Energy Subsidies and Sustainability: The Future of ESG in the UK

This article is part of our collaboration with International Policy Review at IE University. Photo Credits: Natural History Museum.

Abstract

How do market distortions (subsidies) in energy consumption contribute to or counteract ongoing sustainable efforts in consumption? What is the effect of this on ongoing ESG reporting in a given national unit? What lessons can a case study of the United Kingdom offer in this context?

1. Introduction

In recent years, global perspectives on energy abundance and resource management have shifted significantly, driven by factors such as population growth, climate change, and the eventual depletion of non-renewable resources. Klare notes a transformation in mindset, from the post-1940s belief in energy abundance to a growing sense of scarcity that emerged alongside the rise of fracking and changing energy geopolitics, particularly after global oil production peaked in the 1970s and 1980s. Fossil fuels, especially oil, remain the cornerstone of energy supply for the world’s most powerful economies. As such, they have frequently been at the heart of geopolitical tensions and trade conflicts, as seen in events like the Gulf War (1990–1991) and the conflicts in Sudan and South Sudan (1983–2005, 2013).

In addition to longstanding issues in energy markets, such as import dependency, governments have been forced to reconsider their approach to energy subsidies and energy consumption. Growing impacts of climate change have aggravated existing issues like food scarcity, creating conjoint problems like increased food related aid. Naturally, each government makes decisions concerning its energy pricing model based on domestic energy availability, or difficulty of access through tariffs, often affected by political instability, and consumer demand and purchasing power. However, fluctuations in these factors can still have a negative impact on the businesses that provide them and the people that rely on it.

As part of the all encompassing Sustainable Development Goals (SDG) framework and because of the imminent pressures of climate change, business owners are increasingly looking to implement sustainable initiatives like Environmental, Social and Governance (ESG) reporting to hold themselves and their stakeholders accountable for their actions. This is done through transparent and public information about their activities, as part of a conscious initiative from the shareholders and business management or out of recent government implementation. The number of monitored companies worldwide that publish sustainability reports (ESG) has tripled since 2016, standing at 70% in 2021, however there is room for improvement in the extent to which each SDG is reported on.

Progress on SDG 12 (sustainable consumption and production) has been promising with the 2023 progress report showing it as the SDG most on track with its initial timeline and goals, at approximately 35%. Unfortunately, as a specific goal, fossil fuel subsidies are considered as stagnant or regressing to their previous levels of usage before the implementation of the SDG framework.

Fossil fuels have been known to create market distortions and undermine climate change mitigation efforts and most governments are implementing a variety of long term solutions to produce sustainable energy. As SDG 12 focuses on consumption and production processes, it is important to understand that domestic material consumption, including all the raw materials needed to produce every good and service in a given economy to satisfy its demand (e.g. energy), has a material footprint based on the consumption of the goods and services. Material footprints are largely disproportionate between high-income and low-income countries highlighting differences in responsibility for resource consumption and exploitation.

Striking the balance between subsidising energy sources within a country in a way that is sustainable and accessible to its population, and the commitment to sustainability in energy and its wider environmental, social and governmental responsibilities, is something that most governments are still looking to find. This brings about the question of how market distortions, like energy subsidies, can contribute to sustainable business consumption initiatives like ESG reporting ,and what the future of public policy related to business function is, as shaped by ESG frameworks. This paper will aim to answer this question, drawing on the United Kingdom (UK) as a case study as one of two jurisdictions in the world that have implemented mandatory ESG reporting across all sectors for more than a year.

1.1 Definitions

A ‘subsidy’ can be defined as a benefit given to an individual, business or government and is usually provided by a governmental body. This definition alone can be diminutive in nature to the complexity of subsidies and the way that governments use them, as outlined by Schwartz and Clements who define a subsidy as ‘any government assistance that (i) allows consumers to purchase goods and services at prices lower than those offered by a perfectly competitive private sector, or (ii) raises producers’ incomes beyond those that would be earned without this intervention.’

The definition of sustainable consumption varies for the same reasons that ‘subsidy’ is hard to define, as there are more theoretical disagreements about what sustainable consumption means; whether [consumption] be done more efficiently, or more responsibly. The perspective of whose responsibility this is—the consumers or the producers—can be seen as another ideological divergence in its definition.

When definitions on these are not generally agreed upon, each country will only reduce financial incentives that they consider as ‘subsidies’. This limits the extent and speed at which countries will reduce fossil fuel subsidies and the accuracy of ESG reporting on energy consumption, as not all countries will consider the same financial incentives (and subsequently its effects) as ‘subsidies’.

