July 2015 marked a watershed moment in the Arab Gulf’s decades-long history of cheap oil, as the UAE became the region’s first country to remove subsidies for transport fuel. Abu Dhabi-based daily The National reported on July 28, 2015 that prices for 95-octane unleaded petrol rose overnight from Dh1.72 ($0.47) per litre to Dh2.14 ($0.58), as the Ministry of Energy (MoE) switched to a pricing model that more closely reflects the global market. While the move was variously described as both a deregulation of prices and a removal of subsidies, in reality things are a little more complicated. The new system will remain regulated, as prices will be set by an official committee that meets on the 28th day of each month. The committee, which is chaired by the undersecretary of the MoE, includes the undersecretary of the Ministry of Finance, the CEO of ADNOC Distribution and the CEO of Emirates National Oil Company. It is charged with reviewing fuel prices against international benchmarks, before adding transportation, operation and distribution costs to arrive at the monthly price.
A Mixed Bag
Thus, the new system cannot be described as entirely deregulated. Equally, some might consider it misleading to describe the previous system as having been subsidised. Much depends on the particular reference used to calculate the real cost of the fuel in question. In the case of transport fuels, many international organisations tend to base their calculations on the price-gap approach – given that crude oil and its refined derivatives are globally traded commodities, the cost of the subsidy to domestic fuel is calculated as the revenue that the government in question has foregone by not selling it on the global market. The total subsidy is thus, in effect, the opportunity cost of using that fuel domestically at a price lower than the open market. The International Energy Agency, which follows the price-gap approach, estimated through this method that fossil fuel subsidies cost the UAE $22bn in 2013 alone.
The argument against such an approach is that it only considers fuel as a commodity, and not as a potential source of comparative advantage within an economy. The counter-argument would be that for a nation blessed with domestic supplies of oil, the additional economic activity spurred by a comparatively lower cost of fuel may, for a time, outweigh the cash benefit of selling such fuel at a higher price, either domestically or on international markets. For those who follow such a line of thought, the reference price for calculating energy subsidies should not be the global price, but rather the (domestic) cost of production.
If the fuel in question is being sold at below the cost of production, then the deficit is being made up by a direct cash transfer by the government: a subsidy, even if it is paid for by the profit gained from selling a certain portion of that fuel on the global market. By contrast, if the domestic price remains above the cost of production, but below the global price, then proponents of the production costs approach consider it misleading to speak of subsidies. Rather, the question becomes purely a theoretical one related to opportunity costs: whether or not the foregone revenue is made up for by the additional domestic growth produced by comparatively cheaper fuel, something which is often difficult to prove either way.
Other Perspectives
In developmental terms, one could argue that it makes perfect sense for the government of an oil-rich, but less-developed nation to initially sell fuel domestically at below the global price, but above the cost of production, in order to maximise the comparative advantage of cheap energy. However, as that economy grows and develops – and indeed, reaches a stage of development comparable to leading economies – there is a greater likelihood that the gains of cheaper energy will be used inefficiently. Moving toward a price that is closer to the open market will thus not only encourage more efficient use of fuel, but also allow the government to allocate the previously foregone revenues more effectively, for instance, through economic diversification programmes.
One can argue that it is precisely this strategy the UAE authorities have been pursuing. The price of domestic transport fuel has not been suddenly liberalised, which is generally considered a disastrous policy. Rather, the fixed price of both petrol and diesel has risen steadily over the past decade or so. According to a May 2014 report from the International Institute for Sustainable Development’s Global Subsidies Initiative, the price per litre for petrol rose from the equivalent of $0.29 in 2002 to $0.47 in 2012 and from $0.30 per litre to $0.64 over the same period for diesel.
By comparison, in neighbouring Saudi Arabia over the same period the cost of petrol fell from the equivalent of $0.24 per litre to $0.16, while diesel dropped from $0.10 to $0.067. As a result of this policy, by 2015 fuel prices within the UAE were already the most expensive in the Gulf region, and the move to the new pricing system in fact resulted in the cost of diesel initially falling by 29%, while the cost of petrol rose by 24%, according to a September 2015 report from Qatar-based daily Gulf Times. In this light, other Gulf countries may find it difficult to immediately follow the UAE, though they might begin with a gradual move to increase the cost of fuel, in line with the UAE’s own policy.
Supporting Change
Alongside steady increases in the price of fuel, the UAE has also invested in providing alternatives for its lower-income residents. Suhail Al Mazrouei, the minister of energy, told The National that those on a budget “will have a choice to make” following the increases. “In any society, any civilised society, people with low incomes take public transport, except in the UAE and the Gulf,” he said. “Everyone drives a car even if they cannot afford to drive a car. We cannot ask the government to subsidise those people when they shouldn’t drive cars. Public transportation is good and we are spending a lot of money and time to improve it.”
At the same time as these moves were made, Abu Dhabi began implementing a system for administering subsidies for liquid petroleum gas (LPG). LPG remains a fundamental resource in the emirate, as Abdulla Salem Al Dhaheri, CEO of ADNOC Distribution, told OBG. “In Abu Dhabi City, approximately 98% of all cooking in the residential sector is done using LPG,” he told OBG. “Meanwhile, on Abu Dhabi’s islands, 65% of the buildings utilise central LPG installations with rooftop storage tanks. The majority of the remaining multi-unit buildings, villas, commercial establishments and industrial plants use LPG cylinders and outside storage tanks as sources for LPG for cooking and heating.”
More Efficiency
In the second half of 2015 ADNOC Distribution began introducing Rahal e-Gas cards, which provide a monthly allowance for subsidised LPG. The rate varies between Emirati nationals and expatriates: the former can receive a monthly subsidy of up to Dh150 ($40.83) for families and Dh70 ($19.05) for single people, while for the latter the figures are Dh70 ($19.05) and Dh40 ($10.89), respectively.
The move was taken in order to limit the illegal use of subsidised LPG – given the variation in subsidies between different emirates – but can also be seen as an innovative use of technology to limit the kind of excessive consumption that subsidised fuel can often entail.
The shift to e-Gas cards is in keeping with ADNOC Distribution’s recent investment in technological solutions under the company’s adoption of new smart initiatives, which have included implementation of radio-frequency identification tag-based authorisation and payment; near field communication readiness; and mobile business-to-business and business-to-consumer e-commerce platforms. Al Dhaheri told OBG, “We are hopeful that SMART service will bring in a culture of continuous improvement in the way we do business.”
Through a combination of innovative policies and the application of technology, Abu Dhabi and the UAE seem to be demonstrating that, with concerted effort and long-term planning, it is possible to imagine a future for the Gulf region beyond the blanket subsidisation of energy. What is also clear, however, is that neighbouring states may struggle to follow the UAE’s lead any time soon. For their part, UAE authorities appear content to strike their own course. As Al Mazrouei remarked in his recent interview, “We are not comparing ourselves to other countries any more. We are aspiring to build one of the strongest economies in the region.”
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