International experience with energy pricing policy

Masami Kojima

November 2015

Mexico City

Outline

2

• Drivers of price controls and consequences• Alternatives to pricing to achieve comparable goals• Recent developments in response to oil price collapse

– Reform announcements and implementation– Taxes

• Lessons from price smoothing• Special case of household fuels

Why are we here?

3

Numerous problems have arisen around the world from government control of energy prices and sector to• Combat adverse effects of global price volatility and

inflationary pressure • Make energy more affordable

– Reduce reliance on traditional biomass by promoting switch to modern energy

• Encourage development of indigenous resources through producer support

• Lower input energy prices to increase competitiveness

Network energy vs. solid and liquid fuels

4

Targeted price subsidies for liquid fuels have largely failed• Financial incentives for diversion too powerful

Targeted price subsidies for network energy (electricity, natural gas, district heating) are easier to implement• Rural consumers are cross-subsidized by urban

consumers worldwide• Lifeline rates with restrictions can target the poor if

everyone is metered• Cross-subsidies act as taxes and subsidies• Cross-subsidies for certain sectors are distorting

Unintended consequences

5

Market concentration with little or no competition• Price subsidies channeled through national oil companyEnergy shortages with substantial economic damage• Blackouts, reliance on expensive diesel power generation• Fuel shortagesOpaque sector with flourishing corruption• Black marketing of liquid fuels • Fuel smuggling (Algeria, Iran, Malaysia, Nigeria, Venezuela)• Subsidies based on “self-reporting” by companiesDeclining investment in the energy sector• Net exporters becoming net importers (Argentina)• Major crude oil exporters importing petroleum products

(Angola, Iran, Iraq, Nigeria)

Ultimate goal

6

• Efficient economic regulation of natural monopolies (power transmission and distribution, pipeline transportation) by an independent regulator– Open access regime

• Price deregulation in a market with fair and healthy competition and enforcement of sound regulations– Level playing field irrespective of ownership– Efficiency gains passed on to consumers as low prices

• Comprehensive, integrated social protection program meeting the basic needs of the vulnerable– Not sector-specific interventions, but meeting needs arising

from any shock (food, oil, hurricanes, financial crisis, …)

Externalities and social safety nets

7

Externalities• Tax to achieve social optimum• Subsidizing “clean” energy is not as efficient as taxing

“harmful” energy• Fuel taxation is not necessarily an efficient instrument

Examples: Ideal for CO2 emissions, but not for road damage, which is proportional to 4th power of axle weight

Social safety nets• Untargeted price subsidies → inefficient and regressive • Targeted price subsidies for liquid fuels → large leakage • Conditional cash transfers or equivalent• Integrated intervention: unconditional cash transfers

Different ways of providing social protection

8

Approach Pros Cons

1 Universal price subsidy Politically popular, easy to implement

Regressive and costly, requires government price control, difficult to dismantle, energy shortages, smuggling

2 Price subsidies reserved for certain consumers

Restrict budgetary layout for subsidy

Administratively challenging with potentially large leakage

3 Targeted cash transfers conditional on energy purchase

Same as 2 + possibly no interference with market pricing

Administratively challenging with errors of inclusion and exclusion, diversion of cash

4 Expanding existing programs (work, education, pension)

Same as 3 + no need to wait for a strengthened program

May be difficult to match those in need with program participants

5 Targeted unconditional cash transfers

Same as 3 + preserve incentives for efficiency improvement

Same as 3 + cash transferred may be used for nonessential purchases

Opportunity afforded by low fuel prices

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Jan-1

4

Mar-1

4

May-

14

Jul-1

4

Sep-14

Nov-14

Jan-1

5

Mar-1

5

May-

15

Jul-1

5

Sep-15

Nov-15

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2

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10

12Regular gasoline per literDiesel per liter

MX

N/li

ter

or

kg

The dramatic drop in the price of oil to Jan 2015, followed by rise and fall, have tested the resolve of governments announcing subsidy reforms.

• Seeing subsidies slashed, many announced pricing reforms.

• Some have adhered to regular price adjustments.

• Some have sharply increased fuel taxes.

• Some announced subsidy removal at the time of minimum oil price, but failed to follow up with price adjustments.