According to Corden, ‘distortions’ can be classified into ‘distortion’ and ‘endogenous divergence’. Distortions are divergences ‘caused by government policy of some kind, such as a tariff or other form of tax’ and can be further differentiated into byproduct distortions, caused by ‘a government policy designed to correct or partially correct divergence’. Other distortions are caused by tariffs and other public policy related measures like minimum wage and social regulations. Endogenous divergences occur due to market failure from pre-existing policies, or laissez faire policies, such as allowing monopoly of product and factor markets (all related inputs involved in economic activity), asymmetrical knowledge, and other externalities that cannot be easily eliminated by government action. There are a number of different market distortions that can affect energy prices however, and this study will focus on geopolitical occurrences, e.g. the Russo-Ukrainian war (2022 onwards), import dependency, the rate of transition to renewable energy, effects of subsidies and import and export restrictions including tariffs.

Energy security has become increasingly important and can be defined as ensuring sufficient, uninterrupted access to energy supplies at an affordable price. To ensure such access, governments may price energy according to different strategies, including but not limited to the plus pricing model, the national price model, and the value based model.

The plus pricing model is a pricing strategy in which a specific fixed percentage is added to the original price of the product to determine the selling price. It is often used for government contracts. However, it has been criticised for reducing the incentives for suppliers to control other costs related to the production and sale of the product/service.

The national price model is carried out when a company decides to adopt uniform consumer prices across all of the locations they supply in the nation despite different market conditions.

Regional pricing is also an option under which locations across the nation would be grouped into sub-national levels to charge varying prices.

Lastly, the value based model is understood as the price of a good or service being determined by how much it is perceived the consumers are willing to pay for it.

Ultimately, Environmental, Social and Governance reporting (ESG) can be defined as ‘the disclosure of information about business operations in relation to environmental, social and governance areas of the business’. At times this emergent type of business reporting can also be referred to as sustainability reporting. As a party to the UN 2030 Agenda, the UK combines the SDG framework with its own respective frameworks (Task Force on Climate-related Financial Disclosures (TCFD), along with changes to general company law) to create sustainability-centred legislation and hopes to reach the 2030 Agenda and other climate goals.

1.2 Literature Review

Opposing views on the effectiveness of energy subsidies are prevalent throughout existing literature as Koplow argues that subsidies and other exemptions for highly polluting forms of energy reduce domestic incentives to develop and produce cleaner alternative energy. The main intentions for implementing subsidies are creating new jobs at home, social welfare, rural development etc. Despite these schemes, subsidies often fail to make an impact in these areas similarly to existing policies. Existing subsidies can be better implemented with targeted policies as subsidies often benefit the wealthy even when targeting poorer parts of society.

As part of a wider analysis into how fossil fuel subsidies can affect energy consumption in different sectors, Li and Lin studied fossil fuel subsidies that were removed going into the 11th Five Year Plan (FYP) in China (2006-2010). Their findings concluded that energy waste decreases when fossil fuel subsidies are removed, saving 3.7% of energy that would have otherwise been wastefully consumed or wasted altogether. Under the plus pricing model implemented in China, there are specific sectors like ‘transport, storage and post’, ‘residential consumption’ and ‘mining and quarrying’ that show a larger potential for energy saving long term. As forms of energy, oil and natural gas have a greater potential to minimise energy waste in comparison to other energy types, saving between 30%-35% of energy respectively. Fossil fuel subsidies are directed towards oil that is imported because domestic production is significantly lower than demand, so removing subsidies on oil will significantly affect energy consumption.

When Lin and Ouyang further studied fossil fuel reforms in China which, like many other countries, is heavily reliant on fossil fuels due to energy demand, China’s CO2 emissions were found to be rising. Other factors like energy scarcity and environmental deterioration continue to affect energy reforms in the country. They found that the policy reforms in 2009 reduced fossil fuel subsidies and changed the subsidy structure. Oil prices were brought down closer to international levels. During the period studied (2006-2010), China was in a period of industrialization that naturally requires large amounts of energy consumption, becoming the world’s largest carbon emitter in 2006 and consumer in 2010; at the same time China saw the need to transition to a low carbon economy with the implications of such energy and carbon intensities and consumption concerns. Nonetheless, energy price reform has not often been a priority for government officials. A key barrier to reform is lack of transparency surrounding energy subsidies, which can obscure their subsequent short term energy costs and impacts. When governments try to reduce or remove these subsidies, subsequent increases in energy prices are seen as government failures, rather than an inherent inefficiency of subsidies as a system. Price changes provoke public backlash and are often the government’s main obstacle to environmental reform.

