## THE ECONOMICS OF ENERGY PRICE REFORM IN THE ISLAMIC REPUBLIC OF IRAN

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---

### A. Background
- Oil, gas and electricity play a major role in the Iranian economy:
  - Crude oil and gas exports earned an estimated 74 percent of foreign exchange receipts (24 percent of GDP) in 2008/09.
  - Oil revenues provided 65 percent of all fiscal revenues (16 percent of GDP) in 2008/09.
  - Value added in oil, gas and electricity generation accounted for almost 25 percent of GDP in 2008/09.
- Domestic energy prices were among the lowest in the MENA region and set below opportunity cost, with prices differentiated by user type.
- Consequences of low domestic prices:
  - Demand for gasoline grew by 9 percent per year in 1997–2006, over twice faster than per capita income.
  - Energy use per capita grew by about 4 percent per year in 1971–2002, four times faster than in low and high income countries.
  - At 1.5 million barrels per day in 2002/03, Iran’s oil consumption was similar to Spain’s, despite Spain having a GDP six times higher than Iran’s.
  - Iran’s primary energy intensity in electricity production is 30 percent higher than the OECD average.
  - Low fuel prices encouraged energy-intensive industries, excessive driving, congestion, pollution, and slowed development of alternative energies.
- Recent fragility: low prices discouraged energy saving, left insufficient surplus for investment, and Iran became a net importer of gasoline.

### B. Benefits from Reforming the Energy Sector
- Short- to medium-term gains:
  - Short-term: bringing energy prices to opportunity cost levels could strengthen the current account and external reserve position and reduce volatility in government capital spending.
  - Medium-term: improved energy allocation efficiency and lower energy intensity, improving competitiveness.
- Revenue and investment effects:
  - Higher revenues from liberalized energy prices would generate resources to maintain and expand energy production and support economic development and employment growth.
  - Gains in energy efficiency increase oil available for exports, raising export revenues.
  - Higher domestic energy prices increase profitability of the energy sector, providing revenues and incentives for research, investment, and energy-saving activities.
- Broader effects:
  - Support diversification of energy sources; reduce volatility in domestic capital spending, GDP and inflation.
  - Encourage energy saving among companies and households, enhancing competitiveness and benefiting the environment.
  - Allow the government to redistribute benefits more equitably, potentially increasing transfers to low income households that consume a relatively low share of heavily subsidized energy.

### C. International Experience on the Impact of Energy Price Reform on Long-Term Energy Efficiency
- Theoretical and empirical lessons:
  - Price increases induce technological change directly and indirectly.
  - Large increases in energy prices reduce energy consumption; small changes are relatively inelastic, but very large increases produce material falls in demand (example: Nigeria long-run price elasticity for aggregate energy demand estimated at minus 10 percent).
  - Increasing energy prices reduces energy intensity (examples: China after 1985 deregulation; transition economies after 1990s liberalization).
  - Reductions in energy intensity take time (example: Poland reduced overall energy intensity by 46 percent over 1989–2002).
  - Changing relative energy prices impacts producers differently and can change relative intensities across primary fuels.
  - Electricity prices must be increased in line with increases in primary fuel prices to allow electricity sector to absorb higher costs and finance expansion.
  - Long-term demand for energy in reforming developing and transition countries should be expected to grow; income-driven demand growth typically exceeds reductions in energy intensity.
- Policy implication for Iran:
  - Liberalization should include all primary energy prices as well as electricity prices to (a) minimize distortions as relative prices change, (b) allow the electricity sector to absorb higher gas and oil prices, and (c) finance new oil and gas production and electricity generation capacities.

### D. Impact of Price Reform
- Microeconomic impacts:
  - A significant increase in energy prices would:
    - Affect all energy users;
    - Increase production costs and prices of non-energy products;
    - Affect absolute and relative competitiveness of domestic producers depending on energy intensity;
    - Change demand patterns through substitution and income effects;
    - Alter the composition of exports away from energy-intensive goods.
- Household impacts:
  - Cost of living would rise for urban and rural, rich and poor.
  - Gasoline price increases likely induce substitution toward public transportation and an income effect toward less overall traffic.
  - Welfare effects heterogeneous: some households lose welfare; others gain (those using little energy—often the poor—could be compensated; households valuing time, reliable energy services, or environment may gain).
- Enterprise impacts:
  - Energy producers’ profitability would increase proportionately to the share of additional revenues they receive.
  - In electricity, benefit depends on whether tariffs are allowed to increase to fully recover higher primary fuel costs and on extent of electricity sector liberalization.
  - Non-energy, nonfinancial firms: impact depends on initial energy share in inputs, ability to pass costs to output prices, and ability to adopt energy-saving measures.
- Financial sector:
  - Initial impact likely negative; nonperforming loans may increase as weaker firms and some households seek loan deferment.
- Empirical boxed estimate (late 1990s):
  - To reach long-run marginal costs in the late 1990s, final energy prices for urban and rural households should have been raised about five-fold.
  - Resulting living expenses of an average urban and rural household would have increased by about 30 percent at the time, with a somewhat higher increase for rural households.
  - Revenues from higher energy prices could have allowed the government to compensate consumers for a large part of the increase; ultimate welfare impact depends on compensation size.

