Coping with Higher Oil Prices March 8, 2006

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Coping with Higher Oil PricesMarch 8, 2006

• Robert Bacon Masami Kojima
• Oil, Gas, and Mining Policy Division
• Funded by ESMAP

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Sector-level policies for coping with higher oil
prices

• 38 country case studies
• Overview of policies
• Price-based
• Quantity-based
• Substitution and efficiency improvement
• Lessons from effective and ineffective policies

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Country case studies

• Non-oil producing countries
• Africa Ethiopia, Kenya, Madagascar, Malawi,
  Morocco, Mozambique, Rwanda, Senegal, Tanzania,
  Zambia, Uganda
• Asia Cambodia, Lao PDR, Sri Lanka,
• South America Honduras, Nicaragua
• Oil-producing net importers
• Africa Ghana, Tunisia
• Asia Bangladesh, China, India, Indonesia, Kyrgyz
  Republic, Pakistan, Philippines, Thailand
• South America Guatemala, Brazil, Chile
• Net oil exporters
• Africa Cameroon, Egypt, Nigeria
• Asia Kazakhstan, Malaysia, Vietnam
• South America Argentina, Mexico, Venezuela
• Regional
• PetroCaribe

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Policy questions for this study

• How is the burden of the higher costs being
  shared between various parties in the economy?
• How can governments encourage savings in
  petroleum fuel use/cost?
• How can governments achieve public buy-in?
• How can governments design policies for sustained
  high oil prices and likely trends in oil
  consumption?

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Factors affecting policy formulation

• Growth in ratio of oil consumption to GDP
  expected for low-income countries
• ? Long-term policies to address sustained high
  oil prices and increasing vulnerability needed
• Challenges in the transport sector
• Substantial and rapidly growing oil consumption
• Reducing oil dependence difficult
• ? Full price increase pass-through and
  appropriate taxes
• Challenges in the power sector
• Droughts affecting hydro potential
• Fuel substitution difficult for countries with no
  coal and no natural gas
• ? Focus on commercial and technical efficiency
  gains

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Most commonly debated policy questions

• Subsidy/tax reduction or no subsidy/no tax
  reduction
• Price control or no price control
• Frequency of price adjustmentsoil price
  volatility
• When to announce price adjustments (public
  information campaign vs. danger of hoarding, fuel
  shortages)

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Price-based policies

• No government intervention full pass-through of
  world oil price increase
• Partial pass-through through direct government
  intervention
• Tax reductions or exemptions
• Product cross-subsidies
• Temporal cross-subsidies oil price stabilization
  funds
• Direct government subsidies
• Squeezing margins of oil companies
• Price caps, price freeze, requiring written
  justification, urging public to boycott stations
  that raise prices
• Export taxes or bans

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Quantity-based policies

• Rationing
• Fuel rationing (Kyrgyz in response to
  Kazakhstans export ban, diesel in Malaysia),
  vouchers for subsidized fuels, reduced supply
  (suspension of new LPG connections in India),
  rolling black-outs for power
• Energy-saving measures
• Rationing limits on office and street lighting,
  hours of business, neon lights, work days,
  driving, heating and cooling, use of elevators,
  fuel allocation to government agencies
  suspension of government vehicle purchase
• Promotion of energy-efficient appliances and
  equipment, public transport
• Higher taxes or ban on energy inefficient
  appliances and equipment

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Reducing supply costs

• Negotiation with suppliers
• Price hedging
• Bulk purchase
• Strategic reserves

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Diversifying out of oil

• Natural gas (Argentina, Egypt, Pakistan,
  Philippines, Tunisia)
• Coal coal to liquids (China, Indonesia)
• Renewables hydro, geothermal, etc.
• Biofuels
• Ethanol to substitute gasoline
• Biodiesel to substitute petroleum diesel
• Ethanol from sugarcane is the cheapest biofuel
  today

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Winning public buy-in

• Governments perceived legitimacy, public support
• Governments credibility for delivery of public
  goods
• Burden-sharing in acceptable manner, speed of
  policy adoption, strategic timing
• Transparency of policies
• Public awareness raising

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Country Experience
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Government responseprice-based policies

• Incorrect assumptions about size and duration of
  oil price increase led several governments,
  including reformist economies, to rapidly
  re-introduce price controls
• Magnitude and duration of price shock initially
  under-estimated
• Thailand Planned for 2 months duration at 128
  million vs. 19 months at 2.2 billion
• Initial government reaction re-adopt price
  control
• Suspend formula-based automatic pricing
  mechanismsChile, India, Pakistan
• Impose price caps or freezesArgentina, Chile,
  Honduras, Pakistan, Thailand

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High total cost of price control

• Government budget
• Country China Egypt India Indonesia
  Malaysia Morocco
• Billion US 1.2 7.2 0.8
  9.9 1.4 0.4
• Year 2005 FY06 FY06 2005
  2004 2004
• Oil companies (example costs)
• Country Argentina Brazil
  India Nigeria
• Billion US 0.2
  0.84 9.0 0.1
• Time period Jan 03-Apr 04 Jan-Jul 05
  FY06 Jul 2005
• Oil stabilization fund
• Country Chile Thailand
• Billion US 0.2 2.2
• Source Copper fund Bonds and bank loans
• Tax reductions, exemptions
• Many Countries

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Oil price stabilization fund

• Abandoned and not reactivated
• India, Philippines
• Depleted before 2005
• Chile transfer 200 million from copper fund
• Morocco
• Thailand (before 2004)
• Ethiopia (during 2004)
• Operational
• Chile, Malawi, Morocco, Thailand
• Talk of introducing or reactivating a
  stabilization fund
• Nigeria, Senegal, Zambia
• Key issues Is oil price mean-reverting?
  How long will it take before the fund
  becomes self-financing?

