Front Matter

Front Matter

Author(s):
Trevor Alleyne, and Mumtaz Hussain
Published Date:
August 2013
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    © 2013 International Monetary Fund

    Cataloging-in-Publication Data

    Joint Bank-Fund Library

    Energy subsidy reform in Sub-Saharan Africa: experiences and lessons—

    Washington, D.C.: International Monetary Fund, [2013]

    73, 46 p.: col. ill., col. maps; cm.

    At head of title: African Department.

    Includes bibliographical references.

    1. Energy policy—Africa, Sub-Saharan. 2. Electric utilities—Government policy—Africa, Sub-Saharan. 3. Fuel—Prices—Africa, Sub-Saharan. 4. Poor—Energy assistance—Africa, Sub-Saharan. I. International Monetary Fund. African Department.

    HD9502.A357 E53 2013

    ISBN: 978-1-48436-654-7 (paper)

    ISBN: 978-1-48437-508-2 (ePub)

    ISBN: 978-1-48438-560-9 (Mobipocket)

    ISBN: 978-1-48439-072-6 (PDF)

    Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.

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    Contents

    Executive Summary

    Reforming energy (fuel and electricity) subsidies in sub-Saharan Africa (SSA) is critical to ensuring future energy supply to realize Africa’s growth potential. Although subsidies continue to absorb a large share of public resources, power generation and access levels in SSA remain well below those in other low-income countries. There is a link between those facts because energy subsidies create at least two set of problems. First, they are poorly targeted. The subsidies provide benefits to all segments of society, but the main beneficiaries are the better off. Second, subsidies often create a disincentive for maintenance and investment in the energy sector, perpetuating energy shortages and low levels of access. Therefore, reforms are essential to make better use of budgetary resources for pro-poor and development spending and to facilitate the expansion of electricity output. But reforms are also difficult, because the public needs to be convinced that they will benefit more from the reallocation of government spending to other purposes than they will lose from the subsidy removal. Reform efforts must therefore focus on putting together credible packages of measures that are then used to build support for reform.

    In spite of reform efforts, energy subsidies still absorb a large share of scarce public resources in SSA. According to IMF staff estimates, the fiscal cost of fuel subsidies, taking into account both direct subsidies and foregone taxes, amounted to 1.4 percent of the region’s GDP in 2012 (Appendix 1). Quasi-fiscal deficits of state-owned electricity companies in SSA, defined as the difference between the actual revenue collected and the revenue required to fully recover the operating costs of production and capital depreciation, amounted to a further 1.4 percent of GDP in 2009–10 (see Appendix 1).

    These energy subsidies mostly benefit the better off, but their removal also would hurt the poor. Energy subsidies benefit mostly higher-income groups because they consume the most (Figure 11). Electricity subsidies are particularly regressive because connection to the electricity grid is highly skewed toward higher-income groups. Nevertheless, the welfare impact of eliminating subsidies (without compensating measures) would be significant for the poor because the share of total energy in their total household consumption is the same as the rich, although there are important differences in the types of energy products consumed across income groups (Table 3).

    Energy subsidies have a negative impact on economic efficiency, in particular on allocation of resources and on competitiveness and growth. Energy subsidies can lead to resource misallocation through overconsumption. They may crowd out more productive government spending, as indicated by a negative relationship between fuel subsidies and public spending on health and education (Figure 16). More importantly, underpricing and subsidies can create a vicious cycle of underinvestment, poor maintenance, and inadequate supply, notably in the electricity sector and oil refining. In the electricity sector, persistent shortages and limited access further drive up costs, widening the wedge between tariff and cost-recovery levels. As a result, Africa’s power infrastructure lags behind other developing regions, and there has been relatively little convergence toward better-equipped regions (Figure 18). According to World Bank estimates, improving electricity to the regional leader’s level could increase SSA’s annual potential output growth by two percentage points.

    Despite their drawbacks, universal energy subsidies are prevalent for a variety of reasons. An energy subsidy is a readily available mechanism, requiring very little administrative capacity, for governments to provide a highly visible benefit for important segments of the population. Other mechanisms simply may not exist. In addition, energy subsidies might be introduced by a desire to avoid the transmission of price spikes to the domestic economy, or to expand the access of the population to energy, or simply because of the difficulty of controlling the financial performance of energy companies, particularly state-owned ones. Energy subsidies are even more prevalent in oil-exporting countries because of the availability of financing, the presence of lower institutional quality levels, and/or a desire to establish energy-intensive industries. Furthermore, in some countries the population expects to consume petroleum products at below international market prices as a way to share the country’s oil wealth, even if refined products are imported.

    The longer the subsidies have existed, the more entrenched the opposition to reduce them. This is especially the case if their benefits have been capitalized, for example, by the adoption of energy intensive technologies and equipment in businesses. In addition, concerns about potential economy-wide loss of competitiveness and the impact of higher energy prices on inflation are usually raised in opposition to subsidy reform. In oil-exporting countries, the task of removing subsidies has proven even more challenging because it is difficult to convey to the public the rationale for products to be sold at their opportunity cost and not their cost of production.

    Case studies of SSA countries that have attempted to reduce energy subsidies (compiled in the supplement to this paper) suggest several lessons:

    • First, transparency and public communication on the size of energy subsidies and their beneficiaries is helpful to kick-start reform. In Nigeria, the government used the fact that fuel subsidies ($9.3 billion, or 4.1 percent of GDP in 2011) exceeded capital expenditure to call for reform. In Niger, the realization that oil tax revenue shrank from 1 percent of GDP in 2005 to 0.3 percent of GDP in 2010 contributed to triggering reforms. Ghana undertook an independent poverty and social impact analysis in 2003–4 and made the findings public to make the costs and incidence of subsidies, along with the impact of their removal on different groups, well understood.

