The World Wasted Trillions of Dollars on Fossil Fuels Because of Bad Math

The global measurement of fossil fuel subsidies is most likely wrong.

Government subsidies for fossil fuels over the last three decades have been far larger than anyone previously thought, according to a new study published by the University of Calgary's School of Public Policy in March.

A fossil fuel subsidy is any government policy that lowers the cost of fossil fuel production, raises prices received by producers, or lowers prices paid by consumers: they can consist of tax breaks and direct funding for fossil fuel companies. But subsidies can also consist of loans, price controls, or giveaways in the form of land or water at below market-rates, and many other actions.

They have been so high across the world, finds Dr. Radek Stefanski—an economist at the University of St. Andrews in Scotland— that they are nearly four and a half times higher than previously believed.

So what's the damage? It's pretty colossal. For the last year in his model, 2010, Stefanski found that the total global direct and indirect financial costs of all fossil fuel subsidies was $1.82 trillion, or 3.8 percent of global GDP. He also found that the subsidies meant much higher carbon emissions released into our atmosphere.

Compare that to the International Energy Agency (IEA) figure for the same year. In its 2011 World Energy Outlook, the IEA calculated total worldwide fossil fuel subsidies for 2010 to be $409 billion, less than a quarter of Stefanski's figure of nearly two trillion dollars.

Bad Math

Stefanski is not the first to have suggested that older methods of calculating global fossil fuel subsidies were missing the mark by millions, if not billions. But he's the first to have applied a more advanced methodology to go back and see how much we've actually been spending in the past to shore-up the oil, gas and coal industries.

His findings suggest that government spending to keep the fossil fuel industries pumping has been orders of magnitude higher than we ever thought for several decades, not just years.

He argues that the IEA's measures to calculate fossil fuel subsidies are inadequate. Those measures use a "price-gap" approach which infers subsidies by comparing local energy prices with an international benchmark price. The problem is that this approach relies on scarce data and misses a whole lot of smaller, but still important, subsidies that don't directly impact prices. These could be, for instance, payouts to oil and gas producers that keep them in business despite older technology, or help them drill in areas that would otherwise be unprofitable.

To address the problem, Stefanski built a unique model covering 170 countries for 30 years between 1980 and 2010. The model infers the size of subsidies by looking closely at the relationship between a country's "emissions intensities"—its carbon emissions, relative to the quantity of energy it produces—and its GDP. By examining the patterns in these relationships over time, he found that deviations in the patterns were indicators of net fossil fuel subsidies.

The Number's Up

Overall, it's clear that fossil fuel subsidies have increased over the last few decades, not decreased—such is the self-defeating economics of fossil fuels.

In 2015, the International Monetary Fund (IMF) calculated that global fossil fuel subsidies amounted to a monumental $5.3 trillion, which is 6.5% of global GDP—up from $4.9 trillion in 2013. The IMF even had to revise its old figure for 2011, which originally estimated the global subsidies at 2 trillion dollars. The real figure for 2011, the fund concluded, was $4.2 trillion.

Over the same period that fossil fuel spending worldwide has steadily increased, though, the net value of energy being extracted from the fossil fuel resource base has declined by more than half.

Stefanski is critical of the IMF's methodology, which he says could be too wide—attempting to account for the estimated costs of "externalities" like pollution. He prefers not to include such estimates in his calculation because they relies largely on assumptions. His approach also excludes heavy subsidies to major carbon emitting non-fuel industries which are, however, heavily dependent on fossil fuels―like agriculture.

As a result his general estimates tend to be lower for most countries than other available estimates. But, he told me, his estimates are "substantially higher for three crucial countries: China, Russia and the US. Due to the size of those countries—this is a very big deal."

An Obvious Solution

Either way, this has clear-cut implications for economic policy. In 2010, Stefanski finds, carbon emissions would have been 36 percent lower without subsidies than they actually were.

He concludes that fossil fuel subsidies have caused a "major misallocation of resources, which has resulted in sizably lower levels of GDP" while contributing to "enormous additional emissions of carbon." The answer is simple, he said: "Ideally governments should remove all fossil-fuel subsidies as this would help lower emissions, lower government deficits and increase GDP."

That doesn't necessarily mean replacing fossil fuel subsidies with renewable subsidies. Stefanski advocates carbon tax and cap-and-trade schemes―government taxes on users of fossil fuels and mechanisms to cap firms' pollution while allowing them purchase and trade permits to pollute. By putting a price on carbon pollution while simultaneously eliminating state support for fossil fuels, this allows market dynamics to speed a clean energy transition.

Read MoreWe Can Phase Out Fossil Fuels Within A Decade, Study Says

According to Professor Felix Fitzroy, a colleague of Stefanski's at St. Andrews School of Economics and Finance, eliminating fossil fuel subsidies would be a major economic boon. "Abolishing these subsidies, together with health cost savings would thus more than cover costs of transition [to renewable forms of energy]. Multiplier effects of green fiscal policy would generate further financial benefits by reducing unemployment", he said.

Unlike Stefanski, though, Fitzroy calls for exorbitant fossil fuel subsidies to be replaced by government investment in renewables: "A carbon tax is also needed, as well switching subsidies from fossil fuels to renewable subsidies."

Dropping carbon emissions by a third? Closing a multi-trillion dollar blackhole in global GDP? Speeding the transition to a clean energy future? It looks like a win-win-win scenario – except, of course, for the dying oil, gas and coal industries.

Policymakers looking for a quick fix for environmental, energy and economic problems would do well to heed Stefanski's final words of advice:

"Any government looking to ease strained budgets and make a significant (and cheap) contribution to the fight against climate change must consider slashing fossil fuel subsidies."