The IMF Report, “If Not Now, When? Energy Price Reform in Arab Countries”, indicates the importance of regulating energy prices to facilitate access to energy products, which are central to people’s well-being and countries’ economic development.
Prepared by Staff of the International Monetary Fund during the Annual Meeting of Arab Ministers of Finance in Rabat, Morocco, the Report, published June 13, 2017, states, however, that energy price regulation also leads to wasteful and excessive consumption, discourages investment in the energy sector, and locks in inefficient technologies.
Below is the summary of the Report:
Regulating energy prices has been a common practice around the world. Access to energy products is central to people’s well-being and countries’ economic development, and thus many governments tend to regulate domestic energy prices and keep them relatively low and stable— despite the significant volatility of global prices. This practice has been prevalent in Arab countries, where domestic energy prices are among the lowest in the world.
However, energy price regulation also leads to a number of unintended consequences and costs. Low energy prices encourage wasteful and excessive consumption, and they inhibit energy efficiency. Keeping energy prices low also discourages investment in the energy sector, locking in inefficient technologies and affecting energy production. In addition, low energy prices result in subsidies—because prices are lower than import costs plus transportation and distribution margins or, for oil exporters, because prices are lower than what could be earned by selling oil in international markets. Such subsidies, whether explicit or implicit, erode fiscal space. Finally, low energy prices are regressive—they benefit wealthier people more than the poor.
The current environment of low oil prices offers an opportunity for reform. When the price gap—the difference between domestic prices and international benchmarks—is smaller, so is the size of the required adjustment to close it. Hence, it is easier to implement price changes to close the gap. At the same time, when oil prices are low, the urgency of reform is more acutely felt by oil exporters because their budget and external positions are weaker.
Many Arab countries have taken encouraging steps to reform energy prices in the current low oil price environment. Indeed, all Arab oil exporters have raised domestic prices, with many committing to future reforms as well. However, price gaps remain considerable for many. Arab oil importers have also reduced their price gaps to varying degrees and in various ways—either through full indexation or ad hoc adjustments of domestic prices. Overall, ad hoc price adjustments, particularly for non-petroleum products such as natural gas and electricity, have been the instrument of choice.
International experience suggests that a well thought-out and comprehensive reform strategy is key to ensuring success. In examining country experiences, five broad lessons emerge:
Formulate an integrated reform strategy. The various reform pieces—better alignment of energy prices to market/cost recovery levels, creation of incentives to reduce energy intensity and inefficiency, and support for consumers and producers that stand to lose—should be considered holistically. The pace and scope of reform needs to be calibrated countries’ administrative capacity and institutional framework.
Protect the most vulnerable. While the poor do not benefit the most from energy pricing regulation, they are particularly exposed to higher energy prices. Compensating measures should ideally include targeted cash transfers, though in practice universal cash transfers may be easier to implement. Experience also suggests that cash measures are preferable to in-kind compensation.
Build broad public support. The public needs to be made well aware of the costs and benefits of energy price subsidies, and careful consultations and/or clear communication are needed to create buy-in for energy price reform.
Refrain from ad hoc adjustments that do not address the root of the problem. Transparent and simple formulas to adjust prices have shown to be more conducive to successful and sustainable reform. Ad hoc, one-time adjustments do not provide a lasting solution as prices continue to change. Automatic price mechanisms can help depoliticize the reform process, help avoid reform reversal, and facilitate the transition to a fully liberalized pricing system.
Move gradually when feasible. One-off adjustments are often large, leading to popular discontent. Therefore, they come at a large political cost that can lead to reform reversal. Gradual adjustments allow consumers and businesses to adjust to the new reality of higher and more volatile energy prices. However, large and sudden adjustments can be unavoidable when countries face large fiscal adjustments.