The case against energy bail-outs

WHEN CRISES have struck in recent years, politicians in the rich world have been quick to turn to bail-outs. During the covid-19 pandemic and the energy crisis caused by Russia's invasion of Ukraine in 2022, governments opened their chequebooks and made heavy-handed interventions as they sought to cushion the damage that was being inflicted on households and businesses.

So it is with the energy crisis stemming from the Iran war, which has sent the price of oil and liquefied natural gas (LNG) rocketing. Spain has slashed VAT on fuel and household electricity, Italy has cut petrol duties, South Korea has capped prices at the pump and Japan is spending more on subsidies to limit them. Britain's government is considering subsidising the energy bills of welfare claimants, and promises to crack down on "profiteering". Even in energy-secure America, Democrats have called for windfall taxes on oil companies, with the revenue channelled to households.

Such interventions will do more harm than good. High prices and fat profits tell consumers to economise on energy while encouraging producers to find and sell more. And as the energy crisis of 2022 showed, interfering with these signals can hurt some of the world's poorest people.

It is arithmetically impossible for every government to shield its consumers from the energy shortage. So long as the Strait of Hormuz remains closed, the world has lost 15% of its oil supply; add in damage to Qatar's facilities, and the global supply of LNG is down by about a fifth. No amount of subsidy can bring this back. Global energy consumption must fall.

The effect of handouts is therefore to force the adjustment on others. After the continent lost most of its supply of Russian gas in 2022, many European countries spent more than 2.5% of GDP on subsidies over two years. The interventions were clumsy. Across the rich world as a whole more than half the money was spent blunting the price mechanism, and about four-fifths was untargeted, benefiting richer households, which tend to consume the most energy. Europe was always going to pivot to LNG, but subsidies made the global crunch worse. As LNG imports rose by 65% in Europe, they fell by 16% in South Asia. Pakistan and Bangladesh suffered blackouts and deepening poverty.

Repeating the trick would be both shameful and expensive. In 2022 Europe's interventions felt cheap because interest rates and bond yields started the year near zero. Today the cost of debt is much higher. The war has caused bonds to sell off sharply, particularly in gas-dependent countries. Britain must now pay nearly 5% to borrow for ten years, about half a percentage point more than during the height of the panic under Liz Truss. Borrowing more to subsidise energy will eat up scarce fiscal space. And by stimulating the economy, it could make it harder for central banks to control inflation, further unsettling bond markets.

Regulatory interventions do not cost money, but are just as likely to backfire. It is desirable for providers that have not been disrupted by the conflict—including renewables providers—to enjoy high profits, because that encourages a more secure supply of energy. "Windfall" taxes also have a nasty habit of becoming permanent. Britain never scrapped the extra levy it imposed on oil-and-gas profits from the North Sea in 2022, which took the marginal tax rate to a punitive 78%. It would have been better to cut the tax to promote energy security.

Beyond avoiding past mistakes, what should governments do? They could temporarily increase cash payments to poor households through the welfare state, while leaving energy prices, and hence the incentive to economise, intact. In 2022 there were some more calibrated interventions: Germany offered cash support tied to energy usage.

Similar principles could be applied on an international scale to direct aid to the world's neediest. During the energy shocks of the 1970s, the IMF provided extra balance-of-payments support for the countries most seriously affected, and relieved poor countries of much of the interest bill. It may find itself having to do a modern version of that today, much as it ran a dedicated lending scheme for countries affected by high food and fertiliser prices in 2022-24.

The long-run challenge is clear: economies need to be weaned off insecure sources of energy while, ideally, burning less fossil fuel. It is a fantasy to think that this transition can be achieved if governments keep mindlessly absorbing the costs of the present system, while limiting rewards for those offering more robust alternatives.