Energy Price Reform in Saudi Arabia1
Saudi Arabia has low energy prices by global standards. This is a key reason behind the strong growth in domestic energy consumption. Low energy prices disproportionately benefit higher-income groups and energy-intensive industries in many countries. A comprehensive energy price reform plan is needed, which gradually phases out low energy prices and puts in place mitigating measures to protect the vulnerable sections of the population and helps industry adjust to the higher energy cost environment. Higher energy prices could help in retaining priority investment and social spending during a fiscal adjustment process over the medium term.
A. Calculating Cost and Impact of Low Energy Prices
1. Despite large oil reserves in Saudi Arabia (75 years of proven reserves), the country faces some energy challenges. Domestic consumption of refined petroleum products and electricity is growing rapidly and if not contained this will eventually cut into export revenues. Low domestic energy prices also mean that potential fiscal revenue is being foregone. Overconsumption has environmental implications and implies fewer oil resources will be left for future generations. The increase in domestic demand for energy can be attributed to several factors such as rising residential, industrial, and commercial needs of a growing country, and the low regulated energy prices. International experience suggests that the distributional impact of low energy prices largely benefits higher-income groups.
Estimated Implied Energy Cost
2. Saudi Arabia, like many other oil exporting countries, provides energy products to the entire population at prices well below international levels (Table 1). Gasoline prices in Saudi Arabia were almost one sixth of the retail prices in the U.S. in 2014. Even after taking into account a 16 to 35 percent drop in international prices of energy products since 2014, the price gap ranges from 5 to 12 times across most energy products. Retail fuel prices in Saudi Arabia are the lowest in the region. The low domestic price of $0.14 per liter for premium gasoline partly reflects the low cost of domestic oil production. The domestic price for natural gas, set at $0.75 per mmbtu was 7.3 times below international prices in 2014 (Henry hub). The low prices for natural gas benefit the electricity generating companies as well as the petrochemical sector, each consuming roughly half of the total supply. Electricity and water tariffs are also lower than in many GCC countries. The low tariffs may partly reflect the low cost of inputs (crude oil, diesel and natural gas), which are also priced much below international prices, but the operating revenues of the Saudi Electricity Company (SEC) may not be sufficient to meet the capital requirement for the rising demand for electricity in the country.
3. The cost of low energy prices is not explicit in the central government budget in Saudi Arabia, but the implicit cost is substantial. The effects of low prices for the domestic consumption of energy are borne by oil producing companies like ARAMCO, oil refineries, SEC, and other quasi-government entities, who provide energy products at low prices to either the producers or the end consumers. The implied cost of low petroleum products and natural gas prices, computed using the price gap between domestic and U.S. prices (the reference price used as a proxy for international prices) and the quantity consumed, is estimated at $83 billion (11.1 percent of GDP) in 2014 (Table 2). Taking into account the drop in international energy prices since 2014, the implicit cost is estimated to fall to $65.9 billion (10.2 percent of GDP). About 86 percent of this cost is accounted for by petroleum products, dominated by diesel (39.4 percent share) and gasoline (22.1 percent share). Natural gas accounts for another 14 percent of the total cost. The implicit cost for the electricity sector is estimated at $11.4 billion or 1.5 percent of GDP when computed using a similar price gap methodology between the average tariffs in Saudi Arabia and the U.S. in 2014. Post-tax estimates, which also take into account externalities and potentially foregone taxes on energy products, are higher than the implicit energy cost (pre-tax) estimate for Saudi Arabia (IMF 2014).
|Implied Cost 1/|
|US$ mn||percent share|
|Gasoline (Premium 95)||n.a.||n.a.|
|Diesel (Gas oil)||32,736||39.4%|
|Total Petroleum products||71,261||85.9%|
|Total Natural gas||11,726||14.1%|
|% of GDP||11.1%|
|% of GDP||1.5%|
Implied cost is measured by multiplying per unit implied cost with quantities consumed. Implied cost per unit is measured as the difference between the local price and the reference price. The reference price used is the U.S. market price adjusted for taxes.
