Subsidies have become the keyword to an ongoing controversy in the Egyptian energy sector. Arguments swinging between keeping and lifting oil and gas subsidies have raised concerns about the negative effects of “inefficiency” in implementing the subsidization system; its threats endangering the future of energy reserves and its state of being an economic burden on the government. Egypt Oil & Gas Newspaper examines the different perspectives of this debate
Subsidies: The Facts
According to the Shura Council’s Financial and Economic Affairs Committee report, the subsidies allocated to petroleum products have increased from nearly LE290 million in 1970 to more than LE40 billion at present. Egypt’s Minister of Petroleum Eng. Sameh Fahmy revealed in an interview in Al-Ahram Newspaper that the bill of subsiding petroleum products costs around LE44 billion annually ($7.4 billion). Meanwhile, the total revenue of exports counts for $10 billion. However, the bill of subsidies has been increasing and the Ministry of Petroleum (MoP) had to request the interference of the People’s Assembly to decide whether to keep the subsidies or cut them down. Fahmy pointed out that subsidies are not just directed to the lower income bracket, some of the wealthy people benefit from subsidies as well. “We need to face this problem clearly regardless its negative effect on the ministry’s image,” Fahmy said.
Last May, the Shura Council approved an amendment of LE20 billion in the 2005/2006 budget aimed at subsidizing petroleum products and natural gas. In the session, the Minister of Finance Youssef Boutros Ghali stated “three urgent reasons” behind this additional budgetary allocation. The first reason lies in the dramatic increase in oil prices worldwide. This rise has consequently led to an increase in the price of petroleum products, which the government buys from oil companies operating in Egypt. Thirdly, the local consumption of both petroleum products and natural gas has increased. “The government’s strident efforts to raise growth rates to more than seven percent have resulted in a large increase in the consumption of these products,” Ghali said.
However, the increasing subsidies’ budget draws more economic problems as it is a temporary solution to monetary problems. Ghali said that in Africa, governments “usually bear only 10% of the price of petroleum products while the government in Egypt bears around 75%,” which represents a huge economic burden. For instance, the approved subsidies’ increase will result in an additional deficit of LE5 billion to the state budget. To solve this deficit, the government has to ask for either more loans from local or foreign banks or to modify its current subsidies’ policy. The first solution can be considered as an easy way out in the short term “but in the long run it will be disastrous, since it also means a big rise in public debts.” Thus, many may favor the latter choice, which creates a critical debate; to leave subsidies as they are, to lift them or to have a middle ground.
Lift them or leave them?
The suggestion to remove subsidies has been supported by different scenarios. Tarek Selim, assistant professor of economics at the American University in Cairo (AUC) said that the removal of subsidies should be implemented gradually and in specific conditions. The amount of subsidies allocated for the oil and gas sector are excessive, which makes prices artificially low. Subsidies encourage under production, as economies of scale cannot be achieved with subsidized prices, clarified Selim. Asked about public reaction to such a decision, he declared that when fuel prices were raised last summer, people complained for a while and then they got used to this increase.
The gradual lift of subsidies has also been supported by Paul f. Rea, chairman and managing director of fuels marketing at ExxonMobil Egypt. He told Business Monthly Magazine that the subsidies system can be dismantled only gradually. “The government shouldn’t remove subsidies entirely, but the drive should be in the right direction for the safety of the country,” said Rea, who recommended immediate incremental price increases of a few piasters per liter of fuel in order to fulfill this goal. Rea warned from a possible public intense rage in case of removing all subsidies at once. He referred to countries such as India, Indonesia, Nigeria and the Philippines in which ending petroleum subsidies had been “a disaster.”
In an interview with Abdallah Shehata, professor of economics and political science at Cairo University, he tackled this issue from another perspective; the loss of massive amount of subsidized energy utilized in heavy industries. Shehata said that industries which depend on crude energy to produce final products, such as cement, fertilizers, iron and steel enjoy double privileges. They receive oil, natural gas and electricity at low prices, while they sell their final products in international markets at high prices.
Shehata added that, “the subsidization policy, as it exists, does not achieve its purposes. It does not increase the competitiveness of locally produced products and it does not give the consumer affordable products.” He recommended the gradual removal of subsidies, while making a reform strategy in the way dealing with heavy industries.
Agreeing with the same argument, Salah Hafez, former vice president of Egyptian General Petroleum Corporation (EGPC) confirmed the necessity to lift energy subsidies allocated for factories, such as cement and fertilizers. In an interview with Al-Masry Al-Yom Newspaper, Hafez recommended to suspend authorization for new similar factories in regard to the limited source of energy and to direct this energy towards more beneficial use especially that factories export their products to international markets and do not sell them in local markets.
