Arabian Gulf and others take heed – it is time to end energy subsidy

By reining in subsidies, energy producers can remain energy exporters. Most Arabian Gulf governments can roll back these subsidies if they do it transparently and with the support of their citizens.

The IMF managing director Christine Lagarde said she opposed fossil fuel subsidies for economic reasons, but also because of the big climate benefits from eliminating them. Andrew Harrer / Bloomberg NShow more

Smothered by the hullabaloo over the US government shutdown was an important call to action: Let’s end the staggering giveaway of nearly US$2 trillion in energy that goes to people who need it least.

The IMF managing director Christine Lagarde said at the United Nations this month that she opposed fossil fuel subsidies for solid economic reasons, but also because of the big climate benefits from eliminating them. “The IMF is not an environmental organisation, but we can help here.”

Subsidies on petrol, electricity and other fossil-based energy sources ate up “a whopping 2.5 per cent of global GDP that could have been used more wisely”, she added. “Taking action on this issue alone — energy subsidies — would be good for the budget, good for the economy, and good for the planet.”

What she didn’t say was that killing subsidies was also smart policy for those of us who want to keep burning hydrocarbons in cars and homes, at least until viable replacements phase them out.

How’s that?

Because eliminating subsidies will reduce demand for oil and natural gas, which could free up supply and reduce world market prices.

The energy subsidies the IMF targeted in a recent report include relatively small post-tax subsidies like those in the United States and other advanced countries, which allow sales of coal and oil at prices too low to reflect the environmental and health damage they cause.

More onerous are the direct subsidies handed out in the very countries that depend most on exporting energy. These are the Opec countries and a few others like Russia, where energy prices are cheap, consumption is high and rising quickly, and – if trends continue – exports could start to dwindle. In this sense, subsidies are driving demand that could push up market prices.

The problem in Saudi Arabia and the other GCC countries is particularly acute. The amount of oil production being diverted into the domestic economy is growing at around 7 per cent per year, meaning it doubles every decade.

Saudi Arabia is already consuming more than a quarter of its production at home.

The UAE is at more than 20 per cent and Kuwait at 16 per cent. Iran is at nearly 50 per cent.

So, as maturing oil production reaches a plateau – as is starting to happen – domestic oil consumption in the GCC becomes an issue for the importing world. The more the GCC countries consume, the less they export.

As several reports have noted, most recently from Citibank, if current trends continue, Saudi Arabia will be an oil importer, as soon as 2030. While this scenario is unlikely, it highlights a serious problem.

Eliminating subsidies globally by 2020 would cut world energy demand by 5 per cent, according to the International Energy Agency. Reduced demand would also relieve pressure on spare production and export capacity in producer states.

The effects would be strongest in the GCC, where fuel and electricity prices are among the lowest in the world.

Last year, Opec accounted for 63 per cent of the world's nearly $200 billion in direct oil subsidies, with Iran and Saudi Arabia at the top of the list, IEA data showed. Petrol sells for 4 US cents per gallon in Venezuela, 45 cents in Saudi Arabia, and around 80 cents in Kuwait, Qatar, Turkmenistan and Bahrain.

As Ms Lagarde said, most of this largesse goes to people who need it least. The average UAE resident got nearly $4,500 in free energy in 2011, with the richest getting the largest share, the IMF said.

Some observers question how far energy intensity in producer countries can drop, given the typical inelasticity of energy demand and the path-dependence implied by existing infrastructure.

But raising prices has already been shown to reduce consumption. Dubai’s electricity price increases, which pushed non-residential rates as high as those in the US, immediately cut average use by 3 per cent. Iran has also reformed energy pricing and reported efficiency gains. An IMF study on Kuwait finds that consumption in the longer term would drop by as much as 40 per cent if prices were raised to international levels.

Policymakers in the Arabian Gulf understand this problem better than anyone, since the loss of oil exports would be a serious problem for economies as well as political systems that depend on distributing proceeds from those exports.

Gulf governments have put reforms on ice because of the Arab Spring. No one wants to antagonise citizens with revolutions under way next door.

But my own survey research shows that most Gulf governments can roll back these subsidies – like Iran and Dubai have already begun to do – if they do it transparently and with the support of their citizens. Many GCC citizens said they were amenable to the loss of an energy subsidy if it was done in the national interest, or replaced by something attractive, such as a subsidy on mobile phone or internet bandwidth.

Let’s hope the message gets through. By reining in subsidies, energy producers can remain energy exporters.

Jim Krane is the Wallace S. Wilson fellow for energy studies at the Baker Institute for Public Policy at Rice University, Houston, Texas. He is the author of Dubai: The Story of the World’s Fastest City