Implied cost is measured by multiplying per unit implied cost with quantities consumed. Implied cost per unit is measured as the difference between the local price and the reference price. The reference price used is the U.S. market price adjusted for taxes.
4. The implicit cost, computed using various other reference prices, is also substantial. For example, raising domestic prices of only gasoline and diesel products to the average level in the GCC would yield about 2½ percent of GDP and raising them to the average export price of refined products from Saudi Arabia or to the price level in the U.A.E would yield an estimated 3.8 to 6 percent of GDP in additional revenues in 2015 (Figure 1).
Figure 1.Implicit Cost Estimates for Gasoline and Diesel: Under Different Reference Price Assumptions
Sources: Country authorities; and IMF staff estimates.
Box 1.The Electricity Sector in Saudi Arabia
The Saudi Electricity Company (SEC) is the largest provider of electricity in Saudi Arabia and supplies energy to the residential (49 percent share), industrial (20 percent share), commercial (15 percent share), government (11 percent share) and other (5 percent share) consumers. SEC produces 77 percent of total energy supplied and purchases electricity from other corporations to meet the rest of the 23 percent of domestic electricity demand. Other producers of electricity include the state-owned Saline Water Conversion Corporation (SWCC), which also provides desalinated water to Saudi Arabia and is the second largest single producer of electricity (6 percent share), while several privately-owned independent water and power plants account for the rest. Electricity generation in Saudi Arabia is heavily dependent on hydrocarbons, with crude oil accounting for 28 percent of electricity production in 2013, diesel (15 percent), heavy fuel oil (10 percent) and natural gas providing the remaining 47 percent (Electricity and Cogeneration Regulatory Authority (ECRA), 2013). In 2010, following a study by ECRA, the average price of electricity sold to non-individual users was increased by over 20 percent, which increased revenues by SR 3.2 billion in 2011.
However, electricity tariffs in Saudi Arabia on average are still more than three times lower than tariffs in the U.S. (see table).1 Using this price gap to compute the implied cost of low electricity tariffs yields an estimate of $11.4 billion or 1.5 percent of GDP in 2014. ECRA estimates the average cost of electricity production and transmission at SR 0.152 per kwh, reflecting the low cost of inputs, 2 which are priced substantial below international prices. Besides, the capital requirements of the electricity sector are substantial (see paragraph 13). The capital requirement to fund electricity expansion projects is estimated at about SR 526 billion over the next 5 years. Some of these are currently funded by the issuance of government loans and three sukuk issuances (valued at SR 68.6 billion or $18 billion by end 2014).
|Average monthly Tariffs||Annual Electricity Consumption|
|SAR per kwh||USD per kwh||million kwh||US$ millon|
|Private hospitals and schools||0.12||0.03||30.012||1.0|
|Average -Saudi Arabia||0.14||0.04||274.56||10.8|
|Average - U.S.||0.13|
|Fuel Type||in Saudi Arabia||Internationally|
|in USD per million BTU|
|Heavy fuel oil||0.43||15.43|
Growing energy consumption
5. Per capita energy consumption in Saudi Arabia is among the highest in the world, promoted by low domestic energy prices (Figure 2, left panel). Low energy prices have also promoted energy-intensive industries, specifically petrochemicals and the growing aluminum smelting industry, which significantly contributed to high energy intensity (Figure 2, right panel). The elasticity of energy consumption to growth over the period 1980–2011 was estimated to be higher for oil exporters at 1.3 compared to 1.1 for the MENA region (IMF 2014).
Figure 2.Implications of Low Energy Prices
Sources: BP statistical review 2010, Country authorities, Gasoline prices GTZ online data and Fund staff calculations.