U.S. Gulf Coast spot prices for gasoline and diesel, Mont Belvieu spot propane prices for LPG

Emerging lessons

10

How Examples Implementation

Law Mexico 2014 Implemented

Iran 2010 for all forms of energy Law amended in 2012

Presidential decree

Kerosene in Nigeria in June 2009 Decree has not been gazetted

Gasoline and diesel in 2014 in Indonesia Decrees not implemented because of political factors and socioeconomic considerations Ministerial

decreeGasoline and diesel in 2014 and 2015 in Indonesia

Announcement by regulatory authority

China Implemented in recent years

Deregulation in Ghana in June 2015 Implemented so far

Automatic adjustment in Malawi in June 2012 Not systematic

Announcement to reporters

Gas price increase in Nigeria announced in late 2014 to take effect in Jan 2015

Not implemented

The more formal the way in which the decision to reform pricing is communicated, the less likely is policy reversal

Frequency of adjustments

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Getting used to frequent and regular price adjustments is important.• Morocco has been adjusting fuel prices regularly twice a

month, no matter how small the price change.• Gabon, Indonesia, and Malawi announced subsidy removal

but have not been adjusting prices at the intervals required.• The longer the time interval between price changes, the

greater the public and government resistance to change, and the larger the potential price shock when prices are finally adjusted (Egypt, Iran, Ukraine gas for households).

Political challenge of implicit policy reversal

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• Official position of the government of Brazil: all oil product prices were deregulated in 2001.

• In practice: pressure on Petrobras to keep domestic prices artificially low, with no official mechanism to

change “policy”.Evidence:

Static producer prices independent of world price movement

Large losses suffered by the refining segment of Petrobras in recent years Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Gasoline, R$/literDiesel, R$/literLPG in 13-kg cylinders, R$/kgP

rod

uce

r p

rice

s in

R$

/lite

r o

r kg

Price smoothing to manage price volatility

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• Price smoothing schemes are seldom, if ever, self-financing– Budgetary transfer of US$0.7 billion to Chile’s second

stabilization fund– Cameroon’s fund deficit = 3% of GDP in mid-2014

• Self-financing depends critically on frequent price reversion to the mean, not seen since the early 2000s

• Political pressure to withdraw in times of high fund balance can amplify, rather than reduce, price volatility– Example: Vietnam in 2013–14 vs. 2015

• A successful alternative is adjustable tax in Chile

Political economy of Vietnam stabilization fund

14

• There is a levy, base rate at VND 300 (MXN 0.35)/liter but as high as VND 800/liter at the end of 2014.

• The fund was exhausted in 2013 and could not be used to lower retail fuel prices.

• The record balance in Dec 2014 prompted use of VND 3.3 trillion (MXN 2.3 billion) in 1Q2015 to subsidize fuelprices when world oilprices were already low.

Jun

-13

Se

p-1

3

De

c-1

3

Ma

r-1

4

Jun

-14

Se

p-1

4

De

c-1

4

Ma

r-1

5

Jun

-15

Se

p-1

50

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500Fund balance

VND billion

MXN million

Mecanismo de Estabilización de Precios de los Combustibles (MEPCO)

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Implemented since Aug 2014 for small consumers and small/medium-size enterprises.• Automotive fuels only (gasoline, diesel, LPG, CNG)• Specific fuel tax = fixed component + variable component• Fixed component defined in UTM, automatically adjusted

for inflation by Central Bank of Chile every month• Fixed component = gasoline 6 UTM/m3 (MXN 6.5/liter),

diesel 1.5 UTM/m3 (MXN 1.6/liter)• Variable component can become negative, with deficit

limited to US$500 million, with rules for bringing down the deficit if the limit is breached

Price stabilization in Chile

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Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15600

650

700

750

800

850

900

950Retail price of gasoline

With stabilization Without stabilization

Pe

sos

pe

r lit

er

MEPCO →

MEPCO, which came into effect in August 2014, smoothing prices more than the previous regime.

← SIPCO

Subsidy and tax reform in times of low prices

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Several governments have taken advantage of low world oil prices to increase specific fuel taxes• China increased the excise tax on gasoline and diesel

three times between Nov 2014 and Jan 2015.• Ghana introduced a special petroleum levy (17.5% of ex-

depot price) in Nov 2014 for all fuels except pre-mix and heavy fuel oil.

• India increased the excise tax on gasoline and diesel three times in Oct, Nov, and Dec 2014, nearly tripling diesel tax.

• Vietnam tripled the environmental protection tax in May 2015.

Ghana

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Ghana introduced a 17.5% tax in Nov 2014 with minimal effects, thanks to rapidly falling world oil prices.

