Subsidies: not the right price

June 21, 2010
The International Energy Agency recently announced that its upcoming World Energy Outlook (WEO) will have a special focus on energy subsidies.

The International Energy Agency recently announced that its upcoming World Energy Outlook (WEO) will have a special focus on energy subsidies.

In WEO 2010, due to be released in November, IEA's analysis will reveal that fossil fuel subsidies are much higher than previously thought. In 2008, worldwide fossil fuel consumption subsidies rose to $557 billion, up from $342 billion the previous year.

IEA says that phasing out such subsidies would send a price signal to create incentive for more efficient energy use. The Paris-based agency acknowledges, however, that phase-out policies in developing countries must be designed carefully so as not to restrict access to essential energy services, as these fuels often support the basic needs of the poor.

Earlier this month the Financial Times quoted IEA chief economist Fatih Birol as saying that phasing out these energy subsidies worth billions of dollars would trigger vast savings in energy consumption and carbon dioxide emissions and change the energy game quickly and substantially.

"I see fossil fuel subsidies as the appendicitis of the global energy system which needs to be removed for a healthy, sustainable development future," Birol said.

The price signal from phasing out fuel subsidies would provide an incentive to use energy more efficiently. IEA found that compared with a base case in which subsidy rates are unchanged, a phase out between 2011 and 2020 would cut primary global energy demand by 5.8%, reducing global oil demand by 6.5 million b/d in 2020, mostly in transportation fuels.

Some changes

IEA notes that since 2008 a number of countries, including China, Russia, India, and Indonesia, have made notable reforms to bring their energy prices in line with world prices. The efforts should reduce these countries' 2009 energy subsidy costs.

The country with the highest subsidies in 2008 was Iran at $101 billion. This was one third of the country's annual central budget. Iran's leaders agreed earlier this year to a sweeping plan for energy subsidy reform, but IEA says, steep economic, political, and social hurdles will need to be overcome if Iran is to realize lasting reform.

Iran is planning to remove its fuel subsidies at the end of September. In time the country would be better prepared should western powers try to force on it tougher sanctions, including withholding gasoline (OGJ Online, June 9, 2010).

In its latest monthly Oil Market Report (OMR), IEA looked at subsidy reform in India and reported that although previous attempts have failed, some observers still expect the Indian government to modify the country's controlled prices for gasoline, diesel, kerosine, and LPG over the next few weeks.

China, Nigeria

In its March 2010 OMR, IEA discussed price reforms in China and Nigeria.

That was a year after the implementation of China's oil-product price mechanism, and talk of further reform had begun. Before introduction of the current price scheme, shortages emerged periodically in China, since domestic prices were capped well below international prices, thereby discouraging supply to the Chinese market and encouraging much more profitable exports, IEA said.

Since the new prices were adopted early last year, Chinese refiners have earned a guaranteed margin, estimated at 5%, which has provided an incentive to boost runs and export surpluses. This has caused unease among overseas refiners, who complain of dumping by the Chinese.

Speculative stockpiling within China has occurred as a result of the new price mechanism, as prices are adjusted if the average of a handful of crudes fluctuates more than 4% for more than 22 consecutive working days. The National Development and Reform Commission reportedly is looking to make the price mechanism more transparent and scientific this year and prevent the stockpiling, IEA says.

In Nigeria, retail prices for gasoline are among the lowest in the world at about 43¢/l. With gasoline accounting for 55% of Nigeria's total oil product demand, this subsidy burden is estimated at $3-4 billion/year. And with none of the four state-owned refineries operating, Nigeria was forced to import all of its fuel.

"This situation has fostered the emergence of a handful of powerful oil importers, which effectively control the country's fuel supplies, backed by trade unions that consider cheap prices as an irrevocable entitlement," IEA said.

Early last year Nigeria's government announced plans to deregulate the country's refining and marketing businesses, but the plans were scrapped when opposed by importers and trade unions.

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