1

Fossil-fuel Subsidy Reform

7th Annual Meeting of Middle East and North Africa Senior Budget Officials (MENA-SBO)

Abu Dhabi, 11 December 2014

Petar Vujanovic

Head of Indonesia Desk OECD Economics Department

2

The size of global fossil-fuel subsidies V

alue

of f

ossil

-fuel

subs

idie

s

Source: IEA World Energy Outlook 2014.

Billions of dollars (nominal)

• Around US $550 billion in 2013, or around 1% of world GDP.

• These subsidies are over four-times the value of subsidies to renewable energy and more than four-times the amount invested globally in improving energy efficiency (IEA, World Energy Outlook 2014).

3

Fossil-fuel subsidies by country Va

lue

of fo

ssil-

fuel

subs

idie

s

Source: IEA World Energy Outlook 2014.

Percent of GDP and billions of dollars, 2013

4

Fossil-fuel subsidies in Indonesia In

done

sia

Source: CEIC Indonesia; OECD analysis.

Price per liter (rupiah), and ratio of crude price

0

0.5

1

1.5

2

2.5

3

3.5

0

0.5

1

1.5

2

2.5

3

3.5

Nov-91

Nov-92

Nov-93

Nov-94

Nov-95

Nov-96

Nov-97

Nov-98

Nov-99

Nov-00

Nov-01

Nov-02

Nov-03

Nov-04

Nov-05

Nov-06

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Nov-13

Nov-14

Subsidised Premium

Subsidised Diesel

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000Subsidised PremiumSubsidised DieselCrude Oil (World price)

5

Fossil-fuel subsidies in Indonesia In

done

sia

• Subsidies to gasoline, diesel, kerosene, LPG and electricity (heavily petroleum-dependent).

• Fixed price in rupiah. Government exposed to world price fluctuations.

• Subsidy is provided to the monopoly state-owned oil company – Pertamina, which sells fuel at the subsidised price.

• Gaps between subsidy paid and Pertamina costs have resulted in shortages and quotas.

• In 2004 Indonesia became a net importer of oil. • Government is constitutionally obliged to “control” these sectors.

And legislatively obliged to implement some sort of subsidy.

6

Distribution of subsidies in Indonesia In

done

sia

• Richest 40% get 77% of subsidy and poorest 10% get 1% of subsidy.

• Two-thirds of the poor and near-poor households (bottom 5 deciles) do not directly consume gasoline whatsoever.

0

10

20

30

40

50

0

10

20

30

40

50

1 2 3 4 5 6 7 8 9 10

Perc

enta

ge o

f sub

sidy

rece

ived

Consumption deciles Rich Poor

Source : Agustina et al. (2008)

7

Fuel subsidies in India “Under-pricing” In

dia

Diesel : Rs per liter

LPG : Rs per 14.2 kg cylinder

In 2012, the government restricted household purchase to 6 cylinders per year subsidized prices. In January 2013, quota increased to 9 cylinders.

To address rising subsides, regulated retail prices were increased by about Rs 3.50 per liter in mid-September 2012. Still price is 75% of the market price. The gap between petrol and diesel prices has led to increasing substitution of diesel for petrol automobiles.

8

Distribution benefits from subsidies In

dia

Composition of Household Fuel Expenditure by Income Group, 2009/10

Rupees per capita per month %

9

Fossil-fuel subsidies MENA M

ENA

• The Middle East and North Africa region account for about 50 percent of global energy subsidies.

• Seen as a way of sharing the country’s natural wealth (?). • A simple way of transferring income – administratively easier than

social security systems (cash transfers, direct income support, or tax rebates).

• Energy subsidies totaled over 8½% of regional GDP or 22% of total government revenues, with one-half reflecting petroleum product subsidies.

• Oil-producing countries have largest subsidies but these are often indirect – “off-budget” – “implicit subsidy”. o For example : state-owned oil companies retail fuel at just-above-

production cost prices. No compensation provided by governments.

10

Examples of Fossil-fuel Subsidy Reforms

Refo

rm

11

-40

-20

0

20

40

60

80

100

120

-40

-20

0

20

40

60

80

100

120

Jun-

86Ap

r-87

Feb-

88De

c-88

Oct

-89

Aug-

90Ju

n-91

Apr-

92Fe

b-93

Dec-

93O

ct-9

4Au

g-95

Jun-

96Ap

r-97

Feb-

98De

c-98

Oct

-99

Aug-

00Ju

n-01

Apr-

02Fe

b-03

Dec-

03O

ct-0

4Au

g-05

Jun-

06Ap

r-07

Feb-

08De

c-08

Oct

-09

Aug-

10Ju

n-11

Apr-

12Fe

b-13

Dec-

13O

ct-1

4

Subsidised Diesel

Subsidised Premium

Subsidies cuts in Indonesia In

done

sia

Source: CEIC Indonesia; OECD analysis.

Some say that the end of Suharto’s 32-year presidency in 1998 was precipitated by protests that followed IMF-mandated cuts in subsidies. Cuts partly reversed before stepping down. RASKIN started.

February 2000 gas prices increased by 15%. Violent protests but not reversed.