6. Domestic consumption of refined oil in Saudi Arabia has been rising, reaching 2.5 mbd in 2014 and constituting about 19 percent of total crude oil production.2 Oil consumption has grown at an average annual rate of 6.3 percent since 2011, in line with the growth in real non-oil GDP during this period. In the absence of price related or other reforms to curb energy consumption, if oil consumption continues to grow at the annual average rate of 6.3 percent, the additional domestic demand for refined oil would completely crowd out the current refined exports of 1 mbd by 2022. Also, by 2042, all of the total oil exports of 8.1 mbd in 2014 would be required to meet domestic oil needs. Similarly, consumption of natural gas grew by an average rate of 5 percent between 2011 and 2014.3
|Crude oil exports||8.6||5.0||−0.1||−5.5||2.0|
|Refined oil products exports||−5.2||−4.0||−8.2||24.5||1.8|
|Real non-oil GDP||8.1||5.5||6.4||5.1||6.3|
7. Electricity consumption has increased substantially since 2010. Industrial and commercial usage increased cumulatively by 32 percent and 41 percent respectively between 2010 and 2014. The number of residential customers increased by over 50 percent during this period. Vast distances between the main population centers and industrial areas and climatic factors are a source of high energy demand in the transportation sector and for the use of electricity with very high seasonal demand. Water desalination plants are also highly energy intensive, while water tariffs are not cost reflective encouraging very high per capita consumption of water. According to IEA, the per capita consumption of water is 235 liters per day, which is 91 percent higher than the international average (according to a 2012 report by SWCC). Some of these factors could remain a constant source of energy demand in Saudi Arabia.
8. The low retail price of fossil fuels encourages overconsumption of energy and leads to environmental distortions. Carbon dioxide emissions are an important component besides other externalities from emission of local pollutants, traffic congestion and accidents. In Saudi Arabia, carbon dioxide emissions are recorded at three times the world average of 5 metric tons (IMF, 2014). The adjacent chart shows the CO2 intensity of Saudi Arabia, measured in tons per $1,000 of GDP, along with the other top twenty CO2 emitting countries. Saudi Arabia has one of the highest CO2 intensities among this group with CO2 intensity of around 1.0.4
Figure 3.Co2 Emission Shares and Intensity, 2010
Source: IEA, 2014
9. Besides excessive energy consumption, low domestic energy prices also create opportunities for smuggling and black market activities. If domestic prices are substantially lower than those in neighboring countries, there are strong incentives to smuggle products to higher-priced destinations. Fuel smuggling is a widespread problem in many regions around the world.
10. International experience shows that generalized low energy prices disproportionately benefit richer segments of the population and are not particularly effective at redistribution. According to a survey conducted by the World Bank, the poorest quintile in Egypt, Jordan, Mauritania, Morocco, and Yemen receive only about 1–7 percent of total benefits from low diesel prices. In Egypt, the poorest 40 percent of the population received only 3 percent of the benefit from low gasoline prices, and 7 percent and 10 percent from low natural gas and diesel prices respectively. In Jordan, low energy price related benefits received by the richest quintile were about 20 percentage points higher than those received by the poorest quintile. The leakage of benefits from low prices to rich households is most pronounced in the cases of low gasoline and diesel prices, where the richest quintile benefit nearly 6½ (12) times more from low gasoline (diesel) prices than the poorest quintile (IMF 2014).
Figure 4.Share of Benefits from Low Energy Prices to the Bottom 40 Percent of the Population
Sources: World Bank/United Nations Development Program Energy Sector Management Assistance Program (2005); IMF and World Bank reports, Salchi-Isfahani and others (2013); and IMF staff calculations.
Note: LPG - liquefied petroleum gas.
1 Based on household surveys conducted between 2003 and 2009.
11. For Saudi Arabia, the 2013 household expenditure and income survey does not provide sufficient information to compute how low energy prices benefit different income groups. However, based on the survey, households with above average spending in Saudi Arabia spend between 10 and 13 percent of their total expenses on transport, compared to 1 to 7 percent among the low and medium spending households. This suggests that the incidence of transport fuel prices (gasoline) would likely be lower for the low income segment. On the other hand, a much larger share of utilities such as water, gas and electricity are consumed by the low and medium spending households than households with above average expenses, suggesting that raising electricity and water tariffs for the high income groups could be considered.
Figure 5.Saudi Arabia: Government Expenditure and Implicit Fuel Cost
Sources: Country authorities and IMF staff estimates.
12. Reforms to reduce the high implicit cost of low energy prices would allow retaining priority spending during the fiscal adjustment process. Energy price reform could increase government revenues or reduce the support it provides to entities such as the electricity company. The implicit cost of low energy prices is also higher than the fiscal expenditure on either education or health and the additional revenues could be used to protect priority investments and social spending.
