## _111015b

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### Executive summary and context
- Energy prices in the GCC countries are low by international standards and have co-existed with rapid economic development over the past 50 years.
- The implicit cost of low energy prices in the GCC, in terms of foregone revenue, is estimated to be around 5 percent of GDP (about 8 percent of non-oil GDP) this year.
- GCC countries have been embarking on energy price reform in recent years; the recent decision of the UAE to remove fuel subsidies is highlighted as an important initiative.
- Energy prices remain generally below international levels and differ substantially across GCC countries; further steps are needed to raise prices to reduce growth in energy consumption and to support fiscal adjustment in the current lower oil price environment.
- Evidence suggests the inflationary impact of higher energy prices in the GCC is likely to be small, and while there may be some adverse near-term effect on growth, longer-term growth benefits should be positive.

### A. Introduction: motives and political economy
- Key motivations for reform:
  - Low domestic energy prices absorb resources that could be invested or saved for future generations.
  - The drop in global oil prices increases the need for fiscal adjustment; energy price reform should be an important element of fiscal consolidation strategies.
- Political economy challenges:
  - Beneficiaries of low energy prices reluctant to give up benefits.
  - Government concerns: impacts on poor households, inflation, growth, social discontent, and competitiveness for energy-intensive sectors.
- Paper objective: analyze inflation and growth consequences of energy price reforms in the GCC and draw lessons from international experience.

### B. Energy price levels, fiscal costs, and consumption
- Price levels and regional differences:
  - Average gasoline and diesel prices in the GCC, except the UAE, are about 40 percent and 90 percent below pre-tax prices in the U.S., respectively.
  - Natural gas prices: U.S. pre-tax natural gas price (average January-August 2015) about $2.8 per MMBtu; GCC prices range from $0.75 per MMBtu (Qatar, Saudi Arabia, and the UAE) to $3 per MMBtu (Oman).
  - Electricity tariffs are also low compared with the U.S., with the UAE again an exception.
- Explicit budgetary cost (on-budget, 2015):
  - GCC governments, excluding Saudi Arabia, report on-budget fiscal cost from low energy prices estimated at $16.2 billion in 2015 budgets (2.1 percent of GDP), of which Kuwait and UAE account for $11.6 billion.
- Opportunity cost (price-gap approach):
  - Using U.S. pre-tax prices as benchmark:
    - 2014: $111 billion, equivalent to 6.8 percent of GDP.
    - 2015: $73 billion, equivalent to 5.2 percent of GDP.
  - Using the maximum price in the region as benchmark: estimated costs still amount to 4.8 percent of GDP for the GCC in 2015.
- Comparative magnitude and fiscal trade-offs:
  - In Bahrain and Kuwait, estimated opportunity cost of low energy prices was larger than public capital spending in 2014.
  - Ebeke and Lonkeng (2015) find public spending on education and health was on average 0.6 percentage point of GDP lower where opportunity cost of low energy prices was one percentage point of GDP higher.
- Energy consumption per capita and trends:
  - GCC consumed 9.2 tonnes of oil equivalent (TOEs) per capita in 2014; world average is 4 TOEs per capita.
  - Qatar: 23 tonnes per person.
  - Energy consumption per capita growth rates (annual average over last 40 years):
    - Qatar: 2.6 percent.
    - Saudi Arabia: 2.5 percent.
    - UAE: 1.9 percent.
    - Kuwait: 0.9 percent.
    - Average for countries with similar income per capita: 1 percent.
- Price–consumption relationship and elasticities:
  - Correlation between primary energy consumption per dollar of income and gasoline/diesel price about 57 percent (2014).
  - Estimated price elasticity of energy consumption (log regression) is minus 0.5 with confidence interval (-0.62, -0.28).
  - Charap et al. (2013): 10 degrees Celsius colder (hotter) increases energy consumption by 2.9 (2.6) percent.

### Distributional, environmental, and illicit trade implications
- Distributional impacts:
  - Generalized energy support programs often do not reach the most vulnerable.
  - World Bank examples: poorest 25 percent in several countries received only 1–7 percent of resources supporting diesel consumption.
  - IMF/Jordan example: richest quintile received about 20 percentage points more resources than poorest quintile; richest quintile received nearly 20 times more resources for gasoline and 6 times more for diesel than poorest quintile.
  - IEA (2011): poorest 20 percent receive about one tenth of resources spent to keep prices low for natural gas and electricity.
- Environmental and emissions implications:
  - World average CO2 emissions per capita about 10 tonnes in 2014.
  - GCC per capita CO2 emissions:
    - Qatar: 56 tonnes per person, tpp
    - UAE: 29 tpp
    - Kuwait: 28 tpp
    - Bahrain: 22 tpp
  - These high rates occur despite little coal use; domestic energy price adjustment could reduce environmental and health damages.
- Smuggling and black market risks:
  - Low domestic energy prices incentivize smuggling to higher-priced neighbors, increasing opportunity and administrative costs.

### Recent GCC reform actions and non-price measures
- Country actions (selected):
  - UAE: monthly gasoline/diesel price mechanism (August 2015); gasoline +25 percent, diesel -29 percent; Abu Dhabi water +170 percent and electricity +40 percent (January 2015); Dubai water/electricity +15 percent (early 2011).
  - Qatar: gasoline +25 percent and diesel +30 percent (January 2011); diesel +50 percent (May 2014); water/electricity tiered (October 2015).
  - Kuwait: diesel price doubled (January 2015); study on differentiated electricity/water tariffs (2014).
  - Oman: industrial natural gas price doubled (January 2015); energy sector study ongoing.
  - Bahrain: industrial gas +50 percent (from $1.50 to $2.25 per mmbtu) starting January 2012; announced annual increases to reach $4.0 per mmbtu by April 2021; fuel price increases in marine stations (March 2015); adjusted electricity/water tariffs for non-domestic users (October 2013).
  - Saudi Arabia: average electricity price sold to nonindividual users increased by over 20 percent (July 1, 2010); electricity tariffs for industries increased.
- Non-price measures and energy efficiency:
  - Saudi Arabia, UAE, and Qatar: independent bodies for energy efficiency, tougher building codes, appliance standards.
  - Many GCC countries exploring renewable electricity generation.
  - Constraint: low energy prices are a major obstacle to energy-efficiency investments; efficiency policies may be less effective than price increases because they do not reduce vehicle miles travelled (about half of long-run fuel demand elasticity per Small and Van Dender (2006)).

