Huge Benefits of Fossil Fuel Fiscal Policy Reform

Direct or indirect subsidies on fossil fuels are a major factor in rapidly increasing global greenhouse gas emissions, and hindering the progress of renewable energy development. Vietnam has no legal obligation to reduce emissions or even to limit its emissions growth in the near future, but it has declared its intention to join the international community and take responsibilities in this regard. Fossil fuel fiscal policy reform will bring in both social and economic benefits for Vietnam.

 

According to a report by the UNDP at a recent workshop on climate change, Vietnam is facing many macroeconomic uncertainties, including high inflation, trade deficit, and sovereign debt. It will also need to generate additional public and private finance for investments in climate change adaptation and greenhouse gas (GHG) emissions mitigation. Under the United Nations Framework Convention on Climate Change (UNFCCC), Vietnam is not obliged to reduce GHG emissions but the economy is energy inefficient and carbon intensive by comparison with other middle income countries (MICs), and Vietnam is becoming more dependent on imported refined petroleum products and coal.

 

Vietnam is capping electricity and fossil fuel prices, which amounts to very substantial indirect government subsidies to energy prices. These policies are not sustainable, are benefiting the better off more than the poor, and are counter-productive for future growth and modernisation, whilst also contributing to climate change. Fossil fuel fiscal reform may have economic, social and environmental benefits, as has been shown in many other countries.

 

Under a broad definition, fossil fuel subsidies are any government intervention that can reduce the cost of fossil fuel below what it would be without that intervention. Globally, fossil fuel subsidies and support measures are estimated to have fluctuated between US$300 billion and US$554 billion annually in the period 2007-2010, using a ‘price-gap’ approach.

 

Mr Koó Neejes, climate change policy advisor to UNDP Vietnam, said: Vietnam is now dependent on imported fossil fuels and there is a price-rising trend of fossil fuels on the world market. By 2030, coal is projected to cover over 56 percent of all electricity production capacities, and Vietnam would import about 80 million tons of coal per year, which is equivalent to roughly 60,000 average sized loads of coal by river barge. Consumption of refined petroleum products has grown rapidly, and Vietnam is likely to become a net oil importer by volume within the next five years.

 

The International Energy Agency (IEA) estimates with the ‘price-gap approach’ that (indirect) fossil fuel consumption subsidies in Vietnam were US$2.1 billion in 2007, US$3.56 billion in 2008, US$1.2 billion in 2009 and US$2.93 billion in 2010, and were allocated especially to electricity, that is, fluctuating between about 1 and 4 percent of GDP in current USD. The Government revenue from refined petroleum were VND24,922 billion in 2009 compared to VND4,839 billion from electricity or in total about US$1.5 billion, which is above the subsidy in 2009, but lower than the subsidies in 2007, 2008 and 2010.

 

Power sector losses at State-owned energy enterprises must ultimately be borne by the central Government and are therefore essentially indirect subsidies. Block-tariff pricing schemes are in place for residential users and for commercial and industrial users. In 2011, the Government granted EVN greater authority to set prices, but over the period including 2011 it raised them by rates below inflation.

 

According to the UNDP Report on “Fossil Fuel Fiscal Policies and Greenhouse Gas Emissions in Vietnam,” a Computable general equilibrium (CGE) model of the economy and an emissions accounting model with a range of parameters were used to assess future economic and emissions trends by comparing two scenarios with ‘business as usual’ (BAU): one where estimated subsidies are removed, and one where fossil fuel taxes are introduced, in addition to subsidy cuts.

 

The modelling results confirm international experience and found that cutting subsidies and imposing a carbon tax could have several positive effects. The CGE modelling of both scenarios indicated real GDP could be about 1 percent higher in the subsidy cut scenario than in the BAU scenario and about 1.5 percent higher in the subsidy cut and carbon tax scenario, compared to the BAU scenario over the period to 2020, and gross investment rates would be considerably higher. GDP growth is initially lower due to lower consumption and higher production costs, but growth rebounds strongly after the economy has adjusted to the change in energy prices.

 

The increase in fossil fuel prices would lead to lower household consumption growth relative to the BAU scenario, although overall consumption growth would remain robust. Imports and exports would be slightly lower, and if additional revenue is mainly used for low carbon investment, there will be a particular decline in imports due to less reliance on energy imports. The exchange rate appreciates slightly compared to the BAU scenario, suggesting that a deterioration in the current account balance due to the new policy would be unlikely.

 

The power sector is the largest consumer of fossil fuels and the largest emitter of GHGs. It also accounts for the largest decline in emissions due to the price changes under both scenarios. Coal emissions decline with the significant increase in coal price in both scenarios, even though model assumptions are conservative in this regard. There would be a switch of power generators towards gas in response to an assumed strong price increase of coal. Reducing consumption and emissions from refined petroleum fuels will require investment in development and transfer of new technologies.

 

According to the UNDP, phase-out of subsidies and introduction of additional fossil fuel taxes should serve multiple macroeconomic aims, including a gradual reduction of annual budget deficits and public debt; improved efficiency of energy utilities and other SOEs; improved international competitiveness; increased foreign and private sector investment in the (low carbon) energy sector; and maintenance of a reasonably strong Vietnamese dong.

 

Mr Koó Neejes said, importantly, reform must happen gradually and in a phased manner in order to avoid shocks to the economy and inflationary pressure, i.e. a gradual removal of price caps, followed by step wise introduction of selected taxes. Gradual phasing out of subsidies and introduction of taxes must be accompanied by further restructuring of SOEs and the introduction of competitive energy markets. Vietnam needs to enhance financial sustainability and attract more investment capital into the energy sector.