B. Current Energy Initiatives in Saudi Arabia
Expanding energy supply and refining capacity
13. Saudi Arabia plans to increase its domestic supply of energy by expanding its oil refining capacity. Three new refineries in Satorp, Yasref and Jazan (with 0.4 mbd capacity each) are being developed as part of Aramco’s strategy to expand its refining capacity by 57 percent over the medium term. Satorp is fully operational and contributed to the 25 percent increase in refined oil exports in 2014. Yasref is expected to start refining by 2015Q4, while the Jazan refinery is expected to be functional by 2017. Besides meeting rising domestic demand, increased refining capacity will also boost the share of refined exports in total oil exports.
14. Saudi Arabia also has a large expansion plan for electricity generation capacity largely through renewable sources. As reported by SEC in 2013, renewable sources are not yet developed as a source of electricity. However, the growing need for electricity in the country has increased the domestic consumption of fossil fuel for power generation, and has prompted Saudi Arabia to explore renewable sources. The King Abdullah City for Atomic and Renewable Energy (K.A.CARE) is aiming to ensure that half of the electricity generated in Saudi Arabia comes from renewable sources by 2032, when forecast electricity demand growth will necessitate power generation capacity to increase to 120 gigawatts (GW) by 2032 (from 58 GW in 2013). According to a report by Brookings Institution, about 70 percent of the additional capacity is expected to be solar power and 30 percent nuclear power. Besides, newer technologies are expected to use natural gas as the primary input for electricity generation and production efficiency is targeted to increase to international levels over the next 7 years.
Energy Efficiency initiatives
15. Several initiatives are underway to improve efficiency in energy consumption. Saudi Arabia established the Saudi Energy Efficiency Center (SEEC) in 2010, which along with the Ministry of Water and Electricity and SEC is focusing on reducing energy consumption through audits, load management, regulation, and building awareness among users. An energy efficiency program was launched in 2012 with energy conservation targets with a primary focus on buildings, transportation, and industry sectors, while the SEEC, built on the former National Energy Efficiency Program (NEEP) in 2002, has set targets to reduce the country’s energy intensity by 2030 and bring energy intensity in line with G7 countries. Regulations for building codes and appliance energy efficiency standards, along with targets in some industries to maintain efficiency standards, are being implemented to contain excessive consumption (Brookings, 2014).
16. Cross country experiences on successfully implementing measures to improve efficiency in household, commercial and industrial use of energy could provide useful comparisons to current initiatives in Saudi Arabia. The American Council for an Energy-Efficient Economy (ACEEE) compare policies and quantifiable performance across the world’s 16 largest economies covering about 71 percent of global electricity consumption and ranks them in their scorecard. Similar reports from other international organizations have analyzed energy efficiency measures in a cross country context and provide useful recommendations. However, the unique social, cultural and geographic conditions in Saudi Arabia need to be considered while evaluating energy efficiency solutions for the country. According to a report by the Brookings Institution, low energy prices are considered one of the biggest obstacles to investments in efficiency, while non-market obstacles such as institutional barriers, lack of information about savings, and challenges in aggregating finance for small-scale technologies also create energy efficiency gaps in many cases.5
17. The development of public transportation systems is an important element of the authorities’ efforts to improve energy efficiency. These will provide alternate modes of transport, and reduce the impact of fuel price increases on the population. The authorities have embarked on several large scale transportation projects in the country including the ongoing rail metro project in Riyadh which is expected to be completed by 2018. Similarly the high speed rail project connecting Mecca, Medina and Jeddah and the North-South railroad project are also expected to be completed by 2017 and 2018. A metro rail project in Jeddah and several bus projects across the country are being planned between 2015 and 2024.