### International experience: elements of successful reforms
- IMF (2013a) review of 22 country case studies (28 reform episodes):
  - 12 episodes classified as success; 11 partial success; 5 unsuccessful.
- Elements increasing likelihood of success:
  - Comprehensive reform plan with stakeholders and mitigation measures (10 of 23 successful/partially successful episodes, 44 percent).
  - Extensive communication strategy (lack of information a barrier in 17 of 28 episodes; information campaigns underpinned success in multiple countries).
  - Appropriately phased and sequenced price increases (17 of 23 successful/partially successful episodes, 74 percent used phased reductions).
  - Targeted mitigating measures (18 of 28 episodes, 65 percent); cash transfers used in 9 episodes; expansion of social programs in 15 episodes.
  - Depoliticize pricing via automatic mechanisms or delegation to independent agencies (successful examples: South Africa, Philippines, Turkey; failures often due to reappearance of low prices).
  - Improve efficiency of state-owned energy producers to reduce fiscal burden and credibility concerns.

### Case studies: Indonesia and Malaysia (selected lessons)
- Indonesia:
  - Multiple attempts since 1997; 2008 fuel prices +29 percent on average; 2013 fuel prices gasoline +44 percent and diesel +22 percent.
  - December 2014: removal of gasoline subsidies and fixed per-liter diesel subsidy effective January 1, 2015; new pricing mechanism with periodic announcements every two to four weeks; implementation uneven with fuel prices unchanged since April 2015.
  - Compensating measures: unconditional cash transfers and targeted social programs using card technologies; savings aimed to finance social and infrastructure spending.
- Malaysia:
  - Moved from universal subsidies to targeted cash transfers since 2010; gradual price increases and liberalization of diesel and gasoline in April 2015.
  - Electricity +15 percent (January 2014); LPG subsidies remain for fishing and transportation at estimated cost of RM 2 billion (0.2 percent of GDP) in 2015.
  - 2015 budget increases cash transfers to households earning less than RM 4,000 per month and reviews overlapping programs.
- Cross-cutting lessons:
  - Excessively rapid subsidy reductions can generate opposition.
  - Durable reform requires long-term commitment and depoliticization.
  - Targeted cash transfers and effective communication are critical.

### Automatic price-setting mechanisms: design and sequencing
- Objectives: fully liberalize pricing regime or use automatic mechanisms as transitional steps to avoid ad hoc changes and depoliticize pricing.
- Mechanism design elements:
  - Specify pricing formula, timeline for updating components, and rules for when/how much retail prices change.
  - Incorporate smoothing rules to limit volatility.
- Common smoothing mechanisms:
  - Moving Average Mechanisms (MA): retail adjustments based on average of past international prices; longer averaging reduces change magnitude.
  - Price Band Mechanisms (PB): cap retail price variation; if required increase exceeds cap, implement cap; otherwise allow full adjustment.
- Country examples of automatic mechanisms and sequencing include Jordan, Tunisia, Mauritania, Morocco, Cote d’Ivoire, and UAE.

### Inflationary effects: GCC evidence and passthrough
- Pass-through determinants: CPI weight of energy products, anchored inflation expectations, magnitude of energy price increase.
- Cross-country evidence: ten percent increase in global oil prices increases headline inflation by between 0.5 and 1.4 percentage points.
- IMF (2011) median pass-through of oil price shock to transportation prices: 0.13 percent (advanced economies) and 0.17 percent (emerging/developing).
- GCC first-round effects likely low due to small CPI weights:
  - Gasoline and diesel (Transport sub-index) account for 1.79 percent and 3.26 percent of CPI in Kuwait and Bahrain, respectively.
  - A 10 percent increase in gasoline and diesel would increase inflation by 0.2 percentage points in Kuwait and 0.3 percentage points in Bahrain.
  - A 10 percent electricity tariff increase would raise CPI by 0.04 percentage points in Kuwait and 0.2 percentage points in Bahrain and Saudi Arabia.
- Historical shocks:
  - Monthly shocks to Housing and Transport sub-indices do not appear to translate into higher headline monthly inflation during the following 12 months in several GCC countries.
  - Example monthly figures:
    - Bahrain: Housing shock 3.02; Headline inflation when the shock occurs 0.81; Average headline inflation before and after the shock 0.21.
    - Kuwait: Housing shock 2.67; Headline inflation when the shock occurs 1.21; Average headline inflation before and after the shock 0.41.
    - Qatar: Transport shock *1.74; Headline inflation when the shock occurs 0.36; Average headline inflation before and after the shock -0.06.
- Recent country experiences:
  - Kuwait: 100 percent diesel price increase in January 2015 had no significant impact on inflation (data as of July 2015); transport prices did not increase in January, fell in March, and were flat in July.
  - UAE: gasoline +25 percent (August 2015) with diesel -29 percent led to modest annual inflation change (4.4 percent in July versus 4.9 percent in August).