### E. Measures to Mitigate the Impact of the Reform
- Compensatory measures and targeting:
  - Compensatory payments can offset increases in living expenses for vulnerable households.
  - The share and targeting of compensation determines ultimate household welfare outcomes.
  - Electricity tariff adjustments are necessary to enable the electricity sector to cover higher primary fuel costs and to finance expansion.

### Impact on inflation and prices
- An increase in energy prices raises the price of energy products and energy-intensive goods and services.
- A gradual, rather than one-time, price increase could contribute to building inflationary expectations.
- Reduction of government subsidies resulting from the increase in energy prices would—in ceteris—increase fiscal savings, thereby helping to reduce inflation.

### Impact on GDP growth and employment
- Large energy price increases would have a negative impact on GDP growth and employment in the short-term, even though the long term impact should be positive.
- Country examples and quantified impacts:
  - Russian Federation (Mid-1990s): oil, gas, and coal: 30-40 percent → Impact on GDP: - 1.2 to -1.6 percent; Impact on employment: -1.1 to -1.3 percent
  - Moldova (2006-07): gas: 200 percent; electricity: 80 percent; oil price: 10 percent → 2006: -5.1 percent; 2007: -4.4 percent
  - Ukraine (2006-07): gasoline: 50 percent; gas: 123 percent → 2006: - 8.6 percent; 2007: -6 percent
  - Washington State, USA (2003-06): crude oil: 124 percent → -4.9 percent over the period (GDP); - 4.6 percent over the period (employment)

### Energy efficiency, demand, and elasticities
- Reform increases energy efficiency and reduces energy intensity.
- Short-term price elasticity of demand for energy products in Iran and other Middle Eastern countries is very low, but very large price increases needed to bring domestic prices to international levels are likely to dampen demand significantly, even in the short run.
- Short-run and long-run elasticities for gasoline and diesel in selected MENA countries:
  - Iran: Short-run Gasoline -0.124; Diesel -0.055. Long-run Gasoline -0.494; Diesel -0.129
  - Kuwait: Short-run Gasoline -0.143; Diesel -0.404. Long-run Gasoline -0.303; Diesel -2.694
  - Libya: Short-run Gasoline -0.081; Diesel 0.370. Long-run Gasoline -0.548; Diesel 1.585
  - Qatar: Short-run Gasoline -0.098; Diesel -0.149. Long-run Gasoline -0.133; Diesel ...
  - Saudi Arabia: Short-run Gasoline 0.002; Diesel -0.013. Long-run Gasoline 0.008; Diesel -0.033
  - U.A.E: Short-run Gasoline -0.188; Diesel 0.020. Long-run Gasoline -1.064; Diesel 0.163
- High long-run elasticity for gasoline suggests bringing gasoline prices to international level could significantly reduce Iran’s domestic gasoline consumption and substantially decrease, if not eliminate, the need for gasoline imports.

### Government finances and external position
- Net impact on government finances expected to be largely positive:
  - Positive channels: a share of revenues from higher prices could be transferred to the budget; lower consumption reduces need for imports of gasoline products and compensatory transfers to refineries.
  - Negative channels: lower tax revenues as economic activity slows; increased social benefits; higher cost of energy supplies to the government.
- External position effects:
  - Reduced domestic demand for energy would increase oil, gas, and electricity exports.
  - Imports would decline due to overall economic contraction and reduced demand for gasoline.
  - Higher profits could enable the Iranian National Oil Company to increase investment and supply of oil to world markets.

### Microeconomic measures to mitigate impact
- Preconditions and priorities:
  - Supporting measures depend on initial pre-reform conditions (mass public transportation, energy-efficient housing, individual energy meters, culture of energy saving).
  - Prioritize protecting households over enterprises to safeguard the poor and stimulate demand.
- Design of social safety net:
  - Determine eligibility, choose form of household support (cash transfers or low-user tariff schemes), calculate value of household support.
  - In absence of effective means-testing, a uniform compensation payment to the whole population is an option; such a transfer would necessarily be progressive.
- Ensure energy producers can collect receivables:
  - Public institutions must be fully funded and required to pay energy bills.
  - Vulnerable households should receive compensation but be required to pay for energy.
  - All households should be billed for individual energy consumption with high frequency.
  - Energy suppliers must have right to disconnect nonpaying customers and deploy measures (e.g., pre-paid meters).
- Commercial users and financial sector:
  - Commercial energy users must face a hard budget constraint; support (tax or cash for restructuring) could help their profitability and incentivize energy-efficient technologies.
  - Strengthen lending standards and banking supervision to prevent deterioration of banks’ lending portfolios.
- Credibility of accompanying measures is critical to avoid nonpayment culture, bailouts, and ineffective price signals.
- Fast liberalization combined with corporate restructuring yields largest gains in energy efficiency; delays and soft budget constraints impede gains.

