issues in domestic petroleum pricing in oil- producing countries sanjeev gupta imf january 27, 2004

Issues in Domestic Issues in Domestic Petroleum Pricing in Oil-Petroleum Pricing in Oil-

Producing CountriesProducing Countries

Sanjeev GuptaSanjeev Gupta

IMFIMF

January 27, 2004January 27, 2004

22

Introduction: Why study Introduction: Why study domestic petroleum prices?domestic petroleum prices?

Many oil-producing countries keep domestic prices Many oil-producing countries keep domestic prices below free market levelsbelow free market levels

Net oil importers in some cases do not fully reflect Net oil importers in some cases do not fully reflect international prices.international prices.

The resulting subsidies can be large and are The resulting subsidies can be large and are nontransparentnontransparent

Few studies have quantified these subsidies for a wide Few studies have quantified these subsidies for a wide range of countries and examined their economic effectsrange of countries and examined their economic effects

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Subsidy Estimates: MethodologySubsidy Estimates: Methodology Subsidies can be broadly defined as the difference Subsidies can be broadly defined as the difference

between the reduced price of a good with government between the reduced price of a good with government support and the price of the good in the absence of such support and the price of the good in the absence of such support.support.

Subsidy = Subsidy = (M-P)C(M-P)C

MM = “free market price” = = “free market price” = W+D+TW+D+T WW = world wholesale spot price = world wholesale spot price DD = marketing + distribution + transport costs (importers only) = marketing + distribution + transport costs (importers only) TT = general consumption taxes (VAT, etc.) = general consumption taxes (VAT, etc.)

PP = after-tax retail price = after-tax retail price

CC = petroleum product consumption = petroleum product consumption

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Subsidy Estimates: CaveatsSubsidy Estimates: Caveats Marketing, distribution, and transport costs assumed to be Marketing, distribution, and transport costs assumed to be

the same across countries and time periods; introduces the same across countries and time periods; introduces some error, esp. if pipeline constraints create large some error, esp. if pipeline constraints create large marginal transport costs marginal transport costs

However, transport costs are typically only about 2 percent However, transport costs are typically only about 2 percent of after-tax retail priceof after-tax retail price

Excludes implicit subsidies due to tolerance of Excludes implicit subsidies due to tolerance of nonpaymentsnonpayments

Some retail price estimates are an average for only a Some retail price estimates are an average for only a month or quarter (“snapshot”)month or quarter (“snapshot”)

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Subsidy Estimates: SampleSubsidy Estimates: Sample

Subsidies calculated for 86 countries between Subsidies calculated for 86 countries between 1996-20001996-2000

1999 is the latest year available for most 1999 is the latest year available for most countries. In this year, 62 countries in sample:countries. In this year, 62 countries in sample: 15 Major Oil Exporters (of which, 13 subsidize)15 Major Oil Exporters (of which, 13 subsidize) 6 Other Net Oil Exporters6 Other Net Oil Exporters 41 Net Oil Importers41 Net Oil Importers

Table 1. Domestic Petroleum Price Subsidies, 1999(Median values in parentheses)

Average Oil Subsidies(In percent of government expenditure)

Major Oil Exporters 3.5 (2.5) 15.2 (8.6) Of which: Subsidizing Oil Exporters 1/ 4.4 (3.7) 18.7 (10.8)

Other Oil Exporters 2/ -1.9 (-1.8) -7.0 (-7.0)

Net Oil Importers 3/ -2.2 (-2.1) -8.3 (-8.6)Of which:Countries not producing oil 4/ -1.7 (-1.6) -7.0 (-6.4)

Memo items:Subsidy Rate by Type of Product (in percent)for Subsidizing Oil ExportersGasoline 9 (8)Diesel 48 (46)Residential Light Fuel Oil 71 (78)

Source: IMF staff estimates. Based on IFS exchange rates.1/ Includes Venezuela and Ecuador.

2/ Includes Argentina, Bolivia, Colombia.

