MARCH 2017: Issue 108 forum

A QUARTERLY JOURNAL FOR DEBATING ENERGY ISSUES AND POLICIES

This issue of the Oxford Energy Forum of entitlement and expectations, CONTENTS is devoted to energy pricing reforms in complicating the transition to a less the MENA. It has been nearly three years distortive welfare system. The author MENA Energy Pricing Reforms since the collapse in global oil prices uses cross-country data to explore Subsidies and the political economy of and there have been mixed outcomes the links between state and regime wealth-sharing in the MENA for the MENA. While some countries type and subsidies, suggesting that Steffen Hertog 5 (which had already initiated reforms) while the use of subsidies as an Rethinking energy policy in the MENA’s benefited from the low oil price, in others authoritarian patronage tool is a global hydrocarbon economies it triggered a spate of pricing reforms phenomenon, the effect is stronger Rahmat Poudineh 9 following fiscal crises. Although there is and more significant for countries with How might energy price and subsidy now an unequivocal consensus over the rents. Moving towards a new, broader reform affect the use of renewable energy necessity for these reforms, their manner social contract that replaces subsidies in the MENA? and pace of implementation thus far with conventional income support and Jonathan Walters 13 has evoked fresh debates over their active labour market policies will be Energy subsidy reforms and the impacts long-term sustainability and ensuing hardest in the most statist republics on firms: transmission channels and response measures impact on the region’s rigid economic with the deepest nationalist–populist Jun Rentschler and Martin Kornejew 16 and social structures. The first four legacy – ironically, the same regimes GCC energy pricing reforms in a low oil articles in this issue of the Forum explore that set out with the greatest ambitions price environment overarching questions related to MENA of development and welfare more than Anupama Sen 19 energy pricing reforms, while the last half a century ago. Reforming electricity, water, and fuel seven delve deeper into country-specific Rahmat Poudineh argues that while the subsidies in the United Arab Emirates experience. MENA’s copious natural capital has Tim Boersma and Steve Griffiths 22 The issue opens with an article by transformed its economies over the last Challenges of Kuwaiti energy pricing reform Steffen Hertog who looks at the history century, opportunity costs are mounting. in response to petroleum price volatility of wealth-sharing in the MENA. He Further, the conventional ‘social contract’ Manal Shehabi 25 argues that, in contrast with conventional argument is frequently used to analyse Algeria in fiscal crisis: energy policy political economy arguments on the the complexities of energy price (or priorities and implementation challenges Ali Aissaoui 30 social contract, energy subsidies are subsidy) reforms, and while this explains better understood as part of a broader the need for rent distribution, it does Energy pricing reforms in Egypt Tom Moerenhout 34 regime of quasi-welfare in which not account for why subsidies have policies like subsidies and excessive been chosen over other social welfare Iran’s subsidy reform plan: success or public employment are used in lieu instruments. Energy price reform is failure? Sara Bazoobandi 37 of conventional social welfare tools but one element of several interrelated to distribute wealth in the region’s components in a sustainable energy The political economy of energy subsidies in Egypt and Tunisia: the untold story authoritarian systems. This quasi-welfare strategy, which include investment in Ferdinand Eibl 40 system has created rigid systems energy efficiency and alternative energy,

OXFORD ENERGY FORUM impact of declining revenues was declining revenues was impact of by the plummeting clearly represented were from oil price, and since increases amongst the a low base they remained as the However, cheapest in the world. new equilibrium market moves into a lower for where prices could remain further reforms to reflect full longer, involve additional opportunity costs will contract’ and testing of the ‘social its fiscal, striking a balance between elements. economic, and political and Steve Griffiths Boersma Tim which, review experience in the UAE in implementing electricity and water price reforms more than eight years ago, stands out as a leader among its GCC peers. The authors focus on Dubai and Abu Dhabi, where reforms were triggered by a combination of increasing LNG imports, rising domestic energy demand, and falling oil revenues. The two emirates have demonstrated several examples of best practice, which are now being replicated across the GCC. These include communication of the need for subsidy reforms before implementing them, gradual introduction of pricing increases, and tiered pricing based on usage (thereby letting the largest consumers carry the heaviest financial burden). Similar practices – which include the rapid removal of subsidies when opportunity strikes (such as the 2014 oil price collapse) and price setting according to international benchmark prices – have been applied to transportation fuel subsidies. Because of these practices, electricity, and transportation fuel pricing in water, is steadily advancing toward the UAE and more transparent cost-reflective pricing. Manal Shehabi’s article examines energy pricing reform in Kuwait’s response to the recent oil price fall, with model reference to an economy-wide using a computable general equilibrium (CGE) framework which captures key structural features of its economy and issues, Jun Rentschler overarching impact look at the and Martin Kornejew on firms of energy pricing reforms predominant (a departure from the The removal focus on households). through of subsidies is transmitted two channels. to firms’ costs through the price of The direct channel raises firms leading to energy inputs used by in costs, whereas an instantaneous rise applies through the indirect channel an increase supply chains, following in the prices of intermediate inputs. The authors discuss four potential responses by firms to such price shocks: absorption (through accepting lower profit margins), substitution (with cheaper fuels), improvements in resource (energy and materials) and price pass-on (through efficiency, adjustments in the sale price of output). The authors conclude with important policy considerations for the design of fossil fuel subsidy reforms – such as enabling firms to substitute towards alternative fuel types or increasing the efficiency of energy and material usage by providing technical, informational, and financial assistance. experiences Articles on country-specific begin with Anupama Sen, who looks at GCC energy pricing reforms, arguing that fiscal pressures were building long before the oil price collapse. The 2008 financial crisis and 2011 ‘Arab uprisings’ led GCC governments to increase expenditure in order to with pre-empt social unrest. Together a higher reliance on oil revenues to fund this, their economies were exposed further to price volatility. These pressures were not uniform across the GCC so that, following the price collapse, the fiscal adjustment mechanisms available to them also varied and reforms have therefore been implemented at varying paces. Briefly assessing the experience of Saudi Arabia, the author concludes that reforms thus far have constituted a relatively easier initial phase – the OXFORD ENERGY FORUM 2 and an integrated energy sector energy sector and an integrated each The author examines strategy. in the MENA of these components the traditional view context, arguing that electricity, of energy strategy (where are placed oil products, and gas longer works, into separate silos) no these energy as the end market for be separated. carriers can no longer a rethinking of The author argues for century energy policy for a twenty-first growth context, in which unconstrained fuelled by cheap hydrocarbons is unsustainable. Sound communication and mitigation strategies are critical for the successful implementation of energy price reforms, in order to assure the public that it is only the form of rent distribution that changes, and not the rent distribution itself. tests the veracity of Jonathan Walters the popular argument that renewable energy has not been able to compete with subsidized fossil fuels in MENA, and that the use of renewable energy will therefore grow only as fossil fuel subsidies are reduced. Using a line of Socratic questioning, the author argues that while there are few MENA markets where energy is traded competitively and where market structures have not evolved even to the point of wholesale competition, fossil fuel subsidy removal could improve the economics of solar energy in these markets (in areas such as rooftop solar and water heating), with the extent of the outcome being contingent upon the competitiveness of There the renewable technology itself. external factors that are, however, could deliver a renewables expansion in MENA markets even without a reduction in fossil fuel subsidies, these include: rapid technological advances and cost declines in renewable energy storage, the spread of replicable renewable energy auctions across Europe, and scale economies resulting from interconnections with the European renewable electricity market. In the final article dealing with MENA ENERGY PRICING REFORMS ENERGY PRICING MENA

INTRODUCTION TO THIS ISSUE INTRODUCTION TO THIS ISSUE 3 OXFORD ENERGY FORUM involved in the energy sector). the energy sector). involved in implemented following Reforms were communicating a strategic campaign of subsidies. the regressive nature the however, After this initial success, among the government’s support by institutional poor has been eroded which have and political obstacles of the targeted impeded development for social safety nets necessary while economic sustainable reforms, Further reforms activity remains flat. in August 2016 pushed inflation to a record 20 per cent even as Egypt secured an IMF loan to follow through on implementation, on the back of Saudi investments to support the Egyptian economy which, the author argues, it considers ‘too big to fail’. The author concludes that Egypt has little policy space and no room for error in engendering the necessary trust- building measures to shepherd the economy through this austere period to stronger growth. Sara Bazoobandi places Iran’s 2008–9 landmark energy price reform programme (aimed at replacing subsidies with cash handouts) in historical context; as an economic mechanism allowing the distribution of wealth across society to support the subsidies became a fundamental poor, element of the Islamic Revolution’s ethos. Subsidy reforms were motivated by budget deficit concerns, wasteful domestic consumption, worsening and a goal to halve the air quality, country’s energy intensity by 2021. In the first phase of the subsidy reform programme, the government’s financial savings proved insufficient to cover the cost of implementation, which led to additional pressure on the budget, forcing the government to cut some recipients out of the payments system. The author argues that a combination of sudden energy price increases, increased liquidity due to government cash handouts, and devaluation of the riyal (IRR) due to international on the demand side (of which energy side (of which on the demand and is a cornerstone), pricing reform with renewables replacement of gas The author in power generation. price increases concludes that since a low base, they are made from such exert any are insufficient to either on consumption meaningful influence or to cover the (gasoline and diesel), utilities (electricity operating deficits of lacks a coherent and gas). The strategy the gas and pricing structure along electricity value chains, and is impeded by lack of regulatory coordination. Algeria’s 2030 renewables target of 22 GW has been pushed to 2035 and raised to a national priority, Tariff accompanied by a Feed-in (FiT) scheme funded through a combination of hydrocarbon royalties and taxes. A medium-term target to auction 4 GW to foreign investors should generate interest due to the almost completely reformed power poor overall but the country’s sector, investment environment could prove do not an impediment. Policymakers appear to be preparing for a transition market-based to from subsidy-based incentives, which poses risks to the strategy from further fiscal deterioration. Moerenhout In the next article, Tom considers Egypt’s experience, where the transformation of a decades-old social contract represents a balancing exercise which relies on a very thin economic, fiscal, and sociopolitical safety net. Egypt introduced ‘big bang’ pricing reforms comprising massive fuel price increases in July 2014. Although considered a risky move which countered the ‘social contract’, these reforms were implemented without much difficulty as politico- economic conditions were favourable due to three factors: a massive fiscal crisis with subsidies amounting the lack of to 8.5 per cent of GDP, political opposition, and President Sisi’s ability to garner support from the army (which has been historically interactions between its industries. between its industries. interactions has argues that Kuwait The author valves that two primary stabilization impacts of partially absorb the negative first is (intended) oil price shocks; the Fund Wealth inflows from its Sovereign seldom discussed (SWF). The second, in the literature, is (unintended) A negative expatriate labour exit. for oil price shock is contractionary forcing industries economic activity, and profits are whose performance impacted to cut costs, including labour costs. As wages tend to be sticky in the short run, employment levels are will adjust instead. Most Kuwaitis employed by the public sector where contracts are rigid. In contrast, the flexibility of expatriate labour contracts allows affected industries to adjust their employment level. The expatriate labour market will thus adjust and its mechanism This fall. levels employment other GCC and is unique to Kuwait petrostates with similar labour market compositions. The author argues that slashing subsidies further pushes up costs for industries that use energy as an intermediate good, leading to additional adjustments through the expatriate labour channel, and a further contraction in the overall output of the impacted industries. While expatriate labour exit acts as an adjustment mechanism, it will cause an inevitable loss in available skills and resources for certain occupations – an important implication which should be taken into account in the design of energy pricing reforms. Ali Aissaoui focuses on Algeria, where the recent collapse of global oil (and gas) prices and a near-halving later, of state revenues is accompanied by concerns over long-stagnating production, rising domestic demand, and a fall in hydrocarbon export volumes. In response, the government has adopted three strategic priorities: the revival of exploration on the supply side, rationalization of consumption MARCH 2017: ISSUE 108 MARCH MENA ENERGY PRICING REFORMS

sanctions led to very high inflation 2017, the current administration, the major reform. Using a novel dataset, during the first phase, with little impact author argues, is unlikely to persist the author demonstrates three pillars on consumption behaviour. Although with a further scaling back of its cash to his argument: first, this group of the new government, elected in 2013, payments. beneficiaries has a significantly higher opted to continue cash payments presence in sectors that benefit The issue closes with Ferdinand Eibl’s it faced the same difficulties with from energy subsidies; second, the article on Tunisia and Egypt. The author implementing the second phase; it presence of energy subsidies is a challenges the popular attribution of eventually had to cut payments to key determinant for the entry of these governments’ reluctance to reform wealthier citizens and signal plans beneficiaries into energy-intensive for a further reduction in monthly energy subsidies (fear of public sectors; and third, there is anecdotal payment recipients for 2017. The unrest), arguing that this narrative is evidence to suggest that this group author notes that, unlike other MENA incomplete without giving due attention of beneficiaries has used its leverage countries, subsidy reforms in Iran were to another collection of beneficiaries to lobby against subsidy reductions. implemented without social unrest, from energy subsidies. These – namely These results are indicative of the partly due to the strained economic Politically Connected Businessmen important veto powers that politically and political environment at the time. (PCBs) and the army – have become connected actors wield in the context of Faced with an upcoming election in an important lobbying group against subsidy reform.

CONTRIBUTORS TO THIS ISSUE

Ali Aissaoui is a Senior Visiting Steffen Hertog is Associate Professor, Jun Rentschler is a doctoral researcher Research Fellow, Oxford Institute for Department of Government, the at University College London, and a Energy Studies London School of Economics Visiting Fellow at the Oxford Institute for Energy Studies Sara Bazoobandi is Senior Lecturer in Martin Kornejew is a graduate student International Political Economy at at University of Kiel and Stockholm Anupama Sen is a Senior Research Regent’s University, London University, and a Visiting Researcher Fellow at the Oxford Institute for at University College London Energy Studies Tim Boersma is a Senior Research Scholar with the Center on Global Tom Moerenhout is at the Graduate Manal Shehabi is a doctoral researcher Energy Policy at Columbia University, Institute of International and at the University of Western Australia New York Development Studies, Geneva, an and a Visiting Research Fellow at the Associate at the Global Subsidies Oxford Institute for Energy Studies Ferdinand Eibl is Lecturer in Political Initiative (GSI), and an OIES–Saudi Economy of the Middle East, Aramco Fellow Jonathan Walters is a former World Department of Middle Eastern Bank Director of Regional Studies, King’s College London, Rahmat Poudineh is Lead Senior Programmes in the MENA and is now and an OIES–Saudi Aramco Fellow Research Fellow of the Electricity an independent economist Programme at the Oxford Institute for Steve Griffiths is Vice President for Energy Studies The views expressed in this issue are solely Research and Associate Provost at those of the authors and do not necessarily the Masdar Institute of Science and represent the views of OIES, its members, Technology, United Arab Emirates or any other organization or company.

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Subsidies and the political economy of wealth-sharing in the MENA Steffen Hertog

Energy subsidies in the MENA region The history of wealth-sharing in the MENA and welfare by Nasser and other Arab have been much discussed from a nationalist leaders also put the region’s The MENA region, and Arab countries technical perspective. Some of the conservative rulers – some of whom fell in particular, stand out in several literature hints towards the political to, or were threatened by, nationalist regards in comparison with other economy of subsidies, but typically coups – under pressure to expand developing regions: the discussion remains very high-level, provision. Wide-ranging patronage with non-specific references to the fact they have typically achieved faster came to be seen as a key tool for that subsidies have created vested increases in school enrolment and maintaining authoritarian rule, be it interests, or to an authoritarian ‘social quicker reductions in child mortality republican or monarchical. contract’ underpinned by subsidies. in the post-World War II era (see ‘Why are some oil dictators nice to their Both points are valid, yet they constitute ‘MENA QUASI-WELFARE REGIMES ARE people?’, Ferdinand Eibl and Steffen only a starting point for understanding the ROOTED IN THE POPULIST NATIONALISM Hertog, Draft paper, London, 2016); political forces that have been keeping OF THE 1950S AND 1960S …’ MENA energy subsidy systems in they typically provide higher levels of place; these forces need to be analysed public employment (‘Is there an Arab In line with the hypothesis that MENA if such systems are to be reformed variety of capitalism?’, Steffen quasi-welfare regimes are rooted in the without social and political disruption. Hertog, London, 2016); This article argues more specifically that they have provided more extensive populist nationalism of the 1950s and energy subsidies in the region are part subsidies (of both energy and food) 1960s, it is indeed the socialist–populist of a broader regime of quasi-welfare than most other developing countries republics like Egypt, Syria, Algeria, in which policies like subsidies and (‘Subsidy reform in the Middle East and Libya that tend to have the most excessive public employment are used and North Africa’, Carlo Sdralevich, widespread subsidy regimes and, in lieu of conventional social welfare Randa Sab, Younes Zouhar, and outside the GCC, the most expansive tools to distribute wealth in the region’s Giorgia Albertin, Washington, DC: state employment. Most food and authoritarian systems. International Monetary Fund, 2014). energy subsidy regimes were created in the turbulent 1950s and 1960s – Independent of whether the The quasi-welfare system reflected specific tools were in line with good although it was only with the oil shock in subsidies is rooted in the political development practice or not, in of the 1970s that energy subsidies struggles of the post-World War II all these key regards the region’s became particularly costly, at least for period and has created rigid systems of governments have evinced particularly energy-poor Arab countries. entitlement that are difficult to overcome. strong efforts to spread welfare widely. It has also created expectations – vis- Why did regimes choose subsidies à-vis the state – that remain particularly While the origins of this extensive, and and not other – conventional – welfare high, further complicating the transition often distortive, distributive regime tools for wealth-sharing? The coverage to a less distortive welfare system. That remain to be researched in more of unemployment insurance, health being said, this article also presents some detail, it is clear that it emerged in the insurance, pensions systems, income preliminary evidence that high energy era of Arab nationalism and intensive support payments, and other tools of subsidies are part of an authoritarian ideological competition between welfare is highly uneven across the strategy that also exists outside the MENA Arab countries. As Ferdinand Eibl region (‘Inclusion and resilience : the region, if usually on a smaller scale. has shown, domestic elite splits at way forward for social safety nets in times of instability led political rivals the Middle East and North Africa – to engage in wide-ranging welfare overview’, Victoria Levin, Joana Silva, ‘THE QUASI-WELFARE SYSTEM promises (‘Social dictatorships: the and Matteo Morgandi, World Bank, REFLECTED IN SUBSIDIES … HAS political economy of the welfare state Report no. 72975, 1 September 2012; CREATED RIGID SYSTEMS OF in the Middle East and North Africa’, ‘Pensions in the Middle East and ENTITLEMENT THAT ARE DIFFICULT TO Ferdinand Eibl, DPhil thesis, University North Africa: time for change’, David OVERCOME.’ of Oxford, 2016). At the same time, the Robalino, Orientations in Development populist promises of state employment Series, Washington, DC: World Bank,

OXFORD ENERGY FORUM 5 OEF Figures

Preference for government provision across different world regions, 2010–14

Note: Respondents were asked ‘Government responsible that everybody is provided for?’ on a 10point scale. MENA ENERGY PRICING REFORMS Percentages in graph represent share of those who ‘agree completely.’ orce: orld ales rvey ave .

