A:

In order to make the price of oil more affordable to its citizens, governments sometimes provide subsidies, which can allow the price of oil to remain fixed below free floating market rates. For example, in May 2008, Venezuela was heavily subsidizing oil, allowing its citizens to only pay $0.05 per liter, whereas most Western countries pay costs in excess of $1 per liter (or $3.80 per gallon). However, if oil prices increase, countries that heavily subsidize oil prices may suffer, because the cost of the subsidies will start consuming ever-larger amounts their budgets. This could lead to money being taken away from other areas of public funding, such as social programs and infrastructure.

Similarly, this effect will be magnified by the fact that the demand for oil in these countries will tend to remain stable, or even grow, because the lack of change in fuel costs fails to provide any incentive for citizens to reduce their consumption. Eventually, the government will have no choice but to slowly remove the subsidy in order slowly lessen the public's demand for fuel, although doing so is likely to result in some civil unrest.

On a global scale, many of the countries that use subsidies are emerging countries, which need the cheap fuel to power their fledgling industries. However, if these subsidies are still in place over the long term, the price of fuel will grow even higher as the hunger for subsidized fuel grows in emerging countries, regardless on how much demand for fuel drops in Western countries.

For related reading, check out Why You Can't Influence Gas Prices and Getting A Grip On The Cost Of Gas.

RELATED FAQS
  1. How are subsidies justifiable in a free market system?

    Learn some of the arguments in favor of or against providing subsidies in a market economy, including economic and political ... Read Answer >>
  2. How does a government decide what industries to subsidize?

    Learn about the political, economic and developmental arguments in favor of providing public subsidies to industries. Read Answer >>
  3. How does the price of oil affect Venezuela's economy?

    Learn how the price of oil has a direct relationship with Venezuela's economy. High oil prices result in good times for the ... Read Answer >>
  4. How do government subsidies affect the profitability of the airline industry?

    Read about the history of government subsidies to American airline companies since 1918, and why it benefits large companies ... Read Answer >>
  5. Which countries are able to produce oil and gas the cheapest?

    Read about the countries with the least expensive access to oil and gas, most of which are unsurprisingly located in the ... Read Answer >>
Related Articles
  1. Taxes

    What's a Subsidy?

    A subsidy is a benefit given to an individual, business or institution, typically by the government. Subsidies are given to promote a social good or an economic policy. The government usually ...
  2. Investing

    A Guide To Investing In Oil Markets

    Find out how to take advantage of this market without having to open a futures account.
  3. Insights

    Who Wins With Low Energy Prices? 

    Low oil prices are here to stay for some time. Which economies will benefit or lose from the low oil price regime?
  4. Small Business

    Government Subsidies For Business

    Many industries rely on government assistance in both good times and bad. What are the benefits of these programs, and how do they impact the consumer?
  5. Investing

    Who is Most Affected by Lower Oil Prices?

    With low oil prices affecting just about everyone, from citizens to corporations to entire nations, we look at who wins and who loses with the price drop.
  6. Investing

    What We Learned From The Last Oil Shock

    The last oil shock in the 1970s carries some valuable lessons for consumers facing a repeat today.
  7. Investing

    Venezuela Economics: 4 Reasons Why This Country May Go Under

    Find out the reasons behind Venezuela's economic woes and why many economists believe it is headed for collapse in the coming year.
  8. Investing

    Venezuela Teeters On Edge As Oil Revenues Shrink

    Low oil prices have drastically revised the economic status quo -- dealing a destabilizing blow to oil-exporters like Venezuela due to falling oil revenue.
  9. Investing

    Not All Oil Economies Are Created Equal

    One would think that any nation with oil would have a populace rolling in money, but that's not the case. So how does oil influence a country's economy?
  10. Investing

    Understanding How Oil Companies Pay Taxes

    Read about how big oil corporations pay taxes, and learn about tax exemptions and the option to defer. Discover the argument about big oil being given tax exemptions
RELATED TERMS
  1. Subsidy

    A benefit given by the government to groups or individuals usually ...
  2. Countervailing Duties

    Tariffs levied on imported goods to offset subsidies made to ...
  3. Crude Oil

    Crude oil is a naturally occurring, unrefined petroleum product ...
  4. Alien

    Any person who is not a citizen of the country in which he or ...
  5. Market Distortion

    An economic scenario that occurs when there is an intervention ...
  6. Macroeconomic Stabilization Fund - FEM

    A reserve fund established by the country of Venezuela. Also ...
Hot Definitions
  1. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  2. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  3. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  4. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
Trading Center