By Defne Gencer and Jas Singh
The conflict in the Middle East puts energy subsidies back on the agenda – but often they are counterproductive: Broad-based energy subsidies strain public budgets, distort markets, disincentivize efficient energy use, and disproportionately benefit richer households – all while delivering limited support to the poor.
Energy prices and efficiency reinforce each other: Cost-reflective energy prices incentivize investment in energy efficiency, while efficiency improvements help households and firms cope with higher prices and reduce the need for governments to hand out subsidies.
Integrated reforms deliver better outcomes: Coordinating energy price reforms with targeted social support and efficiency initiatives can improve affordability, fiscal sustainability, energy security, and resilience to future energy shocks.
Energy bills are on the agenda, once again. In response to oil and gas supply disruptions and higher prices due to the conflict in the Middle East, many governments around the world have resorted to energy price subsidies, seeking to cushion the impact of rising fuel costs on consumers. Such a reaction is common whenever energy prices surge, as proponents of energy subsidies argue that they support poorer households. However, this is often not the case, as country-specific and global data show. Instead of keeping energy prices artificially low, governments should allow energy prices to rise to send clear economic signals, offer targeted and transparent support to the most vulnerable, and incentivize energy conservation and efficiency.
Contrary to common perceptions, energy subsidies do not help the poorest the most. Take Ecuador, where liquid fuel prices were subsidized until 2024-2025. During that time, the richest households accounted for more than half of total fuel consumption and captured over 41% of diesel subsidies, for which the government spent more than a billion dollars each year. Globally, the IMF estimates that for every dollar spent by governments on fuel subsidies, the poorest 20% of households receive just 8 cents.
Making energy “cheap” comes with significant costs. Energy subsidies put a huge strain on limited public budgets, create economic distortions, disincentivize energy conservation and efficiency, weaken energy sector financials, and divert limited public funds away from investments in policy priorities such as health, education, and job creation. At a time when many governments are concerned about energy security, dependence on expensive energy imports, and fiscal sustainability, energy subsidies exacerbate all three.
Instead, energy prices can provide a powerful incentive to strengthen energy efficiency, often dubbed the “first fuel” in the energy transition. Getting energy prices right is a critical enabler of energy efficiency investments and financing. When households and firms face the true cost of energy, they have more reason to reduce energy use and innovate. Conversely, the mutually reinforcing relationship between energy prices and energy efficiency means that energy efficiency helps mitigate the impacts of high energy prices on households and businesses, while reducing governments’ burden to provide subsidies (along with numerous other benefits). Evidence shows that energy efficiency has a crucial role in helping economies adapt to and absorb energy price increases over time.
Getting Energy Prices Right Can Incentivize Efficiency
When energy prices are kept artificially low, households and firms have fewer incentives to invest in energy efficiency. Cost-reflective energy prices, in contrast, boost returns on energy efficiency investments. In Uzbekistan, a 2016 study estimated that replacing inefficient gas boilers with efficient ones would reduce gas consumption by 2.4 billion m3 (13% of residential and commercial gas consumption). With a payback period of less than eight years; cost-reflective tariffs would reduce the payback period to less than five years. Reforms can become more politically acceptable and socially sustainable when accompanied by efficiency programs that help households and firms reduce consumption, as was done in the Ukraine in 2016.
Reducing energy subsidies free up fiscal resources that can be used to incentivize efficiency. Governments can leverage the benefits of improved incentives by redirecting funds set aside for energy subsidies toward financing of energy efficiency, which can counteract rising energy bills. Alternatively, governments can consider a one-time infusion to capitalize an energy efficiency revolving fund or offer grants to households, as has been done in much of Europe and Central Asia (including in Lithuania, Kosovo and Spain), or support guarantees for commercial or industrial enterprises (as in India).
How Energy Efficiency Facilitates Price Reforms
Energy efficiency is essential to energy affordability. Energy efficiency is among the most cost-effective ways of lowering energy bills. A household that invests in common efficiency measures, such as efficient heating or lighting, can save 10–50% or more on energy bills. At a larger scale, a recent analysis found that, in the United States, households spent an average of $6,000 less, and businesses nationwide $300 billion less, on their utility bills over the past decade due to federal energy efficiency appliance standards.
