Fuel Subsidy Up in Flames

The proposal to remove Australia’s Fuel Tax Credits Scheme (FTCS) is increasingly framed as an obvious climate and fiscal reform: an expensive fossil fuel subsidy that distorts markets, delays decarbonisation, and should be eliminated as part of the energy transition.

On the surface, the argument appears compelling. The scheme costs the Commonwealth close to $10 billion per year, disproportionately benefits mining and heavy industry, and reduces the effective price of diesel at a time when emissions reductions are an urgent national priority.

However, this framing risks oversimplifying both the economic role of the FTCS and the real-world constraints facing Australia’s energy transition. Removing the fuel tax credit in the current policy and infrastructure environment would not be a neutral correction.

It would be a large, abrupt input-cost shock imposed on trade-exposed and regionally concentrated industries, introduced at a time when alternative technologies are not yet reliably deployable at scale. When combined with the government’s ongoing difficulties in rolling out renewable generation, transmission infrastructure, and energy storage, the policy risks undermining economic stability, regional equity, and even the pace of decarbonisation itself.

We argue that while reform of the FTCS may be justified in the long term, outright or rapid removal is economically and politically imprudent. A credible transition strategy must account for inflationary pressures, investment risk, infrastructure readiness, and technological limitations—particularly battery lifespan, grid reliability, and the immature state of heavy-industry electrification.

The Nature of the Fuel Tax Credits Scheme

The FTCS refunds fuel excise paid on diesel and other fuels used by businesses, particularly for off-road activities, heavy vehicles, mining, agriculture, and construction. Unlike household fuel excise relief, the scheme does not directly lower retail petrol prices faced by consumers. Instead, it reduces the effective input cost of diesel for businesses that rely on fuel-intensive operations.

The largest beneficiaries are mining companies, especially iron ore and coal producers, followed by agriculture and freight-intensive industries. Critics often describe this distribution as evidence of corporate welfare. Yet the scale of benefit is closely tied to the physical realities of production: mining and agriculture are energy-intensive by nature, operate over large distances, and often in remote areas where grid access is limited or non-existent.

Crucially, the FTCS has existed for decades and is embedded in project economics, investment decisions, and long-term contracts. It functions less like a discretionary subsidy and more like a baseline assumption in capital-intensive industries with long asset lives. Any sudden change therefore has consequences that extend well beyond budget savings.

Inflationary and Cost-of-Living Risks

Concrete examples help illustrate how indirect cost pass-through operates in practice. During periods of sharp diesel price increases in 2021–2022, freight surcharges were widely applied across grocery, construction, and retail supply chains. Supermarket suppliers publicly cited higher transport and input costs as contributors to food price inflation, particularly for fresh produce transported over long distances to eastern capital cities. While these increases did not always appear immediately in headline CPI fuel categories, they were reflected in higher shelf prices for essentials. The removal of the FTCS would recreate similar pressures, but on a structural and permanent basis rather than as a temporary market shock. We don’t need this in the current inflationary environment.

Proponents of removal frequently argue that because the FTCS is a business rebate, eliminating it would have little effect on households or headline inflation. This argument relies on a narrow interpretation of inflation that focuses solely on direct CPI components, such as petrol prices at the pump.

In reality, the inflationary risk lies in indirect pass-through. Diesel is a foundational input into freight, food production, construction materials, and regional service provision. Even modest increases in transport and logistics costs tend to cascade through supply chains. These effects may not appear as a sharp one-quarter CPI spike, but they accumulate over time and disproportionately affect essentials such as groceries, housing construction, and regional services.

Importantly, these impacts are regressive. Regional and remote households already face higher costs of living due to distance and limited competition. Removing the FTCS would widen this gap, effectively functioning as a regionally concentrated cost-of-living increase at a time when inflation remains politically and economically sensitive.