### Near-term and longer-term growth impacts
- Short-term:
  - Higher domestic energy prices are a negative shock to production costs; energy-intensive sectors (aluminum, chemicals, metals, mining, plastics, petroleum refining, steel) are most affected.
  - Export-oriented firms (price takers) more affected due to limited pass-through.
  - Kuwait sectoral example (10 percent energy price increase):
    - Increment in energy cost about 30 percent of value added for sea transport.
    - Increment in energy cost about 10 percent of value added for air transport.
  - Case study — Aluminum Bahrain (ALBA):
    - Higher natural gas prices from April 2015: estimated annual cost impact about $30 million.
    - Based on 2014 financials: impact equals 1.7 percent of cost of sales and 12.1 percent of net profits; estimated impact during first semester 2015 implies about 8.7 percent impact on profits (cost of sales impact about 1.8 percent).
    - Aluminum production not affected; stock price reaction within volatility range.
- Longer-term:
  - Reform increases resource-use efficiency, encourages rational energy use, raises export revenues and/or lowers import bills, and strengthens budget structure—supporting growth.
  - Estimated permanent real income gains from closing price gaps (US pre-tax prices benchmark):
    - GCC aggregate: between 1.0 and 1.4 percent of GDP (between $14 and 20 billion).
    - Country estimates (percent of GDP, 2015):
      - UAE: 0.1-0.2
      - Oman: 0.4-0.7
      - Qatar: 0.5-0.8
      - Bahrain: 0.6-0.9
      - Kuwait: 1.6-2.2
      - Saudi Arabia: 1.5-2.1
    - Using maximum GCC prices as benchmark: GCC real income gains 0.9-1.3 percent of GDP.
  - Potential additional GDP impact from investing income gains:
    - Average return on equity (2013-2014): Kuwait 3.7 percent; Bahrain 8.3 percent; Oman 11.9 percent; Qatar 14.3 percent; Saudi Arabia 7.5 percent; UAE 7.1 percent; regional average about 8.8 percent.
    - If income gains invested at corporate-sector return rates, investments would generate between $1 billion and $1.5 billion additional income (2015 GDP reference).
      - Saudi Arabia: between $0.7 billion and $1 billion.
      - UAE: less than $0.05 billion.
    - Note: these returns are smaller than welfare gains estimated by Coady et al. (2015) from internalizing environmental externalities (MENA aggregate gains estimated at 4.7 percent of regional GDP).

### Policy recommendations and reform design principles
- Sequencing and mitigation:
  - Phase-in reforms gradually to allow productive sectors to adjust.
  - Provide temporary, targeted support to productive, tradable, and energy-intensive sectors that can remain competitive at post-reform prices; design should consider sector competitiveness and capital market functioning.
  - Restrict temporary support to sectors that can remain competitive; exclude sectors with domestic monopoly power unless competition increases.
- Distributional protection:
  - Appropriately sequence reforms to minimize impact on poor households and allow time to strengthen social protection systems, including targeted mitigating measures (e.g., cash transfers).
- Communication and stakeholder engagement:
  - Discuss reforms with stakeholders and implement extensive communication strategies to explain costs of current policies, benefits of reform, and use of budgetary savings.
- Depoliticize pricing:
  - Ensure reforms are resilient to reversal via transparent rules-based mechanisms ranging from smoothing mechanisms in the short and medium-term to full price liberalization over the longer-term.
- Efficiency of state-owned producers:
  - Improve efficiency to reduce fiscal burden and credibility/administrative capacity concerns.

### Annex I — Deadweight loss framework and illustrative growth scenarios
- Deadweight loss (DW) from domestic price Pd < world price Pw:
  - Government opportunity cost areas: B, E, and DW; consumers’ welfare increases by B and E; net loss DW.
  - DW can be estimated using Pw, Pd, Qd, and price elasticity of demand.
  - Empirical guidance: demand elasticity between -0.3 and -0.5 (Charap et al. (2013)).
- Illustrative scenarios (initial GDP $100 at t=0; reform at t=1; efficiency gains $10 in year of reform):
  - Assumptions: rate of return on investments 10 percent; depreciation 10 percent where applicable.
  - Scenario A — Extra income consumed:
    - Income path: $100 → $110 (t=1) then flat.
    - Economy grows 10 percent first year and zero afterwards.
    - Average growth increase: 1 percent per year over 10 years; 0.5 percentage point per year over 20 years.
  - Scenario B — Extra income invested, no depreciation:
    - Income path: $100, $110, $111, $112, $113, …; after 50 years income = $159.
    - Average growth rate: 1.79 percent over 10 years; 1.3 percent over 20 years.
  - Scenario C — Investments depreciate at 10 percent (investment income consumed):
    - Income path: $100, $110, $111, $111.9, $112.71, …; after 50 years income = $119.94.
    - Average growth rate: 1.54 percent over 10 years; 0.87 percent over 20 years.

*Prepared by Sergio Rodriguez, Malika Pant, and Juan Carlos Flores. Source: IMF staff analysis in the chapter "Energy price reforms will impact inflation and the productive sector, particularly in the near-term."*

