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Current levels of public and private investment cover only a fraction of what is needed to decarbonize the economy, expand energy access, and adapt to unavoidable climatic changes. Yet, perversely, countries spend more on fossil-fuel subsidies that drive climate change than they spend trying to combat it.

The scale of these subsidies is vast. Worldwide, countries provide some $480 billion to $630 billion every year in fossil-fuel consumption subsidies, and more than $100 billion every year in production subsidies. According to the International Energy Agency, or IEA, for every $1 spent subsidizing renewable energy globally, $6 is spent subsidizing fossil fuels.

Numerous benefits would flow from removing fossil-fuel subsidies. First, it would be a financial boon for many countries, freeing up substantial public resources for development. The government of India, for instance, has been grappling with the economic drain from fossil-fuel subsidies, which climbed to some $40 billion in 2011, a full 2.2 percent of total gross domestic product, or GDP. Redirecting money from fossil-fuel subsidies to social goods and services could bring breakthrough development gains in India, where 400 million people live on less than $1.25 per day.

Second, phasing out fossil-fuel subsidies would be a major step forward in the fight against climate change. The IEA estimates that eliminating these subsidies would reduce C0 2 emissions by 1.7 gigatons, equivalent to all of Russia’s annual emissions. And leveling the playing field between fossil fuels and renewable alternatives would unlock substantial clean energy investment.

Third, countries would reap the myriad air quality and energy security benefits associated with curbing fossil-fuel usage. Fourth, it would help developed countries make critical progress toward fulfilling their international commitment from the 2009 Copenhagen Accord to mobilize $100 billion of climate finance from public and private sources annually by 2020.

With such clear and wide-ranging benefits, it is welcome news that over the past five years, countries have committed to phase out their inefficient fossil-fuel subsidies in a number of international fora—from the G20 to the Asia-Pacific Economic Cooperation, or APEC, to the U.N. Conference on Sustainable Development, or Rio+20. And U.N. Secretary-General Ban Ki-moon’s High-Level Panel on the Post-2015 Development Agenda—co-chaired by Indonesian President Susilo Bambang Yudhoyono, Liberian President Ellen Johnson Sirleaf, and U.K. Prime Minister David Cameron—recommends that fossil-fuel subsidy phase-out be included among the post-2015 sustainable development goals.

Over this same period, the World Bank, the International Monetary Fund, or IMF, the Organisation for Economic Co-operation and Development, or OECD, and the International Energy Association, or IEA, have also all ramped up their technical assistance to help countries reform subsidies by providing information about their scope and costs and by building governments’ capacity to implement reforms. Some IMF loans have required subsidy reductions as part of their conditionality packages. In addition, civil society groups have helped deepen understanding and raise awareness of this issue.

Yet, despite this attention, progress is painfully slow. Technical assistance is useful for countries where governments are ready to reform, but there are few such instances because the chief obstacles to removing fossil-fuel subsidies are not technical or economic but political. Subsidies take public money and redistribute it unevenly to fossil-fuel users and producers. These beneficiaries’ interests become vested, creating a powerful constituency to maintain the status quo.

To roll back fossil-fuel subsidies, we need a policy tool strong enough to transform the cost-benefit calculations of key domestic interest groups in order to create the political conditions for reform.

This issue brief proposes just such a tool: subsidy phase-out and reform catalyst, or SPARC, bonds. This new financial instrument would be issued to private investors by an international financial institution, such as the World Bank, on behalf of a country. The country would then be able to use the funds to overcome political barriers to reforming fossil-fuel subsidies, such as investing in alternative energy projects, compensating subsidy beneficiaries, or developing other social projects. The future savings from phasing out fossil-fuel subsidies would then be paid back to investors.

Drawing on private capital markets, SPARC bonds can offer countries the financial leverage they need to tackle the difficult politics of subsidy reform and unlock a host of fiscal, development, and climate-related benefits.

What are subsidy phase-out and reform catalyst bonds?

This new financial instrument would function like a standard bond, allowing governments to raise money from private capital markets by promising to pay investors a fixed amount in the future. But SPARC bonds would have two unique features. First, they would be issued on the condition that they be repaid with the savings accrued from phasing down fossil-fuel subsidies. Second, they would be issued by or in coordination with the World Bank or similar institution with an AAA credit rating on behalf of a government. This would reduce the risk of nonpayment and provide a channel for donors to subsidize the bonds, making SPARC bonds an inexpensive way for governments to borrow.

Backed by international financial institutions—and potentially subsidized by donor countries—SPARC bonds would allow a government to raise money at better terms than the market could currently provide. And because fossil-fuel subsidies are so large, SPARC bonds would provide a reform-minded government with a vast war chest, raised mostly from private capital markets, to cut through the political obstacles to subsidy reform. Governments could use the proceeds from SPARC bonds to invest in low-carbon alternatives to fossil fuels, conditional cash transfers to citizens, protection for vulnerable populations that may benefit from subsidies, or other social projects that could mobilize powerful new coalitions for reform.

Because SPARC bonds are backed by international financial institutions and offer competitive returns, most SPARC bonds would readily find buyers in global bond markets. Indeed, demand for such an instrument is likely to grow as the divestment campaign gathers steam and large investors scrutinize their portfolios for carbon risk. As decarbonizing financial products, SPARC bonds would likely be especially attractive to pension funds, insurance companies, and family foundations or other endowed entities seeking to make a positive social and environmental impact with their investments.

In more difficult cases, some level of public guarantee may be needed to make SPARC bonds attractive to private investors and governments. Public support for SPARC bonds—which on a dollar-for-dollar basis would provide a very attractive way for public money to leverage private capital—could come from a variety of new or existing sources. Existing sources include a redirection of some of the funding currently made available for climate activities through the Global Environment Facility or the Climate Investment Funds under the World Bank.

One promising vehicle for SPARC bonds could be the Green Climate Fund, or GCF. In the 2009 Copenhagen Accord, countries agreed to set up this new fund, and over the past few years, have established a governing structure and other protocols that will allow it to soon receive money and become fully operational. The United States and other countries have been particularly interested in the potential of this fund to better coordinate public and private climate financing, but there is concern that the fund still lacks a clearly defined function in this respect.

By taking the lead on SPARC bonds, the GCF would fill an important void. GCF could serve both as a direct channel for those interested in providing public and private support for such bonds and as the lead coordinator between investors, the World Bank, and others involved in backing and investing in such bonds. With developed countries under increasing pressure to begin pledging funds soon, a clear decision by the GCF to become the lead institution on SPARC bonds would increase its prospects of raising the money from donors that it needs to succeed.

Why subsidy phase-out and reform catalyst bonds can work

SPARC bonds can succeed where other efforts have failed because they focus squarely on the hard realities of how, why, and where fossil-fuel subsidies are deployed.

Fossil-fuel subsidies take many forms, including direct cash transfers, tax breaks, price controls, and other instruments. Pre-tax subsidies include direct transfers or price controls and are generally more common in developing countries. An example of a direct transfer is a subsidized allotment of oil for consumers, while a price control could be capping the price of gasoline below the market rate for consumers. Post-tax subsidies include more abstract forms of subsidy, such as when fossil fuels are taxed relatively less than other consumer products. These types of subsidy are more common in wealthy countries.

Because fossil-fuel subsidies are complex and data are sparse for many countries, they can be measured in different ways. The table below gives an overview of current estimates of pre-tax subsidies.