2005). Investment in such instruments 35 pales in comparison to the cost of excess 30 public employment and energy subsidies. 25 Again, answering this question with confidence will require further research, 20 but likely causes include: 15 10 the symbolism and immediately tangible nature of ‘in-kind’ benefits; 5

of % respondents samplein 0 the relative administrative ease with MENA CAC EU LAC SA SSA EA SEA NA which subsidized prices can be CAC: Central Asia and Caucasus; LAC: Latin America and Caribbean; administered – in comparison with SA: South Asia; SSA sub-Saharan Africa; SEA: Southeast Asia the complexity of creating modern Preference for government provision across different world regions, social security systems – a particular 2010–14 political benefit at times of acute Note: Respondents were asked ‘Government responsible that everybody is provided for?’

instability; on a 10-point scale. Percentages in graph represents share of those who ‘agree completely’. the visible universality of subsidies, Source: World Values Survey Wave 6 compared to means-tested welfare Remarkably, the period of relative arguably still apply today. At the same that can be exclusive in practice; economic liberalization that many time, popular expectations vis-à-vis the absence, at the time, of models Arab countries went through in the government welfare provision remain for modern anti-poverty tools such as 1970s (sometimes called ‘infitah’) particularly deeply engrained in the conditional or unconditional cash changed little in the region’s basic MENA region (see figure above). grant systems. wealth-sharing system. If anything, subsidies and state employment Finally, economic distortions created State and regime type and subsidization by subsidies were less well understood grew and liberalization merely added another layer of business cronyism and The figure below shows that in the scale at the time, while the opportunity costs of energy subsidies, the MENA – and of energy subsidies, in particular, were corruption to systems that remained, Arab countries in particular – does often lower in the initial phase. Since in many ways, predicated on state- then, the quasi-welfare systems have orchestrated protection and wealth- indeed stand out globally. Also, in become so costly that resources sharing. All of the above reasons comparison with the rest of the world, orce: and orld ank for conventional, less economically supporting the provision of in-kind the share of energy subsidies in GDP in distortive, and socially inclusive welfare welfare benefits continued to apply, and the MENA region barely declines with policies have become very scarce. Iran (Islamic Republic of) The bias of state employment and 20 energy subsidies in favour of the

politically critical urban middle class 15 probably also helped make them Egypt politically attractive. This is not to say, Libya 10 however, that the basic intention behind Saudi Arabia AlgeriaBahrain subsidies was not inclusive. One of the Kuwait considerations behind the expansion 5 Yemen OmanUnited Arab Emirates Jordan Qatar of subsidies in 1970s Tunisia, for Tunisia pre-tax energy subsidies %/GDP Sudan Iraq Morocco example, seems to have been that the 0 Turkey Israel informal sector would also benefit from 6 7 8 9 10 11 them (‘The socioeconomic impacts of log GDP per capita energy reform in Tunisia: a simulation rest of world trend MENA trend approach’, José Cuesta, AbdelRahmen populist republics other MENA rest of world El-Lahga, and Gabriel Lara Ibarra, Policy Research Working Papers. World Pre-tax energy subsidies as share of GDP, 2013 Bank, June 2015). Source: IMF and World Bank

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MARCH 2017: ISSUE 108 orce: Polity

higher values for GDP per capita. This is Iran (Islamic Republic of) probably an outcome of the fact that the 20 richer countries in the region derive much of their wealth from oil income, which 15 in turn has tempted them to provide cheap domestic energy, even if this has Egypt Libya ceased to be economically rational in 10 Saudi Arabia the decades since the 1980s oil glut. Bahrain Algeria Kuwait

5 Lebanon As expected, authoritarian republics with OmanUnited Arab Emirates Yemen Jordan

pre-tax energy subsidies %/GDP Qatar a deep legacy of populist–nationalist Tunisia ideology – namely Algeria, Egypt, MauritaniaSudan Morocco DjiboutiIraq 0 Turkey Israel Libya and (although not an Arab case) -10 -5 0 5 10 Iran – stand out in particular. (Note Polity score that Iraq has a low subsidy figure only MENA rest of world because data on petroleum subsidies are missing from the IMF dataset; as Polity scores and energy subsidies transport fuel is kept cheap in Iraq, Source: Polity, IMF actual subsidies are likely to be high Simple exploratory regression shows, the only fully statistically significant in this case too.) Countries with less however, that the correlation between predictor of subsidies. The dummy of a populist–socialist history (Tunisia, authoritarianism and subsidies is robust that indicates whether a country is Jordan, and Morocco) have lower even if we control for oil and gas rents Arab has barely any impact; the same subsidies. The pattern is very similar per capita as well as GDP per capita is true for a MENA dummy that is not for food subsidies (‘Subsidy Reform in (see Model 1 in the table below). (The shown here. So at least descriptively, the Middle East and North Africa’, Carlo inclusion of GDP per capita is standard the authoritarian nature of the region Sdralevich, Randa Sab, Younes Zouhar, and Giorgia Albertin, 2014, Washington, practice but somewhat problematic, seems to account for the generally DC: International Monetary Fund). as the GDP of oil-rich countries is in elevated level of subsidies – although part determined by their oil rents – the the extremely high subsidies in some of Cross-national data also suggests a two variables are not independent from the MENA republics continue to stand link between energy subsidies and each other.) Authoritarianism is in fact out even in this model. authoritarianism: countries with lower Polity scores – in other words, the more authoritarian countries – tend to provide Correlates of energy subsidies as share of GDP (IMF), 2013 higher subsidies (see figure above). Model 1 Model 2 The link for the MENA region appears –0.30*** –0.093 similar to that for the rest of the world, Polity 2 score (0.076) (0.14) suggesting that the use of subsidies –0.41 –0.67* as an authoritarian patronage tool is a Log of GDP per capita (0.38) (0.40) global phenomenon. 0.16 –0.26 Arab country We cannot be sure, however, that the (1.19) (1.20) link is causal: 0.22* 0.39** Resource rents per capita (logged) (0.13) (0.16) oil-rich countries tend to be more –0.036* authoritarian (The Oil Curse : How Polity*rents interaction (0.02) Petroleum Wealth Shapes the 6.52* 7.71** Development of Nations, Michael L. Constant Ross, Princeton University Press, 2012); (3.36) (3.38) at the same time, oil-rich countries Observations 103 103 might be more likely to provide R2 0.37 0.39 energy subsidies, independent of * p < 0.10, ** p < 0.05, *** p < 0.010 their regime form. Note: Standard errors in parentheses

OXFORD ENERGY FORUM 7 MENA ENERGY PRICING REFORMS

Could it be that rents and In the interaction model (Model 2 in authoritarianism interact, notably in the the table), the Arab dummy variable ‘… LARGE PARTS OF THE REGION REMAIN sense that the use of energy subsidies again does not have a significant BEHIND THE CURVE IN BUILDING THE is limited to authoritarian regimes with impact. This all suggests that subsidies INFRASTRUCTURE FOR MODERN SOCIAL natural resource rents? Model 2 (the in the region are so pronounced SAFETY NETWORKS.’ second column in the table) tests this not because the Arab world is hypothesis. As interaction terms are fundamentally different, but simply are threatened by political subversion difficult to interpret, the figure below because it contains many cases that (‘Why are some oil dictators nice to graphically illustrates the marginal effect combine authoritarianism with high their people?’, Ferdinand Eibl and of rents conditional on how authoritarian levels of rent. The average incidence Steffen Hertog, Draft paper, London, a country is. The result is indeed that of energy subsidies for authoritarian 2016). only in more authoritarian countries countries in the rest of the world is (those with a negative Polity value, left pulled up by outlier cases Kyrgyzstan, side of graph) is there a significant, Venezuela, Turkmenistan, Uzbekistan, Consequences for subsidy reform positive link between hydrocarbons and Zimbabwe, all of which (bar The deep political roots of subsidy rents and energy subsidies. The effect Zimbabwe) are resource-rich. systems were illustrated when Arab is substantial: our (logged) measure of One should not draw firm causal regimes, both under old and new resource rents per capita can reach up conclusions from simple cross-country leaders, reversed subsidy reforms or to 10 units in resource-rich countries, regressions. The above results are increased subsidies after the Arab which would imply extra subsidies of hence merely suggestive. They are, uprisings of 2011. This reflexive resort more than 7 per cent of GDP. however, in line with existing qualitative to old distributional patterns indicates By contrast, democratic countries, on research which claims that subsidies that subsidy regimes are seen as a average, do not provide increased are used to bolster authoritarianism. cornerstone of political stability. Given energy subsidies even when rents It remains to be investigated whether Arab citizens’ heightened expectations are available. This increases our rents and authoritarianism also vis-à-vis the state and the patchy confidence somewhat that the link account for other features of Arab nature of other welfare mechanisms, between subsidies and authoritarianism distributional systems – such as this perception is probably not wrong. is not just incidental. A further marginal excessive government employment or The partial adjustments of subsidy effects test (not shown) reveals that above-average public goods provision regimes that have happened since authoritarian systems in general tend in education and health. Preliminary 2011 have occurred under great fiscal to have higher energy subsidies, but research suggests that the conversion pressure, and then only reluctantly. that the effect is stronger and more of rents into broader public goods like Compensation measures have often significant for authoritarian countries education and healthcare only happens with rents. in authoritarian countries whose rulers been ad hoc, as large parts of the region remain behind the curve in building the infrastructure for modern social safety networks. Even historically 1.5 very unequal regions, such as Latin America, have by now built up more

1 experience with modern anti-poverty tools such as cash grants.

.5 If further reforms are to succeed, governments and international organizations need to tackle subsidies 0 Effects on Linear Prediction as part of a broader system of skewed wealth distribution that will require wholesale reform. Citizens -.5 in many Arab countries express -10 10 polity2 disproportionately high levels of distrust Average marginal effects on subsidies (as % GDP) of a one unit log vis-à-vis their governments, which increase in rents: dictatorship and democracy compared will not make the task of distributional

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reform easier and which puts a support and active labour market their political survival. Moving towards premium on immediate and tangible policies, in lieu of exclusive, costly, and such a new social contract will probably compensation (‘Is there an Arab regressive subsidies and government be hardest in the most statist republics variety of capitalism?’, Steffen Hertog, employment. In the long run, the with the deepest nationalist–populist Economic Research Forum, Working chances for an inclusive social contract legacy; these, ironically are the regimes Paper 1068, London, 2016). The region also appear better in democratic that set out with the greatest ambitions is in need of a broader social contract regimes that are less reliant on of development and welfare more than that provides conventional income patronage through in-kind benefits for half a century ago.

Rethinking energy policy in the MENA’s hydrocarbon economies Rahmat Poudineh

Background components (discussed below in ‘… UNCONSTRAINED ECONOMIC subsequent sections): The Middle East and North Africa GROWTH FUELLED BY CHEAP (MENA) is a unique region in many energy price reform, HYDROCARBON RESOURCES IS NO respects, but never more so than investment in energy efficiency, LONGER SUSTAINABLE.’ when it comes to the issue of energy: investment in alternative energy, it contains roughly 60 per cent of world a comprehensive energy sector-level oil reserves and 45 per cent of world issues and a wider gap between the strategy (rather than one that is gas reserves. Over the last century, this poor and the rich, but they have also disaggregated across energy copious natural capital has enabled placed many of these countries on vectors). MENA countries to transform their a fiscally unsustainable path, with economies, boost their standards of the IMF predicting narrowing fiscal However, things are easier said than living, support population growth, and balances or budget deficits through to done. develop industries that rely heavily 2020. Additionally, the Paris Climate This article has four main conclusions. on energy to function. However, Agreement, which came into effect in there is no opportunity without cost, November 2016, implies that in the 1 Successful energy price reform and and these costs are now becoming long run, the future of fossil fuels is at elimination of fossil fuel subsidies clearer. While energy demand in most least uncertain, even if peak oil require an understanding of the logic of the developed world is stagnant/ demand does not materialize in the of subsidies; it is not just about declining, various forecasts show the foreseeable future. politics as we always hear, the MENA and the Asia Pacific region to economic context matters a great In this context, the main contention deal. be the main sources of global energy of this article is that the MENA’s oil consumption growth. The issue of and gas economies need to rethink 2 Energy efficiency is one of the energy intensity fares even worse in their energy policy for the twenty- biggest challenges facing the region; comparative terms. According to the first century, where unconstrained the correction of price signals can BP Energy Outlook (2016) the Middle economic growth fuelled by cheap only partially resolve this due to the East will become the most energy- hydrocarbon resources is no longer presence of other factors such as intensive region of the world by 2030. sustainable. Revision of energy policy path-dependency, market failure, Moreover, high dependence on oil/ will shape their wider economic and and elements of consumer gas revenues has led to economic industrial strategy and improve their behaviour. performance that fluctuates with oil place and future in a rapidly changing 3 Investment in alternative energy price cycles, compromising economic global energy landscape. A sustainable requires that careful consideration is stability. Furthermore, hefty implicit energy policy for the region can have given to the balance of market and and explicit energy subsidies have multiple dimensions but should include government roles in providing resulted not only in severe distributional at least the following key interrelated investment incentives for renewables.

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4 The traditional view of energy follow social welfare theory: strategy (where electricity, oil ‘… IMPROVED ENERGY EFFICIENCY These countries have limited capacity products and gas are placed into (CONSIDERED AN “INVISIBLE FUEL”) to invest resource rents locally separate silos) no longer works. This IS OFTEN CONSIDERED THE CHEAPEST without creating inflation or other is because the end market for these WAY TO CURB UNCONSTRAINED ENERGY adverse macroeconomic impacts. energy carriers can no longer be DEMAND.’ separated. Populations in these countries may not have the confidence that a Energy price reforms Sovereign Wealth Fund (SWF) would electricity sector, the cost of saving bring any benefit, not least because one kilowatt hour (kWh) is a fraction Energy subsidies in the MENA’s the discount rate that the public of the cost of producing it. There resource-rich countries have been would apply to a SWF would exceed are many factors that affect energy always explained around the idea of the likely return of these funds efficiency, these include energy prices, ‘no taxation and no representation’ or (because of uncertainty in future technology, information, consumer alternatively, ‘rent distribution in return revenues and risk attitude). behaviour, and path-dependency for political support’. This was believed A better understanding of the economic (given the long life of energy to constitute an important part of the logic of subsidies would thus help to social contract (although in practice consuming assets). However, among reduce or eliminate them in the future. the social contract also has other these various factors analysts often focus only on under-priced energy dimensions, such as security) between First and foremost, the economic as the reason for exceptionally high rulers and citizens/subjects in the infrastructures (including energy intensity in the MENA region. region’s oil economies. This argument communications, transportation and While price is an important driver has also repeatedly been used to distribution networks, financial of energy demand and associated explain the difficulty of removing institutions and markets, and energy investment decisions, the effect of energy subsidies without introducing supply systems) in the MENA’s non-price factors is substantial when political reforms. While the argument hydrocarbon countries need to be their overall effects are considered. This based on the social contract rightly better prepared for a transition away suggests that even if price distortions points to the need for rent distribution, from commodity-based subsidies to are eliminated, a significant amount given the political structure in these other forms of rent distribution. countries, it tells us nothing about why of energy inefficiency in the MENA Second, communication with the one particular form of rent distribution economies will remain if non-price public and a mitigation strategy are (subsidizing a commodity in this case) factors are not addressed. key here. Sound communication is should be preferred over others. In needed to assure the public that the For example, path-dependency is very fact, rent distribution can be of any removal of energy subsidies implies important. Current energy consumption form, from subsidizing commodities only that the form of rent distribution is influenced by the investment or services to providing insurance decisions that have been made in the and cash payments. Social welfare changes (to the advantage of the past. Consequently, a range of fixed theory tells us that any rent in excess public) and not the rent distribution factors affect energy demand: of basic governmental administration itself. Mitigation measures such as costs should be distributed as lump cash payments are thus needed to the characteristics of the existing built sum grants and be used to finance reassure the public of the environment in the region, government’s commitment to rent essential services such as compulsory the fleet of transport alternatives, education, health, or their equivalents. distribution. population, The fact that the MENA’s resource-rich countries have chosen to subsidize Energy efficiency: the ‘invisible fuel’ the pattern of human settlement. energy carriers rather than follow social The MENA resource-rich economies However, these cannot be changed welfare theory for rent distribution, has are among the most energy-intensive solely through rationalizing end-user more to do with their economic context countries of the world – even prices. These mean that there is some than their political context. though improved energy efficiency form of ‘structural energy inefficiency’ There are at least two economic (considered an ‘invisible fuel’) is often in the MENA economies that a price reasons why resource-rich countries considered the cheapest way to curb signal cannot easily eliminate. The subsidize commodities rather than unconstrained energy demand. In the problem of path-dependency is unique

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to resource-rich countries, in that their Alternative energy sources economies have developed around ‘LITTLE ATTENTION HAS BEEN GIVEN The issue of renewable investment in the idea of cheap and abundant fossil TO THE KEY QUESTIONS OF WHY the MENA’s hydrocarbon economies fuels. RENEWABLE INVESTMENT IS NEEDED has been the subject of various studies There are two other problems relating in recent years, but little attention has … AND HOW THE INCENTIVES FOR to energy efficiency that are relevant in been given to the key questions of why INVESTMENT NEED TO BE PROVIDED.’ every context. These are behavioural renewable investment is needed in barriers and market/organizational these countries and how the incentives gas is the only fuel that is used by failures. for investment need to be provided. all MENA countries for electricity The need for renewable investment Behavioural barriers are related to generation. However, in recent years in resource-rich countries has been hidden costs and attitude towards risk. the demand for gas in many of these previously justified in terms of: Investing in energy efficient appliances countries has surpassed exploration and utilization of new gas reserves. is often costlier and riskier (due to dealing with increasing energy The figure overleaf shows that Kuwait uncertainty in the payback period) and demand, this may cause people to forgo such and the UAE are already net importers, compliance with climate agreements, an option. Moreover, the cost of energy, whereas Saudi Arabia has zero net exploiting the positive externalities of even after removing subsidies, is a tiny trade and Iran is only marginally a net the renewable sector (job creation fraction of households’ expenditure in exporter. Only Algeria and Qatar have resource-rich countries, which creates and economic diversification, among significant production surpluses. This hardly any economic incentive for others). means that if the increase in electricity demand (which is forecasted to grow behavioural change. While these arguments are valid, there significantly over the next 20 years) is Market and organizational failures is also a supply-side argument that is not met with additional gas-powered are related to lack of information, at least equally important. plants, it unavoidably will be met with information asymmetry, and incentives. As seen in the figure below, these oil and/or oil products-fired plants Few programmes exist in the region to countries rely on natural gas, oil which have extremely high opportunity create consumer awareness around products, and oil for power generation costs for these countries. Moreover, high energy consumption levels or to – these three fuels constitute almost in countries such as Algeria, where mandate energy efficiency labels on 100 per cent of the generation mix. government is dependent on gas appliances and energy performance The share of other resources, MENA’s such hydrocarbonexport revenue, economies the growth by fuel of domestictype certificates for homes. Even in places asNote: renewables n addition and fornuclear, ran in0. total of power isgas generated consumption by coal for powerand for generation the 0. is generated from where such programmes exist, their powersolartidalwind generation power.is almost nil. Natural is becoming a concern. Deployment implementation has been sluggish orce of data: nergy alance or inconsistent. There are also issues related to the misalignment Oil products Oil Natural gas Hydro Nuclear of incentives for energy efficiency investment, such as those between Algeria landlords and tenants, or between Iran governments and their departments. Iraq Kuwait Therefore, while energy efficiency is Libya much needed in the MENA’s resource- Oman rich countries, its realization is one Qatar of the most onerous tasks for its Saudi Arabia governments. Analysts often highlight UAE the challenges of removing subsidies in the region, but correcting the price 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% signal is just the first step towards Percentage of total fuel for power generation promoting energy efficiency. Much Generation mix in the MENA’s hydrocarbon economies by fuel type, 2014 remains to be done to promote energy Note: In addition, for Iran, 0.3% of power is generated by coal, and for the UAE, 0.2% is efficiency even after all energy prices generated from solar/tidal/wind power. are fully rationalized. Source: IEA Energy Balance

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MENA ENERGY PRICING REFORMS as consumption and net trade in MENA resourcerich countries orce of data: nergy alance

150 150 abandon the old mentality of placing Net consumption electricity, gas, oil, and renewables 100 100 Net trade into separate silos. The traditional silo 50 50 approach was suited to a time when the end market for these resources 0 0 could be separated. Currently and for -1.8 0.0 2.8 -5.3 0.0 9.8 -7.4 the foreseeable future, gas, electricity, -50 -50 -37.9 and oil compete for various services Net (Mtoe) gas trade of -100 -100 such as heating/cooling and transport

