Fossil Fuel Subsidy Reform Is Not Just for Importers Anymore

An oil pump works at sunset on September 30, 2015, in the desert oil fields of Sakhir, Bahrain.

On January 15, Qatar became the latest country to announce reforms to its fossil fuel subsidy policies—a move prompted by a projected $12.8 billion budget deficit in 2016. In the past few years, numerous countries have capitalized on low global oil prices to slash these costly subsidies.

India, for instance, reformed its gasoline, diesel, and kerosene subsidies from 2010 to 2013, resulting in nearly $18 billion in projected savings for the 2015-16 fiscal year. Indonesia similarly reformed its fuel subsidies and expects to save $18 billion annually. The country will use 60 percent of these savings to invest in its public works, transportation, and agricultural sectors in the future.

Fossil fuel subsidies are inefficient expenditures that are highly regressive, with the top income quintile capturing six times more of the economic benefit from low-cost fuel than the bottom quintile. Often, this is because those in the top income quintile drive larger vehicles and use more energy-intensive goods. Furthermore, these subsidies drive climate change by incentivizing consumption of fossil fuels while inhibiting clean energy market competition. The International Energy Agency and World Bank have both implemented campaigns to phase out and reform these subsidies.

However, subsidy reform in recent years was largely confined to oil-importing countries, such as India, Egypt, Malaysia, and Indonesia, which only account for a fraction of total global fossil fuel subsidies. These countries seized on low oil prices to realign domestic fuel prices with the costs of their imported fuels.

But, as Qatar’s reforms show, oil-exporting countries are joining this trend. With oil prices tumbling even further—and no immediate signs of any reversion to the levels of the past few years—fossil fuel subsidy reform is becoming more commonplace in these countries for the first time. In the past six months, Saudi Arabia, Qatar, Oman, Bahrain, and the United Arab Emirates, or UAE—nations that account for one-fifth of global oil production—have all increased gasoline prices in an effort to raise much-needed revenue. These domestic price increases allow for investment in national infrastructure, help stabilize national budgets, and reduce fossil fuel emissions by limiting wasteful and inefficient energy consumption.

Oil subsidies: The exporter’s perspective

Fuel subsidies in oil-exporting countries are a measure of lost economic opportunity that comes from selling oil for domestic use at a lower price than they could earn through sale on the international market. They do this in order to provide their citizens with such things as cheaper gasoline for their vehicles or electricity for their homes. However, as noted above, this is usually a highly inefficient way of providing assistance to those in need. In Saudi Arabia, for instance, producing a barrel of oil costs approximately $10, while its value in international markets has fluctuated in recent years from $110 in 2013 to about $30 today. When countries such as Saudi Arabia sell petroleum products below the market price of oil, they are both forgoing revenue on the transaction and also incentivizing wasteful domestic consumption of their product by shielding consumers from the real cost of oil.

Low global oil prices have taken a toll on the budgets of oil exporters, which use revenue from fuel exports to underwrite domestic subsidies. As these countries draw down their savings to sustain subsidies for fuel and other social services, they are turning to fossil fuel subsidy reform as a means to reduce the strain on their budgets.

Qatar announced it would raise the price of petroleum 30 percent, joining Oman and Bahrain, which increased petrol prices 23 percent and 56.3 percent, respectively, in January. This was preceded by the UAE’s 24 percent increase in gasoline prices in August and Saudi Arabia’s 50 percent petrol price increase in December.

Although these new fuel prices are still below unsubsidized market levels, issuing these reforms is an important first step in the elimination of regressive market distortions that drive inefficient energy usage. Middle East oil consumption was almost four times higher than the global average in 2015. Saudi Arabia consumed a total of 2.9 million barrels of oil per day in 2013, and demand is expected to grow to 8 million barrels per day if the country does not improve efficiency. From 2009 to 2013, the country consumed 700,000 barrels of oil per day to generate electricity, which could provide enough gasoline to fuel 21,111 cars. Reforming oil subsidies that drive perverse market incentives could help these countries diversify their fuel mixes toward cleaner alternatives, encourage citizens to increase their energy efficiency, and reduce domestic consumption of oil.

However, in spite of the benefits of reform, fossil fuel subsidies are often popular with the general population and remain in place because people become accustomed to low fuel prices. If and when oil prices climb again, there will be tremendous political pressure to restore these subsidies. In anticipation of this, oil exporters can mimic the successful subsidy reform strategies employed by oil importers and build constituencies of strong supporters that make fossil fuel subsidy reform effective and resilient. Constituencies can be cultivated by investing the savings from subsidy reform in national priorities—such as new schools, hospitals, infrastructure, and affordable clean energy resources—while clearly conveying to the public the benefits of such investments. This can allow governments to plan for the future and insulate national budgets against volatile energy markets.

Furthermore, reducing reliance on oil for electricity can also encourage the scaling-up of domestic clean energy industries, as well as free up more oil for export. The UAE, which relies on domestic oil production for 25 percent of its energy consumption, is diversifying its energy sector with a plan to exceed a target of 24 percent renewable energy by 2021 and recently announced a new goal of 30 percent renewable energy by 2030. The country will meet its needs with projects such as the Mohammed bin Rashid Al Maktoum Solar Park, expected to provide 3000 megawatts of electricity when it is completed in 2030. Qatar has set a target of 20 percent renewable electricity by 2024, and Saudi Arabia is seeking 50 percent carbon-free energy by 2040—with plans to add 54 gigawatts of renewable energy during that time. By reforming inefficient fossil fuel subsidies, these countries can improve the domestic clean energy markets that are necessary to achieve these targets.

Conclusion

Fossil fuel subsidy reforms offer oil-exporting countries the opportunity to alleviate strains on their national budgets while improving the competitiveness of domestic clean energy industries. Reforming these energy markets will be necessary to achieve national fuel-mix diversification targets and, ultimately, help the world to meet the urgent climate change challenge.

Pete Ogden is a Senior Fellow and the Director of International Energy and Climate Policy at the Center for American Progress. Ben Bovarnick is a Research Assistant with the Energy Policy team at the Center.

Thank you to Ori Gutin, an intern at the Center, for his assistance with this column.