Five takeaways from a decade of energy subsidy reforms in MENA

Experiences from the MENA region show that successful energy subsidy reforms must focus strongly on mitigating social impacts.

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Tom Moerenhout

Research Scholar, Center on Global Energy Policy (CGEP), Columbia University

The phasing out of inefficient fossil fuel subsidies is a key part of the global climate change agenda as well as the Sustainable Development Goals (SDGs). Their negative environmental impacts and associated costs are well known. They lead to overconsumption, divert business to rent-seeking energy-intensive activities and drain government expenditure at the expense of public goods such as infrastructure, healthcare and education. Low energy prices also mainly benefit the wealthiest populations.

Without innovation in the design and implementation of social safety nets, reforms can be short-lived or can lead to serious political instability.

The MENA region is responsible for almost half of global energy consumption subsidies. Increases in energy prices put significant pressure on MENA social contracts as the benefits are generally not immediately tangible for the wider population. The price elasticity of social discontent is brought under the microscope with the implementation of energy pricing reforms and the (often) associated weakening of purchasing power at citizen level.  Stronger social safety nets, for example via cash transfer mechanisms, are needed to protect livelihoods while simultaneously continuing efforts to rationalize consumption.

Without innovation in the design and implementation of social safety nets, reforms can be short-lived or can lead to serious political instability. Yemen is a case in point. While political turmoil was already creating political chaos, fuel subsidy reforms in 2014 were the straw that broke the camel’s back and led to protests that eventually made way for the Houthi takeover of Sana’a. But protests do not need to reach the level of civil war to ignite political instability. During the 2013-14 fuel subsidy reforms in Tunisia, protests put significant pressure on successive governments that tried to rebuild the economy. In 2018, Jordanian Prime Minister Hani Mulki resigned because of anti-austerity protests, which also focused on energy subsidy reforms.

Five key takeaways

A decade of reform efforts across the MENA region holds five key lessons for the phasing out of energy subsidies.

1. Pricing reforms were only implemented when fiscal pressures were high

Despite pressures on the social contract that gave way to the Arab Spring, record-high oil prices between 2010 and 2014 prompted several energy importers to raise domestic energy prices.  When Jordan, Morocco and Tunisia implemented reforms in 2012,  energy subsidies cost 7.7 per cent, 6.5 per cent and 2.8 per cent of GDP respectively, while Egypt initiated reforms in 2014, when subsidies were as high as 8.5 per cent of GDP.

Conversely, oil-exporting countries increased energy prices when falling oil prices hit revenues. Iran launched its price reforms in 2010 when the drop in international oil prices following the global financial crisis, together with international sanctions, led to sharp reductions in both revenues and capital inflows. Similarly, Gulf governments lowered fuel subsidies when drops in the oil price between 2014 and 2016 had pushed Bahrain, Oman, Saudi Arabia and even Qatar into deficit.

2. Low(er) fuel prices do not necessarily mean large fuel subsidies

Depoliticized, automatic pricing mechanisms can help distance politics and the influence of governments from energy pricing.

Subsidy reform can also allow markets to set prices. Depoliticized, automatic pricing mechanisms can help distance politics and the influence of governments from energy pricing.

Most oil exporters in MENA sell fuel domestically at  prices higher than production cost, but lower than average regional prices. This means their pricing mechanism has large opportunity costs, although they do not fall under the subsidy definition of the WTO and are likely not covered by either COP or SDG commitments.

While all producing countries in the region have increased energy prices in the last decade, domestic prices remain lower than regional averages.

Using regional market prices as a benchmark, the countries with the highest opportunity cost subsidies include Iran, Saudi Arabia and Algeria. On a per capita basis, however, the biggest laggards are Kuwait, UAE, Saudi Arabia and Libya. Champions of reform include Morocco, Tunisia and Jordan. Among oil producers, Oman has the lowest opportunity cost subsidies.