18. Low domestic prices for petroleum products, natural gas and electricity tariffs create barriers to energy efficiency measures and could lower the attractiveness of alternative sources of energy. The cost-benefit calculations of both investors and consumers of energy are skewed by the low prevailing price of energy products. While energy efficiency initiatives would complement energy price reform in reducing inefficiencies, they may not help achieve a substantial slowing in consumption in the absence of a price reform. Delays in reforming energy prices could also reduce the effectiveness and implementation rate of some of the efficiency measures. A study based on 29 advanced and 37 non-advanced countries by Charap and others (2013) found a long-term price elasticity of energy demand between -0.3 and -0.5, which suggests that the responsiveness of energy consumption is quite strong to changes in energy prices, and that countries can reap significant long-term benefits from energy price reform. Their study also indicates that the loss of consumer welfare as a result of price reform is likely to be larger in the short term than in the long term, suggesting the need for either a gradual approach to energy price reform or for more generous safety nets in the short term.
C. Cross Country Experience with Energy Price Reform
19. In the MENA region, energy price reforms have started, albeit at a varying pace in several countries. Many GCC countries have started increasing some energy prices and mostly for a small section of users. UAE and Qatar have increased gasoline prices; Bahrain and Saudi Arabia have increased electricity tariffs for industries; Kuwait has increased diesel and kerosene prices and is studying a proposal to increase electricity prices; and more recently Oman has doubled the industrial price for natural gas. However, the pace and magnitude of energy price reform in the GCC has been slow. Among other energy exporters in the region, Iran and Yemen have initiated energy price reforms. Many oil importers in the region, namely Egypt, Jordan, Mauritania, Morocco, Sudan, and Tunisia, have also initiated reforms over the last decade. Among energy exporting countries outside the MENA region, Malaysia, Nigeria, Indonesia have initiated energy price reforms.
|Bahrain||Gas price for old industrial costumers was increased 50 percent starting in January 2012, from $1.50 to $2.25 per mmbtu, while the price for new industrial customers remained at $2.50 per mmbtu (prices for new customers were increased from $1.30 to $2.50 In April 2010). Starting in March 2015 the gas price for industrial users was unified at $2.50 mmbtu. Also the authorities announced annual increases of $0.25 per mmbtu in the gas price for industrial user starting in April 1, 2015 until the price reaches $4.0 per mmbtu by April 2021. In March 2015 the authorities increased the fuel price in marine stations. Tariffs for electricity and water for non-domestic use were also raised (in October 2013).|
|Kuwait||A study on the impact of a differentiated electricity and water tariff structure was completed in 2014. Subsidies on diesel have been discontinued.|
|Oman||An energy sector study is ongoing, with a view to gradually reducing the overall fuel subsidy. In January 2015, the industrial price for natural gas has doubled.|
|Qatar||Qatar raised the pump prices of gasoline by 25 percent and of diesel by 30 percent in January 2011. Diesel prices were again raised in May 2014, by 50 percent.|
|Saudi Arabia||Saudi Arabia increased the average price of electricity sold to nonindividual users by over 20 percent on July 1, 2010.|
|United Arab Emirates||UAE increased gasoline prices in 2010 to the highest level in the GCC. Abu Dhabi is developing a comprehensive electricity and water consumption strategy, which led to an increase in tariffs in January 2015 (by 170 percent for water and 40 percent for electricity). Dubai raised water and electricity tariffs by 15 percent in early 2011.|
20. Energy price reform strategies implemented successfully by countries have been identified through various cross country studies by the IMF.6 The focus of these strategies was to put in place a comprehensive reform plan, which gradually raised energy prices and implement the necessary mitigating measures to protect the vulnerable sections of the population. Importantly, a well-designed communication strategy is crucial to gain popular support and buy-in of the middle class. Cash transfers and other targeted mitigating measures may need to be implemented almost simultaneously to manage the social impact of price reform. International experience also shows that the absence of some of these strategies is a key reason for the limited success in some countries.
21. Successful energy price reforms are usually underpinned by the following six elements:
A comprehensive energy sector reform plan: Such a plan should be drawn up in consultation with stakeholders and include clear long-term objectives and an assessment of the potential political barriers to the energy price reform and the impact of the reform.
