ERRA Joint Tariff/Pricing & Licensing/Competition Committee Meeting April 13, 2005 Budapest, Hungary Household energy subsidies and its impacts Dr. Molnár László Executive director Energy Center

2 Why Do Countries Subsidise Energy? - Protect industry - Ensure employment - Protect environment - Promote technology - Improve energy security - Social welfare, equity, re-distribution of income - Ensure access to fuel for poor - Fixing market imperfections, energy technology - Development, regional policy, …...

3 Consequences of Subsidies Unintended (negative) consequences - Adverse impact on economic efficiency - Adverse impact on environment - Undermine global trade regime - Threat to the viability of the energy sector (consumer subsidies) - Unintended beneficiaries - Lobbies and vested interests - Promote irrational consumer behaviour - Difficult to phase out - Misuse…..

4 Good subsidy and bad subsidy - What were the objectives? - To what extent objectives were achieved? - What were the unintended consequences? - What were the adverse consequences (and dimension)? Evaluation of subsidy Overall score card Good, average, bad, depending on score.

5 Why social tariffs are necessary? Fuel poverty in the UK A fuel poor household is one that needs to spend more than 10 per cent of its income on fuel to maintain a satisfactory heating regime. In 2001 approximately 3 million households in the UK were in fuel poverty, about than 1 in 8 households, and around 2 millions of these were vulnerable households, containing people who are elderly, sick, disabled or children. The number of fuel poor households in the UK is estimated to have fallen by 2½ million between 1996 and The number of fuel poor in England has fallen by 1½ million households between 1998 and Reduced energy prices form a very significant factor in these reductions in fuel poverty. Not all households that fall within the technical definition of fuel poverty actually spend more than 10% of their income on fuel. Many cannot. They may choose to use less fuel. But many do and may have to substitute expenditure on other items for fuel.

6 Fuel expenditure as a percentage of total expenditure by income group, United Kingdom (Fuel, average = 3 % of total, (2001/2002) Fuel expenditure in 2000 in Hungary: In average: 8 % Households’ expend. in Hungary Food24,43 Alcoholic bev’s, tobacco9,05 Clothes5,79 Durable goods7,04 Household energy8,33 Others, car fuels17,34 Services 28,

7 Recommendations on Energy Subsidies 1 When adjusting energy prices and tariffs to economic levels, aim to eliminate environmentally harmful subsidies taking into account, in particular, that: Subsidies should be eliminated gradually and with great care. Their removal should be accompanied, when necessary, by compensating social-support measures, in order to mitigate any disproportional negative impacts on the poor; Certain subsidies, such as those to renewables, may be retained for a longer period, where they support sustainable development, but sunset clauses should nonetheless be included and transparency ensured. Ensure that energy prices provide market signals that motivate consumers to conserve energy and that promote energy efficiency and the use of renewables.

8 Recommendations on Energy Subsidies 2 Remove any subsidies that fail to achieve demonstrable net environmental or social benefits. Target subsidies, where they are justified, at clearly defined groups and technologies, and devise mechanisms that ensure that the benefits of those subsidies go only to those targeted categories. Where a subsidy scheme is justified, design it so that it does not undermine incentives for producers and suppliers to provide a service efficiently or for consumers to use energy efficiently, and does not harm the financial health of energy-service providers. Ensure limited duration and regular review of energy- subsidy programmes.

9 Supportive mechanisms for the most indigent Criteria for eligibility for support The group of eligible consumers can be determined based on earlier applications for aid, voluntary application and affordability. Affordability may be defined using the income/capita of the household. Another starting point is the share of expenses households spend on energy. Hence affordability ratio = energy expenditure/income. If this ratio exceeds a given level, the so-called fuel-poverty level (e.g. 15 %) the household receives grants. In other countries eligibility is linked to the energy consumption of the household (e.g. setting electricity or gas consumption limits in kWh/year or m3/year: consumers below the limit receive support).

10 Evaluation of the supportive mechanisms When evaluating the supportive mechanisms five objectives must be met: it covers all eligible poor people (i.e. coverage) reaching only those consumers who need it (and not those who can afford to pay cost-recovery prices) – (i.e. targeting) minimising the scheme’s cost for government or utility making it fair and cost effective minimising distortions arising from the scheme

11 Proposed Subsidy Mechanisms The following solutions are acceptable from a professional perspective:  life-line tariffs with two or three fixed or floating blocks (restricting the price subsidy to the initial or to the first two blocks). They can be implemented when consumption is perfectly metered.  targeted subsidies. They are related to the affordability ratio or to burden limit. The metering of the households’ energy consumption and a reliable household income statistics are necessary for the implementation.  income support  support of energy saving investments for poor households combinations of the above systems

12 S ubsidy P rogrammes should be (1) : ● well-targeted—subsidies should go only to those who are meant and deserve to receive them; ● efficient—subsidies should not undermine incentives for suppliers or consumers to provide or use a service efficiently; ● soundly based—subsidy programmes should be justified by a thorough analysis of the associated costs and benefits; ● practical—the overall amount of the subsidy should be affordable and the administration of the subsidy programme should be at a reasonable cost; ● transparent—information on the amount of government money spent on the subsidy and on subsidy recipients should be disclosed;

13 S ubsidy P rogrammes should be (2) : ● limited in time—sunset clauses should be included in the design of subsidy programmes to avoid consumers and producers becoming overly dependent on this support and costs spiralling out of control. A ‘good subsidy’ is one that enhances access to modern energy or has a positive impact on the environment, while sustaining incentives for efficient delivery and consumption. For creating a good social subsidy, a good social statistics is needed!

14 Consequences of undervalued Energy Prices and Subsidies distorted economic structure, economic efficiency loss, “resulting” in loss of GDP, higher energy consumption and waste of energy, discouraging energy efficiency investments, higher air pollution unprofitable operation of the energy sector

15 Subsidies are often resulting in less efficient economy (ie. GDP loss) and increase in energy consumption.