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SUBSIDIES FUEL BUDGETARY PRESSURE
BY FREDERIK RICHTER
Rising oil prices and growing domestic consumption are pushing the cost of fuel subsidies into untenable territory. The FY 2006-07 budget earmarks £E 40 billion for fuel subsidies, up from £E 22 billion this year, and more than is allocated to health and education combined. Oil exports have traditionally helped offset the cost of these subsidies, but oil production has declined nearly 40 percent since 1996 while consumption has risen almost 15 percent.
A projected FY 2005-06 budget deficit has some critics saying the government must rein in spending, including subsidies. The US embassy in Cairo states in its April 2006 Economic Trends Report that, “In all likelihood, the actual deficit will increase over the previous fiscal year, unless the government undertakes a comprehensive reform of subsidies and bloated public sector personnel roles.”
But Prime Minister Ahmed Nazif insists the issue is a difficult one. “We know that they have a serious impact on the national budget, but we also know that people are counting on them. So the removal of subsidies is a [complicated] matter that we will have to address carefully,” he said during the Economist Conference in March. “The question is not whether or not subsidies should be removed, but how and when.”
Fuel subsidies may keep prices low, which is vital for low-income consumers, but some economists contend there are drawbacks. The subsidies enrich the upper class, breed over-consumption, prop up otherwise failing companies and discourage investment in modern machinery.
A November 2005 working paper by the Egyptian Center for Economic Studies (ECES) titled “The Efficiency and Equity of Subsidy Policy in Egypt” found subsidies had contributed to alleviating poverty, but “at a high cost, including increased burden on the treasury, price distortions and commodity arbitrage, and leakage of subsidies to non-target groups.”
Gasoline prices, which have not increased in a decade, would be five to seven times higher without price controls, experts say. By comparison, a liter of fuel is £E 1 in Egypt, but the equivalent of £E 6.6 in Morocco and £E 16.7 in the US.
Cheap fuel reduces the incentive to purchase the most efficient production equipment because energy is no longer a significant operating cost.
Tom Walter, chairman and managing director of ExxonMobil Egypt, recalls having hotels as customers a few years ago that were running on diesel generators, rather than installing electrical lines, because diesel fuel was so inexpensive.
Yet changes are at hand. Until this year, energy subsidies were classified as expenses in the operating budgets of public sector energy companies. Now, according to finance minister Youssef Boutros-Ghali, they are included as line items in the national budget to “force society to deal with it.”
The Nazif government has taken steps to prepare the public for change. In September 2004, a cut in subsidized diesel fuel yielded a price hike from £E 0.40 per liter to £E 0.60. Public outcry ensued, which may help explain why Prime Minister Ahmed Nazif has been reluctant to make further cuts – particularly not to something as sensitive as gasoline.
In February 2005, the government tried to decrease reliance on subsidized gas by introducing two brands of less-subsidized, premium, high-octane gasoline priced at £E 1.40 and £E 1.75 per liter, compared to the cheaper alternatives at £E 1 and £E 0.90 per liter. The lower octane gas was never phased out like some expected, so the new gasoline blends had little impact on the subsidy bill.
In recent months, rumors have spread that the government is preparing to cut subsidies on gasoline – a charge the ministries of petroleum and social solidarity emphatically deny. Minister of Petroleum Sameh Fahmy was so incensed by the rumors that he summoned the press to reassure the public that the government had no such plans. On the contrary, the Shura Council in April approved an additional £E 20 billion in fuel and natural gas subsidies for the first half of the FY 2005-06 budget.
A separate question is whether subsidies actually reach those most in need. As fuel subsidies primarily benefit those who use diesel or gasoline to power their vehicles, some question whether these subsidies even reach the lower and middle class. “Cars are owned by and large by the fairly well-off sector,” says ExxonMobil’s Walter. “As a result, the subsidies are going directly to the people who least need it.”
According to Boutros-Ghali, the rich benefit by £E 1,700 per capita from fuel subsidies, while the poor benefit by only £E 300 per capita. To better target fuel subsidies, the parliament has discussed initiating a subsidy card, similar to the one used by the food subsidy system, that would allow low-income drivers to purchase fuel at lower costs than others. Yet, as of press time, no decision has been made on the scheme.
PRESSURE VALVE
While subsidies are a big issue, so too are the capped domestic prices on petroleum products that reduce the incentive for oil and gas exploration, which in turn affects supply. Speaking during an industry gathering last April in Alexandria, Stuart Fysh, British Gas Group’s executive vice president, outlined the problem upstream producers of natural gas face. “Egypt’s capped domestic gas price is now well below the price levels that others are having to pay for gas; both imported gas and domestically produced gas, in developed and developing economies,” he said. “And yet, Egypt’s upstream partners pay the same prices for rigs, wellheads and tubulars as companies supplying these other gas markets.”
Fysh pointed out that the current cost outlook makes gas exploration in Egypt less attractive than other countries. “About two-thirds of the economic return has been eroded away, markedly reducing the attraction of investing risk capital in Egyptian exploration,” he said.
He recommended that the government review its natural gas shipment and pricing strategies. “Explorers will need to see higher gas prices for their developments if they are to continue to risk their money in Egypt,” he said. “These price increases can come either by clearly identified access routes to global markets, or by increasing the domestic gas price – and most probably, a combination of both.”
Similar pricing structures exist on other oil and gas products.
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