### EXECUTIVE SUMMARY __________________________________________________________________________ 3

### _111015b - EXECUTIVE SUMMARY __________________________________________________________________________ 3

### EXECUTIVE SUMMARY
- Energy prices in the GCC countries are low by international standards and have co-existed with rapid economic development over the past 50 years.
- The implicit cost of low energy prices in the GCC, in terms of foregone revenue, is estimated to be around 5 percent of GDP (about 8 percent of non-oil GDP) this year.
- GCC countries have been embarking on energy price reform in recent years; the recent decision of the UAE to remove fuel subsidies is highlighted as an important initiative.
- Energy prices remain generally below international levels and differ substantially across GCC countries; further steps are needed to raise prices to reduce growth in energy consumption and to support fiscal adjustment in the current lower oil price environment.
- Evidence suggests the inflationary impact of higher energy prices in the GCC is likely to be small, and while there may be some adverse near-term effect on growth, longer-term growth benefits should be positive.
  - Low weight of energy products in the CPI implies limited first-round effects.
  - Well anchored inflation expectations should help prevent second-round effects.
  - Gradual increases should have a manageable impact on industrial activity, though energy intensive industries will be adversely affected and will need to adjust.
- International experience suggests higher chances of successful reform if reforms are:
  - Discussed with, and communicated to, stakeholders;
  - Introduced gradually to allow consumers and energy intensive firms to adjust consumption and production (also helps minimize inflationary impact);
  - Appropriately sequenced to minimize impact on poor households and allow time to strengthen social protection systems, including targeted mitigating measures;
  - Resilient, to avoid reversal—possibly requiring a transparent rules-based mechanism for setting energy prices ranging from smoothing price mechanisms in the short and medium-term to full price liberalization over the longer-term.

### A. Introduction
- Energy prices in the GCC are low by international standards; this has absorbed resources that could otherwise have been invested in human and physical capital or saved for future generations.
- The drop in global oil prices has increased the need for fiscal adjustment; energy price reform should be an important element of fiscal consolidation strategies.
- Reforms face political economy challenges:
  - Beneficiaries of low energy prices are reluctant to give up benefits.
  - Governments worry about impacts on poor households, inflation, growth, social discontent, and competitiveness for energy-intensive sectors.
- The paper provides analysis on possible inflation and growth consequences of energy price reforms in the GCC and draws lessons from international experience.

### B. Energy Prices and Their Impact in the GCC
- Price levels and regional differences:
  - Energy products in most GCC countries are sold considerably below international prices; large price differences exist within the GCC.
  - Average gasoline and diesel prices in the GCC, except the UAE, are about 40 percent and 90 percent below pre-tax prices in the U.S., respectively.
  - UAE prices are significantly above prices in the rest of the GCC.
  - Natural gas prices: U.S. pre-tax natural gas price (average January-August 2015) about $2.8 per MMBtu; GCC prices range from $0.75 per MMBtu (Qatar, Saudi Arabia, and the UAE) to $3 per MMBtu (Oman).
  - Electricity tariffs are also low compared with the U.S., with the UAE again an exception.
- Explicit budgetary cost of subsidies:
  - GCC governments, excluding Saudi Arabia, report an on-budget fiscal cost from low energy prices estimated at $16.2 billion in 2015 budgets (2.1 percent of GDP), of which Kuwait and UAE account for $11.6 billion.
  - Budget fiscal costs generally reflect payments to energy producing companies to compensate for the difference between production cost and domestic selling price, but do not include the opportunity cost (foregone revenue).
- Opportunity cost (price-gap approach) and magnitude:
  - A more comprehensive measure is the opportunity cost: difference between a benchmark price (often U.S. price) and domestic price, scaled by consumption volumes.
  - GCC opportunity cost estimates using U.S. pre-tax prices:
    - 2014: $111 billion, equivalent to 6.8 percent of GDP.
    - 2015: $73 billion, equivalent to 5.2 percent of GDP.
  - Using the maximum price in the region as benchmark, estimated costs still amount to 4.8 percent of GDP for the GCC in 2015.
  - With higher (export) benchmark prices the estimated opportunity cost would be larger.
- Comparative magnitude and fiscal trade-offs:
  - In Bahrain and Kuwait, the estimated opportunity cost of low energy prices (price gap approach) was larger than public capital spending in 2014.
  - For a sample of 109 countries, Ebeke and Lonkeng (2015) find public spending on education and health was on average 0.6 percentage point of GDP lower in countries where the opportunity cost of low energy prices was one percentage point of GDP higher.
- Energy consumption per capita and trends:
  - GCC countries consumed 9.2 tonnes of oil equivalent (TOEs) per capita in 2014; world average is 4 TOEs per capita.
  - Qatar led the sample with 23 tonnes per person.
  - Energy consumption per capita growth rates (annual average over last 40 years):
    - Qatar: 2.6 percent.
    - Saudi Arabia: 2.5 percent.
    - UAE: 1.9 percent.
    - Kuwait: 0.9 percent (compares with average negative growth in the UK, Germany, the USA, and Denmark).
    - Average growth rate for countries with similar income per capita: 1 percent.
- Price–consumption relationship and elasticities:
  - Clear negative association between energy prices and energy consumed.
  - Correlation between primary energy consumption per dollar of income produced and the price of gasoline and/or diesel (proxy for price of energy) is about 57 percent and strongly statistically significant using 2014 data.
  - Regressing energy consumption per unit of GDP against price of gasoline (natural logs) produces an estimated price elasticity of minus 0.5, with confidence interval of (-0.62, -0.28) — in line with other literature estimates.
  - Note: Charap et al. (2013) find that having a winter (summer) period that is on average 10 degrees Celsius colder (hotter) will increase energy consumption by 2.9 (2.6) percent.
- Structural implications:
  - Relatively cheap energy has contributed to large energy intensive sectors in the GCC, which are also capital intensive and net exporters of energy intensive commodities.
  - Low domestic energy prices reduce production costs and create incentives to expand energy intensive production in the short and medium term, absorbing capital that could otherwise expand skill intensive sectors and economic diversification.