For example, in Iran, the 2010 fuel price reform incorporated clear objectives, compensating measures, and a timetable for reform, preceded by an extensive public relations campaign. The public information campaign emphasized that the main objective of the reform was to replace the benefit of low energy prices with cash transfers to reduce incentives for excessive energy consumption and smuggling. Bank accounts were opened for most citizens prior to the reform and compensating cash transfers deposited into these accounts preceding the implementation of price increases. Similarly, a clear medium-term reform strategy backed by careful planning was also a major factor behind the successful electricity price liberalization reforms in the Philippines and Turkey. In Ghana, in 2005, the government commissioned an independent poverty and social impact analysis to assess the winners and losers from low fuel prices and their removal. This was an important foundation for persuasively communicating the necessity for reform and for designing policies to reduce the impact of higher fuel prices on the poor.
A comprehensive communication strategy: A well-planned communication campaign is essential to help generate broad political and public support, and should be undertaken throughout the reform process. The communication campaign should inform the public of the cost of current policies and the benefits of the reform, including the budgetary savings generated to finance high-priority spending on education, health care, infrastructure, and social protection. Another key component of a successful communications strategy involves strengthening transparency in reporting the costs of low energy prices in the budget.
Information campaigns have underpinned the success of a number of countries, including fuel price reforms in Ghana, Iran, Namibia, and the Philippines, and electricity price reforms in Armenia and Uganda. For example, in the case of the Philippines, a public communication campaign began at an early stage and included a nationwide road-show to inform the public of the problems associated with low petroleum prices.
Appropriately phased and sequenced price increases. Phasing in price increases and sequencing them differently across energy products may be preferable. Too sharp an increase in energy prices can generate intense opposition to reform, especially where there has not been sufficient communication or mitigating measures. A phased strategy will allow households and enterprises to adjust and give the government time to develop social safety nets.
For example, fuel prices in Morocco were raised gradually from 2012 to 2014 and the government increased the price of products at different rates and implemented a partial indexation mechanism for certain petroleum products and gradually eliminated low prices on gasoline and industrial fuel after two years. In Jordan, from 2012 onwards, gasoline and diesel prices and electricity tariffs increased gradually over two years and an automatic gasoline price formula has been adopted.
Targeted mitigating measures. Well-targeted measures to mitigate the impact of energy price increases on the poor are critical for building public support for reforms. The targeting could be through higher prices for energy products that are used by the better off or through transfers. Targeted cash transfers or vouchers are the preferred approach for providing compensation. When cash transfers are not feasible because of limited administrative capacity, other initiatives, such as public works programs, can be expanded while capacity is developed. It is crucial that those who are hardest hit by the elimination of low energy prices be compensated from the beginning through more targeted social protection.
➢ Improving Targeting: In several countries, including Morocco and Egypt, higher octane fuel was set at a higher price than diesel fuel used in public transport. Similarly, Jordan and Egypt provide cheap electricity to households for consumption up to a certain threshold. In Iran, the electronic card system introduced in June 2007 for gasoline rationing and quotas also provided a de facto multi-tier energy pricing structure for gasoline.
➢ Cash transfers: In Jordan, the recurrent cash assistance program provides cash transfers to the beneficiaries depending on their income. The poverty alleviation program in Yemen also facilitated cash transfers to mitigate the impact of fuel price reforms. Iran deposited cash transfers in new bank accounts for households financed by the revenue from price increases. In Indonesia, several compensating measures have been introduced or expanded like the unconditional cash transfer payment and health insurance for the poor households, as well as some recently introduced programs which cover education, financial assistance, and healthcare support implemented with card technologies. Similarly, Morocco and Mauritania also introduced cash transfer programs targeting the vulnerable households.
➢ Other mitigating measures for households: In Tunisia, additional programs introduced a new electricity tariff to protect low consuming households, a new social housing program, and increased income tax deduction for the poor households, among others. Morocco is also gradually strengthening existing programs to expand their coverage into social spending and targeting to vulnerable groups.
➢ Other mitigating measures for industries/productive sectors: In Jordan, to reduce dependence on energy imports, especially for energy intensive sectors, other energy sources with lower generation costs are being developed. In Iran, some of the revenue from the end-2010 price increases was to be set aside to provide support for enterprise restructuring and for efforts to reduce energy intensity.