Trade Exposure and Export Competitiveness

Historical experience illustrates how sensitive investment can be to policy‑driven cost changes. In past commodity downturns, relatively small increases in operating costs have led firms to defer expansion projects or place marginal operations into care and maintenance. For example, higher energy and compliance costs in certain regions have previously been cited by mining companies as reasons for reallocating capital toward lower‑cost jurisdictions overseas. Removing the FTCS would add to this cost stack at a time when global competition for mining investment—particularly in critical minerals—is intensifying.

Australia’s mining and agricultural sectors are overwhelmingly price takers in global markets. They cannot simply pass higher input costs on to international buyers. When costs rise abruptly, the adjustment occurs through lower margins, delayed investment, reduced exploration, or, in marginal cases, project closures.

This is not a theoretical risk. Australia’s resource sector operates on long investment cycles and competes for capital with jurisdictions that often offer lower energy costs or explicit transition support. A sudden increase in diesel costs without viable substitutes weakens Australia’s competitiveness and raises sovereign risk concerns. Investors interpret abrupt policy shifts as signals of instability, particularly when they affect long-lived assets.

The downstream effects include reduced regional employment, lower royalty and tax revenues, and weaker trade balances. These outcomes directly undermine the fiscal and economic objectives that subsidy removal is meant to support.

The Reality of the Energy Transition

A central claim of the pro-removal case is that eliminating the FTCS will accelerate the transition to electric vehicles, batteries, and low-emissions alternatives. While price signals matter, this argument assumes a level of technological readiness and infrastructure availability that does not yet exist.

Renewable Rollout Challenges

Recent experience demonstrates that Australia’s renewable rollout is encountering significant practical barriers. Projects such as Snowy 2.0, intended to underpin grid stability and firm renewable supply, have suffered major cost overruns and multi‑year delays. T

ransmission projects critical to connecting renewable generation—such as major interconnectors and renewable energy zones in New South Wales and Victoria—have faced land access disputes, planning delays, and escalating construction costs. These delays mean that, despite ambitious targets, dispatchable low‑emissions power is not arriving at the pace originally anticipated.

Against this backdrop, removing the FTCS would push industrial users toward electrification before the electricity system is capable of reliably supporting them, increasing the risk of higher wholesale prices and supply constraints.

Australia is already struggling to deliver the scale and speed of renewable energy deployment required to meet its stated targets. Large renewable projects face delays due to planning approvals, community opposition, supply-chain constraints, and grid connection bottlenecks. Transmission upgrades—essential for integrating renewable generation—are behind schedule and over budget in multiple states.

In this context, encouraging or forcing large industrial users to electrify operations increases demand on a system that is not yet capable of supplying reliable, affordable power at scale. Rather than smoothing the transition, this risks exacerbating grid instability and driving up wholesale electricity prices.

Battery Lifespan and Technological Constraints

Real‑world examples from mining and heavy transport highlight these limitations. Trials of battery‑electric haul trucks and heavy vehicles in Australian mining operations have shown promise but remain highly site‑specific and capital intensive.

Battery packs degrade more rapidly under constant heavy load, high ambient temperatures , and dusty environments common in remote mining regions,eg the Pilbara environment. Replacement costs are substantial, and downtime associated with charging and maintenance can disrupt continuous operations.

Battery safety and lifecycle issues also impose costs. High‑profile battery fires in industrial and grid‑scale storage projects have reinforced the need for additional safety systems, insurance, and regulatory oversight, all of which raise project costs. These factors make battery‑electric solutions a medium‑term prospect rather than an immediate, economy‑wide substitute for diesel.

Battery technology is often presented as a near-term substitute for diesel across transport and industry. However, for heavy vehicles, mining equipment, and agricultural machinery, batteries remain expensive, heavy, and limited in range. Their effective lifespan is shorter under harsh operating conditions, such as extreme heat, dust, vibration, and continuous high-load use.

Battery degradation imposes real economic and environmental costs. Shorter asset lives mean higher capital replacement rates, increased waste management challenges, and uncertain resale values. For firms operating on tight margins, these risks discourage investment rather than accelerate it.

