Off the Hydrocarbon Dole, Persian Gulf Countries Begin Phase Out of Energy Subsidies
In a process will almost surely take years and vary significantly from one country to the next, the hydrocarbon-rich countries of the Persian Gulf are slowly but surely moving to phase out heavily subsidized energy prices, starting at the pump.
The United Arab Emirates is bracing for a third increase in gasoline prices to eventually reach breakeven production costs; Bahrain and Kuwait have announced similar plans, and even Saudi Arabia is moving in that direction, joining their northern neighbor Iran.
“It is a trend that has gained momentum over the past year. There is a stronger will than before, but it’s going to be quite slow,” said Glada Lahn, energy research fellow at Chatham House. “There is a desire across the region to phase out subsidies to fossil fuel energy for domestic reasons.”
Governments will save billions by raising prices and thereby significantly dent the Gulf’s soaring growth in energy demand. And while the move has many advantages for the individual governments, the process is tangled in a myriad of issues, starting with how to define subsidies. Gulf countries have balked at raising prices to international market prices, mainly because their production costs are much lower and because energy is considered a national resource.
But resource squandering, fuel smuggling, growing climate change awareness, and especially macroeconomic imbalances that have been exposed in the global recession are leading to a change of heart. The International Energy Agency estimates $500 billion went to subsidizing fossil fuels in 2008, with regional countries Iran, Venezuela and Saudi Arabia in the top positions, although homogenized country information won’t be released until later this year.
The challenges are political and economic. Popular opposition is likely to delay any process and will depend on how each country approaches the issue. The billions that will be saved will not be pocketed, but will be reinvested in other forms of subsidies, whether its public transportation or cash allowances. Inflation is sure to rise. And there is concern that phasing out subsidies could scare away foreign investment attracted by low energy prices.
“For many decades, Gulf countries have been saying that this is not sustainable because with the growing population subsidies are now leading to wastage,” said Manouchehr Takin, senior upstream analyst of the Centre for Global Energy Studies. “All these countries have reached the conclusion they have to lift subsidies very gradually, maybe within the next 5 or 10 years.”
But even regionally, the differences are significant because the production costs vary widely and because each country has different priorities. For Saudi Arabia and Kuwait, for example, electricity demand has to be tackled first, while for the UAE it’s easier to start with fossil fuels and for gas-rich Qatar subsidies are not an urgent matter at all.
“For Saudi Arabia it’s about efficiency, reducing smuggling, and freeing-up more oil for potential export. The UAE also wants to stop wasting a precious commodity and has become concerned about its international image as a polluter,” said Lahn.
Iran and the UAE are among the leaders is pursuing the phase-out of subsidies. Tehran has long discussed the need to get rid of subsidies but it recently delayed (until later this month) the implementation of its year-long awaited plan that will eventually save it $100 billion a year. Unlike Iran, which has little choice but to reform its economy in the face of ongoing international economic sanctions, the UAE’s motivation, along with that of other GCC countries, is purely economic.
Earlier this year the government announced it would phase out fossil fuel subsidies to reach production costs, finally yielding to pressure from refiners, including state-owned Adnoc. There have been two significant increases this year and third is reportedly imminent. The UAE’s pump prices have been the Persian Gulf’s highest for some time and the new increase would raise prices to just below $2 a gallon, almost fifteen times that of Iraq, five times that of Iran, almost three times that of Saudi Arabia and more than twice than in Qatar, Kuwait, and Bahrain. Oman has the second highest prices at around $1.40 a gallon.
But the country’s staggering fuel demand growth of around 14 percent was economically unsustainable, especially when compounded with the heavily subsidized gas and electricity market that has led to squandering of precious commodities. Demand growth has already halved as a result of the price increases, according to local media reports, which perhaps explains why other countries have been warming to the idea recently.
Bahrain announced it would also phase out subsidies in fuel, although it appears to have indefinitely delayed its plans after violent protests. Kuwait’s government announced plans to privatize electricity and water to indirectly cut its subsidy bill and lower demand, but it too is facing fierce opposition.
Qatar has mulled the possibility, but its gas bounty gives it more time than any other country, while Iraq is hamstrung by its own reconstruction efforts. There has even been talk of setting a regional price in the six-member Gulf Cooperation Council, but it will be years, if at all, before any agreement.
But nowhere would the reform have such a profound effect than in Saudi Arabia, one of the world’s biggest consumers and producers of fossil fuels. Riyadh is mulling phasing out motor fuel subsidies and has already started increasing electricity prices. “They are just testing the water,” said Lahn. “But low fuel prices are a serious problem for Saudi Arabia, not just with overconsumption, but also with smuggling. They are essentially giving away diesel,” said Lahn.
And while it is yet uncertain how long it will take to wean the region’s consumers off of fat subsidies, the trend in Persian Gulf is a welcome one.