IMF Survey: Iran to Cut Oil Subsidies in Energy Reform

IMF News, September 28, 2010

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The Islamic Republic of Iran has begun eliminating energy subsidies, a reform IMF economists say could transform the economy and influence other energy-producing countries.
Publication date: September 28, 2010.
Reform aims: remove distortions, restore efficiency, increase exports of oil and gas, and generate additional government revenue to be redistributed to the population.

Iran is the 17th largest economy in the world.
Foreign debt: less than 7 percent of GDP.
Underground hydrocarbon resources: $10 trillion in oil alone (at $75 a barrel).
Natural gas reserves: between $3½-4½ trillion.
Real GDP growth estimated to have been about 1-2 percent in the year of the interview.
Inflation trend: declined from close to 30 percent two years earlier to less than 10 percent since September 2009.
Rationale for reform:
- Domestic energy prices were far below international prices, leading to rapid domestic demand growth and reduced availability for profitable exports.
- Wasteful energy use and severe distortions in demand and supply; Iran shifted from being energy-efficient in the 1980s to one of the most wasteful countries.
- Restoring market pricing is seen as necessary for achieving higher growth potential comparable to dynamic emerging markets.

Extraction cost of oil: roughly $5 to $10 a barrel.
International oil price peak cited: almost $150 per barrel in 2008.
Estimated household subsidy (until recently): on average about $4,000 a year for a household of four in various subsidies on oil and natural gas alone.
Typical individual earnings cited for comparison: many Iranians may earn about $300 a month, or $3,600 a year.
Distributional effect: subsidy benefits those who use the most energy (wealthier households); poorer households receive very little of the subsidy.

The subsidy-elimination proposal was approved by Parliament and signed into law in January (year implied in text).
The law objective: quasi-elimination of subsidies on par, more or less, with the international f.o.b. price.
Revenue target specified by the law: $20 billion for the first year.
The law does not specify the exact price increase for the first year but links the revenue target to the needed price adjustments.

Anticipated first-move price increases: potentially of between 4 and 20 times for some energy products.
Allocation of additional revenues in the first year:
- 50 percent to households, all in cash—households to be fully compensated and free to spend as they choose.
- 30 percent to businesses—to help companies invest in energy-efficient technologies and support adjustment, with recognition that heavy industry will take more time to adjust than the service sector.
- 20 percent to the government—to pay for the government's higher energy bill.

Domestic demand for energy expected to decline, freeing energy for export and increasing government revenue.
Energy sector profitability expected to improve, enabling more investment, extraction, and production.
Positive side effect on the global oil market if Iranians restrain consumption.
Automotive sector:
- Iran produces about 1.5 million cars per year for a domestic market of 74 million people.
- Higher gasoline prices expected to incentivize modernization and greater energy efficiency in domestic car manufacture, improving competitiveness for exports.

Importance of low inflation as a foundation for large price increases in energy.
Concerns about operational effectiveness: key is ensuring redistribution plans are operational and effective from day one.
Businesses have had time to plan for adaptation due to multi-year discussion of the reform; government support is targeted to smooth transition and encourage investment in energy efficiency.

Source: IMF Survey: Iran to Cut Oil Subsidies in Energy Reform (September 28, 2010).