### Macroeconomic measures to mitigate impact
- Macroeconomic policies should make reform non-reversible and ensure binding budget constraints to encourage adjustment.
- Fiscal policy design:
  - Gear fiscal policies to establish hard budget constraints while leaving fiscal space for downside risks during the initial phase.
  - A sufficiently large fiscal cushion should allow direct budget support rather than quasi-fiscal financing through the banking system.
- Monetary policy:
  - A tightening of monetary policy would be required to limit secondary effects of the price increase on the aggregate price level.
  - Authorities should monitor inflation closely and adjust monetary aggregates as needed.
  - Estimating money demand and nominal GDP will pose difficulties after energy prices are raised, as nominal GDP will surge when domestic energy sales are measured at higher prices.
- Exchange rate and trade policy:
  - Exchange rate policy should support the reform by ensuring adequate external competitiveness following the increase in prices.
  - Reforms should be accompanied by trade liberalization to ease access to energy-efficient equipment and household appliances.
  - A high degree of trade openness would reduce pass-through of higher energy prices to domestic inflation, especially when combined with tight monetary and exchange rate policies.

### Speed and design of the reform
- Reform approaches:
  - Single-step: single increase in tariffs and full liberalization of future price setting.
  - Multi-step: several incremental increases that eventually reach opportunity cost levels.
- Trade-offs:
  - Single-step preferred when required price change is not overwhelmingly large and supporting reforms are in place; risk of social discontent and reversal if too sharp.
  - Gradual reform easier to manage but risks building opposition that may stop further increases before benefits materialize.
- Design principles:
  - Ideally, all energy prices should eventually be increased to opportunity cost levels.
  - Initial administrative increases should be replaced by a free market mechanism for future price variations.
  - Liberalization of the entire electricity market (generation, transmission, distribution) may be critical to limit long-term increases in electricity prices while ensuring capital flows to competitive companies.
  - Energy sales should be subject to the same VAT rate as other goods and services; policymakers may delay energy taxation or accompany modest price increases with single-step imposition of VAT and excises.
  - Establish a professionally staffed public regulatory body to oversee the energy sector.
- Elements of a price mechanism:
  - Set the target price: export f.o.b.; import c.i.f.; or a fraction of the international price.
  - Choose speed of adjustment: single step; multi-step pre-determined; or multi-step adjusted for changes in the international price during reform period.
  - Decide future price-setting mechanism including decision maker, periodicity of adjustment, price base (market; explicit reference price; explicit price formula; or indexed to CPI/PPI), and price base calculation (single reference point or moving average).

*Source: _cr1076 — THE ECONOMICS OF ENERGY PRICE REFORM IN THE ISLAMIC REPUBLIC OF IRAN (Prepared by Dominique Guillaume and Roman Zytek (MCD); Approved by Middle East and Central Asia Department; January 11, 2010).*

### 2010. The views expressed in this document are those of the staff team and do not necessarily reflect

### THE ECONOMICS OF ENERGY PRICE REFORM IN THE ISLAMIC REPUBLIC OF IRAN

### A. Background
- Oil, gas and electricity play a major role in the Iranian economy.
  - Crude oil and gas exports earned an estimated 74 percent of foreign exchange receipts (24 percent of GDP) in 2008/09.
  - Oil revenues provided 65 percent of all fiscal revenues (16 percent of GDP) in 2008/09.
  - Value added in oil, gas and electricity generation accounted for almost 25 percent of GDP in 2008/09.
- Domestic energy prices have been among the lowest in the MENA region and set below opportunity cost, differentiated by user type (households and selected sectors received very low prices).
- Consequences of low domestic prices:
  - Excessive energy use: demand for gasoline grew by 9 percent per year in 1997–2006, over twice faster than per capita income.
  - Energy use per capita grew by about 4 percent per year in 1971–2002, four times faster than in low and high income countries.
  - At 1.5 million barrels per day in 2002/03, Iran’s oil consumption was similar to Spain’s, despite Spain having a GDP six times higher than Iran’s.
  - Iran’s primary energy intensity in electricity production is 30 percent higher than the OECD average.
  - Low fuel prices have encouraged energy-intensive industries, excessive driving, congestion, pollution, and slowed development of alternative energies (despite high solar potential).
- Recent fragility: low prices discouraged energy saving and left insufficient surplus for investment; Iran became a net importer of gasoline.

### B. Benefits from Reforming the Energy Sector
- Short- to medium-term gains:
  - Short-term: bringing energy prices to opportunity cost levels could strengthen the current account and external reserve position and reduce volatility in government capital spending.
  - Medium-term: improved energy allocation efficiency and lower energy intensity, improving competitiveness.
- Revenue and investment effects:
  - Higher revenues from liberalized energy prices would generate resources to maintain and expand energy production and support economic development and employment growth.
  - Gains in energy efficiency increase oil available for exports, raising export revenues.
  - Higher domestic energy prices increase profitability of the energy sector, providing revenues and incentives for research, investment, and energy-saving activities.
- Broader effects:
  - Support diversification of energy sources; reduce volatility in domestic capital spending, GDP and inflation.
  - Encourage energy saving among companies and households, enhancing competitiveness and benefiting the environment.
  - Allow the government to redistribute benefits more equitably, potentially increasing transfers to low income households that consume a relatively low share of heavily subsidized energy.

