Issues in Domestic Petroleum Pricing in Oil-Producing Countries

1. Issues in Domestic Petroleum Pricing in Oil-Producing Countries Sanjeev Gupta IMF January 27, 2004

2. Introduction: Why study domestic petroleum prices? • Many oil-producing countries keep domestic prices below free market levels • Net oil importers in some cases do not fully reflect international prices. • The resulting subsidies can be large and are nontransparent • Few studies have quantified these subsidies for a wide range of countries and examined their economic effects

3. Subsidy Estimates: Methodology • Subsidies can be broadly defined as the difference between the reduced price of a good with government support and the price of the good in the absence of such support. • Subsidy = (M-P)C • M = “free market price” = W+D+T • W = world wholesale spot price • D = marketing + distribution + transport costs (importers only) • T = general consumption taxes (VAT, etc.) • P = after-tax retail price • C = petroleum product consumption

4. Subsidy Estimates: Caveats • Marketing, distribution, and transport costs assumed to be the same across countries and time periods; introduces some error, esp. if pipeline constraints create large marginal transport costs • However, transport costs are typically only about 2 percent of after-tax retail price • Excludes implicit subsidies due to tolerance of nonpayments • Some retail price estimates are an average for only a month or quarter (“snapshot”)

5. Subsidy Estimates: Sample • Subsidies calculated for 86 countries between 1996-2000 • 1999 is the latest year available for most countries. In this year, 62 countries in sample: • 15 Major Oil Exporters (of which, 13 subsidize) • 6 Other Net Oil Exporters • 41 Net Oil Importers

8. Subsidy Estimates: Results • Subsidies are large — averaged 3.5 percent of GDP in 1999 among major oil exporters • Among net oil importers, the average revenue from petroleum taxation was 2.2 percent of GDP in 1999. • Subsidies positively correlated with world oil price • Residential fuel oil and auto diesel subsidized more heavily than gasoline

9. Economic Effects of Subsidies • Efficiency • In the absence of price distortions, most efficient to set domestic prices equal to the world wholesale spot price plus marketing and distribution costs (W+D) • Caveats: • Need for government revenue may make net taxation more efficient • Environmental externalities may argue for further taxation (in excess of 100 percent, Parry 2001)

10. Economic Effects of Subsidies • On the other hand, large exporters may have some monopoly power in world oil markets so that the marginal revenue from exporting is less than the world wholesale price plus marketing and distribution costs: • R = revenue, X = exports, ηX,P = price elasticity of world oil demand, and XW = total world oil demand • Marginal revenue<(W+D) if significant share of world market (X/ XW is high) and ηX,P is low

11. Economic Effects of Subsidies • Thus, the opportunity cost of not exporting may be lower than the world price for OPEC as a whole or its dominant members. • The marginal revenue for OPEC can be as low as 25 percent of the non-market-power case.

12. Economic Effects of Subsidies

13. Economic Effects of Subsidies • Efficiency • On balance, the arguments for taxation outweigh the arguments for subsidization: • Need for government revenue • Environmental externalities • However, most major oil exporters subsidize, resulting in efficiency (deadweight) losses • Assuming environmental externalities, deadweight losses amount to 0.5 to 12.4 percent of GDP • Assuming no environmental externalities, deadweight losses amount to between 0 and 7 percent of GDP

14. Economic Effects of Subsidies • Equity • Poorly targeted means of distributing purchasing power to the poor—majority of benefits go to the non-poor • In Venezuela, the richest 20 percent receive 6½ times more in subsidies per person than the poorest 33 percent (World Bank 1995) • In Ecuador, the more expensive energy products received the highest subsidies, while household kerosene, used by poor households, was not subsidized (World Bank 1994) • Pro-rich bias compounded by possible smuggling and corruption

16. Economic Effects of Subsidies • Fiscal opportunity costs • In subsidizing countries, the average subsidy is larger than the average fiscal deficit or total health spending • In Ecuador and Venezuela, the implicit subsidy exceeds public spending on health

17. Figure 2. Composition of Government Expenditure in Major Subsidizing Oil Exporting Countries 1/ 6 5 4 In percent of GDP 3 2 1 0 Oil subsidies Education Spending Health Spending (13) (11) (12) 1/ Unweighted averages for subsidizing oil-exporting countries. Oil subsidies are for 1999; expenditure data are an average over the period 1997-99. Number of countries in parentheses.

19. Economic Effects of Subsidies • Cyclicality • For net oil exporters, periods of high world oil prices tend to be both periods of economic boom and periods of higher domestic subsidies • Petroleum subsidies are thus procyclical, exacerbating the effects of oil price shocks on economic volatility

20. Successful Reform • Preconditions • Establish social protection mechanisms to compensate losers (Indonesia); design using PSIA • Use publicity campaigns to inform public of trade-offs (Egypt) • Timing • Optimal speed of reform depends on trade-off between fiscal need and adverse social consequences • Existence of good social protection mechanisms allows faster reform • Political environment • External environment—periods of low world oil prices may facilitate movement to automatic price mechanisms

21. Conclusion • Major oil-exporting countries tend to be large net subsidizers of petroleum • Subsidization does not appear to be a wise use of resources • Reform requires careful design to overcome political opposition