Net gas consumption Net consumption gas (Mtoe) -99.6 in the end-users’ market. Therefore, -150 -150 a comprehensive energy sector Iran Iraq UAE

Libya strategy – in which all energy sources Qatar Oman Kuwait Algeria are treated in an integrated (and Net trade is labelled:

Saudi Arabia perhaps equal basis) – is needed positive: net importers negative: net exporters more than ever. Such a strategy demonstrates the government’s Gas consumption and net trade in the MENA resource-rich countries, 2014 commitment to supporting all energy Source: IEA Energy Balance sources, including renewables, and sends the signal of policy stability. It also allows the realization of not However, these two diametrically only a more sustainable growth path, ‘RENEWABLES CAN HELP ALLEVIATE opposed solutions cannot be but also of improved productivity and THE PRESSURE ON DOMESTIC OIL AND/ implemented in their pure form in the industrial diversification in oil-based OR GAS CONSUMPTION IN THE MENA region. This is because the complete economies. RESOURCE-RICH COUNTRIES …’ removal of fossil fuel subsidies, in the short run, will face significant public Moreover, the governments of the resistance and is likely to have adverse region need to consider energy of renewables can help alleviate the macroeconomic effects – such as and climate policies together, a pressure on domestic oil and/or gas recession and inflation. At the same point which becomes increasingly consumption in the MENA resource- time, a complete subsidy programme relevant following the Paris Climate rich countries and thus boost their for renewables, in addition to the Agreement, with decarbonization export revenues. existing fossil fuel subsidies, would becoming the focal point of many A challenge facing the governments be very costly to the public budget, countries’ energy policy. Such a view of the MENA region is how best to especially in a low oil price environment. can also be justified from an economic incentivize renewable energy, given Therefore, the most practical way perspective, because climate policies their economic context. Overall, to create incentives for renewables (the introduction of renewables, carbon tax, emission performance standards, investors can be incentivized in one of investment, at least in the short to and energy efficiency measures) not two ways – which are polar opposites. medium term, is through partial energy only affect the relative use and price price reform and a partial government One approach would be to remove of alternative energy sources but also subsidy programme. This balances fossil fuel subsidies and internalize the shape of the energy demand curve the fiscal pressure on the government the cost of externalities. This creates and inter-fuel competition. This implies budget against political acceptability. strong incentives for investors in that the separation of climate and It is also compatible with the energy renewables to enter the power energy policies can lead to unintended price reform plans currently underway market as their cost is falling (recent consequences in energy markets which in the region, in which governments are solar auctions in the UAE showed may then require further policies to gradually and partially rationalizing the that solar PV is among the cheapest remedy. price of all energy vectors. options in the region). Finally, if public resources are to be The second method is to subsidize used (through subsidy for example) An integrated energy sector strategy renewables to the level that they can to give one form of energy source an compete with under-priced fossil Resource-rich MENA countries need advantage over another, this needs to fuels. to devise a sector-level strategy and be done a smart way because from

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is little doubt that fossil fuel subsidies society from subsidizing solar PVs than ‘THERE IS LITTLE DOUBT THAT FOSSIL are bad for society, not least because disadvantages. Given this, together FUEL SUBSIDIES ARE BAD FOR SOCIETY, they incentivize wasteful consumption with the need for rent distribution in NOT LEAST BECAUSE THEY INCENTIVIZE and have adverse impacts on the the resource-rich MENA economies, WASTEFUL CONSUMPTION …’ environment. The question is can governments need to rethink their we say the same about subsidizing energy policy to align it with wider a societal perspective there are both household-owned solar PV? Probably societal benefits and the longer-term harmful and harmless subsidies. There not. There are more advantages to objectives of sustainable growth.

How might energy price and subsidy reform affect the use of renewable energy in the MENA? Jonathan Walters

It is often argued that renewable energy In short, the kind of situation that would But that doesn’t imply that the subsidizing has not been able to compete with allow direct or indirect competition with of grid electricity necessarily affects the subsidized fossil fuels in the MENA, renewable energy supply is currently growth of utility-scale solar photovoltaic or and that the use of renewable energy fairly limited. other utility-scale renewables. (RE) will therefore grow only as fossil A further example – one that may rapidly fuel subsidies are reduced. But under Q2. How much difference could it make become more relevant than it is today – is what circumstances, if any, might this in those markets if energy subsidies were that electrification of vehicle transport actually be true? Consider the following removed? may progress more slowly in the line of Socratic questioning. Well, there are some examples of specific MENA, in so far as subsidies reduce the price of vehicle fuel more than Q1. In which markets in the MENA is renewable energy markets in which they reduce the price of electricity. As energy traded competitively? removal/reduction of fossil fuel or grid electricity subsidies could make the cost of electric vehicles falls, such In fact, remarkably few MENA energy a major difference. For example, if subsidy imbalances in the MENA might markets are competitive. In some heating fuel subsidies were reduced, begin to have major implications for countries, there is some retail competition the economics of solar water heating competitiveness, pollution, household in petroleum products (particularly vehicle would improve. It is notable that Israel consumption, and affordability. fuel or cooking/heating fuel) and hence, has almost universal solar water heating indirectly, competition with electricity that – partly because of direct regulation and Q3. Is the bulk supply of electricity traded could be used in those applications. In partly because of a long history of cost- competitively in the MENA? some countries, there is retail competition reflective electricity and fuel prices – while in electricity, but only in the limited sense Let’s think in terms of the classic power no other MENA country has achieved that non-grid alternatives (such as: sector reform model that originated in the anything approaching that coverage of rooftop photovoltaic or private generators 1990s and see how that applies in the solar water heating. that sometimes run as a small business MENA. In the classic model, electricity where the grid is unreliable – for example A more recent example, perhaps, is that sectors are unbundled (separating in Lebanon and Yemen) sometimes subsidized grid electricity is undoubtedly vertically integrated utilities into compete with grid electricity. In a very impeding the growth of rooftop solar in generation, transmission, and distribution few cases, direct sales of electricity from the MENA, even as rooftop solar grows segments – and sometimes separating generation companies to large industrial rapidly in less sunny countries. (However, distribution from retail supply functions). or commercial companies are permitted. more research would be needed to show Sometimes autonomous electricity how the positive impact of rooftop solar regulators are created. Quite often, parts ‘… REMARKABLY FEW MENA ENERGY subsidies in those less sunny countries of the sector are privatized. Once the MARKETS ARE COMPETITIVE.’ compares to the negative impact of elements of unbundling, privatization, subsidized grid electricity in the MENA.) and regulation – in particular, ensuring

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that tariffs cover costs – are in place, some types of energy more ‘competitive’ then competition at the bulk (wholesale) than others, and cause them to be ‘LARGE-SCALE SOLAR PHOTOVOLTAIC and eventually retail levels may be purchased more by the very entity that IS BECOMING COMPETITIVE WITH permitted or encouraged. As the scope pays the subsidy to make that energy CONVENTIONAL ELECTRICITY DURING of competition widens, the role for price ‘cheaper’? The state can (and should) DAYTIME HOURS …’ regulation reduces; correspondingly, simply decide which energy to purchase competition flourishes only where on the basis of relative economic costs generalize or to summarize the situation prices can be set to levels that at least and benefits, without consideration of its in ways that won’t be immediately out- cover costs (Who wants to compete own differential subsidies. of-date, as technologies become even for loss-making sales? Or who wants more disruptive. to make the effort to cut costs in order Q4. If bulk electricity markets become to be competitive when excess costs But broadly speaking, in the MENA, competitive, what will that do to RE? can be accommodated by subsidies large-scale solar photovoltaic is instead?). This is the essence of This is an important question, at least if becoming competitive with ‘liberalization’ of the electricity sector. bulk electricity competition is likely to be conventional electricity during daytime implemented in MENA countries in the But reform often passes through a hours, and will become so 24 hours a foreseeable future (although it does not stage (or even stops there) in which day, seven days a week, 365 days a currently seem to be high on the policy all (or almost all) wholesale electricity year (24/7/365) in many locations once agenda of anyone in the MENA). If bulk is purchased by a state-owned the costs of large-scale batteries fall far electricity competition comes to a country ‘single buyer’ monopsonist, and is enough (which could take some time); in which fossil fuels are more heavily sold by that single buyer to large subsidized than renewable energy, and concentrated solar power has cheaper customers (distribution companies that subsidy differential persists, then storage (thermal) than batteries, but and industrial/commercial customers). obviously that will constitute an important more expensive energy (although the In such cases, there is by definition bias against renewable energy in favour cost of CSP energy is falling); little or no competition in the market. of electricity produced from fossil fuels. wind power is competitive with Occasionally, a (predominantly) single On the other hand, if subsidies are conventional power in a few particularly buyer combines with some limited reduced/eliminated, and competition windy locations (such as the Red Sea direct bilateral trading between large is introduced on a level playing field coast of Egypt, the Atlantic coast, and producers and large consumers, between renewable and conventional the mountains of Morocco), but storage but most of the market remains electricity, then the outcome will obviously remains an issue for dispatchable (in monopsonistic. depend on how competitive the electricity other words reliable, 24/7/365) energy. No country in the MENA (with the produced from renewables actually is. exception of Iran) has progressed in Q6. How competitive will RE be when it its electricity reform beyond the single becomes 24/7/365? Q5. How uncompetitive is RE anyway? buyer phase (some have not even got A lot will depend on what happens that far and remain with a fully vertically Which leads to the question of just how to the cost of the energy storage that integrated sector). In short, there is very competitive or uncompetitive renewable would enable electricity supply from little, if any, competition in bulk supply of energy is, and how might that evolve? renewables to be continuous. In other electricity – it’s all (or almost all) bought Or, to put the question another way, parts of the world, countries might have by the state. That is of course the very could unsubsidized renewable energy large reserve margins of conventional same state that decides by how much compete against unsubsidized fossil electricity generation capacity which to subsidize each type of electricity, and fuels? – and if not now, then what about can kick in when the sun is not shining pays those subsidies. Without actual in the near- to medium-term? or the wind not blowing. In the MENA, competition, how can subsidies render Renewable energy technologies are electricity demand growth is typically very diverse, the resource base for faster than supply growth, partly because ‘THERE IS VERY LITTLE, IF ANY, renewables technologies obviously demand tends to be driven by high COMPETITION IN BULK SUPPLY OF varies from country to country, several subsidies, so reserve margins are often ELECTRICITY – IT’S ALL (OR ALMOST ALL) of the technologies are progressing thin. Similarly, in some regions, cross- BOUGHT BY THE STATE.’ very rapidly, and the costs of those border electricity trade is substantial, and are falling fast. It’s therefore hard to can act like a national reserve margin.

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In the MENA, cross-border electricity (namely a ‘feed-in tariff’), and the other trade is very small. In both cases – thin is to conduct a tender in which the ‘SOME MENA COUNTRIES WITH reserve margins and limited cross-border winning bidder offers a price which EXCELLENT SOLAR RESOURCES … trade – the removal of subsidies might entails the lowest subsidy. COULD BE A SOURCE OF LOW-COST have a positive impact, but that would Feed-in tariffs tend to be used very SOLAR POWER FOR EUROPE …’ undoubtedly take quite some time to early in the process of introducing take effect. So, energy storage will be renewable energy to a country, to quite important for the competitiveness But at the same time, renewable energy create sufficient predictability to of renewable energy on a 24/7/365 basis. is widely subsidized, though to different encourage investors to engage. degrees by the various member states, However, once energy storage is cheap, Tenders (or ‘reverse auctions’) are and on an almost purely national basis it is hard to see how conventional more likely to be used in more (in other words, electricity produced electricity will survive for long in a region mature investment environments. in one member state is generally not so well-endowed with renewable energy eligible for the subsidy of another resources, particularly solar energy. Globally, there is currently a strong member state if that electricity is Existing plants may survive – because shift away from feed-in tariffs towards exported from one to the other). This of long-term commitments, because the tenders. The low prices seen in recent segments the vey national markets that cost of compensating stranded assets is years for solar photovoltaic in UAE, the internal energy market is trying to prohibitive, or because of the economics CSP in Morocco, and wind power in integrate. of sunk costs. But new generation plants Morocco, are very good examples of However, two interrelated developments could become almost entirely renewable the benefits of tenders. They have led are taking place. Increasingly in Europe, – purely on cost grounds. to prices much lower than anticipated – the discovery process of a tender has renewable energy subsidies are being Those costs could be just direct costs, been very positive. determined by auctions (for example, or they could also relate to indirect costs in Germany and in France), and initial and benefits. For example: the benefit of An interesting future development attempts are underway to open those avoiding the risks associated with volatile could be to conduct a tender for the auctions to renewable energy from fuel prices by using renewables for which lowest price of 24/7/365 renewable other member states (for example, ‘fuel’ has a zero price. That outcome energy, without specifying the between Germany and Denmark). The could happen all the faster if the fossil production technology or the storage fact that subsidies are being minimized fuels liberated from electricity generation modality. That could lead to even more can of course make it politically easier are exportable into world markets – this is beneficial price discovery in a market in to share those subsidies with producers likely to be the case for most the MENA which technological progress is rapid from other countries. oil- and gas-producing countries, given and disruptive. These developments in Europe could the relatively low cost of developing impact the MENA in two ways: and producing their resources. That Q8. And how might energy price and very positive outcome for renewables subsidy reform in Europe affect RE The demonstration effect of a could occur even before considering development in the MENA? successful auctioning process could the possibility of environmentally/climate help adoption of that technique in the change-based policies supporting Last, but not least, developments in MENA. European energy price and subsidy renewables in the MENA. In short, for Some MENA countries with excellent reform could play an important role in various reasons, the use of renewable solar resources are in physical MENA renewable energy development. energy in the MENA might grow very proximity to Europe, and are Europe presents the curious rapidly, even without a rapid reduction in interconnected, so could be a source fossil fuel subsidies. However, in some phenomenon of: of low-cost solar power for Europe (this cases, renewable energy will need to be a liberalized internal electricity market, could catalyse scale economies in the at least kick-started with subsidies. manufacture of solar equipment). a single market in electricity for its member states, Again, these impacts could reduce Q7. How can subsidies for RE be minimized? prices that will eventually be the costs of renewable energy in There are really two principal methods determined by electricity trade the MENA, and increase its take-up, of determining subsidies for renewable throughout the European Union without the need for a reduction in fossil energy. One is to pre-set the tariff without barriers to competition. fuel subsidies to enable that process.

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Energy subsidy reforms and the impacts on firms: transmission channels and response measures Jun Rentschler and Martin Kornejew

In early 2016 Saudi Arabia announced these transmission channels, several a significant reduction in fossil ‘… CONCERNS ABOUT COMPETITIVENESS response measures play a crucial role fuel subsidies (FFS), as a way to AND PROFITABILITY HAVE BEEN AN in determining the extent to which firms compensate shrinking government IMPORTANT ARGUMENT OF POLITICAL are affected by subsidy removal. revenues – and the associated fiscal OPPONENTS OF FFS REFORM.’ This section conceptualizes and pressures – due to low oil prices. As discusses these two transmission subsidies were removed across a channels for energy price shocks and range of fuel types, the subsequent While the adverse effects of FFS four common response measures, all price hikes hit consumers and certain removal are increasingly well of which are illustrated in the figure understood for households, the existing industrial sectors to varying degrees. below. Large-scale firm surveys can literature has largely ignored the effect Gasoline prices increased by about 50 help to shed light on most of these of subsidy reform on firms. We argue per cent, mainly affecting motorists. aspects, and aid the identification of that this is a gap in the evidence base A 67 per cent increase in natural gas potential differences between sectors that must be addressed, in order to prices affected electricity generators or regions. In the case of larger, design and deliver FFS reforms more and industrial sectors. One of the publically listed firms, similar analyses effectively. highest price increases was observed can be conducted using firms’ balance for ethane, which rose from USD0.75/ To understand how direct and indirect sheets and accounts; this is of MMBtu to USD1.75/MMBtu or by energy price shocks (induced by FFS particular relevance when an economy 133 per cent (numbers sourced from removal) affect firms’ performance, and or sector is dominated by a single firm ‘Riyadh cuts fuel subsidies, petchem ultimately their competitiveness, it is which is in a strong political position to producers count the cost’, MEES crucial to understand the ability of firms oppose reforms. Archives 59(1), 2016). to cope. In this article, we outline the two transmission channels for energy Soon after the price increases, some Two transmission channels: How energy price shocks, and discuss four main of the largest petrochemical firms price shocks affect firms response measures used by firms. For published estimates for the likely 1 Direct channel: Removing subsidies further details and extensive references impacts on their production costs and on specific energy types will directly please refer to ‘Energy subsidy reforms profits. For instance, several large increase the energy input cost of firms. and the impacts on firms: transmission petrochemical firms estimated the This means that a subsidy removal channels and response measures’ Jun adverse impact on profits to range affects firms’ energy costs almost Rentschler and Martin Kornejew, OIES from 6.5 per cent to 44.1 per cent instantaneously, unless the price of Energy Comment, October 2016. relative to 2014. The Saudi Cement energy inputs has been hedged or Company expected production costs the subsidy removal is implemented to increase by USD18.1 million as a Energy price shocks and competitiveness: gradually. Such immediate cost direct consequence of FFS removal. transmission channels & response shocks cannot be coped with using measures While these self-reported figures longer-term measures (such as technological updates to increase may not be consistently comparable, FFS removals typically induce energy energy efficiency), but require quickly they highlight a common political price shocks (one-off or gradual), which deployable response measures. In economy challenge of FFS removal: affect firms and households throughout practice, energy-intensive industries, Firms – and in particular large energy- the economy. Analogous to the case such as petrochemicals, cement, steel, intensive industries – tend to oppose of households, firms will be exposed manufacturing, or transport, tend to be FFS removal and exert their political to direct (where energy is used in particularly exposed to subsidy reform- clout to do so. Thus, concerns about the production process) and indirect induced price shocks. competitiveness and profitability have (where energy price changes affect been an important argument of political the cost of other inputs that embody The level of a firm’s exposure to direct opponents of FFS reform. energy) price effects. In addition to energy price shocks depends on the

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Enery price shocs due to subsidy remoal channels for shoc transmission and and response measures a–d

1 Direct transmission

Energy Firm X price a) Absorption d) Pass-on increase Firm b) Substitution Firm Firm c) Resource productivity

2 Indirect transmission

Transmission channels Response measures

Energy price shocks due to subsidy removal: channels for shock transmission (1 and 2) and response measures (a–d) extent to which it relies on specific through supply chains in the form of above determine the timing and energy inputs for generating revenue. price increases of non-energy goods. overall size of cost shocks hitting This exposure can be approximated In practice, firms relying heavily on firms. This section discusses the four quantitatively by the share of energy energy-intensive inputs (such as steel) main measures available to firms for input costs relative to total input costs tend to be affected most by indirect responding to price shocks. or revenues. It should be noted, price shocks. a) Absorption: If profit margins are however, that firms’ energy expenditure Indirect price effects are likely to take large enough, firms can absorb energy does not necessarily increase at longer to fully materialize, as price price shocks by accepting smaller the same rate as energy prices. The shocks are successively passed margins. If energy price shocks are fully reason for this discrepancy is that down supply chains. Thus, the speed absorbed into profit margins, firms may firms’ reported energy expenditures with which any given firm will incur be able to continue operations in the may include various payments (such the full indirect price shock depends short term without further adjustments as: suppliers’ labour costs, electricity not least on the number of preceding to technology and production transmission costs, or service fees) to intermediate production stages. quantities, or to sales prices. In energy suppliers that do not directly this case, consumption of both the The level of a firm’s exposure to depend on energy prices. For accuracy (formerly) subsidized energy type and indirect energy price shocks depends it would thus be preferable to use of all other energy inputs can remain above all on the energy intensity of its physical rather than monetary measures unchanged, thus making this measure intermediate production inputs. This of energy inputs, though such data may particularly crucial in the short run. be more difficult to obtain. can be approximated by determining the ‘embodied’ energy content of The ability of firms to absorb energy 2 Indirect channel: Energy price a firm’s production inputs. Various price shocks can be approximated by changes also affect firms indirectly, as databases exist which offer detailed comparing absolute profits with the the production costs of intermediate estimates of the embodied energy combined direct and indirect energy inputs increase. More specifically, of hundreds of the most common price shock. Alternatively, computing the firms producing intermediate goods industrial materials. However, it should ratio of profits and energy expenditures will incur direct energy price shocks, be kept in mind that a domestic FFS can also provide an indication of the which they – at least partially – pass on removal does not affect imported ability to absorb energy price shocks. In to other firms by increasing the price materials – no matter their energy the above referenced example of Saudi of intermediate inputs (see the section intensity. The use of input–output Arabia, the 14 largest petrochemical on ‘Price pass-on’ below). In this way tables, or of CGE (computable general firms had jointly made total net profits of energy price shocks can progress equilibrium) models with detailed over USD9 billion in 2014. It is plausible sectoral disaggregation, can help with that these high profits reaffirmed the ‘… ENERGY-INTENSIVE INDUSTRIES … disentangling these aspects. belief of policy makers that energy price increases could be absorbed by these TEND TO BE PARTICULARLY EXPOSED firms. TO SUBSIDY REFORM-INDUCED PRICE Four response measures: how firms SHOCKS.’ deal with energy price shocks b) Substitution: As subsidy reforms The transmission channels discussed typically increase the price of selected