3/ Includes Brazil, Chile, Guatemala, Paraguay, Peru.

4/ Includes Costa Rica, El Salvador, Honduras, Nicaragua, Panama, Uruguay.

(In percent of GDP)

Table 2. Domestic Petroleum Price Subsidies in Oil Exprting Countries, 1996-2000(In percent of GDP)

Country 1996 1997 1998 1999 2000

Algeria 3.0 2.2 .. 2.5 ..Azerbaijan 1/ .. .. .. .. 16.6Ecuador .. 3.3 1.4 -1.5 12.6Indonesia .. .. 7.7 6.5 ..Iran Official exchange rate 10.0 .. .. 4.2 .. Weighted average exchange rate 2/ 13.2 12.6Kazakhstan .. 4.3 .. 6.8 ..Kuwait 5.1 5.1 .. 4.8 ..Libya .. 5.8 .. 0.7 ..Mexico .. 1.0 -0.9 -0.9 -0.4Nigeria .. .. .. 2.5 ..Norway -4.5 .. -4.8 -3.9 -4.5Qatar 3.9 3.2 .. 2.4 ..Russian Federation .. 5.0 -5.0 8.0 ..Saudi Arabia 7.4 7.0 .. 5.9 ..United Arab Emirates 1.9 1.4 .. 1.7 ..Venezuela .. 5.9 2.9 3.7 4.9

Average subsidy 4.2 4.0 0.2 3.5 7.9Sample size 7 11 6 15 5

Memo item:Average price of crude oil

(U.S$ barrel, U.K. Brent) 20.5 19.1 12.7 17.7 28.3

Source: EIA, IFS, and authors' estimates1/ Based on separate IMF Staff estimates.

2/ Based on a trade-weighted average of the official and market exchange rates.

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Subsidy Estimates: ResultsSubsidy Estimates: Results

Subsidies are large — averaged 3.5 percent of GDP in Subsidies are large — averaged 3.5 percent of GDP in 1999 among major oil exporters1999 among major oil exporters

Among net oil importers, the average revenue from Among net oil importers, the average revenue from petroleum taxation was 2.2 percent of GDP in 1999.petroleum taxation was 2.2 percent of GDP in 1999.

Subsidies positively correlated with world oil priceSubsidies positively correlated with world oil price

Residential fuel oil and auto diesel subsidized more Residential fuel oil and auto diesel subsidized more heavily than gasolineheavily than gasoline

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Economic Effects of SubsidiesEconomic Effects of Subsidies

EfficiencyEfficiency In the absence of price distortions, most efficient to In the absence of price distortions, most efficient to

set domestic prices equal to the world wholesale spot set domestic prices equal to the world wholesale spot price plus marketing and distribution costs (price plus marketing and distribution costs (W+DW+D))

Caveats:Caveats:• Need for government revenue may make net taxation Need for government revenue may make net taxation

more efficientmore efficient

• Environmental externalities may argue for further Environmental externalities may argue for further taxation (in excess of 100 percent, Parry 2001)taxation (in excess of 100 percent, Parry 2001)

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Economic Effects of SubsidiesEconomic Effects of Subsidies On the other hand, large exporters may have some On the other hand, large exporters may have some

monopoly power in world oil markets so that the marginal monopoly power in world oil markets so that the marginal revenue from exporting is less than the world wholesale revenue from exporting is less than the world wholesale price plus marketing and distribution costs:price plus marketing and distribution costs:

–R = revenue, X = exports, ηX,P = price elasticity of world oil demand, and XW = total world oil demand

– Marginal revenue<(W+D) if significant share of world market (X/ XW is high) and η X,P is low

TDX

XWTDX

dX

dWW

dX

dR

XTDWR

WPX

,

11

)(

1111


Thus, the opportunity cost of not exporting Thus, the opportunity cost of not exporting may be lower than the world price for may be lower than the world price for OPEC as a whole or its dominant members.OPEC as a whole or its dominant members.

