Politics and Economics of Energy Subsidies

Baku Summer Energy School June 9, 2010

Introduction
Global financial crisis huge public debt Sharp rise in international oil prices up to 2008, rebound in 2009 Rising energy subsidies

Numbers
In 2003, global consumer subsidies for petroleum products totaled $60 billion. In 2010, they are projected to reach $250 billion. In 2010, tax-inclusive subsidies are projected to reach $740 billion, or 1% of global GDP.

So what?
Halving tax-inclusive subsidies could reduce projected fiscal deficits by one-sixth in subsidizing countries and could reduce greenhouse gas emissions by around 15 %

Subsidy
Money spent, usually by government, to keep prices below what they would be in a free market. Large economic costs due to market distortions.

Energy Subsidy
Electricity, gasoline, diesel, LPG, kerosene, etc. Formula: retail price minus optimal benchmark price

Types of Energy Subsidies

Explicit subsidy: compensation to the national energy company Implicit subsidy: tax exemptions for oil products, the difference between retail prices and import parity

Why subsidize?
Effects of high energy prices on the poor 1) Direct: petroleum product prices rise 2) Indirect: prices of other goods rise The poor cannot access high-quality energy services due to 1) high access costs 2) non-availability of service
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Goals of Energy Subsidies

To help the poor in gaining access to higherquality energy services Provide business incentives to serve rural and poor consumers

Subsidy assessment criteria

Efficacy Sector efficiency Cost-effectiveness

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Efficacy
Subsidy reaches those for whom it is intended Minimize errors of inclusion and exclusion

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Sector Efficiency
Subsidy is structured in such a way that it encourages provision of service at least cost

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Cost-effectiveness
Subsidy achieves social goals at the lowest program cost

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Costs of Energy Subsidies

1) Huge fiscal burden 2) Economic distortions 3) Environmental impact

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Fiscal burden
Low pass-through of the changes in international petroleum products prices leads to serious fiscal costs Pass-through: ratio of absolute change in the domestic retail price to the absolute change in the benchmark price

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Fiscal Burden
Between 2003 and mid-2008 petroleum product tax revenues decreased in 73 countries, with the decrease exceeding 1% of GDP in 41 countries subsidies increased in 27 countries, with the increase exceeding 1% of GDP in 22 countries

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International Petroleum Product Spot Prices, 20032010

Median Pass-Through, 2003-2008

Oil Exporters
are characterized with a low pass-through. The windfall is passed on directly to domestic consumers. According to IMF (2007), in Azerbaijan combined explicit and implicit subsidies were estimated to reach 12.3% of GDP in 2006

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Economic Distortions
Overconsumption Subsidized products used for alternative uses Cross-border smuggling Poor targeting

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Poor targeting
Most of the benefits from universal petroleum subsidies accrue to high-income households Over 80% of benefits accruing to the richest 40% of households

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Distribution by Income Group

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Environmental Impact
Reducing subsidies by one-half could reduce greenhouse gas emissions by nearly 5% by 2050. Source: IEA (2009)

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What could be done?

Reform price-setting mechanism Combine with a package of mitigating measures Make the process transparent Identify priority public expenditures Timing and size important

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Reforming Price-Setting Mechanism

First-best: liberalize prices Second-best: automatic price adjustment mechanism Worst: ad hoc basis

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Mitigating measures
Temporarily maintain universal subsidies on commodities that are more important in the budgets of the poor Introduce a package of short-term measures

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Mitigating measures, Ghana

Fees for attending primary school eliminated Extra funds made available for primary health care programs in the poorest areas Investment in the provision of mass urban transport Extra funds for expansion of a rural electrification scheme

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Mitigating measures, Indonesia

Unprecedented cash transfer program to 16 million poor families: each family receives about $30 every three months Budgetary savings allocated to existing education, health and infrastructure programs Gradual reduction in the kerosene subsidy

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Mitigating measures, Jordan

The minimum wage was increased A one-time bonus to low-income government employees and pensioners An electricity lifeline tariff maintained at current low levels Increased funding for the design and implementation of a national safety net program
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Transparency
Subsidies should be recorded transparently in government accounts Public information campaigns can overcome vested interests

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