*Prepared by Sergio Rodriguez, Malika Pant, and Juan Carlos Flores.*

### 11.      Higher-income households tend to be the main beneficiaries of low domestic energy

### _111015b - 11.      Higher-income households tend to be the main beneficiaries of low domestic energy

### Distributional impacts of low domestic energy prices
- Generalized support programs for energy products do not always reach the most vulnerable and are not particularly effective at redistributing income.
- World Bank findings cited:
  - The poorest 25 percent of the population in countries like Egypt, Jordan, Mauritania, Morocco, and Yemen received only 1–7 percent of the resources used to support diesel consumption.
  - In Egypt, the poorest 40 percent received only 3 percent of resources supporting gasoline consumption, 7 percent for natural gas, and 10 percent for diesel.
- IMF findings cited:
  - In Jordan the amount of resources to support energy consumption received by the richest quintile were about 20 percentage points higher than those received by the poorest quintile.
  - IMF (2013) indicates leakage to rich households was most pronounced for gasoline and diesel: the richest quintile received nearly 20 times more resources when consuming gasoline and 6 times more for diesel than the poorest quintile.
- IEA (2011) finding:
  - The poorest 20 percent of households receive only about one tenth of the resources spent to keep prices low for natural gas and electricity.

### Environmental and emissions implications
- High energy consumption places GCC countries among the world largest emitters of carbon dioxide per capita.
- World average carbon dioxide emissions per capita was about 10 tonnes in 2014.
- GCC country per capita emissions cited:
  - Qatar: 56 tonnes per person, tpp
  - UAE: 29 tpp
  - Kuwait: 28 tpp
  - Bahrain: 22 tpp
- Note: these high rates are striking given GCC countries use little coal, the most carbon intensive fuel.
- Implication: magnitude of per capita emissions points to significant environmental distortions, including health impacts that could be reduced through adjustment in domestic energy prices.
- Reference: Coady et al. (2015) discussion and estimation of costs associated with environmental damage created by energy consumption; conclusion that in many countries domestic energy prices do not reflect the cost of domestic environmental damage.

### Smuggling and black market risks
- Low domestic energy prices create strong incentives to smuggle products to neighboring higher-priced destinations, increasing the opportunity cost for the low-price country, including administrative cost.
- References: Heggie and Vickers (1998) and IMF (2014).

### Recent energy price initiatives in the GCC (summary of country actions)
- UAE:
  - Adopted a mechanism to adjust monthly gasoline and diesel prices against an international benchmark price (August 2015).
  - With the reform gasoline prices were increased 25 percent and diesel prices were reduced 29 percent.
  - Abu Dhabi increased water tariffs by 170 percent and electricity by 40 percent (January 2015).
  - Dubai raised water and electricity tariffs by 15 percent in early 2011.
  - Increased gasoline prices in 2010 to the highest level in the GCC.
- Qatar:
  - Raised pump prices of gasoline by 25 percent and diesel by 30 percent in January 2011.
  - Diesel prices raised by 50 percent in May 2014.
  - Water and electricity prices were raised and tiered according to consumption in October 2015.
- Kuwait:
  - Completed a study on differentiated electricity and water tariff structure in 2014.
  - Doubled the price of diesel prices in January 2015.
- Oman:
  - Energy sector study ongoing to gradually reduce fuel subsidy.
  - Industrial price for natural gas doubled in January 2015.
- Bahrain:
  - Gas price for existing industrial customers increased 50 percent starting January 2012, from $1.50 to $2.25 per mmbtu; price for new industrial customers remained at $2.50 per mmbtu (prices for new customers were increased from $1.30 to $2.50 in April 2010).
  - In March 2015 announced annual increases of $0.25 per mmbtu in gas price for industrial users starting April 1, 2015 until price reaches $4.0 per mmbtu by April 2021.
  - In March 2015 increased the fuel price in marine stations.
  - Electricity and water tariff structure adjusted for non-domestic users, increasing tariffs for higher consumption levels (October 2013).
- Saudi Arabia:
  - Increased the average price of electricity sold to nonindividual users by over 20 percent on July 1, 2010.
  - Increased electricity tariffs for industries (timing noted earlier in text).
- Regional note:
  - Despite reforms, differences in domestic energy prices across the region remain significant.

### Non-price measures and energy efficiency efforts in the GCC
- All GCC countries have begun investigating and implementing policies to improve energy efficiency.
- Saudi Arabia, UAE, and Qatar have:
  - Set up independent bodies for energy efficiency awareness programs.
  - Established tougher building codes and appliance standards.
- Many GCC countries exploring renewable electricity generation to meet additional demand and curb carbon dioxide emissions.
- Constraints:
  - Low energy prices are considered one of the biggest obstacles to increasing investments to improve energy efficiency.
  - Energy efficiency policies may be less effective than higher fuel prices because they do not reduce vehicle miles travelled, which accounts for around half of the long-run fuel demand elasticity (as documented for the U.S. by Small and Van Dender (2006)).

