1 FUEL SUBSIDY REFORM 1 Implementing Subsidy Reforms: Lessons from International Experience Maria Vagliasindi, Program Leader, GCC, World Bank prepared for Oman Energy & Water Conference Muscat, 23 May 2016

2 FUEL SUBSIDY REFORM 2 1.There is considerable international experience in addressing subsidy reforms Oman is not entering uncharted waters and has already successfully started the process 2.To ensure that global lessons of what has and has not worked supports and informs the ongoing dialogue in Oman on fossil fuel reform 3.One size does not fit all: there is no cut and paste; Oman’s program will need to reflect local political, economic and social priorities and realities Motivation

3 3 SUBSIDY REFORM 3 Energy subsidies in selected MENA oil net exporters (percent of GDP) Energy subsidy cost are extremely high Source: IMF estimations

4 4 SUBSIDY REFORM 4 Energy Efficiency in selected MENA oil net exporters over time (kg of oil equivalent per $1,000; GDP constant 2011 PPP) Undermining efforts to improve energy efficiency Source: WDI, World Bank

5 FUEL SUBSIDY REFORM 5 To implement subsidy reforms, governments may want to consider:  Informing the policy framework, through a careful design and sequencing of the proposed pricing adjustments, as well an ex ante analysis of the economic and social impact of reforms, including an incidence analysis of the alternative scenarios;  Determining the domain, by designing the terms of access, eligibility, subsidized quantities, and coverage of the proposed compensatory schemes. Setting the stage, with a well-designed and targeted and timed communication strategy.  In implementing such reforms it is also recommended that the price increases are accompanied by broader reforms in the energy sector, mitigation measures such as energy efficiency reforms and improvement of service delivery. Key Lessons learned from International Experience

6 6 SUBSIDY REFORM 6  An important condition for successful subsidy reforms is the credibility of the government commitment to compensate vulnerable groups and to use the funds freed from subsidy reform for more welfare enhancing activities.  Policy tools to protect the poor include lifeline rates, which generally perform better than universal subsidies as well as cash transfers.  Use of transitional arrangements and short term measures to alleviate the impact of tariff increases on the poor can act to protect low-income groups at the time of the policy change. Key Lessons learned (ctd)

7 FUEL SUBSIDY REFORM 7  Design and implement sectoral mitigation measures strengthening service delivery in infrastructure  Design and implement complementary reforms to absorb the impact of pricing reforms: Improving energy an water efficiency Expanding access to natural gas potential for cost reduction on the supply side Shifting the paradigm toward PPPs and a competitive market structure  Analyze the impact of energy price changes on the economy Electricity & water are critical to the economy of the selected countries and have important backward and forward linkages with the fuel upstream sector. Framing the immediate vs medium-term activities

8 FUEL SUBSIDY REFORM 8 Ensuring the Sustainability of Subsidy Policy through Broader Sectoral Reforms  Where the quality of electricity services is low, engaging in broader reforms to improve service ahead of reforming energy subsidies lends credibility and improves consumer willingness to pay the unsubsidized prices  Steps such as improving metering, billing and payment collection, and enhancement of quality of service can make tariff increases more acceptable as subsidies are removed.  Rationalizing the fuel mix for electricity and transport and discouraging private transport in favor of public transport can help support reforms, as will the prioritization of structural expenses that benefit the poor (e.g. social expenditure).

9 FUEL SUBSIDY REFORM 9 Communicate: One Initiative - Two Perceptions GREATER BUDGET SECURITY REMOVING FUEL SUBSIDIES Reduce corruption Better macro economic situation More for education and health Better governance More money in budget Improved economy Satisfy donors and markets Leaner government Better living standards Better Life Better environment INSECURITY REMOVING FUEL SUBSIDIES Entitled to low fuel costs Reduced Income Higher costs for food fuel and transport Government corrupt no transparency No salary increase Lower lifestyle Who benefits where will savings go Anxiety & mental problems Less $ for school fees Might have to move for job Feeling Trapped Perception of ConsumersPerception of Government

10 FUEL SUBSIDY REFORM 10 The first best option --namely, implementing price reforms while introducing cash transfers-- is a solution which was successfully implemented in several countries, including Indonesia and Iran and more recently Jordan. The path to the optimal scenario has been often characterized by an interim phase: Brazil and the Dominican Republic, just to provide a few notable examples, have moved toward the implementation of a safety net through an interim phase of a “fuel-specific safety net”—. The interim phase is often used by governments to target special groups such as transport providers or the middle class more broadly. Countries including Malaysia, the Philippines, and Iran first implemented other interim solutions, resorting to rationing through smart cards. Smart card rationing systems took a rather long time to become operational, but eventually became a powerful tool for fuel or other item management and pricing. Options for Compensation Mechanisms

