Since the revolution, Egypt’s economy has been in a state of deterioration evinced by an increasing deficit, dwindling foreign reserves, and rising inflation.  Economic reform, specifically the proposed removal of energy subsidies, continues to be a contentious issue particularly when juxtaposed against current energy shortages and increasing domestic consumption. Many argue that the removal of subsidies would have catastrophic consequences for the poorer strata of Egyptian society but others are demanding reform claiming that Egypt can no longer afford the luxury of subsidization.  Egypt Oil and Gas examines the issue of energy subsidies in order to assess current expenditures, attempts at reform, and the potential economic, political, and social costs of inaction.

Historical Context of Subsidies in Egypt
Subsidies have played a significant role in the Egyptian economy since the Nasser regime in the 1950s and 1960s. At the time, and since, subsidization of vital goods served as a mechanism used by Middle Eastern autocrats to achieve appeasement and to quell internal discontent. In the 1970s, and perhaps even more significantly, government authorities increased subsidy spending in an attempt to mitigate the growing disparity in living standards caused by fundamentally western policies of economic liberalization.

Historically, attempts at subsidy reform in Egypt have been meet with hostility and violence.  President Sadat’s 1977 attempt to remove flour subsides resulted in widespread protests and naturally led to hasty re-implementation. In 2004, a reform program was launched in an effort to gradually phase out energy subsidies by 2014. Reforms included sharp price increases applied to gasoline and diesel, as well as a gradual increase in the price of electricity by 5% per year over a four-year period.(1)  The measures were designed to reduce government expenditures and decrease the deficit to 3% of GDP.(2)  Irrespective of the price increases, domestic consumption steadily increased as a result of GDP growth over the same period. The initiative was shelved in 2009 amidst the global economic recession. 

Cost of Subsidies
Subsidy reform is again at the forefront of economic discourse in Egypt, particularly as it applies to energy. Historically, Egypt was able to maintain heavily subsidized energy products due to steady domestic production of oil and natural gas. However, the era of plentiful domestic supply is over. Decreasing production, industry specific issues of cost-recovery, and delayed payments are combined with political and socioeconomic instability to yield a growing energy deficit.

According to Dr. Tarek Abou Bakr, Chairman of the Energy Committee of the Federation of Egyptian Industries, Egypt’s share of domestically produced oil and natural gas amounts to approximately 47 million metric tons (MMT) per year. Egypt consumes 77 MMT, which results in a deficit of 30 MMT before export obligations are considered. The average annual increase in domestic consumption when divided into specific energy products, demonstrate a 10% increase in LPG consumption, a 13% increase in gasoline consumption, and a 6% and 8% increase in gas oil and fuel oil respectively.  Faced with rapidly growing consumption, Egypt is no longer in a position to fulfill its domestic needs, nor its export obligations. This leaves the country dependent on imports while simultaneously struggling with dwindling foreign currency reserves and depreciating currency.

The electrical and industrial sectors are the largest energy consumers.  When examining consumption by sector, 38% of supplies go to electricity, 25% to industry, and 15% to transportation. Electricity consumes 23 MMT of natural gas and 7 MMT of fuel oil. Industry uses 40 MMT, which is largely consumed by energy intensive industries such as fertilizer, cement, petrochemical, and steel. Mustansir Barma, Senior Economic Researcher with the American Chamber of Commerce in Egypt told Egypt Oil and Gas that, “Both power plants and energy-intensive industries such as cement, glass, steel, and fertilizers use natural gas as their main fuel source. The government has already clearly prioritized fuelling power stations…(but)…the fact is that the natural gas supply is limited.  Instead of looking at the supply side, more focus should be placed on the demand side.”

