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A Brief Background on Energy Subsidies

Issues with Measuring Energy Subsidies

Energy subsidies are neither straightforward to define nor simple to measure; this tends to complicate any meaningful debate around them. There is no commonly agreed definition of what constitutes a subsidy, and this fact—in part—is reflected in the continued inability of major international organisations such as the World Bank, the United Nations Development Programme (undp), and Organization of the Petroleum Exporting Countries (opec) to agree on common terms.[1] A widely used definition considers a subsidy as:

... any measure that keeps prices for consumers below the market level or keeps prices for producers above the market level, or that reduces costs for consumers and producers by giving direct or indirect support.

de moor and calamai, 1997, 1

It is clear from the above definition that many governments’ actions can be categorised as involving assistance, including subsidies (in-kind, cash or credit, or relating to tax or procurement). Some of these are on-budget or explicit subsidies that constitute explicit transfers made by the government to either the producer or the consumer receiving the subsidy, registered in the state’s budget. For instance, a government may mandate that a public utility set the selling price below the cost of production. The government then finances that public utility’s losses by transferring funds from the general budget.[2] Energy subsidies can also be cross-financed between different energy user groups. Cross-subsidies occur when tariffs below the cost of production are charged, to household users for instance, and the revenue shortfall is offset by increasing industrial/commercial sector tariffs above cost levels. Countries such as Lebanon, Yemen, Egypt, Libya, and Syria all charge their industrial customers considerably higher electricity prices than charged to residential customers, suggesting some form of cross-subsidisation.[3]

But there is also the question of the benchmark against which domestic prices should be compared. For instance, the national oil company can be mandated to sell petroleum products to the domestic market at below international prices but above production costs. In this case, the national oil company does not incur financial losses, and hence the government does not need to make an explicit transfer to compensate for those losses. Nevertheless, there is still an implicit cost involved, which represents the opportunity cost (the economic rent/revenue wasted by the failure to sell oil at higher, market prices). This entails a transfer from the government to the final consumers, even though such a transfer does not appear explicitly on state oil companies’ records or in the government budget. If this foregone revenue had been collected, it could have been used by the government in a variety of ways, including to reduce the budget deficit and the size of the public debt; to increase expenditure in more productive areas such as infrastructure, education or health; by redistributing it directly to its people through cash transfers; or to reduce, where applicable, taxation (Gupta et al., 2003). Implicit subsidies are less transparent and more difficult to calculate. They typically occur in oil producing countries, where mostly state-owned oil companies produce, refine and market petroleum products.

Based on the price-gap approach—which measures the gap between the subsidised price and a benchmark price to reflect the opportunity cost (defined as the supply cost of an energy product including transport and distribution costs)—a recent IMF report estimates pre-tax energy subsidies in the mena region as having reached USD 237 billion in 2011, equivalent to 48 per cent of world subsidies, 8.6 per cent of regional gdp, and 22 per cent of government revenue (Sdralevich et al., 2014). These figures, however, should be treated with caution given the many caveats to using the price-gap approach in some contexts. Issues such as the production of joint products (for instance crude oil, natural gas, and natural gas liquids (ngls)), the availability of spare capacity in some Arab oil-producing countries, and the ability of key Arab oil exporters to influence international oil prices could affect the measurement of subsidies.[4] A recent study by the imf broadens the definition of an energy subsidy to:

... [a post-tax energy subsidy, which arises] when consumer prices are below supply costs plus a tax to reflect environmental damage and an additional tax applied to all consumption goods to raise government revenues.

COADY ET AL., 2015, 1

Based on this definition, global energy subsidies are estimated at a massive usd 5.3 trillion for 2015, or 6.5 per cent of global gdp, despite the recent fall in the oil price. This higher estimate of global energy subsidies results from the inclusion of components such as local air pollution, global warming, and other (non-internalised) domestic externalities in the post-tax energy price.

  • [1] iea et al. (2010) notes the existence of a major disagreement among international organisations concerning the choice of the reference price, and that consequently ‘a commonlyagreed definition of subsidies has proven a major challenge in the G-20 context and countries have decided to adopt their own definition of energy subsidies’.
  • [2] The budget records of many countries (including Egypt) show how this concept underliesthe measurement of subsidies in the economy.
  • [3] Since in all these countries public utilities do not recover their costs, this form of crosssubsidisation is nevertheless imperfect, and does not prevent the sector from systemic lossmaking.
  • [4] A report notes that the price-gap method has limitations, which apply particularly in thecase of countries with large endowments of energy resources (iea et al., 2010).
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