### International experience and elements of successful reforms
- IMF (2013a) review of 22 country case studies covering 28 major reform episodes (early 1990s – 2010s):
  - 12 reform episodes classified as a success.
  - 11 as a partial success (often because of reversals or incomplete implementation).
  - 5 as unsuccessful.
  - 14 case studies address fuel price reform, 7 electricity sector reform, 1 coal sector reform.
- Key elements that increase likelihood of success:
  - A comprehensive energy sector reform plan:
    - Formulated with stakeholders, clear long-term objectives, assess impacts, and identify mitigation measures.
    - Ten out of 23 successful or partially successful episodes (44 percent) addressed these points (examples: Armenia, Brazil, Kenya, Ghana, Iran, Namibia, Niger, Philippines (1996 and 2001), Turkey).
  - An extensive communication strategy:
    - Inform public of cost of current policies, benefits of reform, financing of costs, and budgetary savings.
    - In 17 out of 28 episodes (60 percent), lack of information was a barrier; information campaigns underpinned success in Armenia, Ghana, Iran, Namibia, Philippines, South Africa, and Uganda.
    - IMF (2011a) found likelihood of success almost tripled with strong public support and proactive communication.
  - Appropriately phased and sequenced price increases:
    - Phased approach provides time to adjust and reduces inflation impact; but gradual reform reduces short-term savings and can allow opposition to build.
    - Seventeen out of 23 successful or partially successful episodes (74 percent) involved phased subsidy reduction.
    - Seven out of 28 episodes sequenced price increases across products, focusing initial increases on products consumed more by higher-income groups and industry (examples: Brazil, Iran, Kenya, Namibia, Peru, Uganda).
  - Targeted mitigating measures:
    - Cash transfers, vouchers, expansion of social programs to protect the poor.
    - Eighteen out of 28 episodes (65 percent) relied on targeted mitigating measures.
    - Targeted cash transfers used in nine out of 28 episodes; expansion of existing social programs in 15 episodes.
    - Indonesia and Armenia used transfer programs to gain support.
    - Measures to help productive sector include gradual adjustment and financial support to reduce energy intensity.
  - Depoliticize energy pricing:
    - Durable reforms require depoliticized mechanisms: full liberalization or automatic pricing mechanisms reflecting international prices.
    - Eleven episodes (40 percent) were not fully successful because low domestic prices reappeared due to unwillingness to pass through continued international price increases.
    - Successful automatic mechanisms: South Africa (five decades), Philippines, Turkey; others include Chile, Colombia, Malawi, Nigeria, Peru, Thailand, Vietnam.
    - Some successful reformers (Armenia, Kenya, Philippines, Turkey) delegated pricing to an independent agency.
  - Improve efficiency of state-owned energy producers:
    - Reduces fiscal burden and addresses credibility and administrative capacity concerns.
    - Lack of credibility hindered reforms in Indonesia (2003) and Nigeria (2011); labor unions impeded Mexico electricity reform (1999–2002).

### Case studies: Indonesia and Malaysia (selected lessons)
- Indonesia:
  - Multiple attempts since 1997 with mixed success; large announced increases can provoke rollback.
  - 2008: domestic fuel prices raised by 29 percent on average; subsidies to larger industrial electricity consumers discontinued.
  - 2013: fuel prices raised by 44 percent for gasoline and 22 percent for diesel.
  - December 2014: removal of gasoline subsidies and fixed per-liter diesel subsidy effective January 1, 2015; lower international prices led to actual reductions in January 2015.
  - New pricing mechanism: gasoline sold at market prices; diesel price adjusts to market prices and exchange rate to maintain fixed per-liter subsidy; price changes announced every two to four weeks.
  - Implementation uneven; fuel prices kept unchanged since April 2015; electricity tariffs being raised monthly since May 2014; small- and medium-size retail users still subsidized.
  - Compensating measures included unconditional cash transfers and targeted social programs using card technologies; savings aimed to finance increased social and infrastructure spending.
- Malaysia:
  - Since 2010 moved from universal subsidies to targeted cash transfers and initiated fuel price reforms.
  - Gradual price increases (2013–14) and liberalization (floating) of diesel and gasoline prices in April 2015.
  - 15 percent increase in electricity prices in January 2014; removal of sugar subsidies; LPG subsidies remain in fishing and transportation sectors at estimated cost of RM 2 billion (0.2 percent of GDP) in 2015.
  - 2015 budget calls for increased cash transfers to poorer households (those earning less than RM 4,000 per month) and review of overlapping cash transfer programs.
- Cross-cutting lessons:
  - Excessively rapid subsidy reductions can generate opposition.
  - Durable successful reform requires long-term commitment.
  - Ad hoc adjustments and failure to depoliticize pricing lead to reemergence of subsidies.
  - Targeted cash transfers reduce opposition and assist the poor.
  - Effective communication of objectives and mitigation is critical.

### Automatic price-setting mechanisms (design and examples)
- Longer-term aim: fully liberalize pricing regime; automatic mechanisms can be a transitional step.
- Automatic pricing mechanisms:
  - Fully transmit international price fluctuations to domestic retail prices.
  - Avoid ad hoc price changes; can incorporate smoothing rules to limit volatility.
  - Implementation requires specifying pricing formula, timeline for updating components, and rules for when and how much retail prices change.
- Common smoothing mechanisms:
  - Moving Average Mechanisms (MA): retail adjustments based on average of past international prices over days/weeks/months; longer averaging reduces magnitude of changes.
  - Price Band Mechanisms (PB): set a maximum cap on retail price variation; if required increase exceeds cap, implement cap; if implied increase below cap, allow full adjustment.
- Country examples of automatic mechanisms and sequencing:
  - Jordan resumed monthly fuel price adjustment mechanism in January 2013.
  - Tunisia reintroduced automatic gasoline formula in January 2014 to allow convergence to international prices over time.
  - Mauritania adopted a new automatic diesel price formula in May 2012.
  - Morocco implemented partial indexation for certain petroleum products in September 2013, eliminated regulating gasoline and industrial fuel prices in January 2014, and introduced bimonthly reviews.
  - Cote d’Ivoire adopted an automatic pricing mechanism with smoothing in 2013.
  - UAE introduced a price mechanism to set monthly gasoline and diesel prices based on international prices in August 2015.