Subsidies and domestic consumption are of course inextricably linked.  Conservation or optimal usage is unlikely as there is little economic or financial incentive to conserve when prices are artificially low. Numerous experts argue that Egypt has become “addicted” to energy subsidies and the government has continually supported a “defective” system.(3) The annual growth of expenditures associated with energy subsidies supports such an assertion.  According to the African Development Bank in 2005/2006, Egypt’s subsidization of petroleum products cost EGP 40 billion or USD 7.2 billion. In 2009/2010, that figure increased to EGP 69 billion or USD 11.9 billion. In 2011/2012 spending on energy subsidies amounted to EGP 112 or 16 USD billion, a 40% increase from the previous fiscal year. The cost of fuel subsidies is expected to increase to EGP 120 billion or USD 17.(4) billion in 2012/2013.  Currently energy subsidies account for 21% of the total budget, cumulatively costing the government more than health and education services combined.4 Even with these extreme costs, however, some economists argue that the subsidy addiction is presently inescapable.  Dr. John W. Salevurakis is an economist at The American University in Cairo and he was noting as early as 2005 that liberalization and subsidy elimination were the real luxuries that Egypt could not afford.  He told us that, “Egypt is currently quite stuck with subsidies.  Just as in the years immediately before the financial crisis, the social cost of liberalization is too great.  This is not a purely humanitarian issue however.  The social cost incurred will manifest politically and more tangibly in the streets of Cairo.  Just as the fundamentally corrupt liberalization of the late Mubarak era manifest on January 25th, further (even organized) liberalization today will likely manifest in the future.”

Subsidies for Whom?
Energy subsidies theoretically help the disadvantaged by providing equitable access to energy resources.  However, research documents that middle and upper class families also reap a disproportionate share of benefits associated with energy subsidies through higher rates of consumption. Mustansir Barma commented on the misallocation of subsidy benefits arguing that the system is, “inherently inefficient because the rich can access the same subsidized goods as the poor, who need it more. It is often said that the poor who represent 80% only get 20% of the benefit from the subsidies, because the rich may have multiple cars and demand more gasoline.”  As higher socioeconomic classes have greater access to consumption goods such as cars, larger living space, and multiple air-conditioning units, a situation is created in which reality contradicts the intent of the subsidy system in Egypt.

Available data and research increasingly highlights a gap between theoretical justifications for and practical applications of Egypt’s generous subsidy program. Nemat Shafik, IMF Deputy Managing Director supported this point asserting that, “It’s a myth that generalized energy subsidies could help the poor.” A recent IMF paper noted that by “reallocating the resources freed up by subsidies to more productive public spending could help boost growth over the long run.” Reform can be beneficial to vulnerable persons so long as the government implements safety nets and increases spending on services targeting the lower class.(5) Through a closer examination of Egypt’s energy subsidies, it becomes evident that not only are they financially unsustainable but they also fail to effectively achieve their purpose.  Dr. Salevurakis notes however that, “While there are leakages in the subsidy system, it is not at all clear that governments can be relied upon to effectively create a social safety net to replace them.  Indeed, subsidies are put in place precisely because other options are often too complex an inefficient to implement in the developing world.”  Additionally, Dr. Salevurakis argues that what developing economies often lack is a “flexible wage environment” in which people can respond to rising prices by demanding higher wages.  Absent this, he notes, subsidy elimination is likely “ a downward spiral of negative political and social expectations.”

Negative Impact of Subsidies
Energy subsidies may however also spill over into other realms of the economy and negatively manifest in price distortions.  Producers and manufactures are able to yield commodities while operating according to a lower cost structure as a result of the government subsidization of raw materials.  Producers can pass on lower costs on to consumers or the savings may translate into higher profits.  Dr. Omneia Helmy, Executive Director and Director of Research at the Egyptian Center for Economic Studies explained to Egypt Oil and Gas that distribution channels are often problematic with subsidized goods such as butane cylinders as “the government is subsidizing [these goods] with a huge amount of money but at the end of the day the ordinary citizen is paying a very high price with the difference going to the middle men who are really profiting from this [system].”

Peripheral to price distortion, the subsidization of energy products in Egypt may also discourage technological innovation and inhibit development. Individuals as well as industries have little incentive to utilize energy-efficient technology, as the government is the entity that ultimately absorbs the loss. This occurs at the micro level with individuals and cars, as well as the macro level with manufactures and factories.

Not only are energy subsidies likely an unsustainable fiscal burden, but they also fuel black markets. Cumulatively, subsidies distort prices, profits, and competitiveness.. However, while pure economic rationality dictates reform, other constraints exist which make carrying out successful reform very difficult.

