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The economics of energy subsidies

June 16, 2010 5:20 by Katherine Azmeh

The politics and economics of energy subsidies in the region are coming into sharper focus, as GCC residents face power outages just as summer temperatures begins to intensify. In what analysts call “economic distortion,” the failure of consumers and businesses to experience the true costs of energy consumption is now demanding immediate action from policy makers, as energy demands tax and outweigh the production capacity in some areas of the GCC.

Last month, Sharjah residents and businesses began coping with outages, due, analysts say, to the emirate’s inability to meet its domestic needs. Sharjah is dependent on imports to meet as much as half its own demand, and shortfalls have long been an issue for the northern emirates, including Ajman, Fujairah, Ras al Khaimah and Umm al Qaiwain, the National reported last year.

Kuwait’s ministry of electricity and water this week reportedly asked for 1,000 megawatts from GCC countries as a reserve, but received a “discouraging” response from its neighbors. For four years running, Kuwait has suffered electricity cuts during the hottest months of summer, when temperatures can reach 50 degrees Celsius. The country’s ill-equipped power stations are expected to produce a mere four to five percent above peak needs. And Saudi Arabia and Bahrain are not expected to be in a position to provide assistance, analysts say, as the two countries are experiencing rising daily energy needs themselves. Qatar has been suggested as the only GCC state with a power surplus, but has not promised to provide additional power for Kuwait.

Qatar’s is coping with a rate of economic expansion that is posing its own sustainability challenges, as industrial and population growth are taxing its energy production capabilities and calling into question the wisdom of continued government subsidies for water, electricity and petrol.

But there is a growing awareness by policy makers in the region that GCC economies are missing out on the significant economic gains to be realized by lowering subsidies and driving economic development.

Earlier this week, Alex Kremer, MENA region economist for the World Bank, said that “In economic terms the payback of energy efficiency is incredible. Where energy is artificially cheap, firms tend not to invest in energy efficiency measures.” Kremer noted that the GCC and wider MENA are the only regions globally where “the amount of oil needed to generate one dollar of GDP is increasing,” the National reported, adding that even China and India are reducing the amount of energy they use to per unit of GDP.

Kremer is not the first economist to question the wisdom of regional price caps on fuel consumption. In a strategy to develop a “social market economy,” Syria began phasing out state subsidies on food and fuel in 2005. In April, the UAE hiked petrol prices 11 percent to the highest level among Gulf nations.
And Jordan has become strongly incentivized to remove subsidies, as the kingdom began paying market price for fuel following the fall of Sadam Hussein’s government in Iraq. With insignificant oil reserves of its own, Jordan has been forced to contend with a subsidized fuel bill that was estimated at $1 billion in 2008, nearly 14 percent of the kingdom’s total annual budget, according to a report by the International Institute for Sustainable Development. For Yemen, the situation is more extreme, the country spends an estimated one-third of its annual budget on subsidizing refined petroleum products, the report said.

For those concerned with sustainability issues, government subsidies create a distortion in the minds of consumers that permits waste and discourages responsible stewardship. Additionally, businesses are discouraged from making investments in the architecture and policies that contribute to fuel efficiency, and ensure a progressive plan for the future.

Tags: economic distortion, energy demand, fuel subsidies, Kuwait outages, power outages, Sharjah outage, subsidies