Sudan
Selected Issues Paper
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
05 Nov 2012
eISBN:
9781616355722
Language:
English
Keywords:
ISCR; CR; price; government; state government; price-smoothing component; price of gasoline; price increase; price reform; subsidized fuel price; Energy subsidies; Consumption; Oil
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This selected issues paper on Sudan was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on September 7, 2012. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Sudan or the Executive Board of the IMF.

Abstract

This selected issues paper on Sudan was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on September 7, 2012. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Sudan or the Executive Board of the IMF.

I. Fiscal Cost and Distributional Impact of Fuel Subsidies1

This chapter examines the nature of fuel subsidies in Sudan, assesses the fiscal savings generated by the recent increase in fuel product prices and estimates distributional impact of fuel subsidies compared to the pre-reform status quo.

A. Introduction

1. The Sudanese government has increased the price of selected fuel products in the context of the revised 2012 budget, thereby significantly reducing fuel subsidies. Effective June 2012 the price of gasoline has increased from 8.5 to 12.5 SDG per gallon, the price of diesel from 6.5 to 8 SDG per gallon, the price of LPG from 13 to 15 SDG per gallon and the price of jet fuel has been liberalized from the regulated price of 6.5 SDG per gallon, resulting in an increase of about 3 SDG per gallon.2

2. A determined subsidy reform was long overdue; petroleum product subsidies have weighed heavily on the budget in the recent past. The lack of an automatic fuel price mechanism, in the context of increasing and volatile international oil prices, has caused fuel subsidies to increase steeply since 2003, when the rally in oil prices began. Petroleum product subsidies accounted for about ¾ of tax revenues in 2011 and have been on the rise as a consequence of the secession of South Sudan and the related loss of oil production. High levels of subsidies are of greater concern in Sudan because competing spending priorities, such as development and social spending, require accurate allocation of public resources.

3. Fuel subsidies are not only fiscally costly, but also inefficient and inequitable; their removal would deliver substantial gains to Sudan:

  • Fuel subsidies magnify the adverse macroeconomic impacts of increasing international prices. Less than full pass-through of international price increases to domestic consumers dilutes their incentives to improve energy efficiency and results in higher import costs.

  • The high fiscal cost of subsidies crowds out both high-priority public expenditures and private investment. The fiscal cost of price subsidies constrains investment expenditures on key social and physical infrastructure, including health, education, and access to safe water, and limits the budget for more effective social protection programs such as targeted cash transfers to the poor.

  • A very large share of the benefits from universal price subsidies goes to richer households, further reinforcing existing inequalities of income and consumption. Overall, almost 50 percent of subsides accrues to the richest 20 percent of households, reflecting the high consumption of subsidized energy among these households.

  • The leakage of subsidy benefits to higher-income households means that price subsidies are a very costly approach to protecting poor households. For example, every SDG transferred to the bottom income quintiles through price subsidies costs the budget almost 33 SDG.

  • Neighboring countries with higher prices are often substantial beneficiaries of price subsidies through cross-border smuggling. Subsidized fuel prices can result in smuggling to neighboring countries where prices are higher, thus promoting shortages, black market activities, and corruption. This effect is particularly significant in Sudan, given the unsettled border arrangements with South Sudan, where fuel products are not subsidized.

  • Price subsidies are a passive approach to social protection and do not induce poor households to pull themselves out of poverty through their own efforts. Programs that condition transfers on beneficiary households investing in the human capital of family members (e.g., education, training, and health status) have been found to be much more effective in generating a sustained decrease in poverty and helping to break the inter-generational transmission of poverty.

4. Although subsidies are fiscally costly, inefficient, and inequitable, removing them presents a number of policy challenges. Governments are often particularly concerned about the adverse impact on the poorest households and the potential for social unrest, while beneficiaries are often very reluctant to give up benefits. Policymakers are also concerned about the adverse impact on the competitiveness of energy-intensive industries, especially for sectors that must compete in domestic and foreign markets with international suppliers. Sudan’s high and rising inflation and unstable political condition have long hampered a swift implementation of the necessary subsidy reform. However, international experience shows that most subsidy reforms occur without major civil unrest, especially if the increase in prices is gradual and well-targeted compensation programs are publicly announced.