Recent Reform
Numerous economic institutions including the IMF, World Bank, African Development Bank have called for subsidy reform in Egypt and the government recently implemented a few reforms aimed at reducing energy subsidies. In July 2012 natural gas prices were increased for households that consume more than 30 cubic meters monthly.(6) In March of 2013, the government announced a price increase of 60% for butane.(7) The increase was widely criticized, as low-income households are primarily reliant on butane cylinders as natural gas lines are concentrated in middle and upper class residential areas.

In November 2012 and February 2013, the government also reduced subsidies on electricity.  The increases are based on consumption; meaning households with higher consumption rates receive lower subsidies. Households that consume 50 kilowatts or less per hour continue to receive the fully subsidized rate, while households that consume 50 to 200 kilowatts per hour have experienced a 4.4% increase to EGP 0.12. This multitier pricing system aims to protect lower income households while reducing subsidies to the upper class who are responsible for the majority of consumption.   In an interview with Egypt Oil and Gas, Dr. Salevurakis also noted that, “This is the only way subsidization can be reduced.  It must be undertaken gradually over a period of years and not months.  Simultaneously, if prices of consumption goods are allowed to move according to the market, so must wages be allowed similar flexibility.”

The government also recently launched a “smart card” initiative in an effort to reduce the consumption of subsidized diesel and gasoline. Under the planned system, each cardholder will be able to purchase 5 liters of fuel per day at the subsidized rate.  Any amount beyond this can be bought at the unsubsidized price. Dr. Omneia Helmy, informed Egypt Oil and Gas that vehicles with large engines (over 2,000cc) will not be eligible for any subsidized fuel.  In July, the distribution of smart cards for trucks and taxis that operate on diesel is expected to begin. Privately owned vehicles that operate on gasoline will be included in the system in August and unregistered cars, tuk-tuks and motorcycles in September.(8)  The government expects the smart card system to save USD 30 billion from Egypt’s fuel subsidy bill in the coming 2013/14 fiscal year.  This bill is still expected to reach EGP 99.6 billion (USD 14.2 billion).(9)

The government has also introduced subsidy reforms targeting industries. In January and February 2013, the government raised the price of fuel oil, which is widely used in energy-intensive local industries, by 50%.(10) The prices of natural gas and diesel for some industries were also increased by the same percentage, industry sources said at the time. According to the current timeline, subsidies to many industries will be phased out by 2016.(11) Subsidy removal places a heavy financial burden on many companies. Until now, most have been able to stay afloat by transferring a portion of the price increases to consumers, but further subsidy reductions will exacerbate costs.

Key industries will continue to be subsidized by the government, according to the Trade and Industry Minister Hatem Saleh.(12) He noted that, “These are labor-intensive industries and strategic industries that have an impact on poor people, such as basic food industries, basic commodities.”  A detailed schedule of price increases for industries is expected in the next few weeks. Soheir Abouleinein of the Institute of National Planning recommended to Egypt Oil and Gas, that the government aid struggling industries by providing them with information and access to experts who can assist industries in adopting energy-efficient technologies and strategies.

Obstacles to Reform
Public opposition will inevitably be one of the largest barriers to subsidy reform as Egyptians widely view subsidies as a government obligation. As Dr. Helmy explained, “to have public support for your reforms, you have to have politically credible reforms and you have to have consensus.  Any economic reform will entail hardships but people will not be ready to bare these hardships unless they are convinced that your legitimacy is there and your decisions are correct.” Credibility issues are further exacerbated by Egypt’s current political environment.

Therefore, any reform plan must include confidence-building measures. According to Dr. Helmy, in addition to sharing the benefits of reform, the government should “be very transparent, have a good communication policy, think twice before announcing any decision, and be well studied in cost benefit analysis.” Another strategy to achieve public buy-in is participatory budgeting, which “involves the public having a say in how their tax payments are spent,” noted Mustansir Barma. According to Barma “this gives the population a sense of ownership.”

The government’s recent reforms seek to reduce subsidies reaching middle class and wealthy households through multitier pricing systems and caps on subsidized goods. However, by continuing to subsidize goods, the government is retaining an inefficient system that permits corruption and black markets. Dr. Rohac of The Cato Institute argues that the best reform strategy is “a temporary stream of conditional cash transfers to every Egyptian, eliminating the distortions of in-kind redistribution.”(13) According to Dr. Rohac, cash transfer systems may limit financial gains of the government initially but they pay off through building credibility.