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energy types (such as electricity or efficiency depends on a variety of petrol), firms may also respond by factors, including the availability and ‘PRICE PASS-ON IS PARTICULARLY substituting these energy types with affordability of efficient technology, RELEVANT IN THE SHORT TO relatively cheaper ones. Such inter-fuel access to credit, and technical support. MEDIUM TERM, AS PRICES CAN BE substitution can be observed in the This also implies that firms require time ADJUSTED FASTER THAN PRODUCTION form of changing energy shares (in to replace machinery and restructure TECHNOLOGIES.’ other words, the energy mix) in total production processes; thus making energy usage. However, the absolute resource efficiency a medium- to long- product. This in turn depends on the quantity of energy consumption may term response measure. remain constant, even if significant market environment: the degree of Various indicators exist to enable the inter-fuel substitution takes place. competition, and the availability and measurement of energy or material affordability of alternatives. Empirical The ability to substitute energy types efficiency, and hence allow a direct evidence suggests that the pass-on of is constrained by the technological comparison with related sectors in carbon taxes varies across industries characteristics of production, which can other countries (‘Material use indicators between 0 per cent and over 100 vary significantly across sectors. Using for measuring resource productivity per cent of the price shock – thus firm surveys, the nature and magnitude and environmental impacts’, Stefan highlighting the important role of sector- of inter-fuel substitutability can be Bringezu and Helmut Schütz, specific conditions. formally characterized and estimated Wuppertal Institute, Resource Efficiency Generally, price pass-on is particularly by own and cross price elasticities, as Paper 6.1, 2010). More complex relevant in the short to medium term, well as Uzawa–Allen partial elasticities indicators can require data which is as prices can be adjusted faster than of substitution. typically not available from standard production technologies. It should be firm surveys, but a basic measure for In addition, substitution requires access noted however, that demand elasticities energy (or material) productivity can be to energy and reliability of supply, which increase over time as consumers can vary across regions. For instance, provided by computing the quantity of acquire new information and their a lack of access to the grid (or frequent output or revenue per unit of energy (or substitution ability develops. power outages in rural regions) often material) input. disqualifies electricity as a substitute for d) Price pass-on: While the first three Implications for the design of FFS reforms fuels such as kerosene. Firm surveys response measures describe how frequently collect information on energy firms respond internally to energy price As case studies of past reforms access and supply quality, which can shocks, the net impact on firms also are studied and lessons learnt, the shed light on firms’ ability to substitute depends on their ability to pass price political economy challenges of in different regions and sectors. shocks to external consumers. In its subsidy reform are increasingly well c) Resource efficiency: Firms may essence, this channel refers to the documented. In fact, concerns about also respond to direct energy cost extent to which firms can adjust the competitiveness and profitability have increases by reducing their overall sales price of their output in response been an important argument used by energy consumption per unit of output to changing input costs. Even if political opponents of subsidy reform, (in other words, by increasing their energy price increases are large, if while adverse impacts can indeed energy efficiency). Similarly, increasing firms can pass them on by charging have knock-on effects on jobs and thus material efficiency can help to mitigate proportionally higher sales prices, the on households. However, while the indirectly transmitted price shocks, overall adverse effect on the firm may potential adverse impacts of subsidy which are due to embodied energy in be limited. In other words, the loss from reform are increasingly well understood intermediate materials. In fact, material reduced sales quantities is offset by an for households, research has given far costs often significantly exceed increased profit margin per unit. less attention to the potential impacts energy costs even in energy-intensive on firms. The ability to pass on price increases manufacturing sectors; thus the role ultimately depends on the price This article has outlined the most of material efficiency is of particular elasticity of demand – in other important transmission channels for importance. This article summarizes words, the ability of end-users energy price shocks, and response both measures as resource efficiency. (such as households) or other firms measures used by firms. These Similar to the case of substitution, (consumers of intermediate goods) transmission channels and response the ability to increase resource to substitute away from a given firm’s measures directly offer policy makers

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a reference framework for designing However, it should be also be recalled complementary measures for ‘… RELIABLE AND AFFORDABLE ACCESS that energy costs are only one (minor) mitigating adverse socio-economic TO ALTERNATIVE ENERGIES…CAN factor among many that determine a consequences of subsidy reforms. BE CRITICAL FOR FACILITATING AND firm’s or sector’s competitiveness. This DIRECTING INTER-FUEL SUBSTITUTION.’ implies that policy makers have a wide Policy makers should consider actions range of measures at their disposal for strengthening firms’ ability to to mitigate potential competitiveness substitute towards alternative fuel machinery, for example). In addition, losses due to energy price increases; types or to increase the efficiency the provision of reliable and affordable for instance, by strengthening of energy and material usage. Such access to alternative energies (for institutions and administrative capacity, measures include technical assistance, example through public investments or by investing in infrastructure and information programmes, and in electrification) can be critical for labour productivity and ensuring a financial support for implementing facilitating and directing inter-fuel stable business environment through efficiency investments (into modern substitution. prudent long-term policy strategies.

GCC energy pricing reforms in a low oil price environment Anupama Sen

It has been roughly two years since the per se. In this article, we look broadly dramatic decline in oil prices triggered ‘RECENT ENERGY PRICING REFORMS at the fiscal pressures which led to a spate of energy pricing reforms HAVE CHALLENGED THE RIGIDITY OF THE the acceleration of reforms in the across most of the Gulf Cooperation SOCIAL CONTRACT INTERPRETATION.’ GCC countries, briefly assessing Council (GCC) countries. The their progress, and at the potential outcomes have been mixed and the implications for the social contract process is far from over – indeed, many ‘Popular’ analysis of the most recent and the sustainability of energy countries may be construed as being energy pricing reforms tends to tie pricing reforms. at the beginning of a long road. One their relevance entirely to the 2014 drop in oil prices, whereas it can interpretation of the historic prevalence The fiscal pressures motivating pricing be argued that the fiscal pressures of low energy prices in the GCC reforms motivating reforms were building long economies is that they are a central before this, and that they were not element of the ‘implicit social contract’ The fiscal pressures leading up to uniform across the region. Further, the between rulers and citizens, and the the 2014 changes were actually incentive to carry through sustainable main method of rent distribution. building during the previous period energy pricing reforms is not just Beyond this, they have also been a of rising oil and gas prices. A slow contingent upon fiscal pressures central part of countries’ attempts global economic recovery following (although the short-term revenue the 2008–9 global recession, as to industrialize through investment requirement serves as a trigger), but well as uprisings in the Arab world, in energy-intensive industries, to also on their economic and political had led most GCC governments to (purportedly) provide a ‘safety net’ for costs. Recent energy pricing reforms announce large increases in wages, low-income households, and to pursue have challenged the rigidity of the employment benefits, social spending, broader macroeconomic stability. At social contract interpretation. Despite and infrastructure development the same time, the distortions and these indications of malleability, it programmes, as part of an attempt to inefficiencies that have been caused by is becoming clearer that the social pre-empt social unrest. low energy prices – such as excessive contract cannot be stretched much energy consumption, disproportionate further without implementing measures Saudi Arabia, for instance, first benefits to rich consumers, high energy which will require greater engagement announced a series of support intensity of GDP, and an impediment with citizens and stakeholders in the measures in 2011 aimed primarily at to economic diversification – are well long term. This in turn will arguably job creation, housing, and education; documented. shape the nature of the social contract this included a 15 per cent pay rise

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for state employees and financial currency devaluation, ‘FROM 2010 TO 2014, GOVERNMENT support for unemployed citizens. imposing taxes (VAT, corporation Another spending package of roughly REVENUES FROM OIL AND GAS tax), USD32 billion (bn) (80 per cent of INCREASED RELATIVELY FASTER cutting government (current) which was current expenditure) was THAN REVENUES FROM OTHER (NON- expenditure, announced in February 2015 – even HYDROCARBON) SOURCES …’ scaling back capital projects, as oil revenues began falling. cutting subsidies. Kuwait, after announcing its Oman was seen as one of the most long-term Vision 2035 plan for vulnerable, drawing down on its In the face of temporary shocks, GCC economic diversification in 2009, foreign reserves and resorting to countries can fall back on their fiscal continued with an expansionary fiscal local borrowing to finance its 2015 buffers (SWFs, foreign assets and policy through 2011–14, including a deficit (roughly USD12 bn), whilst government debt) – with the UAE, focus on public sector wages. also being downgraded by credit Saudi Arabia, Qatar and Kuwait holding Similarly, Oman increased spending rating agencies. relatively large buffers – but in the face of prolonged oil price declines, fiscal during 2010–14 in response to social Bahrain’s soaring budget deficit buffers are difficult to replenish, forcing demands. (estimated at roughly USD8 bn) in governments to consider longer-term 2015 had to be financed by the Consequently, most GCC economies options such as cutting subsidies and Future Generations Reserve Fund, became increasingly reliant on oil government expenditure and increasing GCC aid, and borrowing. revenues to fund such commitments. taxation. Taxation requires the existence Even countries like Qatar, which had of appropriately robust institutions, From 2010 to 2014, government enjoyed years of budgetary surpluses, which are underdeveloped in the revenues from oil and gas increased announced a record budget deficit of GCC, whereas the largest component relatively faster than revenues from roughly USD13 bn for 2016. of government current expenditure other (non-hydrocarbon) sources (see Kuwait followed suit, revising its (around 50 per cent on average in figure below), alongside a concomitant 2016 deficit projection upward (from most countries) comprises current increase in government expenditure. roughly USD27 bn to USD40 bn). spending on public sector wage bills, This increase in government which are also the most difficult to cut. The different options for fiscal expenditure, together with a higher This has meant that cutting subsidies adjustment available to GCC countries reliance on oil revenues to fund (through energy pricing reforms) included: increased spending, exposed GCC and government capital expenditure economies further to oil price volatility. borrowing from domestic and were the most likely options under

The fiscal pressures across the GCC international markets, consideration by governments when faced with a prolonged period of low oil were also not uniform, limiting the drawing down –foreign reserves and/ prices. optionsSource: for ‘ Srfiscal adjustment e r availablece eeror liquidating rc rSovereigneor Wealth o o Fund rce eroe’, ou, to Se,different countries oereoe by 2015., S oe, assets, Beyond the fiscal – other incentives to reform

While the fiscal arguments for energy 700 pricing reforms are clear, their long- 600 Oil and Gas term implementation is contingent 500 Revenue upon a much more complex balance 400 Other between fiscal, economic, and political 300 Revenue incentives. Energy pricing reforms in 200 Expenditure oil exporting countries are best carried 100 out in ‘good’ economic times when 0 revenues and fiscal buffers are plentiful; 2010 2011 2012 2013 2014E however, this is politically difficult GCC government revenues and expenditure, 2011–14 (USD bn) as these are also times when the Source: ‘Striking the right balance? GCC energy pricing reforms in a low oil price environment’, difference between subsidized prices, B. Fattouh, A. Sen, and T. Moerenhout, OIES Comment, 2016 and prices which reflect full costs,

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prices imply that domestic prices ethane was increased by 133 per cent ‘… THE POLITICAL COST OF REFORM have relatively less far to go in order to in Saudi Arabia and methane by 67 per COULD POTENTIALLY BE HIGH AS align with international prices, a high cent over previous levels. Kuwait is the CITIZENS … MAY VIEW PRICE INCREASES reliance on oil revenues for distribution, only country where price reforms are AS CLASHING WITH THE IMPLICIT SOCIAL public spending, economic pending, following the dissolution of its parliament in response to protests over CONTRACT.’ development, and diversification during a period of geopolitical challenges a proposed 80 per cent increase in implies that the political cost of raising energy prices. are highest (see ‘Adjusting to low oil prices to market levels is not prices: prospects for fossil fuel subsidy It can be argued that price increases insignificant. The successful reform in oil producing and exporting in the GCC over the last year or so implementation of energy pricing countries’, S.O. Ladislaw and Z. Cuyler, constituted an initial and relatively reform in resource-rich economies, CSIS, Washington DC, 2015). As ‘easier’ phase – the impact of declining therefore, involves striking a balance shown in the table below, during times revenues was clearly represented by between their fiscal, economic, and of high oil prices: the fiscal urgency of the plummeting oil price and since the political elements; the ‘social contract’ reform is low as revenues are plentiful, energy price increases were from a low is relevant not simply as a constraint, the economic cost of reform is high base they still remained amongst the but is also a key enabler of reform in as the adjustment to opportunity cost cheapest in the world for many GCC this regard, in as much as it relates to prices is steeper, and the political countries. As the oil market moves engagement and communication with cost of reform is also high as prices into a new equilibrium where prices citizens. have further to go to reach full-cost could remain ‘lower for longer’, further levels and governments are under price reforms to reflect full opportunity pressure to increase spending when Assessing progress – energy pricing costs will be more difficult and will also oil revenues are ‘pouring in’. When oil reforms in Saudi Arabia involve additional testing of the social prices are low: the fiscal urgency for contract. Cuts in energy subsidies have been reform is conversely high as export implemented across all GCC countries revenues are lower, the economic cost – with the UAE leading the way in 2015. ‘… FURTHER PRICE REFORMS TO of reform is low as the adjustments to The magnitude of price increases has REFLECT FULL OPPORTUNITY COSTS full or opportunity cost are potentially been large, albeit starting from a low WILL BE MORE DIFFICULT …’ smaller, and the political cost of reform base. In percentage terms, the price is low – relative to full (opportunity cost) hikes for low octane gasoline have prices. Nevertheless, if price increases ranged from 20 per cent in Oman to This particularly applies to Saudi are carried out without introducing 67 per cent in Saudi Arabia, while for Arabia, where the ‘first phase’ (2016) mitigating measures to help offset high octane gasoline, these ranged of price increases in gasoline, diesel, the negative impacts on households’ from 30 per cent in Qatar to 50 per and electricity was largely accepted by welfare, the political cost of reform cent in Saudi Arabia. Diesel price the public despite negligible efforts could potentially be high as citizens of increases were not as high, apart from towards communication campaigns resource-rich governments may view Saudi Arabia where prices increased and compensatory schemes to offset price increases as clashing with the by more than 70 per cent. The biggest the negative impact. Instead, implicit social contract. increases were in the prices of natural households adjusted their In the case of the GCC economies, gas (mainly used in industry and the consumption, with some switching although current low international power sector); for instance the price of from higher to lower grades of fuel; this shift may have contributed (alongside lower GDP growth) to a Fiscal–economic–political matrix of incentives to reform energy prices reduction in energy demand growth to 1.7 per cent in the first half of 2016 High oil price Low oil price compared with 3.5 per cent in 2015. Fiscal urgency of reform Low High The savings estimated from cutting Economic cost of reform High Low subsidies in the first phase were Political cost of reform High Low or high around SAR29 bn (USD7.8 bn). Source: ‘Striking the right balance? GCC energy pricing reforms in a low price environment?’, There was, however, a backlash from B. Fattouh, A. Sen, and T. Moerenhout, OIES Comment, 2016 consumers when the administration

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attempted to adjust water charges for Whilst this represents the Kingdom’s Conclusions the lowest bands of consumption, most radical energy reform move yet, It is possible to draw two main insights resulting in the dismissal of the there are several factors which will from the experience of energy pricing minister for Electricity and Water. need to be addressed before it can be reforms in GCC countries thus far seen through successfully. The (see ‘Striking the right balance? GCC In its second phase of reform ‘reference price’ for adjustments, as energy pricing reforms in a low price (2017–20), the Saudi administration well as the adjustment mechanism environment?’, B. Fattouh, A. Sen, and plans to gradually increase energy (automatic or periodic), have yet to be T. Moerenhout, OIES Comment, 2016). prices from 2017 up to a ‘reference determined for different fuels. It is price’ while instituting a USD6.7 bn unclear whether these would be First, it is clear that they were driven fund for cash transfers to low- and international prices or some primarily by short-term revenue middle-income households based on approximation of import-parity needs, but their longer-term predefined income brackets (see prices (for natural gas, for example). sustainability is contingent upon ‘Historic Saudi budget shows effort to A strategy incorporating energy GCC governments achieving a win support for change’, Bloomberg, efficiency will be needed to manage balance between fiscal, economic, 22 December 2016). Eligible the impact of second-round and political incentives to see households will be able to register for inflationary pressures on the through reform. the scheme from February 2017 and, competitiveness of energy-intensive Second, although the first phase of in a move reminiscent of India’s direct industries which currently dominate reforms indicated (contrary to cash transfer programme, the first the Saudi economy. And last, but not conventional wisdom) that the social cash payments will be made before the least, the system of cash transfers will contract is not as rigid as had been price increases are implemented – need to be designed credibly to be: perceived, this article has argued that reflecting an effort to garner public straightforward, transparent, efficient, its relevance increases, in so much support. These reforms are closely and (most crucially) accompanied by as it relates to the need for greater tied to the administration’s ‘Fiscal measures to engage public support engagement with the public through Balance Program’, which aims at through public awareness and appropriate communication eliminating the budget deficit by 2020. communications campaigns about campaigns and mitigation measures It has been estimated that these the long-term benefits of cost-reflective which emphasize the importance of reforms could save SAR209 bn energy prices. This reflects the energy pricing reform for national (around USD55 bn) per year by 2020 continuing relevance – as well as the transformation. Rather than a (see ‘Blow of higher utility bills softened changing nature – of the social redundancy, what may be in for low-income Saudis’, Arab News, contract, despite arguments to the progress is a reshaping of the social 24 December 2016). contrary. contract.

