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Fuel price hike prompted by IMF views

|By K Raveendran| The deregulation of fuel prices in the UAE is no doubt a highly opportunistic move in the sense that the current oil price levels support market-driven pricing. But a major factor that prompted the decision is believed to be the recommendations of IMF.

The UAE Ministry of Energy recently announced that domestic gasoline and diesel prices would be deregulated starting from 1 August 2015. The official statement suggested that the move was aimed at supporting the economy, lowering fuel consumption, protecting the environment, encouraging adoption of fuel -efficient vehicles and preserving national resources.

The new pricing policy will be linked to average global prices, with the addition of operating costs. Petrol and diesel prices for the following month will be announced on the 28th of every month.

IMF has been advocating energy subsidy reforms, as subsidies have been found to be high in most countries. According to a recent IMF report, total global energy subsidies are projected at US$5.3 trillion in 2015, or 6.5 percent of global GDP. Most of this arises from countries setting energy taxes below levels that fully reflect the environmental damage associated with energy consumption.

According to IMF estimates, pre-tax energy subsidies in the UAE could stand at US$12.6 billion or 2.9 percent of the GDP. China is the top subsidizer in dollar terms, Ukraine in percent of GDP and Qatar in per capita subsidies.

The bulk of energy subsidies is attributed to undercharging for domestic environmental damage, including local air pollution, high population exposure to emissions and broader externalities from vehicle use like traffic congestion and accidents. In many top subsidizers in percent of GDP and in per capita terms, these also reflect the setting of domestic energy prices below their supply cost, IMF said.

The UAE has of late been placing a lot of emphasis on environmental issues and is keen to deflect any blame that could be laid at its door on account of policies that might contribute to the problem. Additionally, the adoption of reforms also brings in fiscal advantages, which may also have contributed to the decision.

It has been widely recognized that the timing of the fuel subsidy reform is opportunistically well chosen. This is because the lower oil prices reduce the differential between market and subsidised prices, and make the size of initial one-off adjustments more manageable. The linking of domestic fuel prices to international benchmarks would also set the way for automatic price increases in the future, eliminating the subsidy costs that would have been incurred if international oil prices increase going forward.

Fears have been expressed about the possible negative impact of the move on cost of living and inflation, but in view of the absence of firm indications on the initial price, quantification of such impact has not been possible.

Bank of America Merrill Lynch, however, believes that the price deregulation is unlikely to materially impact household cost of living.

“We expect the reform impact to have a positive, yet likely modest, indirect impact on fiscal accounts not exceeding 0.7% of GDP in total. The various UAE emirates do not report explicit energy subsidy costs, and state-owned oil companies accounts are not consolidated within the central government fiscal presentations. The Abu Dhabi government subsidies and transfers likely stood at AED48 billion in2014 (5.8% of GDP), but this largely represents ADWEA water and electricity tariff support (as the latter represented a third of total on – budget subsidies in 2011),” Bank of America Merrill Lynch said in its assessment.

The remainder of the subsidies was accounted for by housing support, Northern Emirates support, industrial, social and other support. The fiscal benefits are therefore indirect, in its view.

Energy subsidies and rapid domestic energy consumption growth pushed the fiscal breakeven oil price higher as ADNOC profit taxes remitted to the budget have been lower than otherwise. This is due to likely losses incurred at the distribution level units for subsidized oil products, the report points out. The losses are lower when measured in terms of direct subsidy cost (production cost, which is low, minus selling price), rather than opportunity cost (market price minus selling price), the report says.