2. Market Distortions

Taking into consideration the mixed findings on the effectiveness of fossil fuel subsidies and how their removal can be seen as beneficial in some ways, it is important to also look at various other factors that may affect the implementation of fossil fuel subsidies and the price of energy.

2.1 Global Phenomena

Often through the form of trade agreements and regional sharing schemes, governments buy energy from other countries when they are unable to produce enough energy domestically; this same reliance on international sources of energy can also be the source of market distortions as seen during the global energy crisis, largely exacerbated by the Russo-Ukrainian war in recent years. Starting in 2020, global energy subsidies increased as global operations halted due to the COVID-19 pandemic. The global health crisis forced an unprecedented number to rely on the welfare state due to not being able to work, or rely on personal savings and the government to subsidize basic necessities like energy, that were in short supply due to the aforementioned supply halt and mass unemployment.

2.2 Import Dependency

The UK imports the majority of the energy that it relies on, with its import dependency over the years ranging between 40% and 60%. This large dependency on external powers for energy would make any nation vulnerable to fluctuating energy prices and availability. Hence, governments put in place subsidies and have increasingly needed to vary their energy sources to shield the general public as consumers from these changes.

2.3 Rate of transition of renewable energy

Transitioning from a dominant source of energy to another is a difficult, time consuming and expensive process, and many countries may not have the resources to implement such drastic changes quickly. Having made the commitment to transition away from fossil fuels along with other sustainability goals through the UN 2030 Agenda, the UK has started its respective transition to a society fully reliant on renewable energy.

2.4 Subsidies

Subsidies serve as a market distortion as they bring down the price of various goods including energy, for both long and short periods. Aimed at increasing access to essential goods and services like energy, subsidies are also used to stabilize prices when other factors or market distortions, like global phenomena, threaten the affordability and supply of energy.

2.5 Import and export restrictions

Linked to the aforementioned import dependency, import and export restrictions like tariffs, when not used to protect domestic industries, can limit the availability of energy and raise prices for consumers and businesses, at times limiting operations. Economically, increased energy prices would lead to a decrease in consumption if consumers are not shielded from price changes by these types of subsidies.

Fig. 1: Energy Subsidies in the UK.

Source: Department for Energy Security and Net Zero.

3. Case Study of the United Kingdom

As a common reporting practice, energy prices are measured in six month periods in order to compare prices with minimal seasonal fluctuations; National pricing in the UK allows a single market to exist as buyers and sellers of energy can agree upon a price in private, through schemes or other forms of government facilitation like the Contracts of Difference Scheme. Having started in 2014, the Contracts of Difference Scheme has a £1.5 billion renewable energy budget, and is currently in its sixth round of allocations, and is a common contractual and financial model used to facilitate the UK’s transition to renewable energy. Subsidies will be paid back at an agreed point, while selling renewable energy at a guaranteed price gives both possible developers and investors more certainty in their investment as well as the general population more security in energy prices.

Fig. 2: UK Contracts for Different Allocation Rounds.

Source: Department for Energy Security and Net Zero.

Energy consumption can vary throughout the year and naturally increases during winter months as households and businesses heat their respective spaces. Higher energy prices in recent years have found that six in nine households were not able to heat their homes, while four in nine fell short of the temperature standards for a comfortable and healthy space, causing concern for housing and health systems, further emphasizing the importance of energy security. Subsidies in the form of automatic payments to those already a part of other government welfare programs, e.g. Cold Weather Payments and Warm House Discount, have been established to help the most vulnerable groups in society like the elderly during this time however, have had to be expanded upon by the UK government to support more of the population’s access to energy. In comparison to previous years, recent pressure to transition from an imported fossil fuel reliant economy due to lack of energy security and sustainability goals in mind has led to an increase in funding and proactivity in this area, which can in some

Source: Fossil Fuel Subsidy Tracker ‘United Kingdom’ (Figure 2)

ways can be attributed to the change in government as Sir Keir Starmer, took the office of Prime Minister in 2024.

Fig. 3: Renewable Subsidies in the UK 2002-2023.

Source: Renewable Energy Foundation.