Reforming electricity, water, and fuel subsidies in the United Arab Emirates Tim Boersma and Steve Griffiths

For many years, the reduction been considered an unbendable By initiating electricity and water price of energy subsidies in the Gulf form of social contract between reforms more than eight years ago, the Cooperation Council (GCC) countries GCC governments and their citizens, United Arab Emirates (UAE) stands out was considered a near impossibility. albeit an expensive and inefficient as a leader among its GCC peers. This is because energy subsidies have contract. In contrast, the period from Within the UAE, the emirate of Dubai 2014 to 2016 has been a period of was a trailblazer by carrying out ‘… ENERGY SUBSIDIES HAVE BEEN remarkable change in GCC subsidies. electricity and water reforms in 2008, CONSIDERED AN UNBENDABLE FORM As oil prices have fallen substantially and implementing further pricing reforms in 2011. OF SOCIAL CONTRACT BETWEEN GCC since June 2014, all GCC countries GOVERNMENTS AND THEIR CITIZENS …’ have implemented subsidy reforms in In January 2015, after years of internal one form or another. debate, the emirate of Abu Dhabi

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followed Dubai, and has initiated a a series of energy reforms as one of its reflective water tariff in Abu Dhabi new round of reforms for 2017. first acts. Dubai then had an extensive was considered to be approximately Electricity and water tariffs for the public relations campaign, in which the USD2.84/m3 for all customers. northern emirates (Ajman, Fujairah, incoming tariff changes were explained, Ras al-Khaimah, and Umm al- and the population was urged to Electricity and water tariffs in Abu Dhabi Quwain) were revised upwards in reduce consumption. Prior to that, a In contrast to Dubai, Abu Dhabi has 2015, but the primary focus was on system of four tariff classes based on historically had less financial urgency prices charged to expatriates. consumption level had been introduced in 2008 by the Dubai Electricity and for tariff reform. In recent years, In the emirate of Sharjah, a new tariff Water Authority (DEWA). As costs per however, Abu Dhabi has faced an system for the consumption of tariff class (or slab) rose, the tariff- increasingly short supply of low-cost electricity and water by commercial based system was designed to reward natural gas as well as falling oil export and industrial entities was introduced the most efficient resource users, with revenues to support subsidies. Against in 2014, but residential prices were prices rising for higher tranches of this backdrop, in late 2014, Abu not increased. consumption. Dhabi announced that it was going to In addition, throughout the UAE, increase tariffs for water and electricity In 2011, a 15–20 per cent increase subsidies on fuel (namely gasoline starting in January 2015. in the slab unit cost of electricity and and diesel) have been removed water was introduced for residential to ease pressure on the country’s expats, industry, and government. ‘… ABU DHABI LAUNCHED A CAMPAIGN budget. Prices, based on a global For UAE nationals, a modest HIGHLIGHTING THE NEED FOR ENERGY prices benchmark, are now set each electricity tariff increase was AND WATER CONSERVATION PRIOR month. In this article, electricity, water, introduced, together with a modest and fuel price reforms in the UAE are TO THE IMPLEMENTATION OF TARIFF water tariff for nationals with a assessed, with emphasis being placed REFORMS.’ consumption level exceeding 20,000 on electricity and water pricing reforms imperial gallons (IG) per month. Next in Dubai and Abu Dhabi. to the slab tariffs, DEWA adds a fuel Similar to the subsidy reform approach surcharge to the water and electricity taken by Dubai, the government in Electricity and water tariff reforms in Dubai costs. This surcharge is supposed Abu Dhabi launched a campaign to vary monthly, and is based on the Subsidy reform in Dubai is directly highlighting the need for energy cost of the fuel source that is supplied linked to its energy portfolio in the late and water conservation prior to the to DEWA generation plants. However, 2000s. The emirate has long been implementation of tariff reforms. This UAE nationals are exempted from import-dependent and energy prices campaign, which started in the summer the surcharge and in practice it rarely have therefore always been relatively of 2014, contained key messages changes. Most end consumers stay in high. At the time, soaring demand about sustainability and conservation, slab one for the bulk of the year, except for energy resources (in particular amongst others. during peak demand in summer. The natural gas) outstripped supplies. result is that Dubai expat residents Abu Dhabi’s tariff structure was Subsequently, the emirate turned to pay between USD0.08/kWh and implemented, with differentiation imports of liquefied natural gas (LNG) USD0.12/kWh for electricity and between apartments and villas to and while the costs rose, the sales between USD2.10/m3 and USD2.75/m3 account for the intrinsically larger price did not. There is a widely shared for water, depending on consumption expected consumption of electricity view that this, combined with rising level. UAE nationals pay three to four and water for villas. Within each of demand, incentivized the emirate to times less than expats for electricity these categories, price differentiation, initiate further reforms in 2011. and water. As a point of reference, based on the level of consumption, The Dubai Supreme Council of Energy, Moody’s stated in 2016 that the cost- was imposed. For residential expats which was established in 2009 to reflective electricity tariff for residential the unit cost of electricity rose by serve as a gathering place for all key consumers in both Abu Dhabi and 40 per cent, and by up to 120 per cent stakeholders to discuss long-term Dubai is between USD0.086/kWh for what are considered high or ‘red targets and objectives (mostly focusing and USD0.089/kWh. In 2013, the Abu band’ levels of consumption. There on increased renewable energy and Dhabi Regulation and Supervision was, however, no significant change energy demand reduction) announced Bureau (RSB) stated that the cost- for UAE nationals.

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For the smaller commercial and water. In the commercial, agricultural, the prices will follow international prices industrial users (below 1 megawatt, MW) and industrial sectors, electricity and for diesel and gasoline accordingly. there was a 7 per cent increase and, water tariffs will be adjusted upward What is important, however, is that more significantly, there was a 100 per by more than 30 per cent in 2017, the UAE seized an opportunity to put cent increase for larger industrial users furthering the advance of pricing through important subsidy reforms that required more than 1 MW between reforms in these sectors. at a rare time in history when the 10 a.m. and 10 p.m. (local time) during removal of fuel subsidies actually was the summer peak. The aim of the latter able to provide economic benefit to Fuel price reforms policy was to limit summer peak demand citizens following the implementation of (this was largely responsible for marginal In contrast to electricity and water reforms. new electricity generation capacity). tariffs, fuel prices are set at the UAE federal level. At the end of July 2015, For government entities the subsidies Conclusion fuel prices (gasoline and diesel) were on electricity have been removed. structurally, and rather substantially, As a result of diminished oil export The unit cost of water for residential reformed in the UAE with uniform revenues, the need for all GCC expats was increased by 170 per application to all nationalities. Reforms countries to undertake energy cent, and by up to 374 per cent for were incentivized by the significant subsidy reforms has accelerated. very high levels of consumption. In fiscal burden on the UAE from fuel Although once considered part of an addition, a new tariff for UAE nationals subsidies, which the International unbreakable social contract between was introduced, although this was still Monetary Fund estimated at USD12.6 GCC governments and their citizens, about three times lower than the costs billion in 2014 (or approximately 2.9 all GCC countries have now initiated for expats. Commercial and industrial per cent of GDP). Currently, prices for subsidy reforms in one way or another. users saw their water costs rise by 82 gasoline and diesel are not entirely The UAE has been a leader amongst per cent, and again for the government, deregulated, but are set monthly by a its peers in electricity and water tariff the subsidy was removed. commission, based on international reform efforts; Dubai undertook significant reforms in 2008, Abu Dhabi Building on these reforms, additional prices. followed in 2015, with additional electricity and water tariff increases The most significant thing about the measures being taken in 2017. have been announced to start in Abu UAE’s fuel price reforms is that the Admittedly, the UAE does have unique Dhabi in January 2017. For residential timing of the reforms matters. As a result circumstances, such as a very large expats, electricity tariffs will increase by of the dramatic fall in international oil 28 per cent for the lowest consumption expat population (to which the most prices that started in June 2014, by April bands; for water the increase will be substantial price increases have been 2015 prices for both gasoline and diesel 32 per cent. At the highest levels of applied) and a relatively wealthy UAE were actually lower (significantly lower in electricity and water consumption, national population. the case of diesel) than they had been tariffs will be essentially unchanged. prior to the reforms. In fact, by March of Abu Dhabi and Dubai have The result is that expat residents will, 2016, petrol prices had fallen to a level demonstrated several best practices in 2017, pay between USD0.073/kWh 21 per cent lower than that seen before for electricity and water pricing reforms, and USD0.083/kWh for electricity and the reforms, while diesel prices were 52 which are now being replicated across between USD2.13/m3 and USD2.83/m3 per cent lower. An environment of low the GCC. These include: for water. For UAE nationals, electricity oil prices therefore facilitated the UAE tariffs will increase by 34 per cent for communication of the need for authorities in making the reforms, and the lowest consumption bands; for subsidy reforms before implementing helped both UAE nationals and expats water the increase will be 23 per cent. them, absorb the changes. At the highest levels of consumption, gradual introduction of pricing tariffs will increase by 36 per cent for With oil prices rising again, time will tell increases, electricity and 38 per cent for water. whether the UAE commission that sets tiered pricing based on usage Like the 2015 reforms, a substantial (thereby letting the largest pricing disparity between tariffs for ‘AN ENVIRONMENT OF LOW OIL PRICES consumers carry the heaviest expats and UAE nationals will exist, with …FACILITATED THE UAE AUTHORITIES IN financial burden). nationals continuing to pay four to five MAKING THE REFORMS…’ Similar practices – including the rapid times less than expats for energy and removal of subsidies when opportunity

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approaches being taken in the UAE countries seeking guidance from the ‘… ELECTRICITY, WATER, AND and elsewhere include: UAE’s approach. Finally, the UAE has TRANSPORTATION FUEL PRICING … IS yet to implement subsidy reforms for lower levels of electricity and water STEADILY ADVANCING TOWARD COST- natural gas pricing and is lagging consumption to qualify for the lowest other GCC countries in this regard. REFLECTIVE AND MORE TRANSPARENT consumption band pricing; PRICING.’ While not a focus topic for this article, fully liberalized transport fuel pricing natural gas pricing is an extremely based on a formulaic approach important topic for GCC countries; it strikes (such as the 2014 oil price documented in legislation, rather is critically important for the industrial collapse), and price setting according than on committee deliberations. sector as well as for international oil to international benchmark prices – Because the UAE’s national population and gas companies considering joint have been applied to transportation is rather small, it may not be strictly development of the UAE’s natural gas fuel subsidies. necessary to equalize energy and water resources. In sum, the UAE has taken Because of these practices, electricity, pricing for expats and nationals in important and positive steps regarding water, and transportation fuel pricing in order to achieve resource consumption energy subsidy reforms, but more the UAE is steadily advancing toward and fiscal objectives, although this work is required in the coming years to cost-reflective and more transparent argument does not hold for most of realize the full potential of the progress pricing. Improvements to the subsidy the other GCC and Middle Eastern underway.

Challenges of Kuwaiti energy pricing reform in response to petroleum price volatility Manal Shehabi

Despite Kuwait’s historically introduce reforms at an accelerated economy, and summarizes Kuwait’s strong fiscal surplus and sizeable pace, despite strong resistance, pricing reform experience. It then asset accumulations abroad, the particularly from the parliament that identifies stabilization mechanisms in macroeconomic and fiscal impact of has long opposed energy price the economy – the expatriate labour the recent oil prices collapse has been increases. While other GCC countries channel being key – and relevant severe. In response, the government have embarked on ambitious plans to implications of reforms that should be is reducing energy subsidies as a liberalize energy prices, Kuwait lags considered when attempting successful top priority. Subsidies have been behind – having been the last to raise implementation. long accepted by economists as a gasoline prices. generally inefficient, costly means of This article examines Kuwait’s energy Petroleum price volatility and features of rent distribution that leads to wasteful the Kuwaiti economy consumption. Energy pricing reform pricing reform in response to the has repeatedly appeared as a key recent oil price fall, with reference to Like all petrostates, reliance on an policy objective in Kuwait’s five-year an economy-wide model constructed inherently volatile commodity renders development plans. But mounting by the author for a forthcoming OIES the Kuwaiti economy susceptible fiscal pressures, driven primarily by paper (‘Beyond the promise: subsidies to boom and bust cycles. Kuwait is the recent fall in oil revenues, have reforms assessment following like Norway in that it has enjoyed created a sense of urgency to petroleum price declines in Kuwait enviable wealth, a fiscal buffer, and through economy-wide analysis’). It massive foreign accumulations in its departs from recent policy discussions sovereign wealth funds (SWF). Yet ‘ENERGY PRICING REFORM HAS that have focused on the ‘why’ of price unlike Norway, Kuwait’s economy has REPEATEDLY APPEARED AS A KEY POLICY reforms, instead addressing ‘how’ suffered a large fiscal deficit following OBJECTIVE IN KUWAIT’S FIVE-YEAR to reform. The article highlights the the sharp fall in oil revenues. When the DEVELOPMENT PLANS.’ impact of petroleum price volatility oil price collapsed from USD103/barrel on Kuwait and key features of its (bl) in January 2014 to USD30/bl in

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January 2016, the Kuwaiti government Pricing reform has proved difficult announced an estimated 75 per cent ‘IN LIGHT OF WIDESPREAD DISAPPROVAL, In seeking to address budgetary revenue drop. Despite substantial PRICING REFORM WAS PRESENTED AS concerns, the Kuwaiti government withdrawals from its SWF to smooth out SOLVING FISCAL PRESSURES, ECONOMIC repeatedly attempted to reform fuel, the shortfall in oil (and subsequently electricity, and water price subsidies INEFFICIENCIES, AND ENERGY OVER- budget) revenues, for the first time in 2015 and 2016. Faced with strong CONSUMPTION.’ in over 16 years, Kuwait recorded a public discontent, those attempts budget deficit of USD15.3 billion for the failed or achieved limited success. market price, intending to adjust them fiscal year ended March 2016. Reforms have been difficult, partly every three months. The magnitude of the oil price because generous welfare payments In light of widespread disapproval, volatility impact on Kuwait is due to are at the core of the Kuwaiti political pricing reform was presented as the circumstances of its economy, economy. This arrangement goes solving fiscal pressures, economic including: deeper than the so-called petroleum inefficiencies, and energy over- era ‘social contract’ (in other words, the Reliance on a highly volatile consumption. The government also distribution of resource rents in lieu of commodity: in 2014 hydrocarbon promised that subsequent inflation political obedience). For some of the exports generated 92 per cent of would be muted. Some politicians politically active constituency, reforms floated the possible future taxation of government revenue and 55 per cent contradict the state’s historic role in expatriates’ income and/or remittances. of Kuwait’s GDP. distributing petro-rents to citizens, the If anything, these promises increased Dominance of the public sector: ultimate owners of the resource. the unpopularity of reform. There the public sector generates over In March–April 2016, after various was much parliamentary debate and 65 per cent of Kuwait’s GDP while rejected schemes, the National questioning of the legality of raising the private sector share has Assembly proposed to raise electricity prices, culminating in an executive ranged between 21 per cent (1989) prices ‘only after excluding owner- decree to dissolve the National and 41 per cent (2010). The public occupied residences of Kuwaiti citizens’ Assembly in October 2016. While sector committed two-thirds of total from price increases, effectively the future of pricing reform remains capital formation and employs most raising prices on expatriates. Prices for in limbo, reducing subsidies is working Kuwaitis. residential use by expatriates increased unequivocally needed for the long-term Rigidity of government from USD0.007 progressively to sustainability of Kuwait’s economy. expenditures: current expenditure USD0.05/kilowatt, and for commercial Yet the dynamics and implications of constitutes 80 per cent of total use from USD0.007 to USD0.082/ reform have been less discussed. government expenditures, and half of kilowatt. current expenditure funds the public Modelling the Kuwaiti economy sector wage bill. An economy-wide model, using a Sizeable welfare transfers to ‘REFORMS HAVE BEEN DIFFICULT, computable general equilibrium (CGE) citizens and industry over PARTLY BECAUSE GENEROUS WELFARE framework, was constructed to quantify decades: these include large energy PAYMENTS ARE AT THE CORE OF THE the impact of petroleum price volatility subsidies, with local prices reduced KUWAITI POLITICAL ECONOMY.’ and policies that aid adjustment (such by an estimated subsidization rate of as pricing reform). This framework, 87 per cent compared to the generally considered most suited for international shadow price. Until On 1 August 2016, the government policy evaluation, captures the major mid-2016, electricity prices were less announced the removal of gasoline structural features of an economy than one-twentieth of generation subsidies, circumventing the and interaction between its industries. costs and have not changed since parliament. By then, Kuwait was the The model represents specifically 1990. In 2014, Kuwait was the world’s only GCC country that had not adjusted external financial flows, domestic sixth highest per capita energy its prices, which were the lowest fiscal policy, oligopoly industrial consumer. globally. Effective September 2016, structures, government regulation, Very weak taxation base: Kuwait the government raised local prices labour market composition by skill has no income tax and very low by 41–83 per cent (differentiated by level and nationality source (Kuwaiti vs. corporate taxes. octane levels) to the international spot expatriate), and oil prices.

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A key component of the CGE Construction, and Manufacturing). economy’s value added. Importantly, framework is the construction of the After hydrocarbons, non-traded Other consumers and industries access model database in the form of an Services (such as education, health care, electricity, water, and hydrocarbons augmented social accounting matrix and restaurants) are the second-largest at highly subsidized prices, for which (SAM) depicting all the sectors in the contributor to GDP and employ mostly the shadow price is not included in economy and interactions between expatriates. Net exports over output the reported subsidies above. them within a given time period. The shares for many non-energy industries 3 Expatriates comprise 83 per cent of SAM for Kuwait was constructed (both tradables and nontradables) Kuwait’s labour force, but highly using official data obtained from the imply that imported final goods and subsidized government-owned Kuwaiti government, aggregated in 14 intermediates are also very large. industries such as electricity industries. Input–output coefficients employ mostly Kuwaitis. Overall, The data reveal important dynamics were combined with detailed bilateral around 77 per cent of Kuwaitis are pertinent to assessing the impact of oil trade, transport and trade protection employed by the public sector, price drops and pricing reforms. These data (such as tariffs) characterizing which has high disguised include: economic linkages, labour market unemployment. Approximately structure, national accounts, industry 1 Expenditures on hydrocarbons and 95 per cent of private sector jobs and balance of payments data. electricity are only 3 per cent and are held by expatriates, a substantial Examining the SAM reveals useful 17 per cent of total household and portion of whom are low-skilled with insights. The table below shows that non-oil industry expenditures on low wages. Private sector wages and, the value added (see column 1, GDPFC) goods and services. more generally, expatriate wages, are of the highly subsidized Electricity and 2 The official value of subsidies in lower than public sector Kuwaiti Water industries is low, as are those 2013 was USD8,670 million (see the labour wages. Expatriate wages of non-exporting sectors (Agriculture, table overleaf), or 8 per cent of the constituted around 70 per cent of total wages across all sectors. To increase Kuwaitis’ participation in the Economic structure, 2013 private sector, the government offers private firm allowances to equalize Net Share Export exports Kuwaiti workers’ wages with the Share of of total share of over higher public sector wages. GDPFC* exports output output 4 Industries (including the nationally- Sector % % % % owned energy sectors) exhibit 1 Agriculture 0.3 0.0 1.3 –63.3 oligopolistic (or monopolistic) behaviour. This hampers economic 2 Mining 1.4 0.0 0.0 0.0 efficiency, competitiveness, and 3 Crude oil 48.9 42.1 50.5 50.3 growth. 4 Gas and petro-services 0.9 1.3 50.5 50.3 5 Oil refining 5.4 38.6 72.6 72.2 Stabilization mechanisms following petroleum price volatility 6 Chemical 1.1 3.4 37.4 –1.7 7 Light manufacturing 0.8 0.4 4.1 –56.0 My analysis reveals that Kuwait has two primary stabilization valves that partially 8 Heavy manufacturing 0.8 1.9 8.1 –72.0 absorb the negative impacts of oil price 9 Electricity 0.6 0.0 0.0 0.0 shocks. The first, obvious, channel is 10 Other network 4.6 4.6 32.3 31.4 inflows from the SWF. When a negative services (water, gas) oil price shock shrinks government 11 Construction 2.2 0.0 0.0 0.0 revenues, the government finances its 12 Transport 3.4 5.7 38.9 14.1 fiscal commitments (including welfare payments and subsidies) through 13 Financial services 7.8 0.7 4.1 –1.3 withdrawals from one of its SWFs 14 Other services 21.8 1.3 1.8 –15.6 (created specifically as a macro- * GDPFC is GDP at factor cost, which is the sum of value added in each industry. stabilization fund), mitigating the volatility Source: Author’s CGE model database (SAM) constructed for 2013 impact and stabilizing the economy.