11 FUEL SUBSIDY REFORM 11 Experience from selected case studies IndonesiaMalaysiaIran Brazil Dominican Republican Income Level Lower-middle Income Upper-Middle Income Lower-middle income Upper-Middle Income Subsidized Fuels/Services Electricity, Kerosene Gasoline, Diesel, Electricity Electricity, Kerosene, Gasoline, Diesel Gasoline, Diesel Electricity, LPG Phasing Out (% GDP savings per year) 2005: 3.5% of GDP in two years 2008: 1.3% in one year 2010: 15% in one year 2002 removal of LPG subsidy 2008: 3% of GDP in one year Compensatory measures Unconditional cash transfers 19.2 million Smart cards public transport operators and fishermen Smart cards, Unconditional cash transfers 73 million Conditional cash transfer with a gas component Risks Targeting Exclusion Errors and Leakage Black market Targeting Exclusion Errors and Leakage

12 SUBSIDY REFORM 12 Mitigation through block tariffs Tariff is kept low (below cost) for some minimum-needed level of consumption (“lifeline block”), with the difference made up through above-the-cost for higher level consumption (which tends to be associated with higher-income groups) The advantage is simplicity of implementation, but involves cross-subsidies and needs to be properly calibrated to ensure that the average tariff covers the cost

13 SUBSIDY REFORM 13 The key advantages of cash transfers programs as an element of social safety net are that they: (i) are less distorting to the upstream markets as the price signals are preserved; and (b) can be better targeted A disadvantage is a higher administrative cost, especially if cash transfer is made conditional on certain criteria that need to be to be proven/tested for each household that is to be covered The cost of the program was estimated to be much smaller than the size of the subsidies, with improved protection of the targeted groups There are a number of examples internationally to draw on (Indonesia, Mexico, Jordan, Iran, …) In 2005, Indonesia reduced poorly targeted fuel price subsidies by $10 billion, saved $5 billion, and allocated the rest to well targeted cash transfer and health and education programs Cash transfers

14 SUBSIDY REFORM 14 Cash transfers Cash transfers have been found in general to be progressive, vis-à-vis upstream fuel (or electricity) subsidies which are highly regressive. However, the implementation of targeted cash transfers can be challenging. Their effectiveness and efficiency depend on the targeting method and administrative capacity. Oportunidades is Mexico’s main anti-poverty government program using cash transfers to households linked to regular school attendance and health clinic visits. In 2007 an energy component was added.

15 SUBSIDY REFORM 15 Other mitigation mechanisms An approach is to give discount for electricity consumption on the basis of targeting by some income-test

16 FUEL SUBSIDY REFORM 16 A focus on recent subsidy reforms in GCC countries

17 FUEL SUBSIDY REFORM 17  Since mid-2015, UAE gasoline and diesel prices have declined so that by early 2016 most consumers are paying less than they did when fuel was subsidized. New electricity tariff increases in January 2016 in Abu Dhabi were 50% for electricity and 6.6% for water. However, natural gas remains well below international levels.  Oman increased by a third the price of low-grade gasoline from January 2016 as well as raising by 10% the price of diesel, and in March increased by 14% the price of water for commercial and industrial users. Oman also doubled gas tariffs for industrial producers and the power industry in January Oman has launched a major reform effort after the pioneering effort by UAE

18 FUEL SUBSIDY REFORM 18  Saudi Arabia announced in December 2015 a 5-year plan to raise prices. The largest price increases are 133% for ethane, 79% for transport diesel, and 67% each for natural gas and low-grade gasoline. Prices of electricity and water have also been raised for higher tiers of residential and for commercial and industrial users.  Bahrain announced at the end of December 2015 increases of 60% for low-grade gasoline and 20% for transport diesel (exempting fisheries and bakeries). Gas prices phased increases implemented from April  Qatar increased in January 2016 the price of low-grade gasoline by up to 35% (the first increase since 2011) after raising the price of diesel by 50% in May 2014 and increasing electricity and water prices, tiered according to consumption in October followed with announcements

19 FUEL SUBSIDY REFORM 19  During the 1 st round of tariff increases the emerging model in the GCC region has been to increase prices for energy intensive consumers - industry and commercial users with an assumed higher ability to pay – while then raising prices for the residential sector more gradually, including targeting non-nationals initially.  Most countries have introduced subsidized lifeline tariffs for electricity. In addition, in Bahrain, diesel price increases were exempted for selected sectors (including fisheries and bakeries) while in Oman the general authority for consumer protection has been ordered to monitor prices to ensure there are no unjustified increases.  Given the very generous set of benefits and allowances in place in the GCC region, the opportunity has also been selectively taken to make additional savings by reductions in transport allowances and fuel rationing. Key lessons from GCC countries

20 FUEL SUBSIDY REFORM 20 Importance of consider subsidies within a holistic framework, including:  Sequential phasing out subsidies, from the perspective of price reforms and fiscal impact.  Options to redeploy additional savings (after covering for compensation/transfers), including rebuilding fiscal buffers or growth-enhancing expenditures.  Complementary reforms to absorb the shock of price increases, in relation to energy efficiency, public transport and alternative sources of energy.  Concrete options to support energy and water conservation.  Appropriate mitigation options to minimize the impact on firms and the social contract, through targeted subsidies for the poor and as welfare-neutral as possible for the rest of the population. Key lessons for Oman and potential next steps

21 FUEL SUBSIDY REFORM 21 Fill Your Reform with Communication