Can reducing fossil fuel subsidies advance global climate goals?

Finextra

16-07-2025

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Research from ZEW Manheim found that worldwide climate targets can be met by reducing subsidies for fossil fuels. The Paris Agreement aims to limit global warming to below 2°C to 1.5°C above pre-industrial levels.
Targets range from achieving net zero by 2035 to 2070 depending on the country, with most settling in the middle at 2050. The UK is aiming to become net zero by 2045 and pledged to reduce emissions by 69% by 2030.
What are fossil fuel subsidies?
Many governments have direct and indirect subsidies in fossil fuels – the former being direct payments, and the latter allowing significant tax breaks to allocated businesses and institutions.
In 2022, fossil fuels received $7 trillion in subsidies. Countries with the largest subsidies in fossil fuels are producers of oil, such as Saudi Arabia, Libya, Kazakhstan, Iran, and Algeria. Countries such as Venezuela, Finland, Australia, and Ireland also have large subsidies in fossil fuel industries, according to 2021 research from Our World in Data.
Governments fund subsidies as a privileged form of financial aid, to support sectors of a nation's economy with the ultimate goal of maximising profit and protecting domestic jobs. Other forms of government subsidies are individual subsidies, like student loans and unemployment benefits. In the US, subsidies have historically supported the agricultural, financial, oil, and utility industries – the motivations behind this can be political and economic. Some socioeconomic theories suggest certain industries require protection from global competition to ensure profitability.
There have been arguments against government subsidies that inspire a free economy vs. mixed economy debate; defenders of the free market argue that the free economy cannot exist with government intervention, whereas those who are pro-subsidies state that protecting certain industries allows people to thrive and jobs to remain intact.
'Many governments still help to keep fossil fuels cheap for consumers. For example, explicit subsidies are used to cover part of the supply cost, or external health costs associated with the use of fossil fuels are not included in prices because of implicit subsidies,' stated Professor Sebastian Rausch, head of the ZEW Research Unit 'Environmental and Climate Economics'.
How can reducing fossil fuel subsidies lead to achieving climate goals?
US subsidies in fossil fuels amounted to $757 billion in 2022, $3 billion in explicit subsidies, and $754 billion in implicit subsidies. Subsidies exceeded the federal government's tax revenues from natural gas and petroleum by $2.1 billion in 2022. Under former President Joe Biden, the US pledged to phase out from fossil fuel investments abroad by 2040. However, since then, the new US administration has pulled out of the Paris Climate Agreement and instated anti-ESG laws, allowing climate-killing fossil fuels to continue to thrive.
According to the IMF, reducing fossil fuel subsidies can promote economic growth by limiting uneven division of resources, reduce pollution and climate change, and encourage better social spending by reductions in taxes. The research from ZEW revealed that a third of all countries could meet their climate goals by reducing subsidies in coal, oil, and natural gas – which could lower carbon emissions enough to meet climate targets without additional policies.
The argument against fossil fuel subsidies is not a new one; discussions at 2021 and 2022 UN climate change conferences have been pushed for policies to retract tax privileges from oil and gas industries.
A report from the University of Cambridge published in May outlined that to reach the goals of the Paris Agreement, three climate actions are essential.
Reducing emissions by moving energy production away from fossil fuels that generate greenhouse gas emissions; Reduction of energy use in sectors to ensure greenhouse gas removal; and Optimising land management through solar radiation modification.
The removal of both implicit and explicit fossil fuel subsidies is essential. The report states: 'many countries continue to heavily subsidise fossil fuels, both explicitly (by undercharging supply costs) and implicitly (by failing to account for the non-market costs associated with local externalities of fossil fuel use).'
The figure below outlines the differences between explicit and implicit subsidies based on 2022 data from the IMF, and what approaches are being taken to reduce them.
Source: Our World in Data
Reducing all direct fossil fuel subsidies would not successfully tamp down on global emissions, however identifying hidden costs of fossil fuels in energy prices could cut down global emissions by 32%, whilst improving welfare in nations.
Tim Kalmey, researcher at ZEW and also co-author of the ZEW study, commented: 'Phasing out explicit subsidies, such as tax exemptions on kerosene or gas price ceilings, would only have a limited effect on CO2 emissions. It is crucial that also the local externalities of fossil fuels, i.e. the harmful effects on health caused by local air pollution, are factored in. We estimate that this would reduce global CO2 emissions by 32%.'
Only reducing explicit fossil fuels will not fulfil the climate goals outlined by the Paris Agreement, but eliminating implicit fossil fuel subsidies will allow one-third of countries to overachieve their climate targets. With effective energy pricing, the cost of achieving climate goals can be lowered for all countries, and adding effective energy pricing on top of carbon pricing to meet the Paris Agreement goals will increase welfare by 120%.
By retracting government intervention in gas and oil industries, not only will it protect the planet, but the welfare of individual nations that will take part. This new data is key for policymakers, who can use it to make real progress towards mitigating climate change.