### C. International Experience on the Impact of Energy Price Reform on Long-Term Energy Efficiency
- Theoretical and empirical lessons:
  - Price increases induce technological change directly (energy-saving innovations) and indirectly (less energy-intensive equipment).
  - Large increases in energy prices reduce energy consumption; small changes are relatively inelastic, but very large increases produce material falls in demand (example: Nigeria long-run price elasticity for aggregate energy demand estimated at minus 10 percent).
  - Increasing energy prices reduces energy intensity (examples: China after 1985 deregulation; transition economies after 1990s liberalization).
  - Reductions in energy intensity take time (example: Poland reduced overall energy intensity by 46 percent over 1989–2002; other Eastern European countries showed slower convergence).
  - Changing relative energy prices impacts producers differently and can change relative intensities across primary fuels (coal, oil, gas, renewable).
  - Higher primary fuel prices boost performance and profitability of primary energy producers, while initially depressing non-energy nonfinancial enterprises.
  - Electricity prices must be increased in line with increases in primary fuel prices to allow electricity sector to absorb higher costs and finance expansion.
  - Long-term demand for energy in reforming developing and transition countries should be expected to grow; income-driven demand growth typically exceeds reductions in energy intensity.
- Policy implication drawn for Iran:
  - Liberalization should include all primary energy prices as well as electricity prices to (a) minimize distortions as relative prices change, (b) allow the electricity sector to absorb higher gas and oil prices, and (c) finance new oil and gas production and electricity generation capacities.

### D. Impact of Price Reform
- Microeconomic impacts
  - A significant increase in energy prices would:
    - Affect all energy users;
    - Increase production costs and prices of non-energy products;
    - Affect absolute and relative competitiveness of domestic producers depending on energy intensity;
    - Change demand patterns through substitution and income effects;
    - Alter the composition of exports away from energy-intensive goods.
  - Households:
    - Cost of living would rise for urban and rural, rich and poor.
    - Higher energy prices would change consumption baskets; gasoline price increases likely produce substitution toward public transportation and an income effect toward less overall traffic.
    - Welfare effects heterogeneous: some households lose welfare; others gain (those using little energy—often the poor—could be compensated; households valuing time, reliable energy services, or environment may gain as congestion falls and quality improves).
  - Enterprise level:
    - Energy producers’ profitability would increase proportionately to the share of additional revenues they receive.
    - In electricity, the benefit depends on whether tariffs are allowed to increase to fully recover higher primary fuel costs and on the extent of electricity sector liberalization.
    - Non-energy, nonfinancial firms: impact depends on initial energy share in inputs, ability to pass costs to output prices, and ability to adopt energy-saving measures and technologies; impact varies across and within sectors.
  - Financial sector:
    - Initial impact likely negative; nonperforming loans may increase as weaker firms and some households seek loan deferment.
- Boxed empirical estimate (from late 1990s analysis)
  - To reach long-run marginal costs in the late 1990s, final energy prices for urban and rural households should have been raised about five-fold.
  - Resulting living expenses of an average urban and rural household would have increased by about 30 percent at the time, with a somewhat higher increase for rural households.
  - Revenues from higher energy prices could have allowed the government to compensate consumers for a large part of the increase; ultimate welfare impact depends on compensation size.

### E. Measures to Mitigate the Impact of the Reform
- (Text indicates compensatory measures and targeting are relevant; specific measures discussed in subsequent sections of the original report. The supplied content highlights:)
  - Compensatory payments can offset increases in living expenses for vulnerable households.
  - The share and targeting of compensation determines ultimate household welfare outcomes.
  - Electricity tariff adjustments are necessary to enable the electricity sector to cover higher primary fuel costs and to finance expansion.

### F. Speed and Design of the Reform
- (The supplied content identifies design considerations based on international experience; detailed elements of design are discussed in the report’s later sections and boxes.)
  - Key design elements:
    - Include all primary energy prices and electricity prices in liberalization to avoid distortions.
    - Coordinate electricity tariff increases with primary fuel price changes.
    - Use higher energy sector revenues to finance investment in production capacity and energy-saving technologies.
    - Implement targeted compensatory mechanisms to protect low-income households while preserving incentives for energy saving.

*Prepared by Dominique Guillaume and Roman Zytek (MCD); Approved by Middle East and Central Asia Department; January 11, 2010.*

### 21.      An increase in energy prices would have a direct and indirect impact on the

### _cr1076 - 21.      An increase in energy prices would have a direct and indirect impact on the

### Impact on inflation and prices
- An increase in energy prices raises the price of energy products and energy-intensive goods and services.
- A gradual, rather than one-time, price increase could contribute to building inflationary expectations.
- Reduction of government subsidies resulting from the increase in energy prices would—all other things being equal—increase fiscal savings, thereby helping to reduce inflation.