Depoliticized price setting. Successful and durable reforms require a depoliticized and rules-based mechanism for setting energy prices which can help reduce the chances of reform reversal. Adoption of an automatic fuel pricing mechanism is not in itself a solution for achieving sustained energy price reform, but should be part of a broader reform strategy (see Box 2). As seen in many country cases, energy prices are gradually raised and eventually an automatic mechanism is adopted to liberalize prices. In general, the responsibility for implementing an automatic pricing mechanism can be given to an independent body to help shield it from political pressures. Over the longer term, reforms for petroleum products should aim to fully liberalize pricing.
Improved efficiency of state-owned energy producers. Energy producers often receive substantial budgetary resources to compensate for inefficiencies in production and revenue collection. Strengthening the financial position and operational performance of these enterprises can reduce the need for budget transfers. To address operational inefficiencies, many countries have permitted private companies for electricity generation and distribution. Improved demand management (by charging higher prices during peak periods) has proven effective in shifting demand to periods where marginal costs of provision are lower. Revenue-enhancing measures like improved collection and metering could be initiated with large customers and then gradually extend to medium and smaller ones. (IMF 2013a)
Box 2.Automatic Pricing Mechanism1
Under such a pricing mechanism, international price fluctuations are passed through to the consumer using an explicit fuel price formula. Retail fuel prices are then changed at pre-specified regular intervals (e.g., weekly, biweekly, or monthly) to fully reflect changes in international prices.
This may be accompanied by some price smoothing rules to avoid excessive volatility in domestic prices in the short term. A number of smoothing mechanisms are possible, including price band and moving average mechanisms. The price band mechanism sets the maximum limit on the magnitude of retail price changes, while the moving average mechanism base retail price adjustment on changes in the history of international prices (preferably over a longer period for smoothening).
The adoption of an automatic price adjustment mechanism is intended to achieve a number of objectives. Implementing an automatic fuel price mechanism coupled with smoothing features would help reduce price volatility. Allowing for a large one-off increase in domestic energy prices or an ad-hoc approach could create political pressures that often result in long periods of fixed prices, and tensions between the government and fuel suppliers.
Examples of countries that have adopted automatic price mechanism: Jordan resumed a monthly fuel price adjustment mechanism in January 2013; Tunisia increased fuel prices on an ad hoc basis in 2012–13 and re-introduced an automatic price formula for gasoline in January 2014 to allow for future convergence to international prices over time; Mauritania adopted a new automatic diesel price formula in May 2012; Morocco started implementation of a partial indexation mechanism for certain petroleum products in September 2013, eliminated regulating gasoline and industrial fuel prices in January 2014, and introduced bimonthly reviews of these prices; and Cote d’Ivoire, which used to have fixed prices for fuel products, adopted an automatic pricing mechanism with smoothing in 2013.1Based on the Technical Notes and Manual on “Automatic Fuel pricing mechanism with Price Smoothing: Design, Implementation and Fiscal Implications”, December 2012.
D. Macroeconomic Impact of Energy Price Reform
22. Cross country experiences show that the impact of energy price increases on inflation could be limited if the reform is well planned and gradual. Experiences in Morocco and Jordan suggest that persistent inflation is unlikely if price increases are gradual and well planned (Figure 6). Similarly, in Indonesia, price reforms in 2005 and 2008 caused short lived inflationary pressures which subsided within a few months. A new round of energy price reforms came into effect in Indonesia since January 2015 with no substantial pickup in inflation. In the case of Iran, policy measures were taken several months before the launch of the energy price reform in December 2010. These included a comprehensive communication campaign to create awareness about the planned safety nets, administrative policies to stabilize prices, among others. These efforts helped keep domestic inflation low for the initial months.
Figure 6.Event Study: Impact on Domestic Price Inflation from Energy Price Reforms
Sources: Haver and IMF staff calculations.
The shaded region represents the period around which subsidy reforms were implemented.
