1. Cleaner Fuels in Asia: The Role of Pricing, Taxation and Incentives Grant Boyle, UNU-IAS Cornie Huizenga, CAI, Asia Better Air Quality December 6-8 2004 Agra, India

2. Role of Pricing, Taxation and Incentives… Regulations -Bans -Fuel specifications Market Conditions -Pricing system -Ownership structure Market Instruments -Differential fuel taxation -Direct subsidies /Incentives Stakeholder Consensus Building -Public outreach -Government coordination

3. Overview 1.Market Conditions and Cleaner Fuels 2.Market Instruments and Cleaner Fuels 3.Recommendations for Use of Market Instruments in Asia

4. Market Conditions and Cleaner Fuels CountryPricingOwnership structureRefineries Bangladeshcontrolled/transitionalpublic 1 HK Chinamarketprivate - Indiatransitionalpublic/private7 Indonesiacontrolled/subsidizedpublic8 Japanmarketprivate32 Malaysiacontrolled/subsidizedpublic/private6 Pakistantransitionalpublic/private4 Philippinesmarketpublic/private2 PRCcontrolled/transitionalpublic16 Singaporemarketprivate3 South Koreamarketprivate5 Taipei, Chinatransition to marketpublic/private4 Thailandtransition to marketpublic/private.4 Vietnamcontrolledpublic0 (DOE, EIA, 2004)

5. Ownership Structure A free and competitive refining market is generally more amenable for generating capital for investments in cleaner fuels as well as allowing for imports of cleaner fuels. Example: the inability of Indonesia to phase out leaded gasoline is party due to the absence of mechanisms for attracting private capital for upgrades and the presence of barriers to regional imports.

6. Pricing Structure A free market pricing regime allows refiners to pass costs of higher quality fuels on to consumers and gives greater flexibility to refiners in meeting the costs of cleaner fuels. Example: –Singapore has mandated ULSD for 2005. –Oil companies anticipate a 3-5 S. cent increase in price for ULSD. –Costs to be passed onto the consumer in the form of higher prices. –Similar approach taken in 1999 when 500ppm diesel was introduced.

7. Pricing Structure A controlled pricing regime can have different implications for cleaner fuel markets. –On the one hand, controlled prices with price caps for consumers in countries like Indonesia or Malaysia may inhibit investments, as refiners are not able to pass extra costs onto consumers. –On the other hand, where price setting is accepted practice, governments posses the administrative levers to exert controls in favor of cleaner fuels. The deregulation of fuel prices in India, for example, may diminish the government’s ability to keep CNG prices sufficiently low compared to diesel.

8. Market Instruments and Cleaner Fuels Policy Rationale –To accelerate and support introduction of cleaner fuels and vehicles in conjunction with regulations. –Help to ensure efficient allocation of resources in meeting higher fuel standards in the region. –Help implement “Polluter Pays Principle” (for pump price differentials). Types –Differentiated tax on fuel products –Direct subsides/incentives for refiners –Taxes or incentives for higher quality vehicles

9. Tax Differentials A fuel tax differential creates a cost advantage for a higher quality fuel end product through an increased tax on the un- improved fuel, a lower tax on the improved fuel or both. Environmental/health goals are rarely reflected in fuel taxation, but differentials have been successful in accelerating benefits in many countries: UK, Sweden, Denmark, Germany, as well as in Asia.

10. Tax and Pricing Differentials for ULG in Asia Australia1993: ULG $AS 2 cent / liter less excise tax than LG Bangladeshnone HK China1991: ULG avg. $HK 0.52/ liter less tax than LG over 8 years Malaysia1991: ULG retail price 2.65% lower than LG Philippines1999: ULG 1 Peso/ liter less excise than LG PRC2000: LG tax raised to maintain same price as ULG Singapore1991: LG raised 12 S. cent/liter over ULG Sri Lankanone Thailand1991: ULG 1 Baht/ liter less excise tax than LG Vietnamnone

11. Example: ULSD in Hong Kong 2002 Hong Kong passed regulation for ULSD In July 2000 tax differential of HK$ 0.86 for 50ppm diesel relative to the conventional 500ppm. ULSD penetrated 100% of the market over the summer of 2000. During the summer, the pump prices of ULSD and regular diesel were equal. The government mandated higher vehicle standards- Euro 3, and undertook extensive diesel oxidation catalyst retrofit programme. Ongoing ‘tax revenue loss’. Source: Kong and Tsang, 2003 Tax differential lead to rapid market uptake

