Saturday, 9 May 2020

Now is the time for Europe to raise taxes on hydrocarbons

The collapse in hydrocarbon prices provoked by the Covid-19 crisis has opened up an opportunity for Europe to advance the de-carbonization of the economy. Because the price of oil and other fossil fuels have fallen so much, it makes economic and political sense to increase duties on hydrocarbons and thereby keep renewables competitive. Taking this action would represent a major step towards realizing the European Green Deal, which aims “to ensure effective carbon pricing throughout the economy”.[1]

As can be seen from the chart below, the price of crude oil fell very abruptly, down by two thirds from around $55‒$60/barrel, where it had been hovering in recent years, to $20/barrel or less—the lowest (nominal) level in two decades. The price for certain blends on certain days even fell below zero, as suppliers had to unload excess stocks for which they had no storage capacity. The process started in January-February, when some major producers engaged in a price war, but accelerated with the onset of the Covid-19 crisis. At the time of writing the price has recovered to nearer $30/barrel, which still represents a fall of 50 percent.

                                     Source: U.S. Energy Information Agency
Other hydrocarbon prices have fallen in parallel. The spot price for gasoline has collapsed from $2/gallon to $0.5/gallon. Less dramatically, natural gas prices have fallen in the last three months from around $2.50/MBtu to around $1.70/MBtu.[2] Coal in international markets has gone from $45/ton to $35/ton.
Retail prices have begun to respond: the average price of petrol in the EU and the UK has fallen by about 20 percent so far in 2020, and the price of heating oil has gone down 30 percent (Chart).

                Source:  EU Oil Bulletin
Having users pay for the climate externality of burning fossil hydrocarbon is part of any strategy that is going to be effective in reducing carbon emissions and containing climate change. As emphasized in the EU Commission’s European Green Deal, “decarbonising the energy system is critical to reach climate objectives in 2030 and 2050” (p. 6). To that end, “[w]ell-designed tax reforms play a direct role by sending the right price signals and providing the right incentives for sustainable behaviour by producers, users and consumers… the European Green Deal will create the context for removing subsidies for fossil fuels, shifting the tax burden from labour to pollution, and taking into account social considerations.” (p. 17). In particular, “the price of transport must reflect the impact it has on the environment and on health. Fossil-fuel subsidies should end” (p. 10).

The environmental change has to come sooner or later (preferably sooner), and now it can be effected in a way that actually stabilizes prices. With the prices of hydrocarbons very low, more realistic charging for emissions of green house gases and other pollutants can be introduced with minimum economic and political disruption. For a start, the increase in duties could be calibrated so as to keep prices near 2018‒2019 levels, levels to which the economy had become accustomed. For simplicity, an extra $35/barrel duty on oil would get its price back to where it stood as recently as February, a move which cannot be considered onerous. Analogous charges could be imposed on other hydrocarbons. Alternately, a more sophisticated carbon- or green house gas-based tax could be raised, to comparable effect.

Most households, who are doing little driving due to the lockdown and have seasonally low heating needs, would not notice. In this way, affordability and social equity would be maintained. The gilets jaunes protests were sparked by rising fuel prices, showing that introducing carbon taxation can be politically dangerous. The situation today is very different: there will be much more public acceptance of keeping prices from falling in order to fund medical services.

Fuel-intensive sectors such as road haulage will complain, but for them too current low prices create the easiest environment for getting used to the inevitable. It is worth remembering that petroleum was priced at well over $100/barrel during 2011-2014 without very severe effects on the economy, so it seems that adaptive capacity is considerable.

Restoring hydrocarbon prices at least to pre-crisis levels would also help ensure that renewable energy and conservation measures remain financially attractive. Selling solar or wind power to the grid has lost some appeal, with European wholesale electricity prices roughly halving—as shown on the next chart—from around €40/MWh at the start of the year (with spikes well over €50/MWh) to around €20/MWh in April (with more frequent downward spikes below zero).[3] Sufficiently large-scale investment into renewables, conservation, and de-carbonization generally will not happen without a reliable projection of high and indeed steadily rising carbon prices. At a minimum, the development of renewables would be substantially encouraged if investors had more assurance that swings in hydrocarbon prices would not suddenly make their projects non-viable, and that requires higher duties when wholesale market prices fall. The alternative is that the Covid-19 crisis reverses some of the progress made so far.

    Source: North Pool
Eventually hydrocarbon prices may recover, and when that happens the extraordinary duties might be partially reduced temporarily in order to smooth adjustment. However, on current evidence it is likely that oil and associated prices will be depressed a long while. Moreover, the surcharge should not be abolished since de-carbonization remains the goal; the trend for carbon prices needs to be rising sharply in order to meet climate goals.

Meanwhile, the exceptional fiscal burden of coping with the Covid-19 crisis and its economic fallout has increased the value of budget revenue, including that from hydrocarbon duties. Resources already had to be mobilized for the large-scale, sustained investment needed for de-carbonizing and greening the economy, estimated by the Commission at 1.5 percent of GDP annually. No one likes taxation, but in current circumstances of massive expenditure needs and much reduced revenues, somewhat higher receipts from hydrocarbon today seem worthwhile compared with even higher taxes in the future and raising debt to precarious levels. The European Green Deal and fiscal prudence would be in harmony.[4]

It would be good if Europe as a whole—the EU with Britain—acted together to raise hydrocarbon taxation, so as to forestall “gaming” tax rates to the advantage of national industries. It would be even better if other large consumers, such as India and China and even the U.S., likewise seized the opportunity. Coordinated action would not only generate more benefit for the environment, it would also help keep down pre-tax hydrocarbon prices once recovery gets under way.

Finally, in these days the public may be more accepting of taxation of fuels that create air pollution, which is increasingly recognized as medically (and aesthetically) damaging. The pandemic does not distract from, but rather reinforces the urgency of the European Green Deal.

#CarbonPricing; #Decarbonization; #GreenDeal; #EuropeanGreenDeal; #EU; #Covid19; #ClimateChange; #RenewablesInvestment; #EuPEP; #ESC; #StAntonysCollege; #UniversityofOxford; #PoliticalEconomy

Daniel C. Hardy

Academic Visitor, European Political Economy Project, European Studies Centre, St Antony’s College, University of Oxford

[1] Page 5, EU Commission “The European Green Deal,” COM(2019) 640, December 2019, available at

[2] Source for gasoline, natural gas, and coal prices: U.S. Energy Information Agency.

[3] See also Aurora Energy Research, “Impact of Coronavirus on European energy markets,” April 2020, available at ; and Eurelectric, “Live updates: Working together in the time of COVID-19,” April 2019, available at . The trend is apparent across the EU and the UK.

[4] Transport & Environment “Oil, the plot against Europe, and how to save €100bn a year” at ) makes a related point.

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