Between 2015 and 2023, UK government fossil fuel subsidies exceeded those for renewable energy by more than £20 billion, with both sources of energy receiving £80 billion and £60 billion respectively in support. A fifth of the money given to the fossil fuel industry during this period was given to support new extraction and mining as overall extraction of fossil fuel increased by 20%, valued at almost £2 billion. Despite SDG 12 striving for sustainable production and consumption, it does not specifically prohibit new extraction and mining of fossil fuels, allowing respective governments to decide if this is in line with their transition to a net zero future. Some politicians argue that maintaining some fossil fuels is still part of the 2030 goals and a net zero future, as it is key to remaining attractive to investors for all energy sectors; however, the finite nature of fossil fuels and evidence supporting that recent subsidisation of fossil fuels impedes this very transition speaks to the contrary. The UK, amongst many other countries, subsidized coal, natural gas and end use electricity in 2021/2022 during the energy crisis exacerbated by the Russo-Ukrainian war, in order to meet public demand as global subsidy trends followed suit, with Ukraine being the fifth largest producer of oil in the form of gas and diesel in the world.

Fig. 4: ‘World Energy Consumption’ in mtoe (millions of tonnes of oil equivalent).

Source: Enerdata.

3.1 Policies and support programmes

Aside from the Contract of Difference Scheme, the UK government has implemented various other energy subsidy related policies. As of June 2023, the UK government spent almost £40 billion on energy subsidies for homes and businesses, before a further £21 billion was spent on subsidized energy to homes between October 2023 and March 2024. In this holistic approach to energy security during which supply is constrained by the Russo-Ukrainian war and demand increases due to weather conditions, the need for subsidies is evident in reports from the Committee of Public Accounts, which cite average annual household energy bills as £1,277 during the winter of 2021/2022. In the following calendar year, this amount had increased to £3,549 with a staggering 177.9% increase in prices for the average consumer. Little has stopped this price from increasing with projected costs without government intervention (also referred to as the ‘baseline’) standing at £4,300, a 236% increase from before the war and global energy price surges. Seen as one of the most subsidized moments in recent history across all sectors of the economy, it is difficult to determine not only the proportion of subsidies directed towards households vs businesses, but also for how long these subsidies will be able to stay in place as new and ongoing global phenomena and import restrictions like tariffs continue to drive the costs of goods and services upwards.

Energy security, as previously mentioned, entails not only price stability and affordability for consumers over a prolonged period of time, but also ensuring the future availability of energy/ a specific source of energy.

Fig. 5: Total Energy Consumption in the UK from 2013 to 2022.

Source: Fossil Fuel Subsidy Tracker, ‘United Kingdom.’

Fig.6: Import Dependency of Primary Fuels in the United Kingdom 1970-2022.

Source: Statista.

The UK’s main sources of energy, at 78% of energy consumption, are gas and oil, 48% of which was imported energy in 2013, the highest it had been since the 1970s. More than half of the main sources of the country’s energy being imported at the time created an incredible dependency that was not only financially unsustainable, in the face of various possible market distortions (e.g. the Russo-Ukrainian war), or the unforeseen effects of the 2008 financial crisis on global energy prices, but also increasingly expensive for the UK government. This, coupled with the establishment of the SDGs the previous year (2012), before coming into force in 2015, in many ways re-emphasized the urgency to transition to alternative sources of energy for the UK government not only as a way to increase domestic energy production and cut costs long term, but to ultimately strengthen national energy security by reducing dependency on imported energy. Furthermore, the promise of expanding renewable energy markets and climate technology attracts foreign investors to any given country, solidifying the importance of sustainable energy resources in the transition to a more sustainable and secure future.

3.2 Sustainability Efforts

In light of looking into the implementation of mandatory ESG reporting and frameworks, it is interesting to look at the UK’s sustainability objectives under SDG 12 in terms of environmental, social and governance objectives to understand how sustainable consumption is understood within these frameworks, from the perspective of public policy.

The UK’s current environmental goals include:

Improve the environment through cleaner air and water, minimised waste, thriving plants and terrestrial and marine wildlife. Legislation like the Climate Change Act 2008 established the UK’s long standing commitment to sustainability in the UK by targeting greenhouse gas reductions. This was further strengthened by the Environment Bill (2019-2022) which introduced binding long term targets for air quality, water, biodiversity and waste reduction. It also led to other policy changes including reforms in waste collection and packaging, flood defences and agricultural and animal welfare policy.
Increase the sustainability, productivity and resilience of the agriculture, fish, food and drink sectors-enhance biosecurity at the border and raise animal welfare standards. The UK government aims to protect 30% of land and marine areas by 2030 through the England Coast Path initiative, designating new protected landscapes as well as increasing natural capital and wider green finance initiatives within the country. Other initiatives include the implementation of clean air zones and Planning Reform and National Infrastructure Strategy to support growth and enhance the environment.