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Reported industry and consumption subsidies, 2013 in the real exchange rate renders imported inputs more expensive. These Subsidies Demand sector or source (million USD) factors limit the non-oil industries’ ability to expand and hire more. The 1 Agriculture 255.6 key point here is that the resulting 2 Mining 8.14 unemployment is unlike traditional 3 Crude oil 138.3 unemployment, in that unemployed 4 Gas and petro-services 1.5 expatriates cannot remain in Kuwait until economic recovery because their 5 Oil refining 731.9 temporary residency is sponsored by 6 Chemical 890.4 the employer, without which they must 7 Light manufacturing 194.4 exit. (Interestingly, this exit provides 8 Heavy manufacturing 125.2 mobility opportunity for some of the exiting expatriates across the GCC 9 Electricity 439.3 states.) 10 Other network services 789 11 Construction 184.7 As expatriates’ wages are generally lower than Kuwaitis’, their exit 12 Transport 198 contributes to the above-described 13 Financial services 142.4 adjustments on the production side, 14 Other services 1,232.4 but with potentially smaller impacts on Household consumption subsidies 3,277.4 the consumption side. The expatriates’ Investment and inventory consumption subsidies 61.5 exit acts like a cushion which absorbs the shock. This mechanism is unique to TOTAL reported consumption subsidies 8,670 Kuwait and other GCC petrostates with Source: Author’s CGE model database (SAM) constructed for 2013 similar labour market compositions.

Adjustment by industries can also The second stabilization mechanism is to adjust their employment level. So be potentially stabilizing. Following a expatriate labour exit. The labour market following a contractionary shock, the negative oil price shock, oligopolistic in Kuwait can be viewed as having two expatriate labour market will thus adjust industries reduce the real cost of primary segments: the Kuwaiti labour and its employment levels fall. intermediate services, depreciating the market in the public sector, and the real exchange rate and contributing The reallocation of resources following expatriate labour market. The Kuwaiti to increases in the economy’s overall this drop in oil prices could in theory labour market employs relatively more competitiveness. Further, the diversion provide additional employment of resources away from the contracting workers, pays relatively higher wages, opportunities in the expanding non-oil sectors, coupled with the depreciation and is less competitive with inflexible industries for the additionally-available of the real exchange rate following contracts. expatriate unemployed. In practice, the oil price drop, enables the non- such opportunities will be limited, A decline in the oil price is oil import-competing industries to especially for expatriates. As local contractionary on economic activity as a expand and export more. These prices in Kuwait are set artificially lower whole, but the impact on the two labour benefits, however, depend on the than the international oil price, the segments is different. Industries whose ability of non-petroleum tradable drop in the latter would not translate performance and profits are impacted industries to attract labour and capital to a reduction in local industries’ accordingly will be forced to cut costs. to higher-valued uses, increase their intermediate energy costs. Also, capital Typically, as wages tend to be sticky contribution to GDP, and improve their in the short run is fixed, and the drop in the short-run, employment levels competitiveness. Based on the existing will adjust instead. Most Kuwaitis are economic structure and rigidities, this employed by the public sector where ‘… FOLLOWING A CONTRACTIONARY ability remains very weak in the short contracts are rigid, so their employment SHOCK, THE EXPATRIATE LABOUR run and is doubtful in the long term. will be largely unaffected. In contrast, MARKET WILL THUS ADJUST AND ITS As such, without long-term changes, the flexibility of expatriate labour EMPLOYMENT LEVELS FALL.’ industries too are unlikely to act as a contracts allows affected industries meaningful stabilizing valve.

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While stabilizing, the existing valves economy. Removing subsidies will the country’s GDP. The two shocks (mainly SWF inflows and foreign negatively affect highly subsidized combined will effectuate the exit of labour exit) coupled with petroleum industries, most of which are in the expatriate labour from the economy riches have reduced incentives for public sector (due to large cost (the second stabilization measure), structural economic changes. The increases and revenue reduction, which could be sizeable depending on government remains the preferred necessitating further cost cuts). the magnitude of the shocks. employer and welfare provider, and While the economy contracts due to Further, net welfare gains from pricing investments in non-petroleum tradable the oil price drop, slashing subsidies reform are higher during episodes of sectors remain weak. Moreover, will increase the costs of goods low petroleum price, and household these adjustment mechanisms are and services. The increase in costs (Kuwaiti and expatriate) consumption unsustainable especially if the low (including the cost of hiring) will be on all goods and services is impacted oil price persists. Officials at the particularly high for industries that with real inflation. Central of Bank of Kuwait recently use energy as an intermediate input. surprised a parliamentary committee Collectively, the affected industries While expatriate labour exit acts as by announcing that existing SWF will thus be forced to cut costs and an adjustment mechanism, it will savings could support anticipated fiscal hire fewer people, so employment inevitably decrease available skills deficits for only five years before being levels will adjust in the short run to and resources for certain occupations. depleted. The unsustainability of these achieve the necessary cost reduction. The magnitude of its impact on the adjustment mechanisms necessitates a If public sector employment adjusts, Kuwaiti economy will depend on the relook at energy pricing reform. it will impact expatriates only, due ability of various industries to divert to the flexibility of their employment labour (both Kuwaiti and expatriate) to these occupations and to the private Implications for pricing reforms contracts. Kuwaiti workers with inflexible employment contracts will not sector for higher-valued activities. My analysis confirms a widely accepted be affected. As for the private sector, Notwithstanding the bloating of the view that phasing out distortionary employment cuts will be across all public sector and governmental efforts energy subsidies will yield long-run employees, but given that 95 per cent to increase national labour in the fiscal and net welfare benefits. Reforms of the sector’s employees are non- private sector, Kuwaitis are unlikely to following low oil prices are also Kuwaiti, most of the reductions will leave guaranteed public sector jobs fiscally advantageous. They reduce also be among expatriates. As a result, in a contracting economy. As such, rigid government expenditures, thus the overall output of these impacted navigating the labour market dynamics generating improvements in Kuwait’s industries will drop. in Kuwait will be a very critical aspect of budgetary and SWF positions (one of price reforms. the stabilizing factors). These impacts are in addition to those caused by the previously described But in addition to these anticipated oil price collapse. Further, while the Pricing reform is a continuous balancing benefits, the CGE model can also shed less-established non-petroleum act light on the implications of reforming industries could normally benefit from Recent discussions of public policy on prices following petroleum price declines. a drop in the petroleum price, the energy subsidies in Kuwait have been A particularly important yet under- government austerity measures might largely dominated by two camps. One recognized area is the impact on Kuwait’s freeze support that these industries had has championed the general benefits labour market, which consequently previously used to fund investments of price reform, at the macroeconomic changes the economic opportunities in technology, new capital, or Kuwaiti level (aggregate GDP and welfare) available for both firms and workers. labour wage equalization. Therefore, and the micro level (energy demand despite the economic need for their As described above, an oil price or sector-specific performance). The expansion, these industries could decline is contractionary for the entire other camp has opposed reform due to contract, thus requiring even fewer fears of inflation, welfare losses, and a workers, rather than being able to re- neglected state responsibility. ‘… PHASING OUT DISTORTIONARY employ some of the available expatriate ENERGY SUBSIDIES WILL YIELD labour resources. Without appropriate The CGE model discussed above LONG-RUN FISCAL AND NET WELFARE compensation mechanisms, this highlights seldom-discussed aspects BENEFITS.’ contraction in output could have of pricing reform. These aspects a further contractionary impact on include impacts on the labour markets

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needed for fiscal stabilization, future transfers based on income levels, ‘THE ANALYSIS HIGHLIGHTS THE TRADE- generations, infrastructure, and human rather than consumption, to aid those OFFS BETWEEN MAINTAINING FISCAL capital development. Yet, as this article most negatively impacted by reforms. BALANCE AND COST OF LIVING STABILITY has discussed, the Kuwaiti economic In addition, as pertains to expatriate DURING PERIODS OF HIGH AND LOW OIL structure has additional complexities, labour, it will be necessary to manage PRICES …’ implying that pricing reform alone is not the political considerations of these a universal solution. The distributional mitigation measures. Microeconomic and labour market impacts of pricing reforms can target: competitiveness in Kuwait and shifts in the expatriate reform are critically important in an in oligopolistic industries, meaningful labour market equilibrium. Further, economy where expatriates form 83 private non-petroleum sector the analysis highlights the trade-offs per cent of its labour market. These involvement, the upskilling and mobility between maintaining fiscal balance impacts also have further challenging of labour across sectors, and the and cost of living stability during social and economic dimensions. expansion of non-oil value-adding periods of high and low oil prices, an activities in the private sector. important consideration in any attempt Therefore, pricing reform should at pricing reform. The analysis implies be accompanied by carefully With the complex dynamics underlying that reform can be part of a larger designed mitigation measures and the Kuwaiti economy, a continuous solution towards the trade-off between microeconomic reforms addressing balancing act of short- and long-term local consumption and exports, the ensuing sectoral losses and labour objectives, and of economic and social and between withdrawals from and and distributional effects. Possible considerations, will be unequivocally investments into the SWF, as resources mitigation measures include income important for successful pricing reform.

Algeria in fiscal crisis: energy policy priorities and implementation challenges Ali Aissaoui

As with most other oil-producing increasing various end-user taxes to a major role in the energy balance of countries which have made little or no improve revenues, the government the national economy – all the more so progress on economic diversification, has curtailed public spending and given that it represents (when natural Algeria has been particularly vulnerable embarked on a rationalization of social gas liquids are included) more than half to the volatility and cyclicality of global transfers and subsidies. Furthermore, in the total hydrocarbon export volumes. energy markets. The sharp fall in oil a sign that future budgets will continue This is what must have triggered the prices of recent years has shrunk the to be adjusted to a lasting drop in extraordinary cabinet meeting (held government’s already limited fiscal revenues, the government has adopted on 22 February 2016, at the country’s space and overwhelmed its ability a medium-term fiscal policy aimed at core centre of power and politics) to to cope with the resulting negative consistency and perseverance. address the ‘national policy in the field economic and social consequences. of natural gas’ (‘Algerian gas: troubling Past savings, placed with a stabilization The collapse of global oil prices and, in trends, troubled policies’, Ali Aissaoui, fund, have proved to be inadequate turn, of regional natural gas prices have OIES, May 2016). This meeting outlined to cover a widening fiscal deficit, attracted the greatest concern – as a three-pronged strategy to deal with ultimately forcing a drastic reduction being the main causes of the near- the fall in export volumes: of the state budget. In addition to halving of state revenues. However, deeper worries have set in as it became a) a supply-side response to revive exploration and development; clear that, as a result of long-stagnating ‘ALGERIA HAS BEEN PARTICULARLY production and unrelenting domestic b) a demand-side response to VULNERABLE TO THE VOLATILITY AND consumption, hydrocarbon export rationalize consumption; CYCLICALITY OF GLOBAL ENERGY volumes have also been falling. These c) a more resolute push towards a MARKETS.’ concerns have been particularly acute renewables programme – raised to in relation to natural gas, which plays a national priority, with the aim of

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displacing natural gas in the In order not to divert our focus quasi-entirely gas-fired power ‘… THERE IS HARDLY ANY EVIDENCE from natural gas issues, we will not generation sector. OF AN ARTICULATED ENERGY PRICING elaborate on the price adjustments of POLICY …’ transportation fuels. Suffice it to say In this article, we will examine the that, in Algeria’s Finance Law 2017, two latter prongs of the strategy (for involved. These include the ministry the government decided on further tax the first prong, see ‘Algerian gas’). of finance, which administers, within rises which resulted in gasoline and More precisely, we will discuss first the state budget process, taxes and diesel prices (LPG/autogas has been the challenge of implementing long- direct (explicit) subsidies affecting spared) increasing by an average of overdue energy price adjustments end-user energy prices with the aim 13 per cent. Although the cumulative which, together with the energy of generating additional government effect of recent increases is now efficiency programme, constitutes revenues. Outside the budget process, significant, actual prices for 2017, as the cornerstone of demand-side both the Hydrocarbon Regulating shown in the table below, are likely management. We will then turn to the to have only a moderate impact on Authority (ARH) and the Regulatory lagging renewables programme and average transportation costs, and Commission for Electricity and Gas the current policy initiatives intended to hardly any lasting effect on vehicle (CREG) are in charge of adjusting scale it up boldly. owners’ fuel consumption. energy prices with the aim of covering, as much as possible, the cost of Of more relevance to our present Energy price adjustments: barely begun, supply. While ARH is in charge of discussion are the electricity and already paused setting primary and wholesale prices gas tariffs. Given their complex To some extent, the fiscal crisis is of hydrocarbon products, CREG is in design and the diversity of the resulting seen as legitimizing and allowing charge of setting end-user tariffs of prices, they need some explaining. some adjustments to energy prices natural gas and electricity. Tariffs have been increased across the various consumption brackets – and subsidies. Before examining their The second reason is that, although except for the two lowest, the so-called nature and extent, it is worth noting independent in law, the latter two ‘social brackets’, in order to protect that there is hardly any evidence of an institutions (ARH and CREG) are in low-income users. Furthermore, the articulated energy pricing policy (this fact subject to political expediency and tariff structure for households and would normally be at the ministry of inertia, leading to a lack of continuity commercial activities has been made energy level) that aims to shape the and consistency in pricing adjustments. progressive; in other words, the unit national pattern of consumption. There This is particularly true of CREG which, price of electricity or gas increases may be two reasons for this. after having kept gas and electricity progressively from one bracket to the The first reason is the apparent lack of tariffs frozen for a decade or so, finally next. The percentage increases vary coordination between the objectives got government’s approval to adjust from 15 to 41 per cent depending on and interests of the various institutions them, starting in 2016. the energy form, end-use sector, and

Transportation fuel prices at the pump in Algeria

2017 prices 2015 2016 2017 equivalent DZD/litre DZD/litre DZD/litre USD/litre Gasoline (premium) 23.00 31.42 35.72 0.32 Gasoline (unleaded) 22.60 31.02 35.33 0.32 Gasoline (regular) 21.20 28.45 32.69 0.30 Diesel 13.70 18.76 20.42 0.19 LPG (autogas) 9.00 9.00 9.00 0.08

Note: DZD denotes Algerian dinar. Source: Author’s compilation

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contrast to CREG, which managed to new dynamic. The programme, which ‘… TARIFFS HAVE REMAINED TOO LOW increase retail electricity and gas tariffs originally aimed to implement the 22 GW TO ALLOW UTILITIES TO OPERATE IN A in 2016 (explained above), ARH has capacity by 2030, is composed of: SUSTAINABLE MANNER.’ kept the primary price of natural gas 18.6 GW of intermittent PV and wind, (representing its wholesale price to the 2 GW of solar thermodynamic usage level. However, having been power generators) unchanged for the systems with storage, raised from a very low base, tariffs last five years. Adjusting the primary 1.4 GW from biomass, renewables- have remained too low to allow utilities price using ARH’s cost concepts would based cogeneration, and to operate in a sustainable manner. result in prices increasing by 35 per geothermal. Inferring from estimates provided by cent to USD0.50/MMBtu (see ‘Algerian gas’). However, this level would still be the utilities, the expected additional This programme is being reaffirmed below the weighted average wellhead revenues resulting from these with two potential modifications. cost of production, which we have increases would only cover 14 per cent The first is the extension of the time estimated at USD0.70/MMBtu. It would of the USD1.8 billion operating deficit horizon from 2030 to 2035 (at the also be, by way of comparison, far they registered in 2015. This means earliest). The second is the option below similar prices in most MENA that tariffs would have to rise more to put more emphasis, in the future, countries, where a cross-cutting substantially to even generate enough on thermodynamic solar systems trend of price and subsidy reforms revenue to recoup costs, let alone with storage. For the time being, the is ongoing. Barring significant price self-finance new investment. However, medium-term focus is on implementing adjustments, domestic natural gas as put by the originators of the tariff a whole tranche of 4.5 GW of demand is unlikely to relent any time adjustments, ‘the path to charging the photovoltaic and wind power, of which soon – and not before the renewables true cost is still a long one’. 4 GW would involve international programme has gained sufficient investors partnering with Algeria’s This path is also hampered by traction to penetrate the dominant energy champions, while the remaining concerns about looming discontent power generation sector. and social unrest. On the surface, the 0.5 GW would be assigned to smaller reaction to the rise in electricity and domestic investors. The 4 GW scheme Renewables: jump-starting a slow starting gas tariffs has been placid overall, will soon be put to tender, possibly as point except in the Saharan provinces a single contractual package. In scant where people have been rather To date, Algeria’s 22 GW renewables pre-announcements, ahead of the vocal. This was enough for the programme has performed well release of the tender documentation, government to defer, at least for the below expectations. Ever since it was Algerian policy makers have raised time being, any further adjustment, formulated in 2011, then amended and the programme’s ambitions further, although the value-added tax (VAT) approved by the government in 2015, indicating that this large-scale project, on both products has increased in the programme has functioned in a which will involve public–private Finance Law 2017. Furthermore, sort of quasi-pilot, embryonic mode. partnership (PPP), will have a dual the government has made the low In addition, the projects deployed so purpose: brackets of electricity consumption far could not benefit from supporting energy (generating electric power), in the Saharan region – for domestic policy measures, which were only industrial (manufacturing locally key users, agricultural producers, and completed in 2015 and, at the time of input components and materials). small businesses – eligible for direct writing, still not operational. As a result, subsidies to cover the relevant only a tiny total of 318 MW, mostly small The renewables programme will now tariff reductions. In a context where photovoltaic (PV) capacity, has entered likely benefit from more effective policy electricity-intensive air conditioning is service so far, together with a hybrid support. In addition to the already the only means to mitigate the extreme plant coupling a 25 MW concentrated enacted feed-in tariffs (FITs) scheme, desert temperatures, this pricing policy solar power (CSP) system with a 130 a newly decreed competitive bidding reversal is seen as fair and prudent. MW gas-fired combined cycle turbine (CCGT). In any case, adjusting end-users’ tariffs ‘THE RENEWABLES PROGRAMME WILL is one thing, setting a more coherent With the programme now raised to a NOW LIKELY BENEFIT FROM MORE pricing structure along the gas and national priority, an emerging vision EFFECTIVE POLICY SUPPORT.’ electricity value chains is another. In and momentum are setting in motion a

32 OXFORD ENERGY FORUM MARCH 2017: ISSUE 108 – Source: uor process (the details of which were not available at the time of writing) aims at minimizing the cost of generating electricity from renewables. A key source of funding the FIT subsidies will be the recently merged National Fund for Energy Saving, Renewables and Co-generation. The Fund will receive:

1 per cent of hydrocarbon royalties (Complementary Finance Law 2011), 55 per cent of the revenues accrued from taxing natural gas flaring (Finance Law 2016), and 10 per cent of revenues collected from taxes on energy inefficiency, as part of the VAT on energy-using Gas consumption in Algerian power sector, 2005–35 goods and appliances (Finance Law Source: Author 2017).

