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 do government subsidies help an industry?

    Understand how government subsidies can help an industry, on both the consumer and supplier side. Learn the potential drawback ... Read Answer >>
  2. How does the price of oil affect the stock market?

    Read about how the price of oil might impact the stock market and why economists have not been able to find a strong correlation ... Read Answer >>
  3. How does the law of supply and demand affect the oil industry?

    Learn how the law of supply and demand affects the oil industry. Supply and demand determines the price of oil, which drives ... Read Answer >>
Related Articles
  1. 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?
  2. Taxes

    Should Sports Teams Receive Tax Breaks?

    Here are some of the costs, pros and cons of sports teams receiving tax breaks.
  3. 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.
  4. 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.
  5. 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.
  6. Retirement

    Petrobras Impact on the Brazilian Economy

    How the Petrobas scandal has shaken the Brazilian economy.
  7. Investing

    How Low Can Oil Prices Go?

    Record low oil prices are a welcome development for consumers, but oil companies are struggling with choosing market share over profitability.
  8. Investing

    What determines oil prices?

    Understand the economic factors and other market forces that impact oil prices.
  9. Investing

    OPEC vs the U.S.: Who Controls Oil Prices?

    In the last 100 years, pricing power for oil has swung between the United States and OPEC. What does the future hold?
  10. Investing

    The Strategic Oil Reserves Explained

    Strategic oil reserves are one of the least known and least understood national security measures in the United States.
RELATED TERMS
  1. Countervailing Duties (CVDs)

    Countervailing Duties (CVDs) are tariffs levied on imported goods ...
  2. Cost-Sharing Reductions

    Cost-sharing reductions are a type of federal subsidy distributed ...
  3. Alternative Fuels Tax Credit

    The alternative fuels credit, as outlined by the Internal Revenue ...
  4. Alcohol Fuels Credit

    The alcohol fuels credit is a non-refundable credit that is equal ...
  5. IRS Publication 516 - U.S. Government Civilian Employees Stationed Abroad

    A document published by the Internal Revenue Service that details ...
  6. Peak Oil

    Peak oil is the point at which global oil production will hit ...
Trading Center