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The Time is Now

Energy subsidies are eating into government revenues and must be tackled.

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Jaap Kalkman
Jaap Kalkman

By Jaap Kalkman, Global Head of energy & Utilities at Arthur D. Little

The policy of energy price subsidy has been shaping the political and economic landscape across the Middle East and North Africa for decades. Indeed, energy importers and producers in the region have relied on energy price subsidies as their main tool to provide social protection, share hydrocarbon wealth and promote capital-intensive industries.

However, todayenergy-intensive industries and households make the region require more fuel to produce a unit of GDP than any other region.Moreover, as highlighted in the recent ADL report, half of the world’s total energy subsidies bill of $480bn comes from the region, eating up more than one-quarter of governments’ revenues.

Households in the region consume double what is typically consumed elsewhere and industrial structure is developed mostly around energy-intensive productions. Coupled with continuous economic growth, and demographic projections promising significant population growth, energy consumption in the region is expected to continue to grow, further driving up the policy’s already-high costs and thus rendering it even more economically inefficient.

Needless to say, the policy’s increasing costs will carry important fiscal consequences and only further exacerbate the current trend of sidelining other economically efficient public spending priorities, directly downgrading the regional economies’ capability not only of diversifying and enhancing their competitiveness, but also further maintaining the policy currently in place. Without reforming or abandoning energy price subsidies, governments are very likely to see further increase in their already-high subsidy costs.

The pressure is on and governments must simply reform their energy price subsidies. However, they face a number of challenges, as energy pricing reform has the potential to induce two major effects: decline in households’ welfare, and erosion of regional industries’ global competitiveness.

Although the logic behind subsidy reform is sound – imposing controls on spending and conserving resources – energy subsidy reform tends to be complex, both technically and politically. Therefore, the reform’s broader implications and effects require careful planning, including the timing, sufficient public outreach and pace of reform.

There are two major approaches for reforming the energy subsidy pricing framework – immediate and gradual energy subsidy reform. The pace and extent of potential steps towards reform will be determined by both the fiscal and administrative capabilities of the governments making such reforms.

Removing domestic energy price subsidies entails serious economic and social costs. In addition, the lack of readiness for change on the sides of both households and industries, coupled with a variety of post-removal cost scenarios and effects, require regional policy-makers to link their reforms of domestic energy prices to a set of effective mitigation measures that ultimately protect the poorest and assist the economy in its long-term adaptation.

It is critical that governments start reforming their respective energy pricing framework with no further delay. However, the timing of the reform will, to a large extent, depend on the international oil price, as it spells different constellation for both energy exporters and importers, which reflects their choice of reform approach.

The risk of potential failure is relatively high due to protests that insufficient mitigation measures can potentially trigger. Oil importers experience an economically more favorable environment for implementing the reform steps without having to compromise the extent of the various price adjustments when faced with a higher price gap.

Deflation in oil prices provides for a once in a lifetime opportunity to phase out fuel subsidies and carry through other planned fiscal reforms. Also, support from lower global oil prices for the authorities’ fiscal consolidation efforts will outweigh declines in oil- and gas-related revenues. How long will this window of opportunity last? The time is now.

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