### Impact on GDP growth and employment
- Large energy price increases would have a negative impact on GDP growth and employment in the short-term, even though the long term impact should be positive.
- Existing research indicates that output losses vary depending on the size of the price adjustment, duration of the reform, and mitigating policies.
- Country examples and quantified impacts (from Box 2):
  - Russian Federation (Mid-1990s): oil, gas, and coal: 30-40 percent → Impact on GDP: - 1.2 to -1.6 percent; Impact on employment: -1.1 to -1.3 percent
  - Moldova (2006-07): gas: 200 percent; electricity: 80 percent; oil price: 10 percent → 2006: -5.1 percent; 2007: -4.4 percent (impact on GDP)
  - Ukraine (2006-07): gasoline: 50 percent; gas: 123 percent → 2006: - 8.6 percent; 2007: -6 percent (impact on GDP)
  - Washington State, USA (2003-06): crude oil: 124 percent → -4.9 percent over the period (impact on GDP); - 4.6 percent over the period (impact on employment)

### Energy efficiency, demand, and elasticities
- The increase in energy prices will lead to an increase in energy efficiency and a reduction of energy intensity.
- Short-term price elasticity of demand for energy products in Iran and other Middle Eastern countries is very low, but very large price increases needed to bring domestic prices to international levels are likely to dampen demand significantly, even in the short run.
- International evidence and estimated price elasticities (from Box 3) — Short-run and Long-run elasticities for gasoline and diesel in selected MENA countries:
  - Iran: Short-run Gasoline -0.124; Diesel -0.055. Long-run Gasoline -0.494; Diesel -0.129
  - Kuwait: Short-run Gasoline -0.143; Diesel -0.404. Long-run Gasoline -0.303; Diesel -2.694
  - Libya: Short-run Gasoline -0.081; Diesel 0.370. Long-run Gasoline -0.548; Diesel 1.585
  - Qatar: Short-run Gasoline -0.098; Diesel -0.149. Long-run Gasoline -0.133; Diesel ...
  - Saudi Arabia: Short-run Gasoline 0.002; Diesel -0.013. Long-run Gasoline 0.008; Diesel -0.033
  - U.A.E: Short-run Gasoline -0.188; Diesel 0.020. Long-run Gasoline -1.064; Diesel 0.163
- High long-run elasticity for gasoline suggests bringing gasoline prices to international level could significantly reduce Iran’s domestic gasoline consumption and substantially decrease, if not eliminate, the need for gasoline imports.

### Government finances and external position
- Net impact on government finances should be largely positive:
  - Positive channels: a share of revenues arising from higher prices could be transferred to the budget; lower consumption reduces need for imports of gasoline products and compensatory transfers to refineries.
  - Negative channels: higher energy prices likely to result in lower tax revenues as economic activity slows, increased social benefits (unemployment and welfare), and higher cost of energy supplies to the government.
- External position effects:
  - Reduced domestic demand for energy would increase oil, gas, and electricity exports.
  - Imports would decline due to overall economic contraction and reduced demand for gasoline.
  - Higher profits could enable the Iranian National Oil Company to increase investment and the supply of oil to world markets, possibly impacting oil prices.

### Microeconomic measures to mitigate impact
- Supporting measures depend on initial pre-reform conditions (mass public transportation, energy-efficient housing, individual energy meters, culture of energy saving).
- Prioritize protecting households over enterprises to safeguard the poor and stimulate demand.
- Design of an efficient social safety net requires:
  - Determining eligibility,
  - Choosing form of household support (cash transfers or low-user tariff schemes),
  - Calculating value of household support.
- In absence of effective means-testing, a uniform compensation payment to the whole population is an option; such a transfer would necessarily be progressive.
- Ensure energy producers can collect receivables:
  - Public institutions must be fully funded and required to pay energy bills.
  - Vulnerable households should receive compensation but be required to pay for energy.
  - All households should be billed for individual energy consumption with high frequency.
  - Energy suppliers must have the right to disconnect nonpaying customers and deploy measures (e.g., pre-paid meters).
- Commercial energy users must face a hard budget constraint; support (tax or cash for restructuring) could help their profitability and incentivize energy-efficient technologies.
- Strengthen lending standards and banking supervision to prevent deterioration of banks’ lending portfolios as borrowers face higher energy bills.
- Credibility of accompanying measures is critical to avoid nonpayment culture, bailouts, and ineffective price signals.
- Fast liberalization combined with corporate restructuring yields largest gains in energy efficiency; delays and soft budget constraints impede gains.

### Macroeconomic measures to mitigate impact
- Macroeconomic policies should make reform non-reversible and ensure binding budget constraints to encourage adjustment.
- Transparent and tight fiscal and monetary policies will limit market distortions and noise in market signals.
- Fiscal policy design:
  - Gear fiscal policies to establish hard budget constraints while leaving fiscal space for downside risks during the initial phase.
  - A sufficiently large fiscal cushion should allow direct budget support rather than quasi-fiscal financing through the banking system.
- Monetary policy:
  - A tightening of monetary policy would be required to limit secondary effects of the price increase on the aggregate price level.
  - Authorities should monitor inflation closely and adjust monetary aggregates as needed.
  - Estimating money demand and nominal GDP will pose difficulties after energy prices are raised, as nominal GDP will surge when domestic energy sales are measured at higher prices.
- Exchange rate and trade policy:
  - Exchange rate policy should support the reform by ensuring adequate external competitiveness following the increase in prices.
  - Reforms should be accompanied by trade liberalization to ease access to energy-efficient equipment and household appliances.
  - A high degree of trade openness would reduce pass-through of higher energy prices to domestic inflation, especially when combined with tight monetary and exchange rate policies.