12. 1991 unleaded gasoline introduced and leaded banned in 1995. Costs to refiners estimated at B0.5/liter. Excise tax on unleaded set at B1 per liter less than leaded for both locally produced and imported fuel. Pump price set at B0.3 less for unleaded. Financed by Thai “Oil Fund” Example: Unleaded Gasoline in Thailand Wangwongwatana, 2002

13. Example: Unleaded Gasoline in the Philippines 1999 unleaded gasoline received 1 peso less excise than leaded (5.35 pesos to 4.35) Approximately a 0.5 peso pump price advantage for unleaded. Demand for unleaded in the initial year of operation expanded its market share from 20 to 34% in Metro Manila and 7 to 15% in the rest of the country. However, ULG was imported, rather than produced locally. A $US170 million Policy Loan under the “Metro Manila Air Quality Improvement Sector Development Program” with co-financing from Japan, drove refinery investments subsequently.

14. Direct Subsidies/ Incentives Producer subsidies/incentives can come in the form of a cash subsidy, usually allocated as a set amount or percentage of investment over a given time period or a targeted tax incentive on refinery investments.

15. Example: Lower Sulfur Diesel in Japan 1990-1992 "Tax Scheme for Promoting Investment in the Reform of the Energy Supply-Demand Structure", to lower sulfur content in diesel fuel below 2000ppm –7% deduction in corporate tax or –30% accelerated depreciation on the purchased equipment. –The second stage of the 1993-1997 for 500ppm used the same structure as the first phase. 2004 Japan allocated a 5.2 billion yen cash subsidy for refiners to produce 10ppm sulfur diesel, which has been mandated for Jan 2007. –The subsidy was allocated on a first come first serve basis for those companies that produce or import the fuel. –The scheme was developed by the Ministry of Industry, the Ministry of Finance and the Ministry of Environment –Funded from the "Oil and Energy Conservation Fund

16. Vehicle Incentives Tax benefits and rebates for cleaner vehicles that require cleaner fuels (unleaded gasoline, lower sulfur fuels) can indirectly support the local market for cleaner fuels or niche markets for cleaner fuels. Example: In 2004 the Singaporean government provided market incentives for cleaner vehicles that require ULSD (Euro 4) fuel. –Taxis that move from Euro 2 to Euro 4 standards will gain a rebate of 100% of the basic price of the car. –Euro 4 buses and commercial vehicles get an exemption of ‘additional registration’. –Accordingly, oil companies in Singapore have geared up to provide Euro 4 diesel for direct supply to these particular market segments. Cleaner vehicle incentives can indirectly support market development for cleaner fuels.

17. Factors Influencing Potential of Market Instruments in Asia for Cleaner Fuels Market orientation Finance capacity Institutional capacity Political feasibility

18. Recommendations Governments in the Asian region should develop clear plans for regulations as the primary means of improving fuel quality in the region. Governments in the Asian region should include health and environmental goals in fuel taxation policy in a consistent manner, along with economic, price stabilization and other concerns, particularly when the government is introducing higher quality fuels with public heath benefits and overall economic savings. Where the costs of domestic refinery upgrading to produce desired cleaner fuels are prohibitive or the investment environment is not attractive, governments should look toward regional imports over the short term to supply the cleaner fuel.

19. Recommendations To accelerate or support the introduction of cleaner fuels in Asia, governments should investigate the feasibility of adjusting fuel taxes to create a price advantage to stimulate demand among motorists. This can rest on pricing regimes in both state- owned and market oriented refining sectors. To accelerate or support the introduction of cleaner fuels in Asia, governments should investigate the feasibility of adjusting fuel taxes to create a price advantage for the cleaner fuel to stimulate investments in local refining sectors or expand imports. Tax differentials on end prices in state-controlled sectors are not appropriate means of stimulating investments in local refinery upgrades but may help to stimulate imports.

20. Recommendations To accelerate or support the introduction of cleaner fuels in Asia, governments with both state-owned and market oriented refining sectors should investigate the feasibility of employing direct subsidies and incentives to refiners. To accelerate or support the introduction of cleaner fuels in Asia, governments should investigate the feasibility of employing vehicle tax incentives to consumers to indirectly support the market for required cleaner fuels.