Discounts at the Pump: How Much is Cheap Gas Really Costing Us?

Despite finite resources for gasoline and diesel and the fact that global oil consumption is predicted to reach 90 million barrels per day by 2015, fuel is heavily subsidized for consumers in many countries. Although these subsidies are usually characterized as a way to increase consumer welfare by reducing the burden of high fuel prices, they have been criticized for distorting market demand and increasing negative external effects associated with the oil industry by artificially lowering fuel prices and encouraging excess consumption. Although previous studies have calculated total dollar amounts spent on subsidies, in “The Economic Cost of Global Fuel Subsidies,” Lucas Davis quantifies the actual economic cost to the global economy and finds that these subsidies, totaling $110 billion in 2012, create a staggering global welfare loss of approximately $76 billion annually—or nearly four percent of the total market for fuel.

Although crude oil and other resources involved in the production of gasoline and diesel are traded internationally, there is a wide variation in fuel prices between countries. Davis finds that a small part of this variation can be attributed to variables like transportation and distribution costs. However, the majority of the variance is a result of differing fuel taxes and subsidies. Taking into account the minor variables in cost, Davis is able to approximate the amount of fuel subsidies in each country by finding the difference between domestic prices and international spot prices (the current price at which a commodity can be bought or sold, excluding taxes or other transaction costs) and multiplying this difference by the relative amounts of fuel consumption in each country.

Davis finds that 24 countries subsidize gasoline, while 35 countries subsidize diesel—of these countries, the ten that subsidized most heavily accounted for nearly 90 percent of total subsidies. Countries with the largest fuel subsidies, many of which are also major oil producers, also tend to have the highest fuel consumption. For example, Saudi Arabia, which has the highest amount of fuel subsidies and is the second largest oil producer in the world, has experienced a nine-fold increase in fuel consumption since 1971. Venezuela, the fourth largest provider of fuel subsidies and the ninth largest oil producer in the world, has per capita gasoline consumption 40 percent higher than any other Latin American country.

Davis explains that this correlation is a result of the long-held view that fuel subsidies are, “a way to share the resource wealth with a nation’s citizens,” by lowering the domestic market prices for citizens of oil-rich countries. Interestingly, Davis finds that this is not the case in all oil producing countries. In Iraq, Mexico, and Russia, for example, prices are at or above the spot price, indicating that the market for fuel in these countries is either taxed to raise the price or is not manipulated at all.

Theoretically, any government intervention into the free market will create a “deadweight loss,” but these losses can sometimes be justified by the benefits they provide. While Davis focuses on the losses from subsidizing fuel, he notes that there is also a deadweight loss from taxation. A deadweight loss occurs whenever transactions that would have occurred in the free market are lost (because prices are too high) or when transactions that should not have occurred are taking place artificially (as is the case with fuel subsidies.)

Using conservative estimates for the long-run demand and supply for fuel, Davis calculates a welfare loss of $44 billion in 2012 alone. Unsurprisingly, he finds that roughly half of this amount is from the subsidies of Saudi Arabia and Venezuela, representing $12 billion and $10 billion respectively. Moreover, fuel subsidies impose additional external costs such as increased pollution and traffic congestion. Accounting for these costs brings this loss up to $76 billion. Finally, if the losses from fuel taxation are included, the total annual economic cost is a staggering $92 billion.

While Davis admits these calculations are preliminary, the implication of these findings is that existing fuel subsidies may not be worth the costs they impose. Many oil-producing countries spend a disproportionate amount on fuel subsidies, yet these countries also often have unusually high poverty rates and low expenditures on education and poor health care. Instead of reallocating resource wealth to the citizens of these countries through lower fuel prices, fuel subsidies are instead increasing domestic income disparities and contributing to global economic welfare losses. Further, while this research focuses on gasoline and diesel, the analysis should be expanded to cover the broader energy industry, a market that is subsidized with nearly $500 billion annually, and may result in substantial increases in the negative consequences on the global economy.

Article Source: Lucas W. Davis, “The Economic Cost of Global Fuel Subsidies,” National Bureau of Economic Research, Working Paper No. 19736, December 2013.

Feature Photo: cc/(MJBarnes)