### Speed and design of the reform
- Reform approaches:
  - Single-step: single increase in tariffs and full liberalization of future price setting.
  - Multi-step: several incremental increases that eventually reach opportunity cost levels.
- Trade-offs:
  - Single-step preferred when required price change is not overwhelmingly large and supporting reforms are in place; risk of social discontent and reversal if too sharp.
  - Gradual reform easier to manage but risks building opposition that may stop further increases before benefits materialize.
- Ideally, all energy prices should eventually be increased to opportunity cost levels.
- Initial administrative increases (single-step or phased) should be replaced by a free market mechanism for future price variations.
- Liberalization of the entire electricity market (generation, transmission, distribution) may be critical to limit long-term increases in electricity prices while ensuring capital flows to competitive companies.
- Taxation and VAT:
  - Energy sales should be subject to the same VAT rate as other goods and services.
  - To limit impact of sharp price increases, authorities in some countries have partially delayed energy taxation.
  - Alternatively, modest domestic price increases can be accompanied by single-step imposition of VAT and excises to ensure full budget funding during the reform period.
- Establish a professionally staffed public regulatory body to oversee the energy sector to bring the full benefits of market competition.

- Elements of the design of a price mechanism (Box 4):
  - Set the target price: export f.o.b.; import c.i.f.; or a fraction of the international price.
  - Choose speed of adjustment: single step; multi-step periodic pre-determined increases to pre-set target; or multi-step adjusted for changes in the international price during reform period.
  - Decide future price-setting mechanism including:
    - Selection of decision maker: independent regulatory body; energy monopoly; government; or market-driven mechanism.
    - Periodicity of adjustment: continuous market-based; at pre-determined intervals (weekly, monthly, quarterly); or ad hoc.
    - Price base: market; explicit reference price (import or export); explicit price formula; or indexed to CPI/PPI.
    - Price base calculation: price at a point in time of a single reference commodity or price index; or a moving average of preceding period prices.

*Source: _cr1076 - 21.      An increase in energy prices would have a direct and indirect impact on the price level by raising the price of energy products and energy-intensive goods and services.*

### REFERENCES

### REFERENCES

### Energy consumption, growth, and demand studies
- Apergis, Nicholas and James E. Payne, 2009, “Energy Consumption and Economic Growth: Evidence from the Commonwealth of Independent States,” Energy Economics, 31, pp. 211-216.
- Belloumi, Mounir, 2009, “Energy Consumption and GDP in Tunesia: Cointegration and Causality Analysis,” Energy Policy 37, pp. 2745-2753.
- Hang, Leiming and Meizeng Tu, 2007, “The Impacts of Energy Prices on Energy Intensity: Evidence from China, Energy Policy 35, pp. 2978-2988.
- Mehrara, Mohsen, 2007, “Energy Consumption and Economic Growth: The Case of Oil Exporting Countries,” Energy Policy 35, pp. 2939-2945.
- Sari, Ramazan and Ugur Soytas, 2007, “The Growth of Income and Energy Consumption in Six Developing Countries,” Energy Policy 35, pp. 889-898.
- Zamani, M., 2007, “Energy Consumption and Economic Activities in Iran,” Energy Economics 29, 1135-1140.
- Narayan, Paresh Kumar and Russell Smyth, 2007, “A Panel Cointegration Analysis of the Demand for Oil in the Middle East,” Energy Policy 35, pp. 6258-6265.
- Iwayemi, Akin, Adeola Adenikinju, and M. Adetunji Babatunde, 2009, “Estimating Petroleum Products Demand Elasticities in Nigeria: A Multivariate Cointegration Approach,” Energy Economics, Article in Press.
- Bhattacharyya, Subhes C. and Andon Blake, 2009, “Domestic Demand for Petroleum Products in MENA countries,” Energy Policy 37, pp. 1552-1560.
- Narayan, Paresh Kumar and Russell Smyth, 2007, “A Panel Cointegration Analysis of the Demand for Oil in the Middle East,” Energy Policy 35, pp. 6258-6265.

