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

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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 % 4 .

usually by government. 5 .Subsidy • Money spent. • Large economic costs due to market distortions. to keep prices below what they would be in a free market.

LPG. • Formula: retail price minus “optimal” benchmark price 6 . gasoline. etc.Energy Subsidy • Electricity. kerosene. diesel.

the difference between retail prices and import parity 7 .Types of Energy Subsidies • Explicit subsidy: compensation to the national energy company • Implicit subsidy: tax exemptions for oil products.

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 8 .

Goals of Energy Subsidies • To help the poor in gaining access to higherquality energy services • Provide business incentives to serve rural and poor consumers 9 .

Subsidy assessment criteria • Efficacy • Sector efficiency • Cost-effectiveness 10 .

Efficacy • Subsidy reaches those for whom it is intended • Minimize errors of inclusion and exclusion 11 .

Sector Efficiency • Subsidy is structured in such a way that it encourages provision of service at least cost 12 .

Cost-effectiveness • Subsidy achieves social goals at the lowest program cost 13 .

Costs of Energy Subsidies 1) Huge fiscal burden 2) Economic distortions 3) Environmental impact 14 .

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 15 .

with the decrease exceeding 1% of GDP in 41 countries • subsidies increased in 27 countries.Fiscal Burden Between 2003 and mid-2008… • petroleum product tax revenues decreased in 73 countries. with the increase exceeding 1% of GDP in 22 countries 16 .

20032010 .International Petroleum Product Spot Prices.

2003-2008 .Median Pass-Through.

• According to IMF (2007). in Azerbaijan combined explicit and implicit subsidies were estimated to reach 12. The “windfall” is passed on directly to domestic consumers.3% of GDP in 2006 19 .Oil Exporters …are characterized with a low pass-through.

Economic Distortions • • • • Overconsumption Subsidized products used for alternative uses Cross-border smuggling Poor targeting 20 .

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 21 .

Distribution by Income Group 22 .

Environmental Impact • Reducing subsidies by one-half could reduce greenhouse gas emissions by nearly 5% by 2050. Source: IEA (2009) 23 .

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 24 .

Reforming Price-Setting Mechanism • First-best: liberalize prices • Second-best: automatic price adjustment mechanism • Worst: ad hoc basis 25 .

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 26 .

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 27 .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.Mitigating measures. health and infrastructure programs • Gradual reduction in the kerosene subsidy 28 .

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 29 .Mitigating measures.

Transparency • Subsidies should be recorded transparently in government accounts • Public information campaigns can overcome vested interests 30 .

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