Money To Burn: OPEC's Wasteful Energy Subsidies

Posted by Joseph R. Fonseca
Sunday, May 18, 2014

Fossil fuel subsidies cost governments in emerging markets more than $500 billion every year and are a major contributor to climate change, according to the International Energy Agency (IEA) and International Monetary Fund (IMF).

The biggest subsidies are concentrated in the Middle East, North Africa, Asia and parts of Latin America, according to the IEA's Fossil Fuel Subsidy Database (http://www.iea.org/subsidy/index.html).

Moreover energy-exporting countries accounted for three quarters of all consumption subsidies in 2012, according to the IEA and OPEC members account for more than half the world's subsidies.

Subsidies account for 82 percent of the cost of electricity and fuel in Venezuela, 80 percent in Libya, 79 percent in Saudi Arabia, 74 percent in Iran, and 56 percent in Iraq and Algeria. By contrast, the average rate of subsidy is just 18 percent in India and 3 percent in China.

In cash terms the world's biggest subsidies are in Iran, Saudi Arabia and Russia, all of which are major oil producers. Subsidies cost these three countries a combined total of $180 billion per year in 2012.

RATIONAL PRICING

In September 2009, the leaders of the world's largest economies meeting at the G20 summit in Pittsburgh committed themselves to phase out inefficient fossil fuel subsidies over the medium term.

According to the IEA, phasing out subsidies for oil, gas and electricity and aligning prices with international benchmarks would cut growth in energy demand by 5 percent and carbon dioxide emissions by 2 billion tonnes a year by 2020 - equivalent to the current combined emissions of Germany, France and the UK.

Raising gasoline, diesel and kerosene tariffs to market levels would save 4.7 million barrels of oil a day by the end of the decade ("World Energy Outlook 2011").

Cutting subsidies would also dramatically improve government budgets. Of 58 countries which subsidised gasoline, diesel or kerosene in 2010, 46 were running budget deficits, and in 27 cases the deficit amounted to more than 3 percent of GDP, the IMF explained in a staff note highly critical of the burden on taxpayers.

Halving subsidies would have reduced the average deficit from 2.1 percent of GDP to just 0.8 percent ("Petroleum product subsidies: cost, inequitable and rising" Feb 2010).

Subsidies often crowd out spending on infrastructure, development and social welfare. Indonesia spends more on fuel subsidies than on education or healthcare.

Venezuela sells gasoline for just 6 U.S. cents per gallon. The cost in lost export revenues is $30 billion, more than the combined value of all state spending on social programmes, Jim Krane at Rice University explained in a briefing paper published this month ("Navigating the perils of energy subsidy reform" May 2014).

WASTE AND HARM

Governments justify subsidies on the grounds that they alleviate poverty and promote economic development, but neither claim is really true.

Most of the benefits accrue to the middle class rather than poor because middle class families have more electrical appliances and their own cars.

In Indonesia, for example, the top 40 percent of high-income families absorb 70 percent of subsidies, while the bottom 40 percent of low-income families receive only 15 percent of the benefits ("The scope of fossil fuel subsidies in 2009" Nov 2010).

Subsidies also promote wasteful consumption. Saudi Arabia's artificially cheap gasoline and electricity have made the country one of the highest per-capita energyusers in the world and threaten to restrict the amount of oil left for export.

Another problem is fuel adulteration. Most countries subsidise kerosene used in cooking and lighting more heavily than gasoline and diesel used to fuel vehicles. But the resulting price gap encourages the illegal blending of kerosene into the diesel supply. Policies aimed at providing cheap cooking fuel for the poor end up helping middle class families drive motor cars.

And subsidies promote smuggling. Diesel sells for as little as 12 U.S. cents per litre in Iran compared with $1.20 per litre across the border in Pakistan. As a result the IEA estimates 60,000 barrels of diesel are smuggled out of Iran to Pakistan andAfghanistan every day.

To combat smuggling into Yemen and other neighbouring states Saudi Arabiainspects vehicles crossing its borders to ensure they only have enough fuel in the tank to reach the nearest refuelling station on the other side ("World Energy Outlook2013").

SOCIAL COMPACT

The theoretical case for reducing or eliminating subsidies is overwhelming, but in practice progress has been slow.

The fact that subsidies are concentrated in exporting countries and typically benefit middle-income and lower middle-income groups is no accident. Subsidies have a political dimension that makes them especially hard to reform.

Cheap electricity and fuel is often an important part of the social compact between governments and the population. "In major energy-producing countries consumption subsidies that artificially lower energy prices are seen as a means of sharing the value of indigenous natural resources," the IEA explains.

More bluntly, Rice University's Jim Krane observes: "Fossil fuel subsidies have allowed energy exporting countries to distribute resource revenue, bolstering legitimacy for governments, many of which are not democratically elected."

Even in energy-importing countries, like Indonesia and Pakistan, subsidised electricity and kerosene is a vital way for politicians to buy support from the urban middle and lower-middle classes - the groups most likely to form the core of protest movements.

REFORM EFFORTS

Policymakers in most countries acknowledge the need to reduce or remove subsidies, and the approach has strong backing from the World Bank, IMF and IEA. But efforts to reduce subsidies have met with limited success.

Iran, Indonesia, Ghana, Kenya, the Philippines, Mozambique and several other countries have all pushed through substantial price increases over the last two decades.

In other cases, however, price rises have had to be rolled back following popular protests. And the fact that Iran and Indonesia remain among the world's biggest subsidisers points to how limited the reforms have been even there in the face of tough public opposition.

To succeed reform programmes need to be accompanied by a strong communications strategy which points out that most of the benefits from subsidies go to wealthy households who can afford to pay the full cost of energy, and carefully targeted social measures to compensate the poorest households.

Timing is important. Reforms are more likely to be successful if the oil price is falling, when households are less likely to notice the removal of subsidies, than when energy costs are already rising. China and Indonesia both took advantage of lower oil prices in 2009 and 2010 to reduce support.

Even if it proves impossible to remove subsidies altogether, energy prices can be depoliticised by explicitly linking the retail cost of gasoline, diesel and kerosene to international benchmarks with fixed but adjustable formulas.

"Establishing an automatic pricing formula ... can help distance the government from pricing of energy and make it clearer that domestic price changes reflect changes in international prices which are outside the control of the government," according to the IMF ("Energy subsidy reform: lessons and implications" Jan 2013).

Even so, removing subsidies remains fiendishly difficult. "Many countries have successfully implemented reforms only to see subsidies reappear when international oil prices increase," the IMF laments. The temptation to reintroduce price controls to help households with rising living costs is strong.

And in the biggest petro-states, including Saudi Arabia, Iran, Iraq, Russia, Kuwait,Venezuela, Libya and Algeria there has been virtually no progress towards more sensible energy pricing.

The result is a prodigious waste of energy. The petro-states are among the world's biggest and fastest-growing oil consumers and some are now having to import natural gas for power generation to meet electricity demand. And the greenhouse emissions are enormous.

It is all ultimately unsustainable. "The state itself is teaching people to waste resources," complains one Kuwaiti newspaper editor. But subsidy reform is probably impossible without meaningful political and social change.

(Editing by Greg Mahlich)

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