Global warming is one of the primary global concerns. Countries around the world are increasingly concerned about the buildup of greenhouse gases in the atmosphere, especially carbon dioxide (CO2), methane, nitrous oxide, ozone, and chlorofluorocarbons (CFCs), which can significantly contribute to surface warming (Churchill & Saunders, 1991). Emissions produced from human activities have been the main cause of climate change since pre-industrial times (Jones et al., 2023). From 1990 to 2020, the electricity and heat generation sector became the main source of greenhouse gas (GHG) emissions, followed by the transportation sector (see Figure 1).

Source: ourworldindata.org (2024)

The increase in fossil fuel usage across various sectors—including energy, industry, transportation, waste management, and forestry—has led to higher atmospheric concentrations of carbon dioxide (CO2), methane (CH4), and nitrogen oxides (N2O). This has disrupted the energy balance on Earth. Since the pre-industrial era, emissions from human activities have been the primary drivers of climate change (Jones et al., 2023). Fossil fuels significantly contribute to environmental degradation and are the main source of CO2 emissions (Yoro & Daramola, 2020). According to Figure 1, between 1990 and 2020, the electricity and heat generation sector was the leading contributor to Greenhouse Gas (GHG) emissions, followed by the transportation sector.

The issue of global warming was first discussed internationally at the Earth Summit in Rio de Janeiro in 1992, which highlighted the concept of sustainable development (United Nations, 1993). Global discussions on global warming continued until the Paris Agreement in 2015, which included a commitment by all countries to reduce emissions and work together to improve adaptation to the impacts of climate change. Despite its negative environmental impact, energy is an essential engine for strong economic growth, affecting all dimensions of sustainable human development (United Nations ESCAP, 2007). Various sectors of life such as industry, transportation, communication, and households require adequate energy to function effectively.

In the dynamics of a country's development, energy consumption and economic growth are two inseparable elements. Any increase in economic activity, especially in critical sectors such as industry and infrastructure, demands greater energy supply to support smooth operations. The level of Gross Domestic Product (GDP) is an important indicator that reflects the quality of a country's economic growth, as GDP depicts the value of final goods and services produced in the economy during a given period (Blanchard, 2017). An increase in GDP is usually followed by an increase in energy consumption, as intensive economic activities require more energy resources.

In the current era of globalization, lower- and upper-middle-income countries play an important role in global economic dynamics. High population growth rates and rapid economic growth usually go hand in hand with high energy consumption, especially fuel oil. By 2022, the population of lower- and upper-middle-income countries (80 countries) will reach 3,681 million with an average annual increase in fuel consumption of 4-5% (Black, 2023).

To support economic growth and infrastructure development, the government must ensure that energy, as the primary driver of progress, is available to the community at affordable prices. To that end, the government provides support to the public through the provision of subsidies to ease the burden of energy costs. These subsidies are expected to maintain price stability and improve energy accessibility, as well as stimulate economic activity without placing an excessive burden on the community.

In promoting sustainable development, the government provides support to the community through the provision of subsidies to ease the burden of energy costs. Energy subsidies aim to ensure that all levels of society, especially low-income groups, can access energy at affordable prices. This measure not only helps reduce the economic burden on households but also encourages wider use of energy, which in turn can increase productivity. The subsidy is expected to maintain price stability and improve energy accessibility, as well as stimulate economic activity without placing an excessive burden on the community. In this context, the subsidy will reduce the selling price of fuel to the public, thereby encouraging increased fuel consumption in various sectors, including transportation, industry, and households.

Globally, fossil fuel subsidies in 2022 amounted to $7 trillion, or about 7.1% of GDP. This is an increase of $2 trillion compared to 2020 due to large government support for energy price spikes In many countries, fossil fuel subsidies are predominantly for petroleum products.

Figure 2 shows the comparison of fossil energy subsidies from various types of fuels. According to IMF data from 2015 to 2021, the largest fossil fuel subsidies are allocated to oil, which is prevalent in nearly all countries. Various sectors, including transportation, industry, and household economies, rely heavily on fuel oil. To fulfill this need, the government must ensure that fuel prices remain affordable so that economic sectors can operate efficiently.