“In general, I am against the concept of subsidies, except for natural gas used in the transportation sector. I believe this is the only subsidy that should remain in the energy sector in order to promote the concept of natural gas usage in public transportation to minimize both fuel and economic losses,” commented Salah El-Haggar, professor of energy and environment at AUC. El-Haggar highlighted that removing subsidized energy allocated for industries will result in developing an efficient energy system better than the traditional one, and therefore promote the concept of energy conservation. For instance, encouraging taxies, buses and microbus drivers to use natural gas instead of fuel by providing them with subsidized prices will definitely help in decreasing the rate of energy loss and achieving more economic profit.
Sharing the same vision of promoting energy conservation through subsidies removal, SUCO former chairman Hamed Mohamed Al-Ahmady told Business Monthly Magazine that citizens “are abusing our resources… If gas stations charged LE 3 per liter rather than LE 1, everybody would cut their consumption – even if it means walking to buy a pack of cigarettes rather than driving.” Energy subsidies create a culture of mass-consumption; citizens use fuel carelessly as long as it is available at cheap prices.
Finding middle grounds
Representing the intermediate perspective, some have recommended to differentiate between the quantities and prices of subsidized energy directed at lower-income citizens and the one allocated for factories, and to maintain a balance between the needs of both sides.
Last December, Fahmy proposed to the Shura Council’s Industrial Production and Energy Committee lobbying the High Constitution Court to reverse its 1997 decision prohibiting multi-pricing of gasoline and natural gas. Fahmy argued that since demand for investment in Egypt has increased, especially in the cement and steel manufacturing sectors, the ministry could afford selling energy at higher prices to factories, while maintaining the subsidized price for the public. Fahmy’s suggestion has not been approved yet; however some experts believe that it will solve the problem of subsidies.
Commenting on Fahmy’s suggestion, Selim declared that pricing in general has been a major problem in Egypt’s energy sector. “There is no economic incentive to expand investments and achieve economies of scale because prices are fixed, not market based.” He added that due to this pricing issue, the government is acting as a monopsonist (the only buyer), which is another symbol of inefficiency because being the only buyer of oil means that it is fixing the prices for oil companies to sell their products to the public and expand their activities.
Based on the idea of establishing a middle ground, some suggested setting energy prices based on the international ones only for factories, while maintaining subsidized energy for citizens. Yosry Kotb, Board Member of the Administrative Committee of the Engineering Industries Chamber said that international prices should be used only with factories that sell their products in the international markets.
However, this suggestion has been criticized by some experts. Nabil Farid Hassanein, head of the Chamber of Engineering Industries pointed out that low prices of energy, personnel and infrastructure are factors to attract more foreign investors, thus selling energy at high prices will decrease the level of both local and foreign investments in Egypt.
On the contrary, some foreign investors criticize the system of subsidies, stating that it limits the expansions of investments in Egypt. In an article published in Business Monthly Magazine, Michael Barron, former policy and corporate affairs manager at British Gas (BG) Egypt, said that the subsidies system “distorts the market, is unattractive to investors and provides people with no incentive to buy more fuel-efficient cars or switch to cleaner fuels.” Barron emphasized that BG conducts studies on energy subsidies as an attempt to assist the government in forming a more effective policy.
Rea believes that “the government oil sector is going to have difficulties ahead if the oil subsidies continue. The money is going to have to come from somewhere.”
However, lifting subsidies is a double edged sword. It can be the solution to a possible energy and economic crisis in the oil and gas sector, yet it can create negative effects if the impacts of such a decision on the market are not studied well.
Focusing on the bright positive side, Shehata confirmed that lifting subsidies will strengthen the sense of competition in the market. Most of the factories enjoying subsidized energy are in control of a large share of the local market. For instance, an aluminum company and two iron and steel companies hold around 60% of the market. As for fertilizer factories, three companies control 92% of the market, while in the cement industry, three companies control 70%. This wipes out the competition factor in the Egyptian market.
Concepts of energy conservation can be easily achieved when citizens realize the value of fuels when subsidies are removed, which diminish the sense of careless mass-consumption and save energy reserves for future generations, said El-Haggar.
Besides, Selim confirmed that energy sustainability can be one of the attained goals in the presence of subsidies allocated only for the natural gas, but this sustainability will never be achieved if subsidies are directed to all energy types.
On the other hand, Selim warned of two main social and economic losses that might accompany the implementation of this decision. First, there will be an increase of required expenditures from households; the estimated amount of expenditure needed to break-even these subsidies is almost 100LE per month for every household incorporating four people. This represents an additional economic burden on the government. To tackle this negative consequence of removing subsidies, we need to enforce a minimum wage law. In order to set this law, we have to formalize the informal sector that represents 40-50% of the economy and find out the incentives for this objective. Egypt signed the UN Millennium Development Goals, which sets a minimum wage standard for work contracts, equivalent to 342 LE per month in the case of the Egyptian status.
The second loss lies in inflation. Lifting energy subsidies will create from 5-7% additional inflation repression on the economy because energy is input in almost everything in our daily life.
By Yomna BassiouniDownload