### Oil prices, macroeconomic effects, and shocks
- Barsky, Robert B. and Lutz Kilian, 2004, “Oil and the Macroeconomy Since the 1970s,” Journal of Economic Perspectives 18/4, pp. 115-134.
- Chen, Shiu-Sheng, 2009, “Oil Price Pass-through into Inflation,” Energy Economics 31, pp. 126-133.
- Kilian, Lutz, 2008, “The Economic Effects of Energy Price Shocks,” Journal of Economic Literature 46, pp. 871-909.
- Farzanegan, Reza Mohammad and Gunther Markwardt, 2009, “The Effects of Oil Price Shocks on the Iranian Economy,” Energy Economics 31, pp. 134-151.
- Cameron, Ken and Oliver Schnusenberg, 2009, “Oil Prices, SUVs, and Iraq: An Investigation of Automobile Manufacturer Oil Price Sensitivity,” Energy Economics 31, pp. 375-381.
- Finn, Mary G, 2000, “Perfect Competition and the Effects of Energy Price Increases on Economic Activity,” Journal of Money, Credit, and Banking 32, pp. 400-416.
- Dhawan, Rajeev and Karsten Jeske, 2006, “How Resilient Is the Modern Economy to Energy Price Shocks?” Federal Reserve Bank of Atlanta Economic Review, Third Quarter, pp. 21-32.

### Subsidies, affordability, and distributional impacts
- Coady, David, Moataz El-Said, Robert Gillingham, Kangni Kpodar, Paulo Medas, and David Newhouse, 2006, “The Magnitude and Distribution of Fuel Subsidies: Evidence from Bolivia, Ghana, Jordan, Mali, and Sri Lanka,” IMF Working Paper WP/06/247.
- Dodonov, Boris, Petra Opitz, and Wolfgang Pfaffenberger, 2004, “How Much Do Electricity Tariff Increases in Ukraine Hurt the Poor?” Energy Policy 32, pp. 855-863.
- Fankhauser, Samuel, Yulia Rodinova, and Elisabetta Falcetti, 2008, “Utility Payments in Ukraine: Affordability, Subsidies, and Arrears,” Energy Policy 36, pp. 4168-4177.
- Saboohi, Y, 2001, “An Evaluation of the Impact of Reducing Energy Subsidies on Living Expenses of Households,” Energy Policy 29, pp. 245-252.
- Freund, Caroline and Christine I. Wallich, 1996, “The Welfare Effects of Raising Household Energy Prices in Poland,” Energy journal 17/1, pp. 53-77.
- Navajas, Fernando H., 2009, “Engel Curves, Household Characteristics and Low-User Tariff Schemes in natural Gas,” Energy Economics 31, pp. 162-168.
- Olivia, Susan and John Gibson, 2008, “Household Energy Demand and the Equity and Efficiency Aspects of Subsidy Reform in Indonesia,” Energy Journal 29/1, pp. 21-39.
- Coady, David et al., 2006, “The Magnitude and Distribution of Fuel Subsidies: Evidence from Bolivia, Ghana, Jordan, Mali, and Sri Lanka,” IMF Working Paper WP/06/247.

### Energy sector reform, regulation, and quasi-fiscal activities
- Awerbuch, S. and M. Berger, 2003, “EU Energy Diversity and Security: Applying Portfolio Theory to Electricity Planning and Policy-Making,” International Energy Agency, available at http://www.awerbuch.com
- Awerbuch, S. and R. Sauter, 2005, “Exploiting the Oil-GDP Effect to Support Renewables Deployment” The Freeman Centre, University of Sussex , Science and Technology Policy Research (SPRU), Paper No. 129 (January 2005), http://www.sussex.ac.uk/spru/
- Braber, Rini and Frank van Tongeren, 1996, “Energy Price Reforms in Russia,” Moct-Most- Economic Policy in Transitional Economies 6/2, pp. 139-162.
- Hirschhausen von, Christian and Thomas W. Waelde, 2001, “The End of Transition: An Institutional Interpretation of Energy sector Reform in Eastern Europe and the CIS.” MOCT-MOST Economic Policy in Transitional Economies 11/3, 91-108.
- Jannuzzi, De Martino Gilberto, 2005, “Power Sector Reforms in Brazil and its Impacts on Energy Efficiency and Research and Development Activities,” Energy Policy 33, pp. 1753-1762.
- Williams, J.H. and Ghanadan, 2006, “Electricity Reform in Developing and Transition Countries: A Reappraisal,” Energy 31, pp. 815-844.
- Petri, Martin, Gunther Taube, and Aleh Tsyvinski, 2002, “Energy Sector Quasi-Fiscal Activities in the Countries of the Former Soviet Union,” IMF Working Paper WP/02/60.
- Saavalainen, Tapio and Joy ten Berge, 2006, “Quasi-Fiscal Deficits and Energy Conditionality in Selected CIS Countries,” IMF Working Paper WP/06/43.
- Tchaidze, Robert, 2007, “Quasi-Fiscal Deficits in Nonfinancial Enterprises,” IMF Working Paper WP/07/10.
- Wang, Qiang, Huan-Ning Qui, and Yaoqiu Kuang, 2009, “Market-Driven Energy Pricing Necessary to Ensure China’s Power Supply,” Energy Policy 37, pp. 2498-2504.
- Erdogdu, Erkan, 2007, “Regulatory Reform in Turkish Energy Industry: An Analysis,” Energy Policy 35, pp. 984-993.

