With the global oil market seemingly entrenched in a low-price environment, budget shortfalls in oil-exporting nations are magnifying the inefficiency of government spending on petroleum subsidies. Even countries that have amassed significant currency reserves and wealth funds, such as Saudi Arabia, could soon face difficult decisions on spending cuts. Bloomberg Business recently cited analyst estimates that cutting all fuel subsidies would provide a massive increase in government revenue equivalent to 8 percent of the nation’s economic output—unsurprising given that pump prices for gasoline are 16 cents per liter in the kingdom due to subsidies. These savings could be augmented by cutting the use of crude oil for direct burn in power plants, which approaches 1 million barrels per day (mbd) during the Saudi summer.
If other nations—Saudi Arabia is reported to be considering similar measures at least in part—follow the UAE’s example and scrap fuel subsidies, there would be major impacts on the countries’ economies and global oil demand.
If it decides to reform subsidies, Riyadh would follow in the footsteps of its neighbor. The UAE recently made the decision to drop its fuel subsidies, with oil prices well below its fiscal breakeven price of over $65 per barrel. The UAE was the world’s sixth largest provider of pre-tax fuel price subsidies, providing $12.64 billion annually according to International Monetary Fund (IMF) estimates, and the move could serve as a turning point for subsidy policy among oil exporting economies. If followed by other nations—and Saudi Arabia is reported to be considering similar measures, at least in part—there would be major impacts on the countries’ economies and global oil demand.
The topic was illuminated in May by the IMF Fiscal Affairs Department. In a widely publicized study, the organization estimated that energy subsidies would cost $5.3 trillion as a whole worldwide in 2015—although the vast majority of that figure comes from implicit costs, such as environmental and health externalities, not factored into prices paid for energy. The study estimated that direct pre-tax energy subsidies total $333 billion. While this figure includes all energy sources, petroleum is responsible for the largest share. In absolute terms, the four countries spending the most on direct energy subsidies in 2015 are all major oil exporters—Iran, Russia, Saudi Arabia, and Venezuela—and between them they account for half of that $333 billion.
When compared to the size of their economies, oil producing nations face staggering costs from providing fuel subsidies.
When compared to the size of their economies, oil producing nations face staggering costs from providing fuel subsidies. Iran, after attempts to reform its fuel subsidies faltered amid political contention and sanctions woes, spends more on subsidies than any country relative to the size of its economy, according to the IMF report’s data. While Iran and Venezuela stand out by spending the equivalent of 14.9 and 10.5 percent of their respective GDPs on subsidies, other oil economies still exhibit drastic spending, with Saudi Arabia, Libya, Algeria, and the UAE all handing out between 2.8 and 4.7 percent of GDP on effective energy subsidies. Among OPEC nations, only Iraq and Nigeria fall below the weighted global average of 0.4 percent of GDP.
Demand soars where fuels costs are subsidized
The subsidies have undoubtedly had a major impact on demand. OPEC producers alone saw their share of global consumption rise 42 percent between 1992 and 2012, even as their portion of production rose only 4 percent. The biggest subsidizers have seen major transformations in consumption that are ultimately undermining fiscal stability. Since 1995, Venezuela has gone from consuming only 16.7 percent of the oil it produces to consuming 30.3 percent, while Iran has risen from 35.1 percent to 56 percent (although sanctions have boosted the latter figure from the mid-40s since 2011).
Not only does overconsumption of artificially cheap oil at home mean a loss of potential export revenue; the biggest subsidizers are, to a large degree, countries that can least afford it. Four of the five highest OPEC subsidizers, by percentage of GDP, are also dealing with breakeven oil prices estimated far above $100 per barrel. Against this backdrop, they are only exacerbating their own financial crises.
Oil prices to drop if subsidies scrapped
In the U.S., the issue of subsidies is a much different case than in major oil producing countries. Most of the annual $13.3 billion in the U.S. goes to research and renewables. For reference, EIA estimates that $2.3 billion in government expenditures supported natural gas and petroleum liquids in 2013, and do not consist of handout or price control systems like in many oil exporting nations. While direct subsidies for petroleum are thus negligible for the U.S., subsidies in oil exporters have a massive impact on global oil prices, and thus on total U.S. oil spending. By inflating global demand, subsidies make the world oil market tighter, and researchers at the Dallas Fed concluded last year that if oil producers cut their subsidies entirely, demand would decline sharply enough that the price of oil would drop by six percent, all other things remaining equal.
Given the risk of political upheaval from fuel price hikes, the timing of subsidy removal is crucial for any government.
Of course, given the risk of political upheaval from fuel price hikes, the timing of subsidy removal is crucial for any government. With many countries at the top of the energy subsidy list notably wary of—and harsh on—dissent, the risk takes on even greater significance. The current low-price environment stands to limit that risk, as returning to fuel prices based on the global market today would entail a far lesser shock to citizens than it would have in the first half of 2014. For example, the spread between the local and the U.S. price of a gallon of gasoline has dropped by 91 cents in Venezuela, 95 cents in Saudi Arabia, and 74 cents in Iran since Q2 2014. For oil producers facing budget crunches and looking to fight wasteful overconsumption, now is the time to act.