Moreover, large-scale charging infrastructure requires not only capital expenditure but also reliable grid access. Many remote operations would need substantial network upgrades or on-site generation and storage, further increasing costs and complexity.

Capital Shock Versus Managed Transition

Removing the FTCS would not simply shift firms smoothly toward cleaner technology. In the short to medium term, it would impose a capital shock. Businesses would face higher operating costs immediately, while the benefits of electrification—lower marginal costs and reduced fuel volatility—would remain years away.

This mismatch matters. Firms under financial pressure tend to defer discretionary investment, including investment in new technology. Ironically, the policy intended to drive decarbonisation may slow it by diverting cash flow from transition projects to tax payments.

A managed transition, by contrast, aligns incentives with capability. It recognises that price signals work best when substitutes are available, infrastructure is in place, and firms have confidence in policy stability.

Environmental Effectiveness and Emissions Outcomes

Another weakness in the pro-removal case is the assumption that higher diesel prices will automatically translate into lower emissions. In sectors where fuel use is largely inelastic in the short run, higher prices do not reduce consumption; they simply raise costs.

Without viable alternatives, emissions reductions may be minimal, particularly in the early years following removal. In some cases, firms may respond by extending the life of older, more emissions-intensive equipment rather than investing in new, cleaner technology—a perverse outcome from a climate perspective.

Effective climate policy should prioritise emissions intensity reductions and long-term structural change, not symbolic fiscal wins that generate political backlash and uncertain environmental benefits.

Political Economy and Durability of Policy

Finally, the durability of climate policy matters. Abrupt removal of the FTCS risks triggering strong opposition from regional communities, industry groups, and state governments. This increases the likelihood of policy reversal following a change of government, undermining long-term investment certainty.

Australia’s climate policy history is littered with examples of ambitious reforms that failed due to insufficient attention to political and economic realities. A transition that is perceived as unfair or poorly sequenced is unlikely to endure.

Reform as an Alternative to Removal

International experience suggests that phased reform is more effective than abrupt withdrawal. Jurisdictions that have successfully reduced fossil fuel support have typically paired gradual price signals with substantial investment in infrastructure and transitional assistance.

For Australia, this could mean explicitly linking reductions in fuel tax credits to milestones such as the commissioning of new transmission capacity, demonstrated commercial viability of heavy‑duty electric or hydrogen vehicles (though companies have given up on this), and the availability of long‑duration storage capable of supporting industrial loads.

Arguing against removal does not require defending the FTCS in its current form indefinitely. A more credible approach is reform rather than abolition. This could include:

• A gradual, legislated phase-down of credits tied to the availability of viable low-emissions alternatives.
• Targeted exemptions or extended timelines for remote and hard-to-abate activities.
• Ring-fencing savings to fund grid upgrades, charging infrastructure, and transition support in affected regions.
• Clear, long-term policy signals that allow firms to plan capital replacement cycles efficiently.

Such an approach preserves economic stability while still aligning with emissions reduction goals.

Conclusion

The case for removing Australia’s Fuel Tax Credits Scheme is often presented as straightforward: eliminate a costly fossil fuel subsidy and let market forces drive decarbonisation. In practice, the policy is far more complex. Removing the FTCS in the current environment would impose a significant cost shock on trade-exposed, regionally concentrated industries at a time when renewable energy rollout, grid infrastructure, and battery technology are not yet ready to absorb the transition.

The result risks higher indirect inflation, reduced investment, weakened export competitiveness, and slower—not faster—emissions reductions. Climate policy succeeds not through blunt instruments, but through careful sequencing, infrastructure readiness, and durable political support.

A phased reform of the FTCS, aligned with genuine technological and infrastructural capability, offers a more credible path forward than abrupt removal. In the pursuit of decarbonisation, economic realism is not the enemy of ambition—it is its precondition.

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