Fueling a Problem: The Rising Cost of Energy Subsidies in the Middle East and North Africa

Fuel subsidies have been a key component of a social contract between Middle Eastern and North African states and their citizens. Facing the looming unsustainability of these subsidies due to growing population rates, energy demands, budget deficits, greenhouse gas emissions, pollution, and wastefulness, the region has made some headway in reducing them, but with no clear sign that they will go away completely.
Daily road congestion in Cairo

Egypt’s Minister of Petroleum and Mineral Resources, Tarek El-Molla, announced in January that his country would fully eliminate petroleum-based energy subsidies in the 2019-20 fiscal year. El-Molla cautioned, however, that fuel subsidies “won’t be implemented until the local market is ready and able to deal with it.” Egypt has also been planning to completely cut electricity subsidies by 2022, according to Egypt’s electricity minister Mohammed Shaker. 

These planned subsidy reforms are aimed at fully deregulating public services and commodities, including sanitation, water, electricity, gasoline, and diesel. These sweeping changes to the long-standing subsidy system in Egypt were necessitated by the economic crisis following the 2011 revolution and the subsequent 12 billion USD loan from the International Monetary Fund (IMF) to boost the ailing economy. The disastrous economic crisis had been one of the reasons protesters removed longtime president Hosni Mubarak in 2011. Egypt is now under pressure from the IMF to institute major economic reforms, including eliminating subsidies, which have been a burden on the country’s economy for decades. However, if history is any guide, eliminating subsidies in Egypt and elsewhere in the Middle East and North Africa (MENA) will be a herculean task fraught with potential social turmoil.

Designed to spur economic growth and lift the masses from poverty, subsidies provide a vital social safety net for the poor and enable them to gain access to electricity. But, paradoxically, subsidies also impede the region from making meaningful economic reforms and improving the plight of millions of poor people. The biggest beneficiaries of subsidies are often the richer strata of the population, who do not even need them. 

Fuel subsidies have been the heaviest in oil-exporting Arab countries, with Saudi Arabia leading the pack (See Figure 1). 

Figure 1. Fuel Subsidies in the Middle East

Source: International Monetary Fund, GTM Research

18The proven negative effects of energy subsidies on MENA economies and beyond are significant. Subsidies lead to over-consumption and waste of energy; they reduce incentives to improve and attract investments in energy-efficient equipment; they provide a natural disincentive for investing in alternative and cleaner energy technologies, such as solar and wind power; they help the wealthy more than the poor; and the associated high levels of energy consumption and waste prevalent in MENA result in the release of emissions and greenhouse gases, thereby, causing extensive environmental damage. 

Fuel subsidies have strengthened dependence on fossil fuels, consumption of which has been steeply rising in MENA. For example, relatively small countries such as Kuwait and Qatar, with populations less than 3 million each, and the United Arab Emirates (UAE), with a population of 9 million, have the highest levels of energy consumption in the world. With no incentives to invest in efficient energy technologies given the availability of subsidized oil and gas, energy intensity in MENA economies is also one of the highest in the world, contributing to waste, pollution, and fiscal stress. One of the driest and water-scarce regions of the world, the Middle East remains particularly vulnerable to the devastating effects of climate change. According to research findings of Germany’s Max Planck Institute, without significantly cutting greenhouse gas emissions, extreme heat and reduced precipitation causing more droughts will likely make the region uninhabitable by the year 2100, only 80 years from now. 

The rising fiscal burden of retaining such energy subsidies over the past ten years, resulting in massive budget deficits, has elevated the urgency of reforming domestic fuel prices. Some countries began reducing fuel subsidies with associated positive effects on their respective economies. For example, UAE, a major oil-exporter, launched a fuel subsidy reform effort in 2015, largely prompted by the global collapse in oil prices in 2014 that severely taxed its public finances. It cut subsidies to gasoline and diesel in 2015. Within the emirates, the sheikdom of Dubai went further by hiking tariffs on electricity and water, which reduced consumption. According to a study by the Brookings Institution, despite some negative reactions to the removal of subsidies and tariff increases, they did not result in large-scale popular protests. Although there are other factors that likely would have inhibited protests (such as a lack of freedom of expression), in fact, Dubai residents generally responded positively to the changes. 

Jordan eliminated fuel subsidies between 2005 and 2008, but later re-introduced them after a public outcry over high energy and food prices. In 2012, Jordanian authorities phased out the subsidies again. The subsidy reform improved the country’s public finances and wages went up. Moreover, a government-supported renewable energy program increased investments in the country’s nascent solar industry by 2.5 billion USD in 2016. Jordan’s Renewable Energy and Energy Efficiency Fund also began providing loans and equity-based financing to stimulate the renewable energy sector. 

In its effort to curb energy subsidies, Iran has almost tripled the price of gasoline since 2010, although it is still not fully deregulated. To reduce the blow on the population, however, Iran began providing cash grants to all households before removing the subsidies. While Iran has been continuing cash payouts since 2010, it is considering terminating payments to high-income earners in 2019. 

Oman, Kuwait, Saudi Arabia, and Qatar have all introduced modest measures to raise prices for electricity, natural gas, and gasoline.

Despite these reforms, fossil fuel subsidies have actually started rising globally since 2017 in line with the uptick in oil prices worldwide. According to the International Energy Agency (IEA), “the rise in international fuel prices in 2018 could set back efforts to phase out fossil fuel subsidies.” A strong U.S. dollar together with recent jumps in interest rates depreciated currencies of many emerging markets, thereby raising the prices of imports for them, including energy. 

The IEA has warned that subsidy reforms are not guaranteed, and they may not last if oil prices are not low. Subsidies are particularly difficult to eliminate in MENA, where providing cheap commodities and staple foods to the populations have been woven into the social contract between the rulers and the ruled. 

Jim Krane, a Wallace S. Wilson Fellow for Energy Studies at Rice University’s Baker Institute for Public Policy, wrote that limited subsidy reforms in the Middle East “appear to be designed to update — rather than jettison — rent-based autocratic governance.” Sustaining the rent-based governance is inseparable from subsidies for many leaders in MENA in order to maintain a lid on popular discontent over economic disparities and political status quo. Therefore, the prospect of fully eliminating subsidies in MENA economies remains precarious.

This socio-political-economic interdependence presents a predicament for the region. Growing population rates along with rising temperatures, extreme heat, and droughts due to the changing climate are bound to increase energy use to keep buildings cool, to desalinate water, and to grow food. Many countries in the region have set out renewable energy targets, primarily to satisfy the rapidly growing domestic demand for electricity and to free up oil and gas for exports. These goals will be difficult to meet given the poor incentives to invest in renewables stemming from the availability of subsidized cheap oil and gas. Without drastically reforming the fuel subsidy systems and making room for more efficient and cleaner energy alternatives, the long-term sustainability and viability of these MENA economies have raised the stakes as never before.