January 2003 subsidies cut and tried to link prices to international prices. Link broken and diesel subsidy cut reversed. Compensation packages announced but many not implemented.

2004 Indonesia becomes a net importer of oil

March and October 2005 increases prompted protests. But acceptance aided by compensation aimed at poor. And extensive public information campaign.

2008 spike in world oil prices causes large budget overrun. Again compensation for poor. Only partially reversed after oil prices came down.

Electricity subsidies for industry completely removed.

Fuel subsidies for industry completely removed.

12

-40

-20

0

20

40

60

80

100

120

-40

-20

0

20

40

60

80

100

120

Jun-

86Ap

r-87

Feb-

88De

c-88

Oct

-89

Aug-

90Ju

n-91

Apr-

92Fe

b-93

Dec-

93O

ct-9

4Au

g-95

Jun-

96Ap

r-97

Feb-

98De

c-98

Oct

-99

Aug-

00Ju

n-01

Apr-

02Fe

b-03

Dec-

03O

ct-0

4Au

g-05

Jun-

06Ap

r-07

Feb-

08De

c-08

Oct

-09

Aug-

10Ju

n-11

Apr-

12Fe

b-13

Dec-

13O

ct-1

4

Subsidised Diesel

Subsidised Premium

Subsidies cuts in Indonesia In

done

sia

Source: CEIC Indonesia; OECD analysis.

In June 2013 the prices of diesel and gasoline were increased by 22% and 44%, respectively. Accompanied by unconditional cash transfer to poor households.

In November 2014 the prices of diesel and gasoline were increased by 36% and 31%, respectively. Accompanied by roll-out of social security cards that facilitated cash transfer to poor households.

2004 Indonesia becomes a net importer of oil

13

Fuel subsidy reform in India Fu

el su

bsid

y re

form

• Petrol prices were deregulated in 2010.

• Diesel prices were regulated longer - traditionally seen as a “poor man’s fuel” that powers buses, trucks and irrigation pumps used by millions of farmers.

• 2012 lifted prices of subsidised diesel fuel by 14%. And then raised diesel prices by half a rupee a litre every month until prices hit market levels. Thanks to recent lower global oil prices target has been reached. Now fully deregulated.

• LPG, food and fertilisers are still subsidised.

• New Modi government plans system of direct cash transfer to recipients’ bank accounts, to curb leakages and reduce spending. To be facilitated by biometric unique ID (Aadhaar) linked to bank accounts.

o By January 2014, Aadhaar issued to half the population (~560 million people) and already used for some pension and student payments.

14

Fuel subsidy reform in Egypt Fu

el su

bsid

y re

form

• In 2013, Egypt spent more on fuel subsides (not including electricity subsidies) than on health, education and infrastructure combined. Government deficit was estimated 12% of GDP in 2013/14.

• Petrol cost less than the cheapest bottled water. • Smuggling estimated at 15-20% of that sold. • Fuel subsidies increased from 9% of government spending in 2002 to 22% in

2013. When electricity subsidies are included, share is >30%. • 2005 and 2008 subsidies reduced but halted in 2008 economic crisis. • 2012 raised RON95 prices but users substituted for RON92. • 2013 plan to ration using smart-cards but not implemented. • 2014 : large increases in the prices of diesel (64%), gasoline 80 (78%) and gasoline

92 (40%) . Gasoline 95 subsidies reduced in April 2013. o Cut subsidy bill to around 13% of government spending. o Extensive communication campaign including a Presidential address. o No direct cash compensation but froze stable food prices and increased food

subsides. Minimum wage for public servants introduced.

15

Fuel subsidy reform in Turkey Tu

rkey

• Energy sector deregulation and price liberalization program in the early 1990s.

• An automatic fuel pricing mechanism was adopted in 1998, with responsibility for its implementation transferred to the independent Energy Market Regulatory Authority in 2003.

• The success of the reforms has been attributed to the broad public support generated by the government for economy-wide structural reforms as well as the strong macro-economy with high growth and low inflation.

• Expenditures on existing targeted social safety net programs were also scaled-up, including a targeted cash transfer program.

16

Fuel subsidy reform in Iran Fu

el su

bsid

y re

form

• In 2000s, subsidised price fixed at around 5% of world price (~US$0.10 per liter).

• Subsidies lead to smuggling on a massive scale (estimated 17% of production). Gasoline imports needed.

• Rationing introduced in 2007 with smart cards. • 2010 five-year reform announced. • First phase included direct payments of about $45 per month per individual -

everyone. Directly transferred back to people’s bank accounts. Up to 50% of the income of a family in the bottom decile.

• High rates of inflation due to increase in price of commodities and increased purchasing power of the poor. But also sanctions and large depreciation.

• 2012 second phase postponed. Cash transfers were to be targeted to poor. • 2014 subsidies cuts. Prices up by 75% (but still around 15% of world prices).

Cash transfers were annulled and household needed to reapply in the hope of better targeting (75% did).

17

Implementing Fossil-fuel Subsidy Reforms

Impl

emen

tatio

n

18

The rationale for reform Th

e ra

tiona

le fo

r ref

orm

• Government budgets – high opportunity cost : Alternative uses of government revenues have a much higher social return, especially in the longer term. Infrastructure, education, and health care, for example.