However, should the fiscal crisis linger and significantly will make it difficult the plants, in other words well beyond and worsen, the Fund’s resources for potential investors to commit to the 2035). While such a substitution is one may not be sufficient or sustainable. long-term partnerships sought for the of the most important objectives set In this respect, the government’s renewables programme. for the programme, its significance policymakers do not appear to be In any case, whatever the design could only be appreciated when preparing for a transition from subsidy- and outlook of the programme over factored in, together with the ultimate based incentives to market-based time, it will surely affect the volume of timeframe and anticipated costs, to a ones. gas used by the power sector, and comprehensive cost–benefit analysis With respect to the 4 GW tranche, therefore the size of the domestic that remains to be undertaken. foreign investors are expected to be gas market in the long term; but to the major source of external financing, what extent? In a central scenario of Conclusions capital, and technology transfer. moderate growth, we have estimated While waiting to see the details of that the Algerian power generation In a context of a severe fiscal crisis what might be sought from them and sector will likely develop from 17 GW and inevitable austerity, Algeria what might be offered to them, we capacity in 2015 to some 46 GW in is faced with multiple challenges, can already foresee what could deter 2035, generating about 190 TWh per chief of which is a serious decline them. The barriers to investment are year and consuming, in the absence of natural gas export volumes. As not so much sector-specific. Investors of renewables, some 48 bcm of natural these are the largest source of state could possibly benefit from an already per year at that horizon. Assuming revenues, Algeria’s highest authorities unbundled power grid, liberalized that the renewables programme have committed themselves to three wholesale market, preferential access is implemented successfully, it will strategic priorities in order to reverse to the grid, as well as a decent displace, on the basis of an average this trend. Leaving apart the supply regulatory framework for independent capacity factor of 20 per cent, nearly side, which is beyond the scope of power producers (IPPs); not to mention 12 bcm in 2035. As shown in the this issue of the Forum (for this policy the relative quality of the institutions in figure below, the resulting cumulative dimension, see ‘Algerian gas’), we charge of implementing the renewables gas so saved would amount to 120 programme, chief of which is CREG. bcm over the 20-year planning period The major barriers are rather the (the much higher figures – up to 300 ‘… ALGERIA IS FACED WITH MULTIPLE country’s poor overall investment bcm – reported by local media must CHALLENGES, CHIEF OF WHICH IS A climate and the prevailing weakness have been computed not over the SERIOUS DECLINE OF NATURAL GAS of the business-enabling environment. planned period as mistakenly stated, EXPORT VOLUMES.’ Failure to improve these issues quickly but over the expected economic life of

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have examined critically the current focus on retail gas and electricity in favour of the market, should the price adjustments (which are thought tariffs has left unaddressed primary fiscal outlook deteriorate further. As to be the cornerstone of the demand- and wholesale gas prices, which far as the deployment of renewables side response), as well as the move remain well below upstream costs. is concerned, for the time being, to accelerate the deployment of Furthermore, the fact that a policy the focus seems to be on aligning renewables in the power generation pause has already been decided all available policy instruments to sector. Both these factors have the underscores the paralysing prudence prioritize and scale up the necessary potential to curb domestic demand for of navigating this socially and politically investments through PPPs. While the natural gas. sensitive area of policy. Therefore, almost completely reformed power We were unable to find sufficient we should expect a dual regime sector should generate interest from evidence of a coherent and consistent of subsidies (implicit for electricity foreign partners, it remains to be pricing policy which could alter tariffs and explicit for FITs) to govern seen to what extent the country’s the current pattern of natural gas the renewables programme, with no broader business environment can be consumption. The government’s apparent government strategy to exit perceived as conducive and enabling.

Energy pricing reforms in Egypt Tom Moerenhout

Egypt’s recent decisive moves away Since Morsi’s removal in July 2013, Gulf GDP and 20 per cent of its public from the era of underpriced energy support amounting to tens of billions expenditure. Also, after Morsi’s removal: demonstrate exactly how stressful, if of US dollars (USD) has been Egypt’s Egypt’s debt rate had surpassed not traumatic, such a process can be. primary lifeline. This aid was in the 100 per cent of its GDP, Whereas the July 2014 reforms passed form of grants, central bank deposits, the growth rate had fallen from 5 per relatively easily, the August 2016 and oil products. However, with the cent (pre-Arab Spring) to 0.5 per reform round was less straightforward. falling oil price, Egypt’s Gulf partners cent, The transformation of a decades-old closed the tap, leaving Saudi Arabia, social contract represents a balancing which considered Egypt as too big to there was a record-level budgetary exercise; in the case of Egypt, it is an fail, heavily invested into the Egyptian deficit of nearly 14 per cent of GDP, exercise with a very thin economic, economy. In addition to the August rural–urban income disparities and fiscal, or sociopolitical safety net. The reforms, this bilateral support from (youth) unemployment were on the summer of 2014 also marked the drop Gulf countries, Egypt finally concluded rise. in oil prices, which has been both a an IMF loan of USD12 billion (bn) in An immediate USD12 bn support burden and a blessing: on one side, November 2016. The IMF package, package from Gulf countries helped they made the negative impacts from together with the opportunity offered by Egypt’s balance of payments and subsidy reforms relatively less severe; low oil prices, keeps Sisi focused on the reduced the fuel shortages that had on the other, they have directly caused country’s strenuous macroeconomic been so disruptive during Morsi’s some Gulf countries (Saudi Arabia, rebalancing act. The real challenge on presidency. Nonetheless, it remained the UAE, and Kuwait) to tighten their the rope, however, is that the whole financial support to the Sisi regime. evident that painful and wide-ranging of Egypt is walking it – all 94 million reforms could no longer be postponed. Egyptians, including the country’s Energy subsidies were a clear and suffering middle class. And when the logical first choice. centre suffers, balance is at risk. ‘EGYPT’S RECENT DECISIVE MOVES In July 2014, Egypt under President Sisi AWAY FROM THE ERA OF UNDERPRICED reduced energy subsidies to an extent July 2014 ‘big bang’ reforms ENERGY DEMONSTRATE EXACTLY HOW that the process was considered a risky, STRESSFUL, IF NOT TRAUMATIC, SUCH A In 2013, expenditure on energy big bang type of reform. Transport fuel PROCESS CAN BE.’ subsidies reached USD21 bn, which prices hiked. Diesel prices increased by amounted to 8.5 per cent of Egypt’s about 64 per cent and Gasoline 80 and

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92 prices were raised by 78 per cent threat during the Mubarak and Morsi Post-2014 crumbling of credibility and 41 per cent respectively. Kerosene eras) and by initially excluding LPG When Sisi reformed subsidies in 2014, prices were increased by 64 per cent for from the reform process, he was able he realized that the medium-term all users. Natural gas and fuel oil prices to garner the Army’s support for reform. sustainability of his reform process also increased for all users (except would depend on Egypt’s ability to for the electricity sector, for which fuel ‘SISI’S SUBSIDY REFORMS MAINLY develop well-targeted, non subsidy- oil prices remained constant). In the PRESENTED A CHALLENGE ON A SOCIAL dependent social safety nets. As in residential sector, natural gas prices LEVEL.’ many other MENA countries, Egypt’s increased according to consumption social safety systems were fragmented, level but even the lowest users still had low coverage, and lacked financial saw prices double. Similarly, electricity Sisi’s subsidy reforms mainly presented resources. With the assistance of prices were also increased and blocked a challenge on a social level. They the World Bank, Egypt attempted to according to consumption level, thereby essentially transformed the social reboot its social safety organization allowing for cross-subsidization. contract right at the point when Egypt’s by developing two new cash transfer By all standards, this was a big bang middle class had clearly demonstrated programmes to protect the poor type of reform. It substantially affected (twice) that it wanted more economic (Takaful and Karama). However, the electricity rates, together with the opportunity and a better distribution proper development of such schemes price of all fuels except LPG. That of welfare. Sisi played up to this angst requires a significant amount of said, the process of increasing prices by not only acknowledging the crisis institutional and political innovation may have been less difficult than one faced by Egypt, but also by admitting and the delivery has been slow. This, might have expected, mainly because that subsidy reform was an unpopular among other factors, has eroded Sisi’s Egypt did not have any other choice. intervention. With a few tough support amongst the poor. It is without question a fact that the measures aimed at Egypt’s rich and At the same time, economic reforms went counter to one of the his Nasseresque promise of renewed opportunity did not accelerate as cornerstones of the country’s social economic opportunity, his personal quickly as had been previously hoped contract, but the political economy request for shared sacrifice broadened for either. The tourism sector remained conditions were rather favourable: a a social acceptance of the reforms. in crisis and the Government had crisis the size of that facing the state of Sisi skilfully used behavioural economic considerable problems in attracting Egypt post-Morsi indeed also posed an insights when passing the first round foreign direct investment (FDI). unprecedented opportunity for reform. of reforms. Well before his election, the Sisi’s grand bargain – relying on the transition Government was preparing construction sector for economic Favourable political economy conditions an extensive communication campaign recovery – has also not (yet) paid off as had been expected. For example, the in cooperation with international and Sisi’s ability to pass such reforms expansion of the Suez Canal did not domestic experts (such as ESMAP, without much opposition depended generate as much additional revenue the Global Subsidies Initiative, and on favourable political economy as the government had estimated. Environics). This preparation assured conditions. With the suppression of Together with other factors, the slow that the narrative was consistent and the Muslim Brotherhood, there was economic recovery eroded Sisi’s emphasized the regressive nature of no domestic political opposition. Sisi support amongst the middle class. energy subsidies. When Sisi was then won 90 per cent of the vote and did elected, with over 90 per cent of the Egypt was still in serious need of not need any other political parties to vote, his immediate announcement that macroeconomic rebalancing two govern. (While those political parties energy subsidies would be reformed years after the July 2014 subsidy also did not oppose reform, they did left no choice for the public except to reforms. Measures to this end generally question how exactly to go about it.) accept it at that time. He balanced the frustrate the average Egyptian, who Having been the army’s leader before stick (a repressive security apparatus) being elected president, Sisi was also with a few carrots (tough measures able to negotiate energy subsidy reform ‘EGYPT WAS STILL IN SERIOUS NEED OF on the rich and a broadening of with the army, which has historically MACROECONOMIC REBALANCING TWO food subsidies) and achieved full been involved in the energy sector. YEARS AFTER THE JULY 2014 SUBSIDY implementation of the reforms. By once more covering their interests REFORMS.’ (something which had been under This was the ‘easy’ part.

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is increasingly sceptical about Sisi’s Key price increases resulting from energy subsidy reforms in Egypt competence to lead Egypt away from Source: Author crisis. Trust is at a noticeable low. Not Key 2014 reforms Key 2016 reforms only was Sisi forced to change his 78% (gasoline 80) 47% (gasoline 80) entire cabinet in 2015, due to corruption Gasoline 41% (gasoline 92) 35% (gasoline 92) scandals, but he is also increasingly 7% (gasoline 95) price allowed to float (gasoline 95) criticized for his government’s socially Diesel 64% – repressive security policies. Kerosene 64% 31% 33–204% (energy-intensive +/– 50% (low to medium users) The August 2016 reforms and the great industries) 33% (heavy users) balancing act Natural gas > 200% (low users) 500% (medium users) Due to low oil prices, Egypt was cash 700% (high users) strapped, as its Gulf partners had 50% (cement) 7% (most users) closed the tap because of their own HFO 30% (bricks, other users) fiscal struggles. The second round 40% (bakeries and food) of energy subsidy reforms, in August < 50% (low users) up to 40% residential 2016, should be seen as a part of the Electricity +/– 17% (commercial and up to 20% commercial (mainly great balancing exercise aimed at other residential) medium and heavy users) achieving macroeconomic stabilization LPG – 87% and structural economic reform. This balancing exercise has restrained Sisi from all sides, while structural pressures imports more costly. A falling EGP since the first subsidy reforms in July such as an increasing public wage bill thus increased production costs for 2014. A large part of Egypt’s population have only kept adding more pressure. industry and commerce, and additional is suffering as a result of economic However, inflation had actually been costs were passed onto the consumer. adjustment. Sisi has little policy space decreasing prior to August 2016 and Similarly, energy subsidy reform was also and has to count on reactionary advantage of this positive spell had to needed to repair structural distortions measures, such as the expansion of be taken right away; a set of reforms and reduce the fiscal deficit. Low oil food subsidies, to bridge this austere (needed to secure a USD12 bn, three- prices made this adjustment relatively period to a distant future – one in which year IMF loan) was passed. easier, even if this is more of a theoretical targeted social safety nets operate in a Sisi implemented three structural argument than a practical relief. context of stronger economic growth. reforms in August 2016: To help secure the IMF loan, Saudi Arabia Both Egypt’s government and the IMF 1 Energy subsidy reforms. – which will not admit it, but considers should be cognizant of the fact that 2 Introduction of VAT. Egypt as too big to fail – invested there is no room for error, and that includes issues such as corruption 3 Free-floating of the Egyptian pound heavily into the Egyptian economy. This and unmerited social repression. If Sisi (EGP). immediately boosted foreign reserves. When Egypt then finally concluded the fails to throw his weight behind trust- The combined effect of all three IMF loan, a first slice of USD2.75 bn was building measures, impatient Egyptians measures produced a record inflation immediately released to contain inflation. might very well call his bluff of shared rate of almost 20 per cent in November Aware that the key challenge is to keep sacrifice and jump from the balancing 2016. However painful for the citizens’ domestic support for reforms, the deal cord. This would not just be bad news welfare, the measures appeared to also envisioned a redirection of 1 per cent for Sisi, but for the wider region. Egypt have been necessary. Fixed exchange of GDP from fiscal savings to additional may very well be too big to fail. rates had depleted foreign reserves, food subsidies and cash transfers. and this in turn had reduced FDI into The Author wishes to thank his Egypt. This structural rectification should colleagues for their comments on Too big to fail help tourism and FDI, but it also causes earlier drafts. This article represents the economy-wide inflation. The depreciation In the short to medium term, Egypt’s research and view of the author. It does of the EGP against the USD (the value recovery will not be any less of a painful not necessarily represent the views of of the EGP was sliced in half) made balancing exercise than it has been the Global Subsidies Initiative or OIES.

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Iran’s subsidy reform plan: success or failure? Sara Bazoobandi

Subsidies: a pillar of the Islamic A long journey through subsidy reform biggest promise of the founder of the Revolution revolution: ‘bringing the oil money to By the late 1980s, the founder of people’s tables’. The same challenges Since the establishment of the the Islamic Republic had died and (budgetary pressure and heavy cost Islamic Republic in Iran in 1979, the the devastating years of the Iran– of subsidies) then faced President government has been implementing Iraq war came to an end. Ali Akbar Khatami’s government when he heavy-handed price subsidies. Over Hashemi Rafsanjani became head of came to office in the mid-1990s. His the past decade, subsidies absorbed a the government during the post-war economic advisory team also proposed large share of the government budget reconstruction and development years a subsidy reform. The parliament – roughly between USD70 billion (bn) and his government became the first opposed the proposal and the reform and USD100 bn a year. (See ‘The post-revolution administration in Iran plan failed. subsidies conundrum’, Semira N. to introduce pro-market economic Nikou and Cameron Glenn, 2016, Iran policies. President Rafsanjani’s President Ahmadinejad presented a Premier website.) government proposed some market subsidy reform bill to the parliament reform policies in the 1990s. The key in December 2008. After about a consideration for the government at year, the Iranian legislature approved ‘SINCE THE ESTABLISHMENT OF THE that time was to reduce the heavy the government’s proposal and in ISLAMIC REPUBLIC IN IRAN IN 1979, budgetary pressure of subsidies by December 2010, Ahmadinejad’s THE GOVERNMENT HAS BEEN introducing some price liberalization government launched the subsidy IMPLEMENTING HEAVY-HANDED PRICE policies. At a time when rebuilding reform programme. The programme SUBSIDIES.’ the country’s shattered infrastructure aimed to phase out energy subsidies required substantial investments, the over the course of five years (see government could no longer afford the ‘The economic legacy of Mahmoud The founder of the Islamic Republic, cost of subsidies, as the alternative was Ahmadinejad’, Nader Habibi, June Ayatollah Khomeini, vowed to form to continue accumulating deficit. As 2013, Middle East Brief Crown Center a government that would deliver a result, policies such as government for Middle East Studies). economic equality and social justice coupons, together with some price in Iran. In his historic speech in Tehran subsidies (particularly in the food Cemetery immediately upon his arrival Subsidy reform’s motives market), were gradually phased out from exile in France, he promised to during President Rafsanjani’s eight As noted above, budgetary pressure ‘bring the oil wealth to people’s tables’. years in office. on the government was the key motive Thus, the economic mechanism that for ending the subsidies programme allowed the distribution of wealth Due to social and political in Iran. In addition to that, decades of across Iranian society, to support the considerations, Rafsanjani’s subsidized energy prices have had poor and under-privileged, became government did not initiate any other consequences such as: a fundamental element of the Islamic cuts in energy subsidies, and these Revolution’s ethos. However, shortly continued to absorb a large share high and wasteful domestic energy after the Islamic Republic was of the budget. Some government consumption, established, the Iran–Iraq War broke subsidies for some food items were, creating a market for smuggled out and the heavy costs of financing however, abolished, and this tarnished refined products (mainly petrol) from nearly a decade of war put mounting President Rafsanjani’s reputation, Iran to neighbouring countries, pressure on the Iranian economy. particularly amongst lower-income air pollution in big cities. Rationing programmes and the Iranians. Although his market reforms subsidization of ‘necessary items’ remained incomplete during his eight Hydrocarbon resources dominate Iran’s (such as food, medical goods, and years as president, Rafsanjani became total primary energy consumption: energy) became vital components recognized as the first revolutionary natural gas and oil account for up to of the government’s economic Iranian political leader whose 98 per cent of Iran’s energy management strategy during the war. economic policies diverged from the consumption. Also, official reports

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distribution networks, transportation, payment recipients was reportedly ‘CHEAP ENERGY PRICES ENCOURAGED and household heating systems (see higher than the total population of the HOUSEHOLD CONSUMPTION TO FORM A IFCC’s website, in Persian). country. (This was mainly due to poor SIGNIFICANT SHARE OF THE COUNTRY’S identification procedures during the About two decades after the passing initial registration of recipients in 2010.) ENERGY CONSUMPTION.’ of the founder of the revolution, the Mohammad Reza Tabesh, a member Islamic Republic found it practically of the parliament, was quoted by a showed that Iran’s energy intensity impossible to continue with the price local online media platform saying that index was eight times that of China subsidy policies. By this point, cutting ‘the Afghans and dead people also in 2004. Cheap energy prices the subsidies became the obvious registered and have been receiving encouraged household consumption solution for the government. However, cash handouts’ (see Khabar Online to form a significant share of the the implementation of subsidy cuts website, in Persian). country’s energy consumption (see has been both a politically and a Iran’s Petro Energy Information Network socially sensitive issue and President Reducing household consumption by (SHANA) website). At the current rate Ahmadinejad managed to win the 2005 changing the wasteful consumption of consumption (similar to that of the presidential election in the second culture and cutting down air pollution Gulf Cooperation Council Countries) round (against former President were also amongst the objectives of the country faces the risk (confirmed Rafsanjani) by promising the nation the subsidy reform plan. There has by a recent OPEC Annual Statistical that he would protect the poor and been no sign of success in achieving Bulletin) that increased domestic underprivileged. To fulfil his presidential those objectives. While cutting the consumption of hydrocarbon resources campaign promises, Ahmadinejad energy subsidies has had a significant is likely to reduce its exports in the replaced energy subsidies with cash impact on prices, the consumption long run. According to OPEC, in 2016, handouts, in order to help lower-income culture has remained relatively Iran’s crude oil production was about Iranians cope with rising prices. The unchanged. Prices of gasoline, natural 3.15 million barrels per day (mbd), total cash handouts, however, presented gas, and diesel increased by 400 oil demand was 1.79 mbd, and crude the government with a new list of per cent, 800 per cent, and 900 per export was 1.08 mbd (see OPEC’s challenges that will be discussed in the cent respectively (see ‘Iran: subsidy Annual Statistical Bulletin, 2016). next sections. reform amid regional turmoil’, Djavad Salehi-Isfahani, Brookings, 3 March According to the Iranian Fuel 2011). But the traffic jams and air Conservation Company (IFCC) – a What has subsidy reform achieved? pollution problems in bigger cities government body affiliated with the The government planned to achieve a have remained unresolved, or perhaps oil ministry – by 2015 the country number of goals through the subsidy have even worsened. Most middle was consuming about 2 bn barrel reform programme, most importantly, class, and upper–middle class Iranians of oil equivalent every year, of which tackling the budget deficit problem. In rely on driving private, and often 20 per cent had been wasted before practice, however, the programme did inefficient, vehicles for work and leisure. reaching consumers (see ‘Iran leaping not achieve what the government had Household central heating systems to economize $870bln by halving hoped for. During the first phase of and home insulation are also inefficient, energy intensity’, Dalga Khatinoglu, 16 the plan, the government’s financial causing excessive energy waste. September 2015, Trend News Agency). saving was not sufficient to cover the IFCC reports show that over the past A combination of sudden energy price costs of implementing the plan. As decade, household consumption has increases, increased liquidity due to a result, the administrative costs of grown by about 4 per cent every year government cash handout payments, the plan and the paying out of cash and by 2015, it accounted for 41 per and devaluation of the riyal (IRR) due handouts put additional pressure cent of the country’s total natural gas to tightened international sanctions led on the budget. The government consumption. to very high inflation figures during the borrowed from the Treasury and the The Iranian government is planning to Central Bank of Iran in order to make halve the country’s energy intensity by the payments (see Khabar Online ‘… THE CUT IN ENERGY SUBSIDIES 2021. Official estimates show that in website, in Persian). The costs were WAS A SIGNIFICANT CONTRIBUTORY order to achieve this goal, the country so high that the government had to FACTOR IN THE CONSTANT INCREASE OF will need USD200 bn to invest in areas start cutting people out of the payment INFLATION…’ such as electricity production and system – indeed the number of cash