Several studies have found that fossil fuel consumption is a major cause of environmental degradation including global warming((Fleurbaey et al., 2014); (Omri, 2013);(Yoro & Daramola, 2020)). Additionally, air pollution from fuel combustion can cause health problems, such as cardiovascular and respiratory diseases, chronic bronchitis, and increased morbidity (Mukhopadhyay & Forssell, 2005).

When it comes to environmental impacts, fuel subsidy policy is a key factor influencing energy consumption patterns. Government subsidies on fuel prices can change market dynamics and encourage increased consumption. Increased fuel consumption can accelerate environmental degradation and exacerbate global warming issues. Setting appropriate fossil fuel prices is a top priority in economic policy to reduce greenhouse gas emissions (Larsen & Shah, 1992).

The transmission mechanism from fuel subsidies to environmental costs, particularly global warming (in Figure 3) can be explained as follows: the government subsidizes fuel to lower the selling price for consumers, which can include direct price reductions, other fiscal incentives, or external costs that should be accounted for in the fuel price. As a result, fuel subsidies tend to increase fuel consumption among the public. Lower prices stimulate demand, leading to higher fossil fuel usage. The increased fuel consumption driven by these subsidies contributes to a rise in greenhouse gas emissions, such as carbon dioxide (CO2), as fuel combustion produces emissions that exacerbate global warming. This increase in greenhouse gas emissions contributes to climate change, causing environmental impacts such as rising temperatures, changing weather patterns, and rising sea levels. When these environmental losses are monetized, each liter of fuel consumed incurs associated global warming costs.

Since fuel subsidies tend to increase fossil fuel consumption, this study aims to examine the effects of fuel subsidies on global warming costs in lower-middle-income and upper-middle-income countries. By better understanding the relationship between fuel subsidies and global warming costs, more effective policy measures can be taken to reduce negative environmental impacts.

Most previous studies have focused on the relationship between fuel subsidies and carbon emissions, as conducted (Solarin, 2020), (Arzaghi & Squalli, 2023), Q. (Wang & Li, 2016), and (Husaini et al., 2021). However, no study has specifically quantified the magnitude of global warming costs caused by fuel subsidy policies, especially those related to fuel oil. Thus, this study aims to provide new insights into the economic impact of fuel oil subsidy policies on global warming costs, an area that has not been explored much in previous research.

This study emphasizes global warming costs as a direct economic impact related to fuel subsidies, rather than focusing solely on carbon emissions. By highlighting this aspect, the study addresses a critical gap in the existing literature and aims to provide a new perspective for developing more effective and sustainable energy policies.

According to IMF data (2023), there is a positive relationship between fuel subsidies and global warming costs. Figure 4 shows the relationship between fuel subsidies (X-axis) and global warming costs (Y-axis). Based on the pattern in the graph, there is a positive correlation between fuel subsidies and global warming costs. This means that the higher the fuel subsidy, the higher the resulting global warming costs.

The graph shows that when fuel subsidy values are low, global warming costs tend to be lower. However, as fuel subsidies increase, global warming costs also rise in a fairly consistent pattern. This positive correlation indicates that high fuel subsidy policies can encourage greater fossil fuel consumption, thereby increasing greenhouse gas emissions and contributing to higher global warming costs. This graph supports the hypothesis that fuel subsidies are correlated with global warming costs and strengthens the argument that reducing subsidies could be a strategy to control the environmental impact of global warming.

In processing panel data, there are several commonly used regression methods including the Random Effect Model (REM) and the Fixed Effect Model (FEM). The results of regression estimation through these two approaches are presented in Table 3.

Based on the regression results in Table 3, it is evident that the coefficients of all independent variables have positive values in both methods, meaning that fuel subsidies, fuel consumption, GDP per capita, and population have a positive influence on the cost of global warming. This is in line with research conducted by (Solarin, 2020),(Husaini et al., 2021), and (Adekunle & Oseni, 2021) which states that fossil energy subsidies and consumption have a positive effect on the level of CO2 emissions. The variables “GDP per capita” and “population” also have positive values have negative values, consistent with the studies conducted by (Omri, 2013), (Adekunle & Oseni, 2021), (Sasana & Aminata, 2019), and (Solarin, 2020), which indicate that economic growth (GDP) and population drive an increase in CO2 emissions.