*Source: _111015b - 11.      Higher-income households tend to be the main beneficiaries of low domestic energy*

### 17.      Energy price reforms will impact inflation and the productive sector, particularly in the

### 17.      Energy price reforms will impact inflation and the productive sector, particularly in the near-term

### Inflationary Pressures
- Pass-through determinants:
  - Share of energy products in the consumption basket (CPI weight).
  - How well inflation expectations are anchored.
  - Magnitude of the increase in energy prices.
- Cross-country empirical evidence:
  - Studies estimate that a ten percent increase in global oil prices increases headline inflation by between 0.5 and 1.4 percentage points.
  - IMF (2011) reports the median pass-through of an oil price shock to transportation prices is 0.13 percent for advanced economies and 0.17 percent for emerging and developing economies.
- GCC-specific first-round effects (likely low):
  - Energy products have relatively small weights in the CPI for Bahrain, Kuwait, and Saudi Arabia.
  - Example impacts:
    - Gasoline and diesel (Transport sub-index) account for 1.79 percent and 3.26 percent of the CPI in Kuwait and Bahrain, respectively.
    - A 10 percent increase in the price of gasoline and diesel would increase inflation by 0.2 percentage points (pp) in Kuwait and 0.3 pp in Bahrain.
    - If electricity tariffs (Housing and Utilities sub-index) were increased 10 percent, CPI will increase 0.04 pp in Kuwait, and 0.2 pp in Bahrain and Saudi Arabia.
- Historical domestic shocks:
  - Monthly inflation shocks to CPI sub-indices Housing and Transport do not seem to translate into higher headline monthly inflation during the 12 months after a shock.
  - Example (monthly price changes in percent):
    - Bahrain: Housing shock 3.02; Headline inflation when the shock occurs 0.81; Average headline inflation before and after the shock 0.21.
    - Kuwait: Housing shock 2.67; Headline inflation when the shock occurs 1.21; Average headline inflation before and after the shock 0.41.
    - Qatar: Transport shock *1.74; Headline inflation when the shock occurs 0.36; Average headline inflation before and after the shock -0.06 (Transport difference statistically significant for Qatar; Housing significant for UAE).
- Recent country experience:
  - Kuwait: 100 percent increase in diesel prices in January 2015 had no significant impact on inflation (data as of July 2015); transport prices did not increase in January, fell in March, and were flat in July.
  - UAE: Gasoline price increase of 25 percent in August 2015 combined with a 29 percent reduction in diesel had a modest impact on annual inflation (4.4 percent in July versus 4.9 percent in August).

### Short–term impact on growth
- Immediate effect:
  - Increase in domestic energy prices is a negative shock to the productive sector via higher production costs.
  - Energy-intensive sectors affected include aluminum, chemicals, metals, mining, plastics, petroleum refining, and steel.
  - Export-oriented firms (price takers) are likely more affected because of difficulty passing on cost increases.
- Sectoral evidence for Kuwait:
  - Transport sector is largest consumer of fuel and oil products.
  - If fuel and oil product prices increase by 10 percent:
    - Increment in energy cost would be about 30 percent of value added for sea transport.
    - Increment in energy cost would be about 10 percent of value added for air transport.
  - Other vulnerable activities: renting of construction equipment, manufacturing of basic metals, and nonmetallic products.
- Adjustment approach:
  - Existence of energy-intensive sectors favors adopting a gradual approach for raising energy prices, particularly if systemic impacts are possible.
- Case study — Aluminum Bahrain (ALBA):
  - Announced higher natural gas prices starting in April 2015.
  - Estimated annual cost impact on ALBA at current consumption rates: about $30 million (ALBA Press Release, January 29, 2015).
  - Based on 2014 financial statements:
    - Impact represents 1.7 percent of the cost of sales and 12.1 percent of net profits.
    - Higher profits during the first semester of 2015 suggest a lower impact on profits of about 8.7 percent (impact on cost of sales about 1.8 percent).
  - Aluminum production has not been affected.
  - Stock price reaction: day before ALBA released assessment stock fell 1.21 percent (compare average daily returns of minus 0.09 percent during month before press release); change within volatility range.

### Longer–term impact on growth
- Efficiency and growth benefits:
  - Energy price reform increases resource-use efficiency, encourages more rational energy use, raises export revenues and/or lowers import bills, and strengthens budget structure—creating an environment conducive to economic growth.
  - Non-competitive firms at higher energy prices will need to reallocate capital and labor to more efficient activities.
- Estimated permanent real income gains from closing price gaps (using US pre-tax prices as benchmark):
  - GCC aggregate: between 1.0 and 1.4 percent of GDP (between $14 and 20 billion).
  - Assumptions: energy consumption price elasticity in range (-0.3, -0.5); consumers are fully compensated equal to the consumer surplus lost due to higher prices and lower consumption.
  - Country estimates (percent of GDP, 2015):
    - UAE: 0.1-0.2
    - Oman: 0.4-0.7
    - Qatar: 0.5-0.8
    - Bahrain: 0.6-0.9
    - Kuwait: 1.6-2.2
    - Saudi Arabia: 1.5-2.1
  - Using maximum prices prevailing in the GCC as the benchmark yields GCC real income gains in the range of 0.9-1.3 percent of GDP.
- Potential additional GDP impact from investing income gains:
  - Average return on equity in GCC corporate sector (2013-2014) ranges:
    - Kuwait 3.7 percent; Bahrain 8.3 percent; Oman 11.9 percent; Qatar 14.3 percent; Saudi Arabia 7.5 percent; UAE 7.1 percent.
    - Regional average about 8.8 percent.
  - If income gains are invested at corporate-sector return rates, investments would generate between $1 billion and $1.5 billion of additional income (using 2015 GDP as reference).
    - Saudi Arabia would receive between $0.7 billion and $1 billion.
    - UAE would receive less than $0.05 billion.
  - Note: these investment returns are smaller than welfare gains estimated in Coady et al. (2015) from increasing post-tax energy prices to account for externalities (MENA aggregate gains estimated at 4.7 percent of regional GDP).