### Iran-specific studies and regional energy issues
- Alnatheer, Othman, 2005, “The Potential Contribution of Renewable Energy to Electricity Supply in Saudi Arabia,” Energy Policy 33, pp. 2298-2312.
- Davoudpour, Hamid and Mohammad Sadegh Ahadi, 2006, “The Potential for Greenhouse Gases Mitigation in Household Sector of Iran: Cases of Price reform/Efficiency Improvement and Scenario for 2000-2010,” Energy Policy 34, pp. 40-49.
- Farzanegan, Reza Mohammad and Gunther Markwardt, 2009, “The Effects of Oil Price Shocks on the Iranian Economy,” Energy Economics 31, pp. 134-151.
- Jafari, Houri H. and A. Baratimalayeri, 2008, “The Crisis of Gasoline Consumption in the Iran’s Transportation Sector,” Energy Policy 36, pp. 2536-2543.
- Karbassi, A.R., M.A. Abduli, and E. Mahin Abdollahzadeh, 2007, “Sustainability of Energy Production and Use in Iran,” Energy Policy 35, pp. 5171-5180.
- Mohammadi, Hassan, 2009, “Electricity Prices and Fuel Costs: Long-run Relations and Short-run Dynamics,” Energy Economics 31, pp. 503-509.
- Mostafaeipor, Ali and Neda Mostafaeipor, 2009, “Renewable Energy Issues and Electricity Production in Middle East Compared with Iran,” Renewable and Sustainable Energy Review 13, pp. 1641-1645.
- Shafie-Pour, Majid and Mojtaba Ardestani, 2007, “Environmental Damage Costs in Iran by the Energy Sector,” Energy Policy 35, pp. 4413-4423.
- Sobhiyah, M.H., and Y. Kh. Kashtiban, 2008, “Challenges of Iran’s Energy Conversion Agreements in Future Competitive Market,” Energy Policy 36, pp. 2846-2849.
- IMF, 2008, “Subsidies in the Islamic Republic of Iran,” in Islamic Republic of Iran: Selected Issues, Country Report No. 08/285, http://www.imf.org/external/pubs/cat/longres.cfm?sk=22282.0
- World Bank, 2004, “Iran—Energy and Environment Review Policy Note.”
- World Bank, 2005a, “Islamic Republic of Iran—Cost Assessment of Environmental Degradation.”
- World Bank, 2006a, “Islamic Republic of Iran: Economic Growth in Iran: Opportunities and Constraints.”
- World Bank, 2006b, “Mainstreaming Environment in the Energy Sector—the Case of the Energy-Environment Review for Iran.”
- World Bank, 2007, “Islamic Republic of Iran: Power Sector Note.”

### Energy efficiency, technology, and environmental assessments
- Kratena, Kurt, 2007, “Technical Change, Investment and Energy Intensity,” Economic Systems Research 9/3, pp. 295-314.
- Markandya, Anil, Suzette Pedroso-Galinato, and Dalia Streimikiene, 2006, “Energy Intensity in Transition Economies: Is There Convergence Towards the EU Average?” Energy Economics 28, pp. 121-145.
- Maruyama, Naoko and Matthew J. Eckelman, 2009, “Long-term Trends of Electric Efficiencies in Electricity Generation in Developing Countries,” Energy Policy 37, pp. 1678-1686.
- Okushima, Shinichiro and Makoto Tamura, 2009, “What Causes the Change in Energy demand in the Economy? The Role of Technological Change,” Energy Economics, Article in Press.
- Shafie-Pour, Majid and Mojtaba Ardestani, 2007, “Environmental Damage Costs in Iran by the Energy Sector,” Energy Policy 35, pp. 4413-4423.
- Davoudpour, Hamid and Mohammad Sadegh Ahadi, 2006, “The Potential for Greenhouse Gases Mitigation in Household Sector of Iran: Cases of Price reform/Efficiency Improvement and Scenario for 2000-2010,” Energy Policy 34, pp. 40-49.

### Studies on transition economies, power sector, and social impacts
- Cornillie, Jan and Samuel Fankhauser, 2004, “The Energy Intensity of Transition Countries,” Energy Economics 26, pp. 283-295).
- Urge-Vorsatz, Diana, Gergana Miladinova, and Laszlo Paizs, 2006, “Energy in Transition: From the Iron Curtain to the European Union,” Energy Policy 34, pp. 2279-2297.
- Sandu-Loisel, Rodica, 2007, “Hardening Budget Constraints in Romania: An Approach by CGE Modeling,” Post-Communist Economies 19/1, pp. 93-115.
- Hossain, Shahabuddin Mosherraf, 2003, “Taxation and Pricing of Petroleum Products in Developing Countries: A Framework for Analysis with Application to Nigeria,” IMF Working Paper WP/03/42.
- Holland, David, Leroy Stodick, and Kethleen Painter, 2007, “Assessing the Economic Impact of Energy Price Increases on Washington Agriculture and the Washington Economy: A General Equilibrium Approach,” School of Economic Sciences Working Paper 2007-14, Washington State University.
- Baclajanschi, I, L. Bouton, H. Mori, D. Ostojic, T. Pushak, and E.R. Tiongson, 2007, “Rising Energy Prices in Moldova: Macroeconomic and Distributional Impact,” Problems of Economic Transition 49/10, pp. 5-40.

*Reference list as provided in the source PDF.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr1076.pdf_