Based on the estimation results in Table 3, the R-squared value in FEM is much higher than in REM. However, to ensure the best model selection, Hausman test is required. Table 4 shows a p-value < 0.05, indicating that based on the Hausman test, the Fixed Effect model is better than the Random Effect model. Next, heteroscedasticity and cross-sectional dependence tests were conducted.

The results in Table 5 show a p-value <0.05, thus it can be concluded that there is a heteroscedasticity problem in the model. Based on the cross-sectional dependence test in Table 6, testing with Pesaran CD and Friedman has a p-value <0.05, indicating cross-sectional correlations in the model. To overcome this problem, the Driscoll-Kraay standard errors technique can be used.

Table 7 shows the estimation results of the variables studied using the Driscoll-Kraay Fixed Effect model. Fuel subsidies have a positive and significant impact on global warming costs, meaning that when the amount of fuel subsidies increases, the global warming costs also increase. Similarly, fuel consumption and GDP per capita have positive and significant impacts on global warming costs. Meanwhile, the population has a positive but not significant impact on global warming costs.

Heterogeneity Analysis

Heterogeneity analysis was conducted by dividing the sample into sub-samples based on country income level (lower-middle and upper-middle) and period (2015 - 2018 and 2019 - 2020). This approach will help determine whether the impact of fuel subsidies on global warming costs differs between the two groups of countries and across the two time periods.

The results of heterogeneity testing by dividing countries by income level in Table 8 show that the effect of fuel subsidies on global warming costs varies between the two groups of countries. The effect of fuel subsidies on global warming costs in upper-middle-income countries is larger than that in lower-middle-income countries.

The results of the heterogeneity analysis by dividing countries by income level in Table 8 show that the effect of fuel subsidies on global warming costs in upper-middle-income countries is greater than that in lower-middle-income countries. Meanwhile, the heterogeneity analysis in Table 9 shows that the effect of fuel subsidies on global warming costs in the 2015-2018 period is greater than that in the 2019-2022 period. This is likely due to the influence of the COVID-19 pandemic in the 2019-2022 period where large-scale social restrictions have an impact on fuel consumption patterns and ultimately affect fuel subsidy policies.

Climate change resulting from global warming is driven, in part, by the use of fossil fuels, which are major contributors to CO2 emissions in the atmosphere. Any policies enacted by the government, particularly those related to energy, will affect the consumption patterns of fossil fuels, ultimately impacting the level of carbon emissions. Energy policies related to fuel subsidies have a significant impact on global warming costs in both lower-middle-income and upper-middle-income countries. Panel data analysis from 2015 to 2022 shows a strong dependency between fuel subsidies and global warming costs. The results indicate that fuel subsidies are positively correlated with global warming costs.

In addition to fuel subsidies, other factors also influence global warming costs, such as fuel consumption, GDP per capita, and population. These factors as a whole show a positive and significant relationship with global warming costs.

Fuel subsidies aim to keep fuel prices lower for consumers, but their role in increasing global warming costs is becoming more significant. Given the findings of a positive relationship between fuel subsidies and global warming costs, governments should consider future policies to reduce fuel subsidies through more targeted allocation (focused on the underprivileged) and price adjustments as part of a strategy to reduce carbon emissions and global warming costs. If subsidy reduction policies cannot be implemented, other measures to control carbon emissions should be considered, such as energy efficiency, promoting the use of more environmentally friendly energy, developing clean energy technologies, and implementing strict regulatory policies related to carbon emissions, including emission limits for countries, industries, vehicles, and other major emission-contributing sectors.

Since fuel consumption has a positive effect on global warming costs, the government could diversify energy sources by utilizing renewable energy such as wind, solar, biomass, and geothermal as environmentally friendly and sustainable energy alternatives.