The United Nations Environment Programme's en.Lighten initiative commissioned me to explore the role of energy subsidies in the off-grid lighting market. Following is a brief summary of the just-released report, which can be downloaded in full report here.
Global subsidies to the energy sector are immense and impede entry of improved energy-using technologies.
Thanks to widespread subsidies, the world is largely in the dark about the true cost of energy, including the price of light. Annual outlays for energy subsidies (to all fossil fuels and grid electricity) have reached nearly US$2 trillion, approximately 2.5% of GDP or 8% of total government expenditures. Out of these, fossil fuels ‘consumption’ subsidies reached US$523 globally in 2011, most of which in developing countries. Sub-Saharan Africa accounted for about 4 percent of global energy subsidies, 1.5 percent of regional GDP or 5.5 percent of total government revenues. The question of fuel subsidies is key to understanding dynamics in the off-grid lighting marketplace, and for formulating policy.
Energy subsidies compete with—and sometimes eclipse—public investment in other social programs such as healthcare and education. This is particularly pronounced in countries like Nigeria, where kerosene subsidies alone amount to more than those for security, critical infrastructure, human capital development, and land and food security combined.
While the primary intended role of subsidies in the developing world is poverty alleviation (in some cases the goal is to support energy-producing industries), they can also impede progress toward solutions that were not commercially available when historical subsidies were established and that ultimately stand to more reliably reduce the costs of energy services for the poor. The report synthesizes and reviews existing information on the presence and interplay of energy subsidies and off-grid lighting in ECOWAS countries, explores unintended consequences, and the prospects for subsidy reform and associated policy strategies.
As a case in point, subsidies for lighting fuels in the West African economic community have doubled in the past decade to approximately $4 billion per year, and these public funds often do not even reach the intended audiences.
Official statistics are not available in most cases, but it is estimated in this report that current subsidies for kerosene are US$4 billion per year in ECOWAS. About 180 million people as well as many businesses, schools, and clinics in the ECOWAS countries regularly rely on fuel-based lighting. This makes the average subsidy about $20 per person each year. Many others who are grid-connected must periodically revert to fuel-based lighting during power outages.
There is a wide consensus about the inefficiencies and adverse impacts of energy subsidies. They often fail to reach the intended populations. The poorest 40% of the population typically receive only about one-third of the total subsidy for kerosene, the chief lighting fuel. This has the perverse effect of amplifying the very economic inequalities that subsidies are intended to reduce. Smuggling or other efforts to obtain and resell subsidized kerosene at elevated prices often result in complete diversion of subsidy awards from any and all consumers.
Lighting fuel subsidies vary widely in ECOWAS, and slow the entry of new and improved technologies that were not available when subsidies were originally introduced and lead to diversion of kerosene to transportation uses or dangerous adulteration (mixing) of kerosene with transport fuels.
All energy subsidies lead to increased energy inefficiencies (a specific form of economic inefficiency), energy import dependency, hoarding, corruption, roadway congestion, and public health costs. A widespread example is where transportation fuel prices are suppressed through subsidization, stimulating an increase in fuel demand. Subsidies also represent a cost (often substantial) to governments, competing for limited resources with other development investment and social funding needs. Reforms to curtail subsidies are most vulnerable to collapse during spikes in world oil prices—precisely when they are most needed.
As a reflection of subsidy practices—present in all ECOWAS countries—kerosene prices vary by three- to four-fold. Moreover, these subsidies consistently position kerosene costs well below those of transportation fuels (as much as 65% lower). This results in diversion of scarce lighting fuel to be mixed with transportation fuels, which in turn creates not only scarcity and black markets for lighting fuels but also increased vehicle pollution. Ironically, transportation fuel scarcity can also trigger diversion in the opposite direction, the adulteration (mixing) of lighting fuels with explosive transportation fuel, resulting in extensive burn injuries, house fires and loss of life. As of 2011, five ECOWAS countries had successfully reduced their kerosene subsidies so that they would not attain transport-fuel price ratios favorable to diversion or adulteration. The other ten ECOWAS countries, however, need to look more closely at the social and economic impact in their markets due to these subsidies.
Subsidies spent on operating kerosene lanterns could instead finance the purchase an LED replacement lantern.
Under typical conditions, the annual cost of subsidizing the fuel consumed by a single kerosene lantern is equal to the cost of replacing that lantern with a solar alternative and thus eliminating need for fuel at any price.
Perversely, the presence of these subsidies increases the payback times of alternative technologies considerably. For example, a 50% subsidy effectively doubles the payback time for a US$50 solar lamp from 6 months to 12 months. This differentially discourages the purchase of more costly (higher quality, more features) systems insofar as the user has to wait relatively longer to recoup their investment. For example, while a US$10 system takes only 2 months longer to pay back under a 50% subsidy, a US$100 system takes 20 months longer.
There is clearly a strong case for subsidy reform.
Fortunately, more efficient, equitable, and fiscally sustainable alternatives to conventional subsidy instruments are available to policymakers. However, kerosene subsidies are arguably the most difficult to reform in comparison to those applied to other forms of energy, and many efforts to do so in ECOWAS countries have been unsuccessful although there is overall movement towards closing the gap. Harmonizing subsidies across neighboring countries is a highly desirable, but is an even greater challenge than reforming subsidies at the level of an individual country.
While kerosene is the chief form of subsidized energy most used for lighting, policy analysis must consider a broader range of fuels and nuances. These include the relative pricing of transportation fuels. Similarly, any changes in kerosene subsidy will impact other end-uses for that fuel, notably cooking, and measures must be taken to proactively minimize any unintended consequences. Grid-electricity pricing and subsidies (including grid connection fees/subsidies) must also be considered, as this, too, is a backstop form of energy that will be compared to off-grid solutions powered by distributed generation systems.
Promoting a transition to LED lighting is perhaps the most effective ways of reducing dependence on lighting-fuel subsidies, but great caution should be exercised in shifting subsidy to these alternatives.
There is wide agreement that the most effective approach to mitigating potential economic impacts of subsidy reform is to redirect those funds to well-targeted social programs, which can be far more efficient in terms of delivering support to those who need it most.
While it is clear that fuel-based lighting receives vastly more subsidy than solar alternatives, policymakers should exercise caution because, if done improperly, shifting subsidies to new lighting alternatives could inadvertently disrupt existing otherwise vibrant emerging markets. Other more nuanced options to support the market for energy efficient lighting include indirect efforts to remove market barriers to alternatives, improve financing, and relax import duties and other taxes on solar-powered lighting systems that meet specified minimum quality standards. Lowering import duties could be a very powerful instrument. Each million dollars of kerosene subsidy reduction could offset tariffs on about 250,000 solar lanterns, in the sense that the combination of these two policy actions would be revenue-neutral for the respective government.
Consumer costs of inefficient lighting strategies—even when subsidized—can be higher than those of more efficient and unsubsidized alternatives. In addition, the quality, quantity, and safety of the alternatives are far superior to the current status quo.
Download the full report here.