5. A successful reform strategy needs to address these policy challenges. This requires an effective public information campaign that clearly sets out the shortcomings of subsidies, the fiscal risks and urgency for reform, and the details of a reform strategy that addresses the various policy challenges. This reform strategy should be (i) gradual to allow consumers to adjust their consumption and minimize the inflationary impact; (ii) sequenced to minimize the impact on poor households and allow time to strengthen the social protection system; and (iii) durable to avoid a recurrence of subsidies.

6. This chapter assesses the fiscal savings generated by the recent June reform and estimates the distributional impact of fuel subsidies after the recent increase in fuel product prices in contrast to the pre-reform status quo. After examining the magnitude of fuel subsidies pre- and post-reform, we estimate the fiscal space generated by the increase in fuel prices and we assess the distribution of the subsidy benefits in the pre- and post-reform scenario.

B. Market Structure, Pricing Regime, and Fiscal Cost of Fuel Subsidies

Structure of the Fuel Product Market

7. The consumption of petroleum fuels draws from domestically refined crude oil as well as from imported refined products. Fuel consumption has increased steadily over the past decade, owing to increased industrialization, improved access to the electricity grid, and rising car ownership. In 2012 diesel accounts for the bulk of consumption, followed by gasoline and fuel oil (Figure I.1). These fuels are used primarily for electricity production (diesel and fuel oil) and public and private transportation (diesel and gasoline). Consumption of kerosene is minor (Box I.1).

Figure I.1.
Figure I.1.

Fuel Product Consumption, 2012

(Thousands of Metric Tons)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Sources: Ministry of Petroleum, SPC; and IMF staff calculations.

8. Two refineries—the main Khartoum refinery and its extension, and the El Obeid Refinery—refine domestic crude oil to produce a full range of fuels. The main Khartoum refinery can refine up to 50 thousand barrels per day (bpd) of Nile blend crude and produces 2.5 million tons of fuel products per year, almost entirely for domestic consumption. The extension to the Khartoum refinery was constructed in 2004 to process the highly acidic Fula blend. It has a capacity of 40 thousand bpd and can produce 2 million tons of heavy fuel products (for instance, heavy coke and petroleum coke) each year, mostly for electricity production. The El Obeid Refinery has a capacity of 15 thousand bpd of Nile blend and produces gasoline, diesel, and fuel oil, with the latter—again used primarily for electricity generation—accounting for the largest share.

9. Imports account for about 20 percent of total consumption. Diesel, jet oil, and LPG are imported to cover the shortfall in domestic production. In 2011 the volume of imports accounted for 25, 20 and about 50 percent, respectively, of total consumption of these products, but the shares of imports are likely to rise following the secession of South Sudan and the recent events in the Heglig3 area. In addition, about 75 percent of the Fula blend refined by the Khartoum expansion is purchased from the share of the China National Petroleum Corporation (CNPC), Sudan’s main partner in the extraction and refining of petroleum. Since the secession of South Sudan in July 2011, an unspecified quantity of Nile blend has also been purchased from the CNPC share, in order to keep the operations of the refineries closer to full capacity. However, the purchase of crude from partners has come to an end in 2012 due to repetitive rescheduling of payment by the government. Almost 40 percent of produced gasoline was exported until 2011, although exports of gasoline were discontinued in response to the interruption in the supply of crude from South Sudan and the Heglig incident.

Main Uses of Fuel Products in Sudan

Diesel: Transportation for large vehicles and some small ones; small-scale electricity generation (e.g. back-up generators at residences).

Gasoline: Mainly private transportation.

Fuel Oil: Large-scale electricity generation.

LPG: Cooking and heating for higher income families, with some use as a vehicle fuel.

Jet A1: Aviation.

Kerosene: Lighting and cooking, especially by poorer families and in rural areas; being replaced by LPG.