Dr. Gerhard Glomm of Indiana University Bloomington informed Egypt Oil and Gas that dividend transfers would also be easier to implement. Dr. Glomm noted that cash transfers provide households with a choice, which is beneficial as “not all families have the same preferences” or needs.  Dr. Helmy cautioned that with “cash-transfers you have to be very careful with the inflation rate.” Additionally, a “graduation policy” is necessary with clear criteria on how long cash-transfers will last, explained Dr. Helmy. Mustansir Barma told Egypt Oil and Gas that under this type of strategy, “eventually wages should rise such that poor families no longer need subsidies and they can gradually be eliminated.”  Dr. John Salevurakis noted however that, “Wages in the developing world tend to be extremely sticky and this stickiness is often imposed and ensured over time by the very powers implementing liberalization.  History shows us that this is a recipe for unrest.”

Johnny West of OpenOil, asserts that a cash transfer system in Egypt would permit the gradual removal of energy subsidies within five years.(14) Dr. Glomm also recommends a “slow gradual transition” in order to mitigate opposition. However gradual transitions can also be problematic. As Dr. Rohac points-out, the difficulty of gradual reform is continuation through government transitions. Mustansir Barma, similarly notes that “continued policy incoherence and inconsistency gives the government even less credibility when it comes to implementing reforms.” In order to mitigate the likelihood of reform suspension, Rohac proposes binding legislation on gains sharing and restructuring energy regulation by moving it out of government departments and into an independent body to ensure continuity.

Conclusion:
In an attempt to address Egypt’s current subsidy dilemma, Dr. Helmy notes, “economic and institutional reforms are very much needed because they should have started yesterday. Any delay is not beneficial for the Egyptian economy that is already suffering from many macro economic indicators that are at historically low levels,” However, the government has yet to implement significant reform. Some speculate that the administration is delaying reforms until after parliamentary elections to avoid triggering public opposition.  Implementing significant reform in such a politically polarized climate will likely prove difficult for the current administration but the country can ill afford further delays. “The consequences of inaction are a further collapse of foreign reserves,” cautions Mustansir Barma, “in addition, there are risks of not being able to meet energy demands by industry and power stations, of not being able to pay energy producers and of further weakening of the Egyptian pound.” Egypt Oil and Gas concurs that, given Egypt’s current economic state, a comprehensive reform plan must be constructed…one addressing creditability, safety nets, wage flexibility, and a transparent distribution of gains.  Further, this must be developed sooner rather than later.

1. Castel, Vincent “Reforming Subsidies in Egypt” African Development Bank March 2012
2. Oxford Business Group, The Report: Egypt 2012. 2013.
3. Dr. TarekAbouBakr, Chairman of the Energy Committee, Federation of Egyptian Industries“Energy Challenges in Challenging Times” May 12, 2013.
4. J. West, How 150 Million People Went Missing in India.August 4, 2012.
5. IMF, Energy Subsidies in the Middle East and North Africa: Lessons from Reform.
6. Ahram, Egyptian Households See Energy Prices Increase.March 31, 2013.
7. The Wall Street Journal, Egypt’s Subsidies Stall Its IMF Aid. April 2, 2013.
8. Daily News Egypt, Mismanaging the Fuel Crisis. June 2, 2013,
9. Ahram Online, Oil Minister Osama Kamal: Subsidy reform not stalling IMF deal. April 24, 2013, 
10. Reuters, Egyptian factories, hit by subsidy cuts, highlight Cairo’s fiscal dilemma. May 22, 2013.
11. Financial Times, Egypt’s power crisis worsened by declining natural gas production. May 29, 2013.
12. Reuters, Egypt to issue schedule next month for gradual fuel subsidy cuts. April 24, 2013.
13. D. Rohac, Fixing Egypt’s Subsidy Nightmare. March 22, 2013.
14. J. West, How to End Fossil Fuel Subsidies Without Hurting the Poor. December 11, 2012.

By: Julie Herrick, Maya Moseley and Laura Raus