### Policy recommendations and conclusions
- Reform sequencing and mitigation:
  - Phase-in reforms at a gradual pace to allow productive sectors to adjust.
  - If needed, provide temporary, targeted support to productive, tradable, and energy-intensive sectors that can remain economically competitive at post-reform prices.
  - Design of temporary support should consider sector competitiveness and the functioning of capital markets providing investment credit.
  - Restrict temporary support to sectors that can remain competitive; exclude sectors with domestic monopoly power unless reforms increase competition (to avoid protecting inflated profits).
- Opportunity cost and ongoing reform status:
  - Opportunity cost of maintaining low domestic energy prices is substantial:
    - Estimated at $73 billion or 5.2 percent of GDP in 2015 using the price gap approach with US pre-tax prices as benchmark for gasoline, diesel, natural gas, and electricity.
    - Opportunity cost similar if maximum prices prevailing in the GCC are used as reference.
  - Recent reforms:
    - Kuwait raised diesel prices; UAE raised gasoline prices to align domestic price with export prices.
    - Energy prices generally still below international levels and vary substantially across GCC countries.
    - Further steps are generally needed to raise energy prices to reduce growth in energy consumption and support fiscal adjustment in the lower oil price environment.

*Source: IMF staff analysis in the chapter "Energy price reforms will impact inflation and the productive sector, particularly in the near-term."*

### 31.      As they consider energy price reforms, governments are understandably concerned

### 31.      As they consider energy price reforms, governments are understandably concerned

### Economic and social concerns about energy price reforms
- Higher energy prices impact poorer households despite most benefits of low energy prices being enjoyed by better off households.
- Higher prices could lead to higher inflation and hurt competitiveness and growth.
- Evidence from the GCC region and elsewhere suggests potential downside risks can be managed and proper design of reform programs can greatly enhance prospects for success.

### Evidence on inflationary and growth impacts in the GCC
- The inflationary impact of higher energy prices in the GCC is likely to be small.
- First-round effects of higher energy prices should be limited given the low weight of energy products in the CPI.
- Well anchored inflation expectations should prevent second-round effects.
- Near-term: there may be some adverse effect on growth, particularly on energy intensive industries which might need support as they adjust.
- Longer-term: energy price reforms could generate permanent real income gains between 1.0 and 1.4 percent.
- Preliminary analysis suggests a gradual increase in energy prices should have a manageable impact on industrial activity.

### Design principles that increase likelihood of successful reforms
- Discussed with, and communicated to, stakeholders.
- Introduced gradually to allow consumers and energy intensive firms to adjust their consumption and production; gradual introduction should also help minimize the inflationary impact.
- Appropriately sequenced to minimize the impact on poor households and allow time to strengthen the social protection system, including targeted mitigating measures.
  - Evidence from reform efforts in other countries suggests that transfers to lower income households can mitigate the impact of higher energy prices on their well-being.
- Resilient, to avoid a reversal of reforms.
  - Could require a transparent rules-based mechanism for setting energy prices ranging from smoothing price mechanisms in the short and medium-term to full price liberalization over the longer-term.

### Annex I — Efficiency costs of price distortions: deadweight loss and impact on income (growth)
- Applied welfare economics postulates used:
  - a) The demand price for a given unit measures the value of that unit to the demander;
  - b) The supply price for a given unit measures the value of that unit to the supplier;
  - c) When evaluating net benefits or costs of a given action, costs and benefits accruing to each member of the relevant group should be added.
- Under a perfectly elastic supply curve (marginal cost zero, country is price taker at world prices Pw), consumer surplus equals area A for consumption Qw.
- If government sets domestic price Pd < Pw, consumption increases to Qd and the opportunity cost per unit is Pw – Pd.
  - The government’s opportunity cost is areas B, E, and DW (implicit subsidy or forgone revenue).
  - Consumers’ welfare increases by areas B and E.
  - Net loss to the economy is DW (deadweight loss / excess burden).
- Deadweight loss (DW) can be estimated using data on Pw, Pd, Qd, and price elasticity of demand.
- For a Cobb-Douglas type demand function, relationships provided:
  - (1.1) DWPw Pd Qd Qw
  - (1.2) (1()) Qd Qw DWPw Pd Qd Qd  
  - (1.3) ( ) Opportunity CostPw Pd Qd
  - (1.4) ()Qw Qd Percent Change in Quantity Consumed Qd  
  - (1.5) For a Cobb-Douglas type demand for Q: 4/ ; QwPw is the elasticity of demand QdPd      
- Empirical guidance: Charap et al. (2013) estimate the price elasticity of the demand for energy products between -0.3 and -0.5.

### Estimating impact on income (GDP) from reforms — illustrative scenarios
- Example assumptions:
  - Initial income (GDP) is $100 at t=0.
  - Energy price reform occurs at t=1.
  - Efficiency gains from the reform amount to $10 materialize during the year of the reform.
  - Rate of return on investments is 10 percent.
  - Depreciation rate is 10 per cent.
- Scenario A — Extra income consumed:
  - Income path: $100 (t=0) → $110 (t=1) then flat.
  - Economy grows 10 percent during the first year and zero percent afterwards.
  - Average growth rate increase: 1 percent per year over a 10-year period; 0.5 percentage point per year over a 20-year period.
- Scenario B — Extra income invested, no depreciation:
  - Investment produces $1 extra of income per year starting in t=2.
  - Income path: $100, $110, $111, $112, $113, …
  - After 50 years income = $159.
  - Growth rates: 10 percent in t=1; from t=2 growth falls from 0.9 percent in t=2 to 0.6 percent in t=50.
  - Average growth rate: 1.79 percent over 10 years; 1.3 percent over 20 years.
- Scenario C — Investments depreciate at 10 percent per year (investment income consumed):
  - Income path: $100, $110, $111, $111.9, $112.71, …
  - After 50 years income = $119.94.
  - Growth rates: 10 percent in t=1; from t=2 growth falls from 0.9 percent in t=2 to almost zero percent in t=50.
  - Average growth rate: 1.54 percent over 10 years; 0.87 percent over 20 years.

*Source: GCC ENERGY PRICE REFORMS — International Monetary Fund (excerpts from the supplied content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_111015b.pdf_