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Oil Price Subsidies—How Are Developing Countries Adjusting to $100 Oil?

Masami Kojima's picture


A cup of coffee in Caracas costs almost 200 times a liter of gasoline. Households in Turkey paid 74 times more than their Egyptian counterparts for bottled cooking gas in early 2013. The price differences across countries for gasoline and diesel are even larger, as much as 250-fold for diesel.


All countries have been affected by sharply rising oil prices on the world market in the past decade. Between 2003 and 2012, in real terms (after adjusting for local inflation and converting to local currency units), the annual world prices of gasoline, diesel, and kerosene more than doubled on average across 160 countries, while the prices of bottled cooking gas (liquefied petroleum gas) increased by two-thirds. Where world oil price volatility has been passed on to consumers, they have had to adjust by paying much more and looking for ways to find substitutes and reduce oil consumption.


But as petroleum product prices began to soar, many governments came under political pressure to shield consumers from price hikes. According to a recent survey of pricing policy for gasoline, diesel, kerosene, and cooking gas in 65 developing countries, two-thirds have kept domestic prices below market-based levels for one or more fuels in the past three years, subsidizing consumers. Two-fifths have frozen the retail prices of gasoline, diesel, or both, for months or even years at a time.

These policies were intended to help consumers. But in almost all cases, the rich have benefitted far more than the poor, especially when it comes to gasoline and cooking gas subsidies. And there are plenty of examples of adverse consequences. Cheap domestic fuels invite smuggling and diversion to end-users not eligible to buy subsidized fuels. Rationing subsidized fuels to limit the fiscal drain creates powerful incentives for black marketing, where fuels fetch much higher prices. Underpricing has caused the infrastructure in the downstream oil sector to languish, leading to inefficiency and higher costs. Mounting financial losses have prompted some refineries to cut back on crude processing, importers to stop importing, and oil companies to shut down filling stations. Acute fuel shortages follow, resulting in long queues and high prices on the black markets, harming the economy and punishing the poor. In Nigeria, some rural poor have reportedly paid as much as six times the official price for kerosene. In Egypt, people have been killed in scuffles over heavily subsidized cooking gas. In India, whistle blowers reporting fuel diversion have been murdered.

International experience demonstrates that sectoral subsidies, such as those for petroleum products, are suboptimal. Given the weight of evidence, governments ought rather to pursue policies to make the downstream petroleum sector competitive and move away from control over pricing and fuel allocation. There are more efficient and less distorting ways of achieving the same policy objectives. To help the vulnerable cope with high oil prices, it would be better to put in place a plan to phase out fuel price subsidies and replace them with effective social service delivery. The most efficient and least distorting approach is to transfer cash as part of an integrated, comprehensive social protection program.

The path to market-based pricing depends on the starting conditions. These include the size of the gap between current and market-based price levels, how aware the public is of this gap, how concentrated and competitive the downstream oil market is, how subsidies are actually delivered, how robust current social service delivery is, and how credible the government is perceived to be.

Moving away from government control is far more difficult if the government has little credibility because of a poor record of service delivery or worse, or if the legitimacy of the government is being challenged. If the oil sector is perceived to be corrupt―not an uncommon perception in major oil producers―then the public may come to believe that subsidies are actually affordable, only if corruption can be stamped out and subsidy delivery made more efficient. The government’s argument that savings from subsidy removal can be used more productively and equitably falls on deaf ears, as voiced by a former secretary general of a workers’ union in Nigeria: “Until they stop corruption, all these ideas will not work… Nigeria is rich, we have money.”

Strengthening social safety nets and making the oil sector transparent and accountable are essential for lasting price reforms. Communication and consultation are also critical. The variety of current media, including electronic media, makes it much easier to conduct a national conversation about price reform today. Quick visible “wins” in the early days of reform could go a long way in garnering support. Shortening or even eliminating long queues by making more supplies available—thanks to higher prices that begin to enable cost recovery—could be one such example.

Recent international experience suggests that pricing reform does not necessarily have a definitive end point. It may be more helpful to view it as a continuous process of adjustment as new challenges arise—another oil price shock, a financial crisis, a food price shock. This type of vigilance and awareness may help equip governments for the long haul.

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Comments

Submitted by Demetrios Papathanasiou on

Very good and with 'burning relevance' post Masami. Many thanks.

Submitted by Augusto Bonzi on

Ms. Kojima,

Very nice and well-written article.

It was interesting to notice the emphasis on strengthening the social safety nets as part of the actions to address the issue, in particular knowing its global extension (according to the IMF, ~$480 billion in 2011). It was also nice to underscore the “process” characteristics of adjustments.

Moving forward, mentioning cases of countries that made successful reforms could be a nice supplement to future articles.

I am looking forward to future postings.

Regards,
Augusto Bonzi

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