tax
tant form of current subsidies. Moreover, a more falls in practice and some Member States have re-
specific measure, focusing just on transport, has sults outside this range. However, as a very simple
other advantages, both in terms of transparency rule of thumb for the minimum requirements for
and ease of calculation for reporting, and in terms the adequacy of energy taxation, it is nevertheless
of avoiding some of the methodological pitfalls a potentially informative benchmark. Further-
of having to define EU and economy-wide bench- more, this measure would be complementary to
marks for broader measures of indirect subsidies other measures such as relative fuel tax rates, since
(For instance, normatively it is not clear that dif- it captures the level of overall energy taxation,
ferent Member States should apply common en- rather than simply the relative tax rates. It would
ergy tax rates across fuels and sectors). also help to capture the impacts of falls in fossil
Practically speaking, this measure could be fuel prices on the adequacy of energy taxation lev-
based on a simple comparison of their own do- els. For instance, the 60-70% declines in gas and
mestic tax rates on diesel vs gasoline (Figure 6). oil prices in 2014/2015 have significantly impacted
A higher ratio would indicate a better equalisa- not only final consumer prices for fossil fuels, en-
tion of tax rates. It would also ask Member States couraging their continued use; they have also re-
to cite other examples of exemptions that have duced tax revenue from these sources. A measure
IDDRI WORKING PAPER 09/2016 15Fossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
of energy taxation as a share of GDP would capture as well as their national strategies for imple-
this phenomenon, allowing for it to be called it to menting those objectives. A key part of any
the attention of policy makers. strategy for decarbonisation must involve fiscal
Nevertheless, it remains true that the level of policy incentives. Member States should there-
energy taxation may be more or less adequate for fore be asked explicitly within the framework of a
driving the price-related parts of the low-carbon binding template for their plans to explain: “how
transition depending on the incidence of where fiscal policies, including taxation and the removal
that taxation falls. To correct for this blind-spot, of subsidies for fossil fuels, will contribute to their
we therefore suggest a fourth and final measure decarbonisation objectives”.
of the level of CO2 emissions taxation. This would Since every Member States situation will differ
capture the average CO2 price on all fossil fuel use to some extent, Member States will need to be left
throughout the economy. Once again, this would some flexibility in answering this question. How-
be a relatively simple measure for Member States to ever, to ensure that the answers nevertheless cover
calculate, being just the total taxation paid on CO2 the essential issues as highlighted above, the tem-
emissions from energy divided by the total emis- plate could ask Member States to detail the pres-
sions in tonnes of CO2 from energy in the economy. ent status and expected evolution of fiscal policies,
These four measures, their policy relevance, and as captured by each of the above 4 measures. This
the sources of the relevant data are captured in would include as a minimum a quantitative indi-
Table 1. cation of the direction and magnitude of changes,
the timeframe, as well as a qualitative descrip-
Table 1. Four key measures of the status of fiscal policy in tion of the kinds of specific taxes or subsidies that
Europe as it relates to fossil fuels would be removed or reduced.
Measure Policy relevant Data source In short, there needs to be sufficient detail to en-
information captured sure that the strategy is credible and coherent and
Direct subsidies Direct payments to fossil National data that it provides sufficient transparency for Member
to fossil fuel fuel energy production as used for States to be held accountable by other stakehold-
production or and use (especially Commission ers. Indeed, creating accountability to stakehold-
consumption otherwise non-competitive methodology under
ers and to the EU via cycles of bottom up policy
energy production assets). European Semester
(7th EAP)
commitments and delivery is to a large extent
Relative tax rates of Tax advantages granted to Eurostat / Enerdata
the basis of the new EU governance mechanism.
main substitutable one of the main fuels used Transparent and comparable information on strat-
fuels (diesel and for road transportation. egies for phasing out FFS is therefore essential.