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30 stop payments to those with at least USD850 salary a month (see ‘Iran 25 scraps cash handouts to its wealthiest 20 to ease burden’, Daily Mail, 29 April 15 2015). The government has indicated further plans to cut more citizens from

Inflation (%) Inflation 10 the payment system in 2017. 5

0 Conclusion

Iran’s subsidy reform programme was implemented in an environment Official inflation in Iran, 2005–12 in which the international economic Source: Central Bank of Iran sanctions on Iran had been tightened in response to the country’s nuclear first stage of the subsidy reform plan Upon his election in 2013, President programme, and the country’s (see figure above). Although the cut Rouhani was presented with the same structural economic problems were in energy subsidies was a significant difficulties in implementing thesecond magnified as a result of the wrong contributory factor in the constant phase of the reform programme as monetary and fiscal policy choices by increase of inflation, it was not the the previous government had faced. Ahmadinejad’s government. The results only reason for soaring prices in Iran. While regular monthly payments had of the reform were therefore, as Iran’s High inflation was indeed hurting become a citizenship entitlement for Minister of Economic Affairs recently lower- and middle-income Iranians. the population, the government did not called it, ‘a great catastrophe’. Contrary But the excitement of receiving monthly have the financial means to continue to the government’s initial plans, the cash payments outweighed the pain the previous payment structure. Indeed cuts in subsidies did not generate of disappearing subsidies for many the cash handouts were not significant sufficient financial resources to pay (especially for about 10 per cent of the for middle class Iranians, but they did the expenses of their administration, population who were living on under make a difference for the lower-income let alone cover the budgetary gaps. USD2 per day in 2010). and rural population. The low-income The continuation of monthly payments Iranian households received hundreds imposed substantial financial pressure The cost of monthly payments was of dollars each month in their bank on the government’s budget, and so high that in November 2012 the account. It was not an easy task for the heightened already-rising inflation parliament suspended implementation government to ‘simply apologise and figures. Challenges associated with of the second phase of the programme. announce that the subsidies reform the payment system have attracted It also rejected a large part of the program has failed and end it’, as a most of the government’s resources government’s budget request for that member of the parliament suggested and prevented it from putting fiscal year. The government continued (see the Tabnak website, in Persian, 13 much effort into achieving the non- the monthly payments and President October 2013). financial objectives of the reform. Ahmadinejad publically criticized the These included changing the driving parliamentary decision, claiming that In December 2013, President Rouhani culture, lowering domestic energy every time he wanted ‘to put money told the parliament that ‘the current consumption, lowering air pollution, in people’s pockets, his enemies payment system will remain in place and improving energy efficiency in the would block it’. The conflict between until a reasonable replacement is found’ industrial sectors. Ahmadinejad’s administration and the (see the BBC Persian website). Shortly parliament escalated until the case was after that, the parliament allowed the Despite all the economic and political referred to a special Arbitration Board. government to cut some of the wealthy challenges faced by Iran since 2010, However, no settlement was reached as citizens out of the monthly payment implementation of the subsidy reform the end of Ahmadinejad’s presidency system. Ahmadinejad claimed the was approaching, and the country was government’s money was coming ‘… IMPLEMENTATION OF THE SUBSIDY struggling with numerous economic ‘from the 12th Shiite Imam’, and cash REFORM PLAN DID NOT CAUSE ANY challenges due to the tightened US-led handouts should be continued. But SOCIAL UNREST.’ economic sanctions. the current government decided to

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plan did not caused any social unrest. the country’s capital. A year after the Maintaining the cash handout The government decided to increase election crisis, when people were still system has been extremely difficult the price of energy shortly after the terrified of the news of arrests and for the government, but Rouhani’s election crisis of 2009, launching the torture by the security apparatus, there administration has avoided taking any plan in an environment in which the was absolutely no social momentum drastic measures to end the payment country was still going through the for protesting against the energy system. Although the government has shock caused by the authorities’ heavy price increase. In addition, the cash signalled plans for a further reduction handed response to the post-election handouts became immensely popular in the number of monthly payment uprising. Hundreds of political and civil amongst lower-income and rural recipients, as the next presidential activists were in gaol, the heads of the Iranians. Therefore, the risk of any election is due in June 2017, Rouhani Green movement under house arrest, social unrest in response to the price is unlikely to end his first term in office and people were still mourning those increase was eliminated. attempting to implement such an who were shot dead in the streets of unpopular policy.

The political economy of energy subsidies in Egypt and Tunisia: the untold story Ferdinand Eibl

For decades, the subsidization of absence of a meaningful overhaul of energy has been a pervasive feature ‘EVIDENCE HIGHLIGHTING THE MANIFOLD the status quo is indeed striking. While of economies across the Middle DISTORTIONS OF ENERGY SUBSIDIES some of the obstacles to reform might East and North Africa (MENA). By IN THE MENA HAS NOT BEEN IN SHORT lie with limited institutional capacity supplying electricity, gas, and petrol SUPPLY.’ and problems of implementation, to households and companies at most explanations have underlined the prices well below the world market importance of the political economy average, MENA energy importers and in particular during periods of high oil of energy subsidies in explaining the exporters alike have made energy prices. persistence of the status quo. By far subsidies a hallmark of their industrial Evidence highlighting the manifold the most widespread argument in policy and a key pillar of their social distortions of energy subsidies in the this context is the fear of a popular contract. Though the goals of this MENA has not been in short supply. backlash and attendant unrest in policy – facilitating industrialization and Alongside financial concerns, the response to subsidy reductions that is attenuating social inequalities – may be existing studies have particularly allegedly felt by governments. commendable, energy subsidies have highlighted deleterious effects on While this argument seems pertinent come at a huge price for the MENA the environment, undue reliance on – especially in the light of the Arab economies. The estimated cost of energy-intensive industries, and the Spring – it is incomplete and overlooks energy subsidies amounts to about generally regressive distributional obstacles to reform that stem from the 8.5 per cent of regional GDP or consequences of energy subsidies. unintended, yet powerful and politically 22 per cent of government revenues The latter point is particularly damning connected, beneficiaries of energy (IMF estimates for 2011). As a whole, as in most countries energy subsidies subsidies. After a brief outline of recent the region accounts for half of global are an important, if not the sole, pillar reforms of energy subsidies and a energy subsidies. The fiscal burden of of otherwise underdeveloped social summary of the ‘standard’ political safety nets and they often dwarf other this policy has been particularly heavy economy explanation, this article will welfare expenditures, such as health for the relatively resource-scarce and highlight the importance of these actors and education. labour-abundant countries in the region – politically connected businessmen such as Tunisia and Egypt which, by Given the manifest shortcomings of (PCBs) and the army – in the case of the early 2010s, had both become subsidized energy and persistent Tunisia and Egypt. By demonstrating the net energy importers and have thus advice from international financial extent to which these actors are present seen their budgets put under strain, institutions (IFIs) in favour of reform, the in subsidized sectors – which they often

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specifically enter because of energy increased the price of fuel by 7 per cent policy measures to date have consisted subsidies – I argue that these actors in 2012 and 2013, and also hiked up of ad hoc price increases which have, have become key stakeholders in the electricity and gas prices for medium- overall, maintained comparatively low status quo and have used their leverage voltage consumers by 20 per cent in domestic prices. For example, the to water down reform attempts. Thus, 2014. The authorities also reintroduced most expensive price for fuel and for any meaningful reform will have to come the automatic indexation mechanism electricity still only represents 32 and to terms with this group of actors. for petrol and began the gradual 0.6 per cent of average US prices phasing out of energy subsidies for a respectively. few energy-intensive industries, such as Energy subsidies in Tunisia and Egypt cement, textiles, ceramics, and food The told political economy story: mobilized Tunisia has established a system of processing. On the whole, however, beneficiaries extensive energy subsidies in the form there has been no serious attempt at a of cheap electricity, gas, and petrol. systemic overhaul of energy subsidies In both countries, the reluctance to Since the state has acted as a quasi- post-2011. reform energy subsidies is attributed monopolist in the production and to popular revolts against price hikes Like Tunisia, Egypt has also maintained provision of energy, energy subsidies of subsidized goods in the past. Food an extensive system of energy subsidies take the form of a monopolist price riots in response to food subsidy cuts which offers energy products – such as setting by the state, with prices are believed to have left a particularly petrol, gas, and electricity – at favourable generously below the level of the enduring legacy. In Tunisia, these rates below the world market price. world market. Tunisia was a net energy events hark back to a series of riots While energy subsidies have never been exporter from the early 1970s until the that lasted from December 1983 until ‘cheap’ in Egypt, the costs soared after late 1990s and was able to provide January 1984. Representing the worst the 2011 uprising as Egypt transitioned cheap energy from its own domestic violence since independence, protests from a net exporter to a net importer of resources in this period. With falling left about 100 people dead and caused energy, and oil prices peaked as a considerable devastation as a result of production levels and increasing result of political turmoil in the MENA. rioting and plundering. In view of this consumption, the country turned into In 2013 and 2015, energy subsidies thus public discontent, President Bourguiba a net importer of energy in the late amounted to nearly 16 and 10 per cent first announced a 50 per cent reduction 1990s, having to import nearly 30 per of Egypt’s GDP respectively. cent of its energy needs by 2015. As in the price increase, before scrapping energy is supplied at prices below In view of Egypt’s strained post-2011 the measure entirely a few days later. budget, successive governments those in the world market, the resulting In Egypt, the major event dates back to have carried out a number of price deficit of Tunisia’s two main energy 18 January 1977 when President Sadat increases; for example, in July 2014 providers (STIR for oil; STEG for gas announced price increases for a number prices rose by as much as 78 per and electricity) is covered by transfers of subsidized food items, such as rice, cent for most consumers, including from the state budget. With the rapid tea, and gas cylinders for households. low-income households. In the same rise of oil prices during the most recent Demonstrations against the measures vein, the Sisi administration reduced oil boom, the costs of subsidized first broke out in Egypt’s centre of steel subsidies for a number of energy- energy have hovered between 4 and 6 production, Helwan, and quickly spread intensive industries, such as cement, per cent of GDP, or about 13 per cent of to the urban centres of Cairo, Alexandria, fertilizer, and glass and ceramics. the total expenditures over the past 10 and other big cities, mobilizing industrial Another wave of electricity and fuel years, and have only abated recently as workers, students, state employees, price increases occurred in late 2016 a result of falling world market prices. and, to a lesser extent, the urban poor in the run up to the conclusion of along the way. As demonstrations To alleviate this fiscal burden, in 2009 Egypt’s recent IMF programme, when rapidly turned violent, with administration the authorities introduced an automatic the government implemented price buildings and consumer centres being indexation mechanism for local petrol increases of between 30 and 50 per prices (indexed on the world market cent for household supplies of fuel and price); this was repealed shortly after electricity; increases for commercial ‘… THE RELUCTANCE TO REFORM the uprisings in 2011. In the wake of the consumption were considerably lower. ENERGY SUBSIDIES IS ATTRIBUTED TO ousting of President Ben Ali and under While the stated goal of the government POPULAR REVOLTS AGAINST PRICE HIKES the aegis of an IMF-led stabilization is to phase out all energy subsidies OF SUBSIDIZED GOODS IN THE PAST.’ programme, the Tunisian government within a five-year period, the main

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attacked and burnt, a state of army in ISIC four-digit sectors and is emergency was declared in several ‘… THE POLITICAL ECONOMY OF SUBSIDY thus time-invariant (for a detailed note provinces and the regime deployed the REFORM REVOLVES AROUND TWO KEY on the methodology, see ‘The politics army (for the first time since 1952) to GROUPS: POLITICALLY CONNECTED of partial liberalization: cronyism and quell the unrest. Rioting only stopped BUSINESSMEN AND, IN THE CASE OF non-tariff protection in Mubarak’s after Sadat repealed the measures on EGYPT, THE ARMY.’ Egypt’, Ferdinand Eibl and Adeel Malik, 20 January. The army had to be called CSAE Working Paper 2016–27). The upon a second time when minor dataset seeks to capture Ben Ali- and businessmen (PCBs) and, in the case increases in the price of bread Mubarak-era ‘cronies’, yet most of the of Egypt, the army. prompted rioting in the textile centre of identified actors can still be considered Kafr al-Dawwar in 1984. To understand this point, it is important politically influential post 2011. (The to briefly explain how private sector only exception are companies Evidence for the long lasting effect actors benefit from the system in place. belonging to the Ben Ali–Trabelsi clan, of these events can be found in Regarding energy subsidies, it is first as these were subject to confiscations.) statements of policy makers and and foremost the energy-intensive archival sources alike. For example, Based on this dataset, my argument sectors that reap an important part of Monceur Rouissi, former minister relies on three important pillars: the energy subsidies. These include, on and personal advisor to President the one hand, energy-intensive 1 Presence in heavily subsidized sectors Ben Ali, described the subsidy issue manufacturing sectors, such as cement, as a ‘nightmare for all successive The figure below summarizes the textiles, and chemical products. On the governments, too sensitive to be presence of politically connected actors other hand, energy subsidies reformed’ (personal interview, Tunis in Egyptian and Tunisian manufacturing disproportionally benefit companies in 2013). And according to the former and sectors in 2010. Failing a direct the transport and logistics sector, which current Minister of Supply Ali Moselhi, measure of energy subsidies to each rely heavily on subsidized fuel. the government has ‘a real fear’ of sector, energy intensity is arguably the touching the subsidy issue as a result To demonstrate how these actors have best proxy to capture the extent to of past unrest (personal interview, Cairo affected the system of energy which businesses benefit from energy 2012). Archival sources point in the subsidies, I rely on a novel dataset on subsidies. Clearly, as the figure shows, same direction. References to the food PCBs and the Egyptian army that I politically connected actors in Egypt riots are paramount in correspondence compiledOEF 108 together Figures with for Adeelfinal articleMalik at and Tunisia display a significantly higher between the Egyptian government Oxford. Regarding PCBs, the dataset presence in sectors that benefit from and the IMF, which was declassified in records the entry and presence of energy subsidies. While Egyptian PCBs PCBs in Egypt and Tunisia at the are ‘only’ present in 60 per cent of low the early 2000s. Therein, the Egyptian

Double column government repeatedly insisted four-digit level of the International energy intensity sectors, their presence throughout the 1990s that ‘the pace of Standard Industrial Classification (ISIC, in sectors with high energy intensity reform had to be geared to the likely Rev. 3.1) since 1997. As for the amounts to nearly 80 per cent. The public reaction’. EgyptianSectoral army, presence the dataset of PCBs only andrecords army bypicture energy for the intensity Egyptian army and theNote presence: Manufacturing and not the sectorsentry of theonly. ClassificationTunisian PCBs of isenergy similar, intensity albeit at lower taken from UNCTAD.

The untold story: politically connected actors

Fear of consumer unrest is the 90 Low energy intensity Medium energy intensity High energy intensity predominant narrative that explains the 80 70 persistence of subsidization. However, 60 though important, this narrative is 50 incomplete without giving due attention 40 to another group of beneficiaries from 30

energy subsidies which has become Percent of sectors 20 an important lobbying group against 10 major reform. In both countries, the 0 untold story of the political economy of PCBs Egypt Army Egypt PCBs Tunisia subsidy reform revolves around two key Sectoral presence of PCBs and army by energy intensity groups of actors: politically connected Note: Manufacturing sectors only. Classification of energy intensity taken from UNCTAD.

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keep less than double column

MARCH 2017: ISSUE 108 PCB entry and energy subsidies in Egypt Note: Predictions based on observed values from pooled logit model. Whiskers show 95-per cent confidence interval.

‘… POLITICALLY CONNECTED ACTORS HAVE BEEN AMONGST THE MAJOR BENEFICIARIES OF ENERGY SUBSIDIES.’ levels: their presence is, respectively, 22 and 14 per cent higher when comparing low to high energy intensity sectors.

While these descriptive figures are not evidence that these actors enter sectors because of energy subsidies, they nonetheless highlight the fact that politically connected actors have been PCB entry and energy subsidies in Egypt amongst the major beneficiaries of Note: Predictions based on observed values from pooled logit model. Whiskers show 95-per energy subsidies. cent confidence interval.

2 Entry into sectors because of energy subsidies ‘cronies’ as the dependent variable and It was only in Tunisia that I was unable to There is also evidence to suggest a binary indicator of high or low energy find a systematic association between that politically connected actors enter intensity as the main explanatory energy intensity and PCB entry. Taken sectors because of energy subsidies. variable. It further controls for other together, this suggests that resistance Establishing this point is important; the confounders, such as level of tariffs, from politically connected actors against entry into a sector because of energy exports, imports, broad sectoral fixed subsidy reform should be expected to subsidies gives us a much stronger effects, and skill intensity. be higher in Egypt than in Tunisia. indication of the importance of energy The most striking result can be found in subsidies for these actors and, by 3 Observed lobbying of politically the case of PCBs in Egypt, displayed in extension, their (un)willingness to give connected actors against subsidy them up in the future. For example, if the figure above. It shows that the reform it turned out that PCBs in Egypt enter average probability of an Egyptian PCB There is anecdotal evidence that sectors for reasons other than energy entering a sector is about 3 per cent for politically connected actors have used subsidies – such as skill intensity, level low and medium energy intensity their leverage to lobby against subsidy of imports and exports – this would sectors, increasing to about 27 per cent reductions. For example, in July 2016 suggest that they would not put forward for high energy intensity sectors. With the head of the Federation of Egyptian major obstacles to subsidy reform. If, the average probability of PCB entry Industries, Mohamed El Sewedy, on the other hand, energy subsidies being 4 per cent in the sample, this declared that cutting natural gas prices are a primary factor driving entry into a represents a significant increase and for manufacturers is ‘better for the sector, we would expect considerable demonstrates the importance of energy state’s budget’ and would ‘help reduce resistance to systemic change given subsidies in the entry decisions of the budget deficit’ as the benefits would that their business model is, at least politically connected entrepreneurs in outweigh the direct financial costs for Egypt. As for the Egyptian army, the partly, predicated on the presence of the state. His lobbying efforts met with results (not displayed) suggest that the cheap energy supplies. We would thus partial success as the government army is about three times less likely to expect noticeable lobbying activity reduced gas prices from USD7/MMBtu be present in low energy intensity against subsidy removal. to USD4.5/MMBtu for steel producers, sectors than in medium or high energy To test this claim, I ran a number of despite the looming IMF agreement intensity sectors (21 versus 65 per cent). pooled and conditional fixed effects at the time and the stated goal of logit models which both suggest reducing energy subsidies. While this that the energy intensity – as a proxy ‘… RESISTANCE FROM POLITICALLY anecdote cannot be more than an for subsidies – is a key determinant CONNECTED ACTORS AGAINST SUBSIDY illustration, it is nonetheless indicative of entry into a sector. This finding is REFORM SHOULD BE EXPECTED TO BE of the important veto powers that particularly pronounced for PCBs in HIGHER IN EGYPT THAN IN TUNISIA.’ politically connected actors wield in the Egypt. The model takes the entry of context of subsidy reform.

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