 3. Energy subsidy reforms should also address gas and electricity

Electricity subsidies can become increasingly problematic given the trend of electrification.

In the past, fossil fuel subsidies were principally centred around transport fuels. However, electricity subsidies play an increasingly important role, either via tariffs that lie below the cost of production or through the use of low-priced fossil fuel inputs for power generation. Electricity subsidies can become increasingly problematic given the trend of electrification. The largest electricity subsidizers in 2020 include Iran ($12.5 billion) Saudi Arabia ($4.6 billion), Egypt ($2.6 billion), Kuwait ($1.9 billion) and Algeria ($1.4 billion).

As a key input to electricity and industry, gas subsidies have also grown. After Russia, three MENA countries have the highest gas subsidies worldwide: Iran ($12.1 billion), UAE ($5.4 billion) and Saudi Arabia ($3.9 billion).

4. Energy subsidy reforms cannot be considered in isolation

Macroeconomic reforms and trends can make pricing reforms more painful. Introducing taxation alongside energy subsidy reform and exchange rate dynamics – specifically free floating currencies previously pegged to the dollar – can all increase reform pains by pushing inflation and lowering purchasing power. This was seen in Egypt after reforms in 2016. Despite a series of far-reaching reforms between 2014-19, Egypt still had about $5 billion in oil subsidies when it finally launched an automatic pricing committee to help keep consumer prices close to real costs. In Saudi Arabia, too, energy pricing reforms were implemented at a similar time to the introduction of VAT and expat fees.  

Countries that have successfully implemented multiple rounds of subsidy reforms have all focused strongly on mitigating social impacts.

Many companies, especially those in energy-intensive industries, found it hard to adapt. Industry usually has limited options including accepting lower profit margins (absorption), switching or substituting energy products, becoming more resource efficient or, if possible, increasing prices.

The pace and sequencing of reforms, as well as a comprehensive understanding of impacted stakeholders and segments, are central to their success. Moreover, effective communications that galvanize behavioural change can make unpopular reforms more palatable, particularly at times of widespread government mistrust and legitimacy deficits.

5. Social safety nets cushion the impact of energy austerity measures

The biggest challenge of increasing energy prices is the immediate impact on the livelihoods of citizens, via direct price increases and inflation. Regrettably, the benefits of subsidy reform to the wider population are in most cases not immediately tangible.

Countries that have successfully implemented multiple rounds of subsidy reforms have all focused strongly on mitigating social impacts. Morocco and Tunisia extended existing social safety nets, while Egypt focused on food subsidies to limit the impact of rising energy prices on the cost of food.

Others have successfully used cash transfer mechanisms, popular because they are immediate, tangible, and demonstrate that the government takes its side of the social contract seriously. In 2010, Iran replaced almost all existing subsidies with universal cash transfers. The programme was immensely popular, despite subsequent criticism of the resulting inflation (in a large part caused by international sanctions). Jordan used cash transfers when global oil prices topped $100 per barrel. In 2012, 70 per cent of Jordanians received cash transfers leaving the two lowest income quintiles better off. Egypt and Saudi Arabia also developed new cash transfer mechanisms and targeted them to specific beneficiaries. Saudi Arabia’s ‘citizen’s account’ programme, part of its second round of reforms in 2018, was targeted both in terms of income level and citizenship status, with non-nationals excluded from receiving any benefits.

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The biggest lesson from the past decade is that future pricing reforms require investment in better social data collection and in setting up effective cash transfer mechanisms. Better targeted welfare interventions are an indicator of higher levels of state capacity and has been made even more urgent by the pandemic. Recent history has demonstrated that even when cash transfers are universal, they have been shown to reduce poverty, be less regressive than price subsidies, improve consumption choices and lower energy demand.

With Egypt and the UAE scheduled to host the next two COP summits there is ample opportunity to demonstrate regional leadership and put subsidies under the spotlight, while working together to design more robust social safety nets that improve welfare, reduce poverty and cut emissions.