10. Domestic refining and imports are regulated by the Ministry of Finance and National Economy (MOFNE) and executed by the Ministry of Petroleum (MOP) through the Sudanese Petroleum Corporation (SPC), the MOP’s operating arm. The SPC is responsible for exploration, production, and distribution of crude oil and petroleum fuels in accordance with the policies set by the MOFNE, who owns the crude. SPC buys crude oil from the MOFNE at US$49 per barrel and from CNPC at negotiated prices that reflect the world market. It then contracts with the refineries—owned jointly by the government and CNPC—for processing. It also manages the tenders for fuel imports and sells both the domestically produced and imported fuels to distribution and marketing companies that reflect margins and retail prices that are, again, administratively set by the MOFNE.

Fuel Product Pricing

11. Fuel product prices remain low by regional standards. The prices of gasoline, diesel, and kerosene are lower than in bordering countries, including Chad, the Central African Republic, Uganda, the Democratic Republic of the Congo, Ethiopia, and Kenya, and lower than regional averages (Figure I.2) which in Africa are very close to indicative international prices of US$1.28 and US$1.23 for diesel and gasoline, repectively. Low domestic prices have led to substantial smuggling to neighbouring countries that face higher domestic prices, curtailing domestic supply and effectively “exporting” the subsidies.

Figure I.2.
Figure I.2.

International Comparison of Diesel Prices, 2012

(USD/Liter)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Sources: Ministry of Petroleum, SPC; and IMF staff calculations.

12. Pass-through of international fuel prices to the domestic market has been limited since the early 2000s. The government has been reluctant to pass through the increases in international prices that have occurred since 2003. Domestic retail prices have been increased only three times since 2002: in 2004, in 2006 and most recently in 2011. Initially, tax revenue was eroded, but in several periods retail prices fell short of even the before-tax cost, resulting in significant direct subsidies (Figure I.3). On the other hand, the drop in international fuel prices in the second half of 2008 was not passed through to domestic prices either, leading to a positive tax margin in 2009. As fuel prices bounced back starting in end-2009, direct price subsidies have reappeared despite the increase in retail prices in January 2011, and persisted even after the June reform. Overall, domestic prices have increased by only 45 percent of change in international prices since end-2008, compared to an average of 60 percent in neighbouring African countries

Figure I.3.
Figure I.3.

Diesel Price and Pass-Through

(SDG/Gallon)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Sources: U.S. Energy Information Administration; Ministry of Petroleum, SPC; and IMF staff calculations

Magnitude and Fiscal Cost of Fuel Subsidies

13. Fuel price subsidies currently arise at several points in the distribution chains of crude oil and refined products:

  • the Nile and Fula blends used for domestic production, including the share purchased from CNPC at international prices, are sold to SPC at the fixed price of US$49 per barrel instead of the international prices of US$110 per barrel for light crude and US$82 per barrel for heavy crude, respectively, in 2011.

  • domestically refined fuels are sold at a price that is lower than their production costs, even after allowing for the subsidy on crude oil; and

  • imported fuels are sold at prices well below the cost of importation.

14. Despite the June increase in fuel prices, subsidies remain high. This is mainly a result of the 66 percent devaluation of the exchange rate, which makes the cost of crude oil in local currency more expensive. Eliminating the subsidies—including the subsidy on purchases of crude oil by SPC—would require an average increase in retail prices of about 97 percent, (Table I.1), compared to 110 percent prior to the reform. To eliminate only the direct subsidy but not the tax subsidy, the required price increases would need to be 88 percent.

Table I.1.

Production Costs, Retail Prices, and Subsidies

(SDG/Metric ton)

article image
Source: Ministry of Petroleum, SPC; and IMF staff calculations.

15. The estimated fiscal cost of the direct and tax subsidies, including the subsidy on crude sales to refineries, is estimated to be SDG 10 billion in 2012, or 5.2 percent of GDP. This compares to over SDG 11 billion, or about 6 percent of GDP, in the pre-reform scenario and takes into account the half-year effect of the reform. The subsidy on crude oil is estimated to account for 44 percent of total subsidy, the subsidy on domestic refining for 41 percent, and the subsidy on imports for the remaining 15 percent. The direct subsidy was SDG 8.6 billion, and the tax subsidy was SDG 1.4 billion, 4.5 and 0.7 percent of GDP respectively. Diesel is estimated to account for over 60 percent of the total tax-inclusive subsidy alone (Figure I.4). Overall, the savings generated from the June subsidy reform over the second half of the year amount to SDG 1.3 billion, or 0.6 of 2012 GDP. The fiscal space generated from the reform increases to about SDG 2.3 billion, or 1 percent of GDP, in 2013–14 (Figure I.5).

