Cutting the Cord- Wrestling with subsidised oil prices
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It was said in 2008, when oil prices reached their all-time high, that the only countries that showed an increase in oil consumption that year were those that capped prices or subsidized them to some degree. With prices rising again, though still a long way from the 2008 peak, those subisidies are once again becoming an issue in many countries.
Moving away from artificially-restrained prices is hard for a government to do. But think of the distortions it creates, Venezuela being the prime candidate. With retail gasoline prices there measured in mere cents per gallons -- the exact figure is hard to measure given the rapid collapse of the bolivar against the dollar -- it creates both inefficiency in consumption and a gigantic smuggling opportunity. So crude oil gets sold into the local market at less than $20/barrel, gets consumed inefficiently or smuggled out of the country, and an opportunity to sell it to international markets at more than $70/b goes up in smoke. Which policy benefits the Venezuelan people?
So as oil prices continue to march toward the century mark, it's been notable how many subisidized countries are wrestling with this issue, just in the last few weeks. Here's a rundown:
- Thailand is taking steps to deregulate. Last week, the country's National Energy Policy Council agreed to liberalize the price of LPG to encourage local refiners to boost output and cut imports. LPG is always a highly sensitive price in countries where it is the primary cooking fuel. In the case of Thailand, the cost of the subisidy had become an enormous burden on government coffers. The ex-refinery price had been capped at around $333/mt. But now, refiners will be able to set their ex-refinery price in line with the Saudi Aramco monthly LPG contract price, which is set for $935/mt for propane in January. When it was capped at $333, the government refunded the difference to refiners. Not surprisingly, as our correspondent Boonsong Kosit wrote from Bangkok, "LPG demand in Thailand has been soaring as local consumers have been taking advantage of the artificially low prices."
A more stunning development has occured in Bolivia, where the government of leftist President Evo Morales turned tail and reversed a deregulation of local fuel prices. On the day after Christmas, Vice President Alvaro Garcia issued a decree that removed subisidies which cost the government about $380 million each year. When the subisidies went out, prices soared as much as 83 percent. The Bolivian people weren't real happy about that, and protests were described as "violent." So Morales rescinded the price increase. But on Monday, Garcia said there will be an increase but only after "consultation with the Bolivian people." That should be an interesting conversation.
- Fuel subsidies in Iran have been close to sacrosanct. But on December 19, some of that support was withdrawn. Late last week, an Iranian news agency cited figures from the National Iranian Oil Products Distribution Co. and said gasoline consumption had fallen 5% over the first 10 days since the price increase, diesel fuel consumption was down 20%, kerosene 50%, fuel oil 18% and CNG 15%. Under the first stage of the the plan, Iran increased the price of oil products to 10% less than the spot FOB price in the Gulf (or in other words, 90% of the full price). It's a four-year program, and the cut came with an increase of $42 to monthly allowances to compensate for the cuts...yet consumption dropped anyway, showing that price signals can reduce consumption, even if the income of the consumer is adjusted for the higher price.
- In India, state-owned refiners are getting hit on their inability to raise gasoil prices. Gasoline has been deregulated, but not other prices, including LPG and gasoil. It's a problem for Indian Oil Corp., in which the government is seeking to sell a stake. The Indian government plans to sell a 10% stake in IOC and the company has planned an additional 10% share sale to raise money to fund its expansion plans. But with profitability at times based strictly on government subisidies for money-losing sales of various products, that fact is said to be complicating the sale.
NUTSHELL:
Around the world, the rising oil price will always spark the debate of whether subsidizing the oil price is good for the economy or not. What are the considerations? Well, we can write a whole book about those- but in summary, the subsidy debate typically involves discussions on market distortions and allocative inefficiencies which lead to black markets (that seem to defeat the purpose of the subsidies most of the time). Also, there is the question of poverty and adjustment mechanism of an economy to oil price shocks; do you apply a gradualist policy approach or do you apply a shock therapy approach. The gradualist approach could connote a gradual and step by step ''deregulation'' of the oil prices (case in point: Iran- as mentioned above). There is also the shock therapy approach in which the local prices are made to reflect the international fluctuations without any recourse to government intervention (Bolivia tried to do this but reversed the policy; typically the US and UK markets are examples of deregulated oil markets). Poverty (see earlier post) and external reserves are at stake. Of course deregulation is the economic prescription to the subsidy situation for most economies. No matter what approach to weaning the world's economies off subsidies, the average policy maker may experience some confusion and double vision in the process of achieving a workable solution. When it shows up, however, some may think it's a bird or a plane, or even external interference from one's national enemies....; whereas it's nothing more than just subsidies again.
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