    • Second, careful preparation, including public education and consultation with key stakeholders, is critical for success. In planning a reform, it is important to clearly outline the goals and objectives, identify main stakeholders and interest groups, and develop strategies to address their concerns. In Kenya, consultation with unions allowed the electricity reform process to proceed without the retrenchment of staff in the utilities. In addition, early in the reform process, the support of large consumers for tariff increases was secured only with a commitment to use extra revenues to expand electricity supply. In Namibia, the National Deregulation Task Force in 1996 examined fuel price deregulation through a broadly consultative process, culminating in a White Paper on Energy Policy in 1998.

    • Third, a gradual phasing in and sequencing of subsidy reforms seem to work best. This is especially true if subsidies are large or have been in place for a long time. A gradual approach will allow time for energy consumers to adapt and prevent sharp price increases that could undermine support. A gradual approach would also be preferred when the available instruments for delivering mitigating measures to the most needy are less developed, and when time is needed to improve the government’s track record on spending quality. In Namibia, fuel subsidies started to be scaled back only in 2001, a full three years after the adoption of a consensual white paper on deregulating energy prices. In the case of electricity, the complex nature of the reform process requires that it be gradual. In Kenya, subsidies were eliminated over the course of 7–8 years through a combination of tariff increases, improvements in collections, and reductions in technical losses.

    • Fourth, strong institutions are needed to sustain energy subsidy reforms. In Tanzania, the establishment of a specialized regulatory entity, not only to issue licenses and technical regulations (e.g., on the quality requirements of fuel products), but also to keep the public constantly informed about (current and historical) prices and price structures and to review the proper functioning of the market (e.g., to investigate concerns about potential price collusion practices) seems to have played an important role in sustaining fuel subsidy reforms.

    • Fifth, durably reducing electricity subsidies involves much more than tariff increases. Breaking through the vicious cycle of underinvestment, poor maintenance, and high costs requires creating an environment conducive to seizing the considerable scope for efficiency gains. Low levels of public debt in many countries in sub-Saharan Africa provide an opportunity for significant investment in cheaper sources of energy production. Regional production and distribution pools can yield significant economies of scale. Public and private energy distributors have considerable scope to reduce distribution losses and improve revenue collection rates. And a strong, knowledgeable, independent regulator can play a critical role in assessing how much subsidy removal is done by tariff adjustment versus cost containment.

    • Finally, the credibility of the government’s commitment to compensate vulnerable groups and use the savings from subsidy reform for well-targeted development interventions is essential for the success of energy subsidy reform. In the case of electricity, timing subsidy reform with improvements in power services, such as new capacity or more reliable supply, seems to raise the likelihood of success (Kenya). Kenya also maintained a “lifeline” electricity tariff (below costs) for households that consume less than 50 kWh a month (cross-subsidized by higher rates imposed on larger consumers) together with donor-financed subsidies to connect the poor to the electricity grid. In terms of measures to mitigate the impact of higher fuel or electricity price on the poor, conditional cash transfers are the most appropriate instrument. However, this may not be feasible in the short run because of administrative constraints. A range of actions has been introduced in practice. For example, in Niger and Ghana, the authorities introduced a subsidy for public transport to keep it affordable for the poor despite the increase in oil prices.

    Introduction

    The reform of energy subsidies is an important but challenging issue for sub-Saharan African (SSA) countries. There is a relatively large theoretical and empirical literature on this issue. While this paper relies on that literature, too, it tailors its discussion to SSA countries to respond to the following questions: Why it is important to reduce energy subsidies? What are the difficulties involved in energy subsidy reform? How best can a subsidy reform be implemented? This paper uses various sources of information on SSA countries: quantitative assessments, surveys, and individual (but standardized) case studies.

    This paper is organized as follows. Chapter 1 discusses a few stylized facts about energy subsidies in SSA, their (quasi-)fiscal costs, distributional incidence, and their impact on economic efficiency. Chapter 2 focuses on policy issues linked to reforming the power sector and associated subsidies, while Chapter 3 presents a strategy for energy subsidy reform. A supplement to this paper builds on the lessons distilled from a number of case studies on energy subsidy reform—Ghana, Namibia, Niger, Nigeria (fuel); and Kenya, Uganda (electricity).

    The paper was written by a staff team consisting of Trevor Alleyne, Christian Josz, Sukhwinder Singh, Mauricio Villafuerte, Javier Arze del Granado, Antonio David, Philippe Egoume-Bossogo, Farayi Gwenhamo, Mumtaz Hussain, Clara Mira, Anton Op de Beke, Edgardo Ruggiero, Slavi Slavov, and Geneviève Verdier. Research assistance was provided by Promise Kamanga, Brian Moon, and Douglas Shapiro. Administrative assistance was provided by Elise Brun and Edison Narvaez. A presentation of some preliminary results was made at a Ministerial Seminar on Energy Subsidies in SSA during the 2012 IMF-World Bank Annual Meetings in Tokyo. The paper was also an input into a joint FAD/AFR/MCD paper, “Energy Subsidy Reform—Lessons and Implications” that was published in March 2013.

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