gasoline) for
transport. 4.4. Ensuring progress is made
Energy tax revenues Extent to which falls in Eurostat
as a share of GDP fossil fuel prices are The new governance mechanism for energy and
compensated by rises in
climate should not be a punitive mechanism. Past
tax rates to maintain fuel
switching incentives. experience with international agreements for
Extent to which climate suggest that punitive and burden sharing
externalities of energy based approaches do not necessarily yield suffi-
use are captured by tax ciently ambitious and cooperative outcomes.
system. However, it is also important that the process be
Average CO2 tax rate Extent to which one of the EU Monitoring credible, and thus that it is perceived that there is
per unit of CO2 from main externalities from Mechanism a high likelihood that Member States will honour
fossil fuels fossil fuel use is being Regulation (ETS
priced consistently with revenues, energy
their commitments. This can be achieved, in part,
needs for low-carbon emissions proxies), by increasing the transparency of the NECP and
transition. National fiscal reporting process to national and EU stakeholders,
authorities, as this puts pressure on Member States not to de-
Source: IDDRI. viate too far from their commitments. Hence the
value of a template with detail on FFS. It can also
be achieved by establishing an annual/biennial EU
4.3. What level of detail should level process for tracking, summarising and mak-
be provided about fossil fuel ing recommendations based on the progress of
subsidy phase-out policies? the EU on the different dimensions of the Energy
Union. The annual State of the Energy Union re-
The new National Climate and Energy Plans port has begun that process, although it remains
should describe Member States’ policy objectives incomplete.
16 WORKING PAPER 09/2016 IDDRIFossil fuel subsidies and the new EU Climate and Energy Governance Mechanism
In practice, any such process would also need to 5. CONCLUSION
have a role for the Commission to regularly review
and made recommendations on the progress on the There is currently a major gap in EU energy
set of key commitments that Member States make, policy on the issue of fossil fuel subsidy reform.
or on the fulfilment of key parts of their strategies In particular, in the wake of the removal of
that underpin the content of the plans. Any signifi- energy from the European Semester, there is no
cant and persistent deviation in either of these cat- dedicated process to track the extent of FFS, nor
egories should be brought to light by this process. to ensure that Member States phase them out.
Doing so, would allow for FFS to be addressed in This situation is inconsistent with the EU’s stated
the Commission’s recommendations either indi- decarbonisation and energy efficiency dimen-
rectly (via their interference with the achievement sions under the Energy Union.
of key commitments in the NECPs) or directly (via The EU is therefore in need of an alternative
a persistent deviation with a national plan which process for tracking and ensuring the phase-out of
detailed their phase-out). The combination of FFS by the Member States. The new Energy Union
these two possibilities should be sufficient to give governance mechanism presents an opportunity
adequate attention to FFS as a relevant part of de- for creating this alternative.
carbonisation governance. This could be done by including requirements
Finally, since FFS remain essentially a fiscal is- for reporting on specific kinds of FFS within in
sue, it may be necessary in some instances to re- a dedicated sub-section of the National Climate
insert the issue into the European Semester. It is and Energy Plans on policies and measures. Pro-
possible that in some specific cases this may be gress on implementation should also be tracked
necessary to garner sufficient attention from fi- through the biennial reporting process focusing
nance ministers to the need for fuel tax reform. We on implementation of national plans. It should be
would therefore suggest that some “permeability” seen as a means to achieving the EU’s goals rather
between the European Semester and the new cli- and treated appropriately. The door to reinsert-
mate and energy governance mechanism be left ing specific climate and energy issues into the
in place, especially in cases where fiscal policy European Semester should not be closed either,
barriers must be lifted to achieve energy policy given that in some instances there may be a need
outcomes. to bring finance ministers into the discussion on
implementation of fiscal policy for climate and
energy.
Regardless of how they are defined, FFS are a
potentially important barrier to the EU achieving
its medium- and longer-term climate and energy
goals. It is important that the EU gives itself the
means to address this issue. ❚
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