Figure I.4.
Figure I.4.

Subsidies, 2011

(SDG millions)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Source: Ministry of Petroleum, SPC, and staff estimates.
Figure I.5.
Figure I.5.

Fuel Subsidy Projections

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Source: Ministry of Petroleum, SPC; and IMF staff calculations.

C. Welfare Impact of Price Subsidy Reform

16. The welfare impact of price subsidy reform on households arises through two channels. First, household real incomes decrease due to the increase in the prices of energy directly consumed by households for cooking, lighting, heating, and private transport. This is referred to as the “direct impact.” Second, real incomes also decrease due to an increase in the prices of other goods and services that use energy in their production and distribution. This is referred to as the “indirect impact.” The reform of fuel subsidies would entail a substantial indirect impact due to higher transportation and production costs.

17. Sudanese households allocate a minor portion of their budgets to subsidized energy.4 Consumption of subsidized energy accounts on average for 1.4 percent of total household consumption (Table I.2). At 0.6 percent of total consumption, expenditures on LPG account for the largest component of energy consumption. The pattern of energy expenditures varies across income groups, with the budget share increasing with household income. Yet, whereas the budget shares of LPG, generator fuel and gasoline are larger for higher-income groups, the budget share for kerosene is larger for lower income groups.

Table I.2.

Distribution of Total Subsidies and Real Income Effect of Eliminating Subsidies, by Welfare Group

article image
Source: NBHS (2009); World Bank (2011); IMF staff calculations.

18. The direct welfare impact of the simulated price increases is minor and mostly related to the direct effect of the subsidy removal. On average, the simulated price increases result in a 3.5 percent decrease in household real income (Table I.2). About 56 percent of such welfare loss (1.9 percent of real income) is due to the direct effect of the subsidy removal, while the remaining 44 percent (1.5 percent of real income) is attributable to the indirect impact on the price of electricity and other goods and services that use energy in their production and distribution. Such effect is typically very high for diesel, as it is used for commercial transportation and electricity production.

19. The welfare impact is progressively distributed, with the loss in real income higher for higher-income households. The progressivity of the total impact is driven by the highly progressive direct impact of higher fuel prices on households, while the indirect impact is less progressively distributed because of the slightly regressive indirect effect of the increase in food prices. As a result, the direct impact accounts for 43 and 59 percent of the total in the bottom and top quintile respectively. On average, the welfare loss of increased energy prices for households in the top income quintile is 4.1 percent compared to a 2.2 percent loss for households in the bottom income quintile.

20. Since most of the benefits from subsidies are captured by higher-income households, these households will also bear most of the burden of their removal. Overall, the top income quintile receives 48 percent of total subsidy, compared to 3 percent received by the bottom income. (Figure I.6, Table 2). In other words, every SDG transferred to the bottom income quintile through price subsidies costs the budget more than 33 SDG. The leakage of benefits is especially pronounced in the case of gasoline, where the top income quintile households receive more than 56 times more in subsidies than the bottom quintile. Accordingly, the total leakage to richer households decreased following the recent increase in the price of gasoline, from 51 percent in the pre-reform scenario, to 48 percent since June.

Figure I.6.
Figure I.6.

Distribution of Subsidy, 2012

(Percent of total benefit)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A001

Source: Ministry of Petroleum, SPC, and staff estimates.

D. Policy Recommendations

21. The increase in fuel prices implemented in June was appropriate, but the fuel subsidy remains high and the reform momentum should be maintained. The analysis of the welfare impacts of subsidy reform and how it is distributed across different income groups can inform the design of a reform strategy that gradually eliminates price subsidies while protecting poor households. The success of any reform strategy can be enhanced by an effective public information campaign that clearly sets out the shortcomings of price subsidies and the urgency of the need for reform. Given the unstable political conditions, such a campaign should be launched ahead of any further price increase. To be credible, this campaign should also identify the details of a reform strategy that addresses the various policy challenges. This reform strategy should be gradual, sequenced, and durable.