The marginal revenue for OPEC can be as The marginal revenue for OPEC can be as low as 25 percent of the non-market-power low as 25 percent of the non-market-power case.case.

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Table 3. Marginal Revenue from Exporting for Largest Oil Exporters

Marginal Revenue 2/ Exports as Share of World Consumption 1/ (η = -.25) (η = -.50) (η = -.75)

All OPEC 32.7 .25 .63 .75 Saudi Arabia 10.8 .75 .88 .92 Russian Fed. 5.1 .88 .94 .96 Norway 4.3 .90 .95 .97 Venezuela, RB

4.0 .91 .95 .97

Sources: Energy Information Administration (various years); and authors’ estimates. 1/ For 1998 (Energy Information Administration 2001). 2/ As fraction of small exporter (no-market-power) case; assumes distribution and marketing costs are 75 percent of wholesale price.

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Economic Effects of SubsidiesEconomic Effects of Subsidies EfficiencyEfficiency

On balance, the arguments for taxation On balance, the arguments for taxation outweigh the arguments for subsidization:outweigh the arguments for subsidization:

• Need for government revenue Need for government revenue • Environmental externalitiesEnvironmental externalities

However, most major oil exporters subsidize, However, most major oil exporters subsidize, resulting in efficiency (deadweight) losses resulting in efficiency (deadweight) losses

• Assuming environmental externalities, deadweight Assuming environmental externalities, deadweight losses amount to 0.5 to 12.4 percent of GDPlosses amount to 0.5 to 12.4 percent of GDP

• Assuming no environmental externalities, Assuming no environmental externalities, deadweight losses amount to between 0 and 7 deadweight losses amount to between 0 and 7 percent of GDPpercent of GDP

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EquityEquity Poorly targeted means of distributing purchasing Poorly targeted means of distributing purchasing

power to the poor—majority of benefits go to the power to the poor—majority of benefits go to the non-poornon-poor

• In Venezuela, the richest 20 percent receive 6½ times more In Venezuela, the richest 20 percent receive 6½ times more in subsidies per person than the poorest 33 percent (World in subsidies per person than the poorest 33 percent (World Bank 1995)Bank 1995)

• In Ecuador, the more expensive energy products received In Ecuador, the more expensive energy products received the highest subsidies, while household kerosene, used by the highest subsidies, while household kerosene, used by poor households, was not subsidized (World Bank 1994)poor households, was not subsidized (World Bank 1994)

Pro-rich bias compounded by possible smuggling and Pro-rich bias compounded by possible smuggling and corruptioncorruption

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Table 5. Share of Total Expenditures by Quintile: Mexico and Ecuador (In percent of total spending)

Quintile Electricity Gasoline 1/ Gas/ LPG Kerex Others 2/

Mexico1 5.4 0.9 6.7 15.1 26.12 10.2 3.9 13.8 18.3 24.03 15.9 9.3 18.5 20.2 20.44 21.6 19.4 25.1 21.7 17.45 46.8 66.5 35.9 24.8 12.1

Ecuador1 9.2 … 15.2 43.2 …2 15.3 … 23.2 20.6 …3 16.2 … 20.1 13.8 …4 26.4 … 22.1 7.6 …5 32.9 … 19.4 14.8 …

1/ Gasoline refers to gasoline, diesel, or gas purchased as fuel for vehicles.2/ Includes coal, fire wood, heating oil, candles, and others such as paper or cardboard.

Sources: UNDP/World Bank (1994) “Ecuador: Energy Pricing, Poverty and Social Mitigation” Report No. 12831-EC, p. 40; and IMF staff calculations based on the 1996 Mexican Income and Expenditure Household Survey; INEGI 1996.

