The energy subsidies dam has finally broken in the Middle East

The sudden wave of subsidy reform only highlights the policy blockage of previous years. Despite many warnings, most regional governments allowed subsidies to escalate to absurd levels.

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When dams break, they begin with a small crack – until the swirling waters suddenly break through and the whole edifice collapses.

The array of Middle East energy subsidies now is also being swept away. Following on the UAE's change to market-based fuel prices, Abu Dhabi raised utility rates, Saudi Arabia's latest budget cut subsidies and Oman has said they will be eliminated. Bahrain will raise diesel and kerosene prices gradually, while Kuwait's finance ministry proposes to trim more than a third from handouts.

Three powerful forces are driving this change.

The first is the desperate need to shore up budgets under pressure from the oil price slump. Saudi Arabia's budget deficit is forecast at US$87 billion for this year, assuming an oil price of about $40 per barrel. At this rate, its financial reserves will be exhausted within seven years.

Now, Riyadh has decided to step up petrol prices by up to 60 per cent, gas by two thirds, ethane (a petrochemical feedstock) by 133 per cent, and to increase electricity prices for heavy users. Saudi subsidies amounted to $107bn in 2014, with the investment bank Jadwa forecasting this to fall to $61bn this year. So, in simple terms, eliminating energy subsidies would wipe out most of the kingdom's deficit.

The second force is the ebbing level of global energy prices. US pre-tax petrol prices reached a high of $0.94 per litre in 2008, which has now fallen to about $0.38. Saudi petrol prices, raised by 60 per cent, now stand at $0.24 for higher-grade fuel – still short of world market levels, but a change that would have been unthinkable in 2008. Meanwhile, the UAE’s petrol and diesel prices have actually fallen since the reform of subsidies, tracking global oil markets.

The third force is the power of example. Iran’s 2010 reform perhaps did not attract the attention it deserved in the Arab Middle East. But Jordan, Morocco and Egypt have all been chipping away at handouts in recent years. Within the GCC, the UAE has taken the lead. Of course, its high level of incomes, public transport alternatives and preponderance of expatriates make the reforms less politically problematic, but their success may have reassured governments elsewhere.

The sudden wave of subsidy reform only highlights the policy blockage of previous years. Despite many warnings, most regional governments allowed subsidies to escalate to absurd levels. Before reforms, Egypt spent more on fuel handouts than health, education and infrastructure combined. Kuwait, with the world’s highest proportion of obese people, hardly needs subsidised food.

The oil-exporting countries’ coffers were bursting with petrodollars, but money burnt in cheap fuel could instead have gone to growth-enhancing investments or savings that would now be very welcome. Even raising prices in line with inflation would have narrowed the gap that now has to be made up.

In turn, artificially cheap energy has engendered inefficient, wasteful machinery, vehicles, habits, building designs and urban layouts. These cannot be fixed in a hurry. Higher prices might cut Saudi Arabia’s 0.5 million barrels per day of petrol use by 30,000 barrels per day in the short term, but that is only a drop out of the bucket.

Saudi Arabia in particular faces a ceiling to increasing gas prices further. Its petrochemical industry is built on cheap ethane, with the government and Saudi private investors owning companies such as Sabic and Saudi Kayan. But its ethane price is now barely below US levels. Raising gas prices to power plants does not help much when Saudi Electric Company has heavy debts and struggles with non-payment of bills.

The tide is flowing in the right direction. But budgetary measures are the easy part. Now the hard work begins – forging industries, economies and populations that can survive, and flourish, without the deceptive lubrication of cheap energy.

Robin Mills is the head of consulting at Manaar Energy and the author of The Myth of the Oil Crisis.

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