Energy efficiency can moderate the impact of energy price shocks on families and businesses. Using more efficient equipment is an effective defense against the impacts of energy price increases, be they policy-induced or due to external shocks. In 2022, the IEA estimated that, in its member countries, prior energy efficiency investments lowered consumers’ energy bills by $600 billion. For firms, energy efficiency helps responding and adapting to energy price shocks: when energy prices go up, firms substitute inputs, innovate, or reduce output. Research shows that more energy efficient firms are less affected by price increases.
Price reforms that leverage energy efficiency can address the needs of the poor while eliminating distortions. Because the poor tend to live in older housing with older appliances and little insulation, their energy bills are typically much higher (34–82% or more) than those of better-off families. In Eastern and Central Asia, the poor tend to spend a larger share of their household budgets on heating: 34% of the population spend 10% or more of their average monthly expenditure on energy. However, with programs in place that facilitate investments in energy efficiency with affordable options, many do opt to invest, easing fiscal pressures from broad-based subsidies.
An integrated policy approach for better results
Despite global efforts to lower energy subsidies and improve energy efficiency, much more needs to be done. Energy subsidies stood at a staggering $600 billion per year in 2024. Such subsidies divert funding from more pressing needs such as healthcare, education, job creation, or poverty eradication. On the energy efficiency side, about two-thirds of energy was still wasted and developing countries struggle to access the trillions of dollars needed for new energy infrastructure to fuel economic growth. Governments need to do better to achieve global development, poverty eradication, and climate ambitions. The missing ingredient has been political will.
With renewed attention to energy affordability, security and sustainability, time is ripe for action. Getting energy prices right and improving energy efficiency reinforce one another, creating momentum to overcome political resistance. Both can be difficult to scale up separately but tackling them jointly gives governments a better chance of success. The good news is that here has been growing recognition of the value of combining and coordinating energy price reforms and efficiency interventions over the last two decades, as shown in work by the World Bank, ESMAP, and IEG, and recent government action on that front. For instance, under an ESMAP-supported pilot in India, the government of Punjab deployed incentives in 2019 to shift from free electricity toward rewarding verified electricity savings and sharing the subsidy bill savings with farmers. Enrolled farmers responded by adopting efficient pumps and better irrigation practices. In Tajikistan, a recent government initiative combines gradual electricity tariff increases for the country’s large aluminum smelter with the adoption of energy efficiency standards.
Evidence and experience indicate that energy price reforms and efficiency will be important parts of government toolkits going forward. Governments can leverage the complementary relationship of energy prices and efficiency by following a holistic approach that combines several key elements:
Considering energy price reforms and efficiency together in energy sector strategies and investment plans. Tariff designs should reflect efficient costs and incentives for improvements in efficiency of energy use; while consumption and efficiency improvement projections should assess the impacts of adjusted energy prices.
Incorporating energy efficiency in energy price reform designs. Energy efficiency measures should ideally precede energy price reforms, and fiscal savings from energy subsidy reforms can finance energy efficiency incentives, along with targeted compensation for households and firms. Public communication efforts should highlight why price reforms are needed and how mitigation measures, including energy efficiency programs, can help citizens cope.
Monitoring and evaluating programs to assess impacts on energy consumption and consumer behavior. In addition to regular monitoring of the impacts of efficiency initiatives, household surveys and distributional analyses can assess the impacts of price reforms, and how targeted support and efficiency programs help mitigate impacts and improve outcomes.
In sum, energy price reform and energy efficiency are strongest when pursued together. By allowing prices to reflect real costs of energy supply, while reinvesting funds otherwise spent on subsidies into targeted support and energy efficiency, governments can protect vulnerable households, strengthen energy security, and ease fiscal pressures. This virtuous cycle offers a more durable and equitable path to affordability, resilience, and economic growth in an era of recurring energy shocks.