Unpaid environmental damages from fossil fuels are a $600B annual subsidy

Image of a mine with a power plant in the background.

Arguments about our shift to renewable power often focus on the raw economics of the change—the cost of the power itself and, in some cases, the cost of managing its intermittency. Those factors are often compared to the costs of producing electricity with fossil fuels. But that calculation ignores one of the major reasons we’re switching to renewables in the first place, namely that they help us avoid environmental costs.

Burning fossil fuels exacts a number of costs on society as a whole. These include a growing collection of costs associated with climate change. But there are other forms of environmental damage from mining and waste left behind when coal is burned, and particulates and toxic materials in the exhaust cause significant health damages. These factors are termed “externalized costs,” or simply externalities, since they are a cost of doing business which is not internalized into the cost of doing business.

While people have calculated the magnitude of these externalized costs, Yale’s Matthew Kotchen has now gone through and figured out what these costs mean for the companies in the fossil fuel market. And the results are substantial, with the externalized costs acting as a $62 billion subsidy each year in the US. In fact, he finds that much of the coal industry might go completely bust if it weren’t for this subsidy.

Energy meets economics

Calculating externalities is so well understood that the International Monetary Fund already has methods published for doing so, which Kotchen used. As part of that process, he also obtained the amounts and prices of the fossil fuels used in the US, including gasoline, diesel, coal, and natural gas. Rather than stopping with the pure costs, however, he used these to inform an economic model figures out what level of taxes would be required to internalize the cost into the energy markets. The model also includes information on how flexible supply and demand are for different fuels, and creates a counter-factual market to estimate prices for energy.

While substantially more complex than simply estimating the subsidy, this approach is needed to separate out the impact on the two different parties involved in the energy market. One of them is obviously the energy companies, which don’t pay for their environmental damages. But consumers also benefit in the form of lower energy prices. The question is how much is consumer benefit, and how much is a subsidy to the fossil fuel industry.

Kotchen finds that there’s a lot of money to divide up, with a total externality subsidy in the US coming in at over $550 billion every year from 2010 to 2018. The total amount doesn’t vary from year to year but, not surprisingly, the target of those subsidies has shifted. That’s simply because the pollution and health damages are going to scale proportionally to how much of a given fossil fuel we’re using. So, the subsidies have tracked the rise in natural gas and concurrent drop in the use of coal.

For 2018, most of the subsidy went to gasoline, at $200 billion, with diesel getting another $120 billion, giving petroleum products a combined subsidy of over $300 billion. Coal, despite its drop over the course of the decade, was still taking in $150 billion in subsidies, and natural gas was last with $125 billion. That relatively low figure reflects the reduced environmental impact of natural gas, as we produced over twice as much electricity using natural gas as we did using coal. Part of the reason transportation fuels racked up so many costs is the impact of congestion costing people time and creating pollution without any benefit whatsoever. Vehicle accident costs and road maintenance also figured.

Who’s winning?

Those subsidies are for the use of fossil fuels in general. The other issue that Kotchen tackles is how that ends up split between consumers, who play less for their energy in exchange for these impacts, and producers, who get to make more from their products without worrying about the higher prices suppressing demand. (Note that, because the model takes into account supply and demand flexibilities, the total of consumer and producer benefits don’t add up to the total subsidy. The slack is taken up by the taxes needed to get the externalities priced into the system.)

Overall, if you don’t count things like medical bills, consumers come out pretty well out of this, typically getting three to five times more out of the subsidy than producers do. This is largely because the supply of the fuel is quite flexible and can change to match altered consumer preferences. For 2018 numbers, the big consumer with was in gasoline and diesel, combining for over $200 billion in lowered costs. Coal and natural gas combined came in at about $30 billion.

The producers’ slice of the pie comes in at $71 billion in 2018 and averaged $62 billion over the study period. Gasoline was the largest portion of that, averaging $25 billion, with coal and natural gas varying with the changing usage pattern. Here, the split was quite different, with gasoline and diesel coming in under $50 billion, natural gas at about $20 billion and coal at about $10 billion.

But the author went quite a bit further by assigning the benefits to specific companies based on their shares of the US market. Here, many petroleum companies also got benefits from natural gas, making their cut even more substantial. EQT corporation, a large natural gas producer, pocketed about $700 million in 2018, with Exxon getting another $690 million. BP and Chevron were also in the top five, combining for roughly a billion dollars. In all but Chevron’s case, most of their share of the subsidy came from their natural gas production.

Given petroleum products are part of an international market where prices are largely independent of the source, Kotchen also looked at where the subsidies went based on total global oil production. Here, Exxon dropped to fifth, at about $900 million of the 2018 subsidy. It trailed nationalized oil companies from Iran, Kuwait, Russia, and Saudi Arabia, with the later taking in over $3 billion.

Coal is unusual in that the contracting market has seen companies consolidate. As a result, the two largest companies, Peabody Energy and Arch coal, took home more (over $2.5 billion) in 2018 than the next five companies combined. And, since many coal companies are losing money, this subsidy made a large difference. Of the nine coal firms that had a profit in 2018, the profits of six were smaller than the subsidy they received. In other words, if it weren’t for the fact that the health and environmental costs of coal were externalized, 20 of the 23 top companies in the market would have lost money in 2018.

What’s equitable?

It’s easy to focus on the fact that consumers get most of the benefits of the externalized health and environmental costs, and think that things aren’t so bad—that the subsidies are offsetting the costs. But that’s very unlikely to be true. Health and environmental impacts disproportionately strike those in the lower income brackets, while energy use tends to rise with income. Many of the consumers in this analysis are also other corporations rather than people. So, it’s unlikely to be a neat offset.

Beyond that, the analysis isn’t especially shocking. Various estimates have placed the externalities of fossil fuel use in the billions for the US, and this paper doesn’t stand out in that regard. Beyond that, its apportionment of the benefits to different companies largely parallels the size of their sales, which is predictable.

Still, as the US edges into various forms of carbon pricing, understanding where the impacts would show up could be valuable for setting policies that don’t disproportionately impact low-income consumers.

PNAS, 2021. DOI: 10.1073/pnas.2011969118  (About DOIs).