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Fiscal opportunity costsFiscal opportunity costs

In subsidizing countries, the average In subsidizing countries, the average subsidy is larger than the average fiscal subsidy is larger than the average fiscal deficit or total health spendingdeficit or total health spending

In Ecuador and Venezuela, the implicit In Ecuador and Venezuela, the implicit subsidy exceeds public spending on healthsubsidy exceeds public spending on health

1/ Unweighted averages for subsidizing oil-exporting countries. Oil subsidies are for 1999; expendituredata are an average over the period 1997-99. Number of countries in parentheses.

Figure 2. Composition of Government Expenditure in Major Subsidizing Oil Exporting Countries 1/

0

1

2

3

4

5

6

Oil subsidies (13)

Education Spending (11)

Health Spending (12)

In p

erce

nt o

f G

DP

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Table 7. Social Indicators and Social Spending in Subsidizing Oil-Exporting and Other Countries, 1997–1999 Education Spending Health Spending

Life Expectancy

Illiteracy Rate

(percent of adult

population)

Infant Mortality Rate (per 1,000 live

births)

Under 5 Mortality Rate (per 1,000 live

births)

Immunization Rate against

Measles (percent of

children aged less than 12

months)

GDP Per Capita

(constant 1995 US$)

(in percent of GDP)

(in percent of total

expenditure)

(in percent of GDP)

(in percent of total

expenditure)

Subsidizing Oil-Exporting Countries (13) 1/ 69 20 26 36 88 3,259 5.0 15.7 2.0 5.8 Of which:

Algeria 71 35 35 39 76 1,534 8.8 28.0 1.5 4.9 Ecuador 69 9 29 37 87 1,521 3.1 15.6 0.9 4.8 Indonesia 65 14 43 54 80 1,025 .. .. 0.6 3.3 Nigeria 49 39 82 149 48 253 1.4 7.6 0.7 3.8 Saudi Arabia 72 25 19 26 92 6,841 8.8 23.1 2.9 7.6 Venezuela, República Bolivariana de 73 8 21 24 79 3,451 3.8 19.7 1.4 7.0

Low-Income Countries (56) 55 41 75 126 67 423 4.0 15.0 2.0 6.8 Lower-Middle-Income Countries (42) 68 16 33 44 86 1,642 4.8 16.6 2.3 7.5 Upper-Middle-Income Countries (26) 71 11 18 26 90 5,306 4.7 14.4 3.3 9.7 Source: World Development Indicators (World Bank, 2001). Expenditure data from IMF Staff Reports. 1/ Numbers in parentheses refer to the number of countries in the different income groups in 1999.

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CyclicalityCyclicality

For net oil exporters, periods of high world For net oil exporters, periods of high world oil prices tend to be both periods of oil prices tend to be both periods of economic boom and periods of higher economic boom and periods of higher domestic subsidiesdomestic subsidies

Petroleum subsidies are thus Petroleum subsidies are thus procyclicalprocyclical, , exacerbating the effects of oil price shocks exacerbating the effects of oil price shocks on economic volatilityon economic volatility

2020

Successful ReformSuccessful Reform

PreconditionsPreconditions Establish social protection mechanisms to compensate losers Establish social protection mechanisms to compensate losers

(Indonesia); design using PSIA(Indonesia); design using PSIA Use publicity campaigns to inform public of trade-offs (Egypt)Use publicity campaigns to inform public of trade-offs (Egypt)

TimingTiming Optimal speed of reform depends on trade-off between fiscal Optimal speed of reform depends on trade-off between fiscal

need and adverse social consequencesneed and adverse social consequences Existence of good social protection mechanisms allows faster Existence of good social protection mechanisms allows faster

reformreform Political environmentPolitical environment External environment—periods of low world oil prices may External environment—periods of low world oil prices may

facilitate movement to automatic price mechanismsfacilitate movement to automatic price mechanisms

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ConclusionConclusion

Major oil-exporting countries tend to be large Major oil-exporting countries tend to be large net subsidizers of petroleumnet subsidizers of petroleum

Subsidization does not appear to be a wise use Subsidization does not appear to be a wise use of resourcesof resources

Reform requires careful design to overcome Reform requires careful design to overcome political oppositionpolitical opposition