• Better means of achieving social welfare objectives : Can be thought of as a government transfer. But very badly targeted.

• Energy security : Excess demand and limited supply. Works against diversification of energy supply.

• New technology : Inhibits upgrading to more efficient technologies (eg. more efficient cars).

• Overinvestment in capital/energy intensive industry – rather than in job-creating industries.

• Worsens negative externalities : Excess demand : CO2 and other pollution, congestion etc. Inhibits investment in other “cleaner” energy sources like geothermal, biofuels, and other renewables.

• Other economic distortions : Smuggling, diversion, racketeering, scamming, black markets, corruption.

• Monopoly SOEs often implement subsidies and receive compensation. This masks inefficiencies and low productivity.

19

Reform strategies Im

plem

entin

g re

form

• Second best is to move to a system that sets prices automatically according to the market (perhaps fixed subsidies), and disassociate price-setting from political decision making.

• Reforms should be part of a comprehensive package that includes preparation, communication, and compensation.

• Build support for reform : o Transparency about subsidies is vital to build support for reform. o Governments need to communicate why reform is a structural change

for the better. o Identify the opportunity cost of subsidies – healthcare, education etc.

• Sequencing cuts in small steps. • Compensation : Compensation needs to precisely targeted, or across

the board for political reasons? Middle and upper income households are most (directly) affected.

• Eventually move to applying an excise tax on fossil fuels – to fund roads (indirect user-pays) and cover negative externalities.

20

Barriers to reform Im

plem

entin

g re

form

• Political opposition from those that most benefit from the subsidy – net losers (or those that perceive themselves as net losers – middle class).

• Adverse impact on the poor. • Lack of understanding or information. What is the upside to reform

for the general public? • Lack of government creditability. Public prefers what they have now

rather than what the government promises of reform. • Technical or administrative capacity to implement reform – eg. to put

in place a cash-transfer scheme - complex. • Macroeconomic impacts : inflation (wages), international

competitiveness. • Weak macroeconomic conditions often oblige reform of subsidies to

address fiscal crisis (Egypt). But especially difficult time to do it.

21

Communication strategies Im

plem

entin

g re

form

Reform should be preceded by a public information campaign highlighting the motivation for reform. • The campaign should highlight rationales for reform. • Compensation package is part of communication campaign.

o Indonesia : 2005 reforms included public information campaign: newspapers, TV talk shows, village notice boards, pamphlets and brochures, as well information provided with Energy Compensation Card. 2014 reforms widely discussed during the election campaign including coordination between outgoing and incoming administrations. Even text messages explaining the new policy.

o Egypt : July 2014 reforms (64% increase in diesel prices) involved an intensive PR campaign by the government, including direct daily involvement by the President.

o India : Committees appointed to assess how best to address the issues raised by fuel subsidies (2006, 2010, 2011, 2012).

22

Compensation strategies Im

plem

entin

g re

form

Better targeting of fuel subsidies • Thailand “Energy Card” is an example. But restricted to taxi drivers

and other commercial drivers etc.

Development and implementation of targeted mechanisms that protect poor and vulnerable consumers from higher energy prices as they rise is critically important. • Need to be able to scale up during economic shocks or provide

mitigation against adverse impacts of subsidy reform. • Avoid weaknesses, including fragmentation and poor coordination,

poor targeting, and low poverty impact. • Targeted cash transfers. • Or across the board compensation for political reasons. • A unified registry of poor households and/or sophisticated electronic

smart card systems.

23

Compensation strategies (2.) Im

plem

entin

g re

form

Indonesia • Subsidized rice (RASKIN) introduced in 1998 as part of wider reforms

including fuel subsidy cuts. • 2005 reforms included a series of unconditional monthly cash

transfers targeted at low income households (BLT) : ~20 million households eligible for “Energy Compensation Card”. o Four quarterly disbursements of 300,000 Rupiah (Rp) (around 30

USD) to the poorest 30 per cent of households. o 2005 reforms provided the means to a establish nationwide registry

of poor households (PSEP05) to better target compensation. This is now being expanded for use for targeting all social security programmes.

• 2014 reforms compensation facilitated by rollout of social welfare cards which included cash payment to poor households.

24

Compensation strategies (3.) Im

plem

entin

g re

form

An example of issues with compensation - RASKIN in Indonesia • Mandate to provide subsidized rice to households in the bottom 30

percent of the income distribution. • In 2011, over three million tons of subsidized rice distributed (US$1.5

billion). It is the largest social assistance program in Indonesia, accounting for 53 percent of all social assistance expenditures.

• In practice, however, eligible households receive only one-third of the amount of rice they are eligible to receive and at a cost that is 25 percent higher than their entitled subsidy.

• Leakages are also high: nearly 70 percent of households that purchase subsidized rice are non-poor. o Research suggests that the village leaders, who are responsible for

distributing the subsidized rice to eligible households, frequently distribute rice evenly to all households in their communities, rather than distributing it only to poor households, in order to maintain social cohesion.