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Oil price stabilization fund Illustration
Transfer into and out of fund based on average
price between 1990 and 1999 daily consumption
500 barrels
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Smuggling and adulteration

• Substantial fiscal implications (ex. Cambodia)
• Pricing principles that give incentives for
  smuggling/adulteration entrench criminal elements
• Opec boys in DRC
• Murder of IOC official in India in November 2005
• Smuggling and adulteration make fair competition
  difficult
• Adulteration can make implementation of other
  regulations difficult
• Euro III and IV and diesel adulteration in India

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Reducing consumption

• Economic pricing of fuels including externalities
  addresses optimal consumption
• Few countries have announced systematic and
  policies to save energy, most policies
  exhortatory
• Some governments have mandated or offered
  incentives for reductions in energy use
• Philippines active and aggressive promotion by
  President
• Thailand mandatory limits on activities
• Vietnam all state agencies to cut gasoline use
  by 10
• Indonesia all government agencies to implement
  energy-saving measures
• Honduras state of emergency

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Squeezing oil companies India

• Burden sharing oil companies 51, government
  36, consumers 13 in FY06
• IOC, HPCL, BPCL, and IBP all reported first-ever
  losses in 20042005. Their under-recoveries are
  expected to reach 9 billion in FY06.
• ONGC, OIL, and GAIL in upstream are required to
  contribute 2.2 billion toward the shortfall
• 2.6 billion oil bonds issued in 2006

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Biofuel programs

• China ethanol 20 of gasoline consumed contained
  ethanol in 2005
• Colombia 10 ethanol in gasoline
• India 5 ethanol in certain states if ethanol is
  not more expensive, biodiesel purchase policy
• Indonesia 3 of energy from plant-based fuels by
  2025
• Malaysia biodiesel from palm oil, trial underway
• Philippines coco-biodiesel, ethanol
• Thailand 10 ethanol in gasoline

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Compensation schemes

• Cash transfer
• 29 per household to 2.2 million poor households
  in Chile
• 10 per month to 17.8 million poor households in
  Indonesia
• Inadequate database on the poor
• Change to conditional transfer in 2007
• 1.2-2.5 per month to the poor in some provinces
  in China
• Education
• Ghana (elementary and secondary school fee
  waiver)
• Indonesia (elementary school fee waiver,
  scholarships, free books, higher teacher
  salaries)
• Health
• Ghana (spending on primary health care)
• Indonesia (free medical treatment at some clinics
  and hospitals)
• Higher pension, minimum wage, civil service
  salaries
• Thailand

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Transparency of compensation policies

• Is compensation easy to verify?
• Universal schemes more easily verifiable by
  individual citizens
• Location-specific projects more difficult
• Road construction
• Can benefits be felt immediately?
• Is the delivery scheme designed to minimize
  diversion?

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Winning public buy-in

• Perceived legitimacy, popularity, and credibility
  of government
• Credible compensation scheme
• Historical record on effective delivery with
  tangible results
• Strategic timing
• Post election (Ghana, Indonesia, Thailand)
• After harvest (Morocco), beginning of Ramadan
  (Indonesia)
• Public information
• Ghana Identification of winners and losers,
  impact analysis, and design of compensation
  schemes informed by PSIA, followed by public
  debates on TV and radio

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Public buy-in Indonesia, January 2003
The fuel demonstrations are symbolic of a wider
public dissatisfaction with Ms Megawati's
government, and with the corruption and
inefficiency that still permeates political and
bureaucratic life in Indonesia The subsidy
reductions stand against the background of other
decisions that appeared to favor powerful
interests. In November, the government sought to
relieve five of the countrys largest debtors
from repayment obligations the incident has
reinforced the view that wealthy, influential
figures continue to receive special
treatmentwhile average Indonesians are faced
with price rises they can ill afford.
Economist Intelligence Unit - Business Asia, 27
January 2003
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Public buy-inIndonesia October 2005
A poll conducted in mid-December put President
Susilo's job approval rating at 56, a decline
from 63 in September. The President won respect
across the country for his integrity, as well as
performance in the areas of legal, security and
social welfare ever since he took office 15
months ago. Jakarta Post, 30 Dec. 2005
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Concluding remarks

• There is no dominating policy for amelioration,
  and governments will need a combination of
  policies, each making small contribution.
• Over medium term, governments should let fuel
  prices rise to market levels, and let market
  forces drive fuel consumption.
• Protection given to domestic refineries, poorly
  maintained infrastructure, and inefficient
  operations all increase supply costs.
• Greater efforts should be made to save energy,
  particularly where fuel substitution
  opportunities are limited.

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Concluding remarks

• Governments fiscal position, political support
  it enjoys, and history of governance all affect
  success of policies.
• Given oil consumption growth in transport,
  efforts at public transport reform, traffic
  management, and improving road infrastructure,
  all of which can reduce fuel consumption, merit
  serious attention.
• Fuel switching among poor households from solid
  fuels to cleaner commercial energy will be more
  challenging than ever before.
• Recognize the inefficiency of petroleum
  sector-specific intervention, and strengthen
  delivery mechanisms for general assistance
  targeting the poor.