23. In Saudi Arabia, the impact on inflation of gradual energy price increases could be limited for several reasons. Energy related products—utilities (water, gas, electricity) and transport fuels—together constitute about 3.7 percent of the total CPI basket. The impact of the first-round increase in gasoline and diesel prices could be bigger on the middle and high income groups in Saudi Arabia with a bigger share of transport fuel expenses than others. The impact of rising transport costs could be partly mitigated by the development of the public transport system. However, the middle and low income households in Saudi Arabia would be more impacted by increases in utilities prices, such as cooking gas, electricity and water. The price dynamics will also be affected by the second-round impact on the non-fuel components of CPI, which depends on expectations of future inflation (IMF 2014). Since the prices of food and many other commodities in the consumer basket in Saudi Arabia are imported, some of the impact of fuel price hike could be restricted. Detailed information on the consumption basket across income groups is needed to estimate the full incidence impact on inflation.
24. Since some industries in Saudi Arabia are energy intensive (plastics, petrochemical and aluminum), their production costs would increase due to higher energy prices and their competitive advantages will decline and potentially slow export growth. However, improving the economy’s competitiveness and business climate could help the economy adapt to higher energy prices over time, including the ongoing measures to support energy efficiency in Saudi Arabia (paragraph 15). Higher energy prices would create incentives for industries to pursue strategies to minimize energy costs, making them more efficient, and strengthen incentives for research and development in energy-saving and alternative technologies. Nonetheless, short-term adjustment costs may be large, and temporary measures can be introduced to help mitigate these costs.
Figure 7.Energy Intensity by country, 2000 and 2010
Sources: World Bank, World Development Indicator database; and IMF staff calculations.
Note: PPP = purchasing power pant.
E. Conclusions/Key Takeaways for Saudi Arabia
25. The costs of low energy prices in Saudi Arabia, while not immediately obvious, are substantial. While businesses and consumers benefit from low energy prices, the costs include the rapid growth in consumption of energy products, potential fiscal revenues forgone, and a distribution of the wealth that likely disproportionately benefits the better off. A gradual increase in energy prices could reduce these costs. A reduction in the high implicit cost of low energy prices would also allow retaining priority investment and social spending during the fiscal adjustment process. Additional gains from current initiatives to increase energy supply and improve energy efficiency could also be achieved by raising domestic energy prices.
26. Saudi Arabia could draw from the energy price reform strategies implemented successfully by other countries. These experiences suggest that Saudi Arabia should develop a comprehensive energy price reform plan with clear long-term objectives and a detailed assessment of the impact of the reform on households as well as the productive sector. In addition to the current substantial efforts that are being made to increase energy efficiency, the reform plan should gradually phase out low energy prices and put in place mitigating measures to protect the vulnerable sections of the population and help industry adjust to the higher energy cost environment. Importantly, a well-designed communication strategy is needed. This should include the authorities calculating and publishing the cost of low energy prices, discussing the benefits of raising domestic prices, and announcing mitigating measures for targeted households and industries. Cash transfers and other targeted mitigating measures may need to be implemented almost simultaneously. The availability of public transportation systems, which the authorities are developing, is expected to reduce the impact of fuel price increases on the transportation costs of the population.
27. The availability of detailed household level data on the consumption basket across income levels will be essential to conduct a thorough analysis on the impact of increase in domestic prices on the low and middle income groups. A detailed breakdown of the consumption basket would also facilitate planning for cash transfers and other mitigating measures needed to protect the most vulnerable sections of the population, as part of a comprehensive reform strategy.
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ParryI.VeungC. and HeineD.2014 “How Much Carbon Pricing is in Countries’Own Interests? The Critical Role of Co-Benefits”Working PaperInternational Monetary FundSeptember.
Prepared by Malika Pant.
Refined oil consumption of 2.5 mbd in 2014 includes 0.04 mbd of LPG, 1.9 mbd of other refined oil products and 0.6 mbd of crude oil consumed as input by electricity and water companies as well as by cement, petrochemical companies among others.
Saudi Arabia produced about 1.95 million barrels of oil equivalent per day of natural gas in 2014, all of which was consumed domestically.
“How Much Carbon Pricing is in Countries’ Own Interests? The Critical Role of Co-Benefits”, Ian Parry, Chandara Veung, and Dirk Heine, IMF working Paper 2014.
“Low-carbon energy transitions in Qatar and the Gulf Cooperation Council region”, Brookings Institution, February 2014.