Jan

-14

Ma

r-1

4

Ma

y-1

4

Jul-

14

Se

p-1

4

No

v-1

4

Jan

-15

Ma

r-1

5

Ma

y-1

5

Jul-

15

0

2

4

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14

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Gasoline Diesel KeroseneLPG

Co

nve

rte

d t

o M

XN

pe

r lit

er

or

kg

Imposition of 17.5% fuel tax

Challenge of subsidy reform for cooking fuels

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Subsidy removal is easier for gasoline than diesel, and easier for diesel than for cooking and home heating fuels. • Household fuel price subsidies remain in India

(kerosene), Indonesia (kerosene and LPG), Malaysia (LPG), Morocco (LPG), Tunisia (LPG), Ukraine (natural gas)

• Conditional cash transfers enable price deregulation– Deregulate price if there is sufficient competition, and

compensate poor fuel purchasers• Conditional cash transfers are easier for LPG than

kerosene – Register each customer who has to hand in cylinder for

refill

Targeted conditional cash transfer: FISE in Peru

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• A 2012 law established Fondo de Inclusión Social Energético, one use of which is to subsidize LPG purchase by the poor

• Financed by surcharges on consumption of various forms of energy by other consumers

• Stringent eligibility criteria: – Electricity consumption in previous 12 months < 360 kWh– Possession of national identity document and LPG cylinder– Information verified by home visit

• FISE provides S/. 16 (MXN 82) for refill of 10-kg cylinder once a month– Digital voucher distributed by the power utility

Determinants of household use of LPG

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Findings from econometric analysis of household surveys:• Income and LPG prices affect the decision to use LPG (selection)

and how much to use (quantity)• Selection increases with rising (highest) levels of education

attained by men and women, with women’s education being more important than men’s → awareness about LPG

• Gender of household head not statistically significant• Proxies for infrastructure (selection), availability of cheap or

free biomass (selection and quantity) significant• Very low cross-price elasticity with respect to firewood →

firewood prices would have to rise sharply before households consider purchasing more LPG

Reducing spending on LPG by households

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Decrease barrier to entry and increase price competition

Hospitality arrangements; third-party access; competition policy; posting of prices by firm, location, and cylinder size on government website

Minimize short-selling Clear marking of tare weight, enforcement of scale calibration, industry association’s seal of quality certification, publication of names of companies caught short-selling

Target financial assistance

Spread or reduce upfront adoption cost via dealer incentives or dealer-financed installment plan

Improve auxiliary infrastructure

Road conditions, port infrastructure

Minimize shortages Ensure reasonable returns to efficient operators to build capital for construction of storage facility; encourage hospitality and third-party access

Enforce safety regulations

Clearly mark last date of cylinder recertification; set up registries of certified installers and of certified private inspectors operating under government supervision

Household fuel subsidies

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• Subsidizing one’s way out of this problem is not financially sustainable

• Price deregulation coupled with targeted cash transfers distorts the market the least and can still help the poor– Adequate market competition is a pre-requisite– In remote areas, could consider competition for the

market followed by exclusive license to serve• Unconditional cash transfers in integrated social protection

program may be the long-term goal, but given a choice, the poor may not spend extra cash on household fuel – Top spending choice was rice, not kerosene, in

Indonesia in 2005

How will governments respond to next price shock?

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• Ghana, Jordan, and several others suspended automatic pricing mechanism in 2008

• Although price increases starting in 2009 were gradual, subsidy reforms stalled

• Pass-through of fuel price and exchange rate increases in the power sector were frequently not implemented

• Many countries today are not in markedly better position to replace price subsidies with targeted social protection measures than in 2008

Concluding observations

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• There is ample global evidence that pricing is usually not the right instrument to achieve policy goals price controls are intended for

• There is no substitute for fundamental reform and strengthening of– Power, oil, gas, and other energy sectors: strengthening

competition where appropriate; reducing technical, commercial, and collection losses as much as possible

– Social protection: work steadily to put an administrative system in place to identify beneficiaries and deliver benefits efficiently, and make social protection integrated and comprehensive

Publications cited

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Fossil fuel subsidy and pricing policies: Recent developing country experienceForthcoming as a World Bank Policy Research Working Paper

Petroleum product pricing and complementary policies: experience of 65 developing countries since 2009

http://documents.worldbank.org/curated/en/2013/04/17513782/petroleum-product-pricing-complementary-policies-experience-65-developing-countries-2009

Reforming fuel pricing in an age of $100 oil (English)http://documents.worldbank.org/curated/en/2013/01/18019602/

Who uses bottled gas? Evidence from households in developing countrieshttp://documents.worldbank.org/curated/en/2011/07/14612680/uses-bottled-gas-evidence-households-developing-countries

The role of LPG in reducing energy povertyhttp://siteresources.worldbank.org/INTOGMC/Resources/LPGReportWeb-Masami1.pdf