Some best international practices for removing energy price subsidies

Some best international practices for removing energy price subsidies

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The initial question: Why did subsidies emerge in many countries around the world? The answers to this question are certainly varied; however, I now want to focus on a different question: For many countries, especially developing (poor) countries, it was very difficult to pass on the significant and sustained growth of international oil prices to domestic prices, particularly for gasoline, diesel, and liquefied petroleum gas (LPG). This created an increasingly large gap between international and domestic prices.

That said, the situation was not the same for all countries. For those with ample financial resources and diversified economies, the process was not as complex – note the expression “not as” – since even in these countries, significant protests occurred in the productive and service sectors. I still remember the large-scale mobilizations in Spain and the problems faced by airlines in the U.S. due to the increase in international oil prices.

On the other hand, poorer countries that were net oil importers suffered but had “no choice” since they did not produce oil domestically. However, as prices rose beyond expectations, subsidies began to appear. Finally, countries with varying levels of wealth but that were net exporters of oil (and gas, let’s say) did not increase domestic prices because they either produced oil and did not need to import it, or they produced gas and used the revenues from its exports to sustain subsidies on gasoline, diesel, and LPG prices… you know who I’m talking about.

Well, that was in the past. In the present, almost all countries agree that subsidies need to be eliminated, which necessitates increasing domestic prices for gasoline, diesel, and LPG. One of the most important reasons for this is that subsidized prices encourage the “use and abuse” of fuels and, on the other hand, discourage production by companies, making the situation unsustainable.

Now for the title’s focus: What successful experiences exist worldwide for eliminating subsidies? And, in fact, what policies seem to have been effective in these countries? To avoid relying solely on local experiences (e.g., countries in the region) or overly specific ones (e.g., Iran), I referred to an excellent text from 2013: Energy Subsidy Reform: Lessons and Implications by Clements et al. Naturally, I don’t intend to summarize it here. Instead, I will highlight some key policies and invite readers to explore the text thoroughly, as it surely contains more insights than what I mention here.

With that, let me share that the study examines 22 countries worldwide that decided to eliminate energy price subsidies. Note the term “energy,” as the study covers not only oil derivatives but also electricity, natural gas, and coal. However, many of the recommendations for these energy sources can also apply to gasoline, diesel, and LPG. By now, the impatient reader might already be frustrated, so without further ado, here are what I consider the most interesting policies and strategies for eliminating subsidies:

Communication

When people understand the cost of subsidies, what the country loses because of them, and the public policies that could be funded if subsidies were eliminated, they tend to agree on the need for their removal. Additionally, the success of the policy depends on ensuring that people know the elimination strategy, its timeline, and the long-term objectives being pursued.

 

Gradual Phasing

If the gap between domestic and international prices is very large, eliminating the subsidy all at once is not advisable. A phased program over time appears to be the optimal strategy for its elimination—haven’t we learned this ourselves?

Dialogue with Key Groups

Clearly, the removal of gasoline price subsidies should be discussed with the transportation sector, diesel subsidies with the productive sector, and LPG subsidies with neighborhood associations. In other words, subsidy removal should, to some extent, be coordinated with the affected groups so they know what to expect in the future.

Direct Transfers

Direct cash transfers are one of the primary mechanisms for compensating the poorest families when subsidies are removed. Typically, the banking system (using debit cards) is used to deliver this money. However, when direct transfers are not feasible, other existing programs can be expanded, such as increasing public transport subsidies, boosting education spending, or improving health programs.

Automatic Price Adjustment Mechanisms

This measure involves applying automatic methodologies to set domestic prices based on international prices. Although Bolivia faced serious political and economic challenges when attempting this, in the current context of economic abundance, its implementation could be reconsidered.

Institutional Independence

The success of subsidy elimination measures often depends on creating a regulatory institution to control domestic prices of key petroleum derivatives and oversee the performance of the national oil company.

Finally, in the Bolivian case, for the elimination of subsidies on gasoline, diesel, and LPG prices, I suggest considering the following:

Part of the price increase should be allocated to producers according to a predetermined methodology. The 2010 experience, when the entire increase was directed to the state (through higher taxes on hydrocarbons and their derivatives) and later partially transferred to producers, introduced a very risky discretionary component.

The increase in gasoline price should also be accompanied by an increase in the price of compressed natural gas (CNG). Though it may seem harsh, domestic natural gas prices are also subsidized.

The National Hydrocarbons Agency, as the regulatory and oversight body, is the institution best positioned to lead this process.

S. Mauricio Medinaceli Monrroy

La Paz

January 27th 2014.

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