  • Gradual withdrawal of price subsidies allows households and enterprises sufficient time to adjust their consumption behavior (e.g., to increase energy efficiency) thus reducing the adverse impact of future price increases. It also reduces the inflationary impact arising from the indirect effect of higher energy prices on the prices of other goods and services consumed by households. In this respect, the government’s commitment to phase out subsidies within three years is appropriate.

  • An appropriate sequencing of subsidy reforms, concentrating first on items that are less important for lower-income households (for example gasoline, LPG, and generator fuel), can minimize the adverse impact on these households and allow time to build a more effective social protection system. In this respect, the government’s choice to frontload the increase in the price of gasoline is also suitable.

  • An essential prerogative of a sustainable price subsidy reform is the institution of a targeted social protection system, which shields poor households from price increases (and other economic shocks). If properly designed, an effective social protection system could help needy households pull themselves out of poverty through investing in the human capital of family members. International evidence suggests that the combination of large relative price increases and a lack of compensation programs and public outreach can lead to political unrest in a politically fragile environment. Contextual to the increase in fuel prices, the authorities have more than doubled the provision for social spending. However, such spending is not targeted and the government should intensify its efforts to design a well targeted and efficient social safety net.

  • To be durable, the reform strategy should address the underlying causes of price subsidies. This requires a new approach to pricing, especially energy pricing. The first-best approach is to move to a fully liberalized pricing system backed up by an effective regulatory framework that ensures competition. However, introducing an automatic fuel pricing mechanism is a key component of the transition to a liberalized system and away from a subsidized regime. The political acceptability of such a mechanism may be enhanced by the adoption of a price-smoothing component, which would ensure full pass-through of international price changes over the medium term, but avoid large short-term increases in domestic prices. Under this approach, the government continues to protect the population from extreme price volatility by absorbing it into fiscal policy.

22. The fiscal savings can help to protect public spending plans for high-priority items such as education, health, infrastructure, and targeted social assistance, while maintaining fiscal sustainability. This approach, in turn, can reinforce economic growth, which also helps to offset the adverse welfare impacts of price reforms on the population.

1

Prepared by Valentina Flamini. The incidence analysis has been computed by Kenichiro Kashiwase based on data provided by the World Bank.

2

In January 2011, the government increased the price of diesel and gasoline by 2 SDGs per gallon, and the price of jet oil by 1.85 SDG per gallon—equal to a 44 percent increase for diesel, a 40 percent increase for jet oil and a 31 percent increase for gasoline-and the price of LPG from 12 to 13 SDGs per cylinder. The additional margin is collected by the customs and credited to the Ministry of Finance and National Economy (MOFNE) as a stabilization fund.

3

On April 10 2012, South Sudan seized the contested Heglig oilfield, which produces almost half of Sudan’s 115 thousand bpd, creating extensive damage to the oil infrastructure in the area. By May 7, most of the oil production from the Heglig area was reportedly resumed.

4

Since consumption of diesel and jet fuel is not covered in the 2009 National Budget Household Survey (NBHS), the welfare effect of an increase in the price of those commodities on household income cannot be directly quantified with the methodology used in this chapter.

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Cover IMF Staff Country Reports
Sudan: Selected Issues Paper
Author: International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2012: Issue 299
Publisher:
International Monetary Fund
ISBN:
9781616355722
ISSN:
1934-7685
Pages:
76
DOI:
https://doi.org/10.5089/9781616355722.002

Fuel Product Consumption, 2012

(Thousands of Metric Tons)

International Comparison of Diesel Prices, 2012

(USD/Liter)

Diesel Price and Pass-Through

(SDG/Gallon)

Subsidies, 2011

(SDG millions)

Fuel Subsidy Projections

Distribution of Subsidy, 2012

(Percent of total benefit)