Sustainable energy consumption is not explicitly included in the above targets. The reduction of greenhouse gas emissions and the widening of green initiatives implies investment and increased usage of renewable energies to meet these longstanding initiatives through multiple pieces of legislation. The UK government takes a holistic approach to SDG 12, considering the labour shortage challenge, affected by COVID-19, in its planned judicial reforms and investment in public infrastructure like schools and hospitals when considering the possible overuse and over-extraction of resources for these projects and societal priorities, as well as possible foresight into security risks, technological innovation and outer space exploration.

3.3 Analysis

Energy consumption may not be affected by the importation of energy because subsidies are designed to shield consumers from fluctuating costs of energy (hence why they are also classified as market distortions). This is possible through various policies like the Contracts of Difference Scheme in the UK, as well as the overall pricing model chosen within the country that is importing the energy.

Looking specifically at the relationship between energy consumption (Figure 5) and the use of subsidies, it can be seen that within the UK, consumption (Figure 5) had steadily increased from 2014-2016, while all energy subsidies (Figure 2) declined. As an essential resource for the majority of daily tasks and public functions, slight decreases in subsidisation will not change consumption habits significantly. Until 2019, energy consumption in the UK stayed consistent before drastically dropping, despite subsidies staying consistent throughout this period. Consumption levels gradually increased between 2020-2022 but not to pre-2019 levels, as all energy sources became heavily subsidized in the UK, with coal peaking in 2022 and all other energy sources the following year. The fact that consumption varied throughout the years even when energy subsidies increased, can be attributed to the catch up effect that the Russo-Ukrainian war had on the UK’s energy security and consumption habits.

4. Conclusion

To conclude, increased subsidisation of fossil fuels in light of the global energy crisis is natural, evident and predictable, as the aim of energy subsidies is to provide energy at a lower cost to the population to satisfy demand or shield them, as consumers, during unexpected circumstances. In either case, the UK’s policies tried to do exactly that.

However, ultimately subsidies being used to balance the price of heavy import dependence, as seen in the UK, is not sustainable, can have long term budgetary effects, and can counter ongoing environmental efforts.

As seen during the crisis, energy subsidies protect consumers from price variation, while sacrificing environmental responsibilities by leaning further into fossil fuels as they are still the dominant source of energy. This shift can slow down the rate of transition to other sources of energy due to market distortion. Nevertheless, if an increase in energy subsidies is not as a result of market distortions, but rather a steady increase over time, with consideration to ongoing sustainable efforts:

Sustainable policies may not target energy wastage and their impacts on a) environment, b) social, c) governance reporting (ESG) specifically,
When both energy consumption and subsidisation are high, governments may be encouraging wasteful spending habits, further enabling their reliance on fuels that contribute to climate change, not the opposite. As a budgetary oversight, over-subsidisation of fossil fuels could be otherwise redirected to subsidizing renewable energy production and technology, in line with sustainability targets like the SDGs.

Despite previous assumptions, there is no clear evidence that the subsidisation of fossil fuels or other market distortions affect businesses more than households. Lacking this link however, does not negate the increasing importance of ESG reporting and how businesses will be affected by lack of transparency in policy, around not only subsidies but the metrics and definitions to abide by. As a continuous form of updates, ESG reports are more likely to show these smaller policy pitfalls as subsidy policies designed for short term use or to counter import dependency contradict ongoing sustainability efforts by prolonging reliance on fossil fuels.

4.1 ESG policy recommendation

Lastly, for no target adjustments to be made for the SDGs with the critical year being 2030, the adoption of legislation at an international and domestic level, is not proving to be enough.

Material footprints, access to renewable energy as a dominant source and reduced import dependency, are all able to be tackled concurrently even in the face of market distortions, as it is a matter of short term or long term goals. Subsidies are designed for short term relief while ESG reporting contributes to our future sustainability. The SDGs prove their compatibility by emphasizing them in SDG 12; despite not being expressed and it being costly, sustainable energy consumption should be an explicit target of the UK with increased policy transparency surrounding energy, allowing for more accurate and important data to make a change.

5. List of Figures

Figure 1: Energy Subsidies in the UK …………………………… 6

Figure 2: UK Contracts for Different Allocation Rounds. 7

Figure 3: Renewable Subsidies in the UK 2002-2023 ……. 7

Figure 4: World Energy Consumption’ in mtoe………….. 8

Figure 5: Total Energy Consumption in the UK from 2013 to 2022 ……………………………………………………………………… 9

Figure 6: Import Dependency of Primary Fuels in the United Kingdom 1970-2022…………………………………….…. 9

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