Fuel Pricing and Subsidy Reforms in Asia

Interview with Vandana Hari
December 5, 2016

Countries across Asia are looking to reform (and often, ultimately eliminate) many forms of subsidies, while simultaneously maintaining their commitments to addressing energy poverty. Vandana Hari (Vanda Insights) discusses the complexities of ongoing fuel-pricing reforms across the region and the implications for global oil market outlooks.

As of September 2016, over 700 million people in Asia and the Pacific remain without access to electricity. Subsidies for fuel (including diesel, gasoline, liquefied petroleum gas, and kerosene) have usually been implemented with the goal of expanding access to transportation, cooking, and electricity. Yet many analysts have noted that such subsidies can distort necessary signals for encouraging sustainable economic development and also do not necessarily benefit the communities most in need due to challenges in their design and execution. As a result, countries across the region are looking to reform (and often, ultimately eliminate) many forms of subsidies—while simultaneously maintaining their commitments to addressing energy poverty.

To explore the implications of this policy shift, NBR spoke with Vandana Hari, the founder of Vanda Insights, about her recent research paper “Fuel Pricing and Subsidy Reforms in Asia after the 2014 Oil Price Crash: A Comparative Study of Strategies.” In this Q&A, Ms. Hari comments on key issues and findings presented in the report and explains the complexities of ongoing fuel-pricing reforms across Asia and the implications for global oil market outlooks.

Why has it been so challenging for Asia to implement fuel-pricing reforms?

Governments need to weigh a few factors carefully before withdrawing fuel subsidies or adopting market-based pricing of refined products, because such moves typically result in higher prices for the end user. Costlier fuels can prove to be a drag on economic growth, as they feed into higher-priced goods and services, which can reduce the consumer’s discretionary spending and thus dampen overall demand. The inflationary impact also needs to be considered, which was especially the case during the “easy money” years following the 2008 global financial crisis, even though oil prices had slumped at the same time.

Governments in Asia also must take into account the considerable number of energy-poor among their populations. Any increase in prices can put the fuels even farther out of the reach of the poor, hindering their progress and ability to contribute effectively to the country’s economy. These families are then forced to turn to cheaper but environmentally damaging alternatives such as biomass. As women and young girls get saddled with the job of collecting such fuel, they are denied more economically productive jobs and education, respectively.

Finally, we can’t ignore the political ramifications of the public anger that fuel-price hikes could provoke, which has the potential to destabilize governments and remove political parties from power. Many of these concerns, however, have receded with the steep price slide that began in mid-2014, as benchmark international market prices of refined products began to converge with the subsidized rates, effectively obviating the need for subsidies. Pegging the previously controlled domestic fuel rates to international benchmarks became easier as it did not result in a price spike at the pump. In fact, a few governments in the region decided to partake in the bonanza of cheaper oil by raising taxes on the retail product.

What benchmarks or key indicators can be used to evaluate the progress of a country’s fuel-pricing reforms?

While there are commonalities across emerging Asian economies with regard to their reasons for subsidizing fuel and maintaining some form of control over the pricing of domestic oil products even as they were “deregulating,” each country’s circumstances and the evolution of its pricing strategies are unique.

A fundamental divergence is seen, for instance, between a country like Indonesia, which continued to gradually phase out subsidies on diesel in the two-year period studied in the report, and India, which adopted market pricing for the product in one go. Some governments, such as Vietnam, still must approve retail price adjustments proposed by the oil companies before they can be implemented, despite having embraced free-market pricing. Liquefied petroleum gas and kerosene, deemed the most sensitive of fuels when it comes to pricing and the last ones remaining under subsidies and regulated pricing across several countries, present a contrast in China, where they are fully liberalized. But then much of household cooking fuel in China is natural gas, whose prices have been strictly controlled by the government until recently, and this needs to be taken into account when measuring the country’s progress on liberalization. Thailand has used subsidies to push the adoption of biofuels such as ethanol-blended gasoline, while regular gasoline is fully liberalized.

This diversity, combined with variables such as the range of fuels that need to be taken into account, the degrees and forms of subsidies offered, and the extent to which the government exerts control over retail price adjustments, makes it difficult to measure a country’s progress over time or compare a country with its peers. The research paper proposes an oil price deregulation index to address this issue—a proprietary tool that quantifies the variables and scores each country on a harmonized set of metrics and common methodology.

You note that some of Asia’s major oil consumers—Pakistan, Indonesia, India, China, Thailand, and Malaysia—have been transitioning national policies away from fuel subsidies. Which country has been doing particularly well? How could other countries replicate this success?

India has made significantly more progress than the others in its fuel-pricing reforms over the past two years. Prime Minister Narendra Modi’s government, no doubt helped by the strong mandate that swept it into power in 2014, has taken some bold and decisive steps. These include scrapping subsidies on diesel—long considered a politically sensitive product—in one stroke and successfully launching a “direct benefit transfer” subsidy scheme for household LPG cylinders, which lends itself to eventually limiting the subsidy benefit to the poor. This scheme, which has begun by capping the number of subsidized cylinders a family gets per year, with any surplus purchases to be paid for at regular market rates, is aimed at eventually offering subsidized fuel only to consumers below a certain income level. Under the initiative, which goes by the name “Pahal,” all consumers pay the market price for a cylinder at the point of purchase, with the subsidy amount directly transferred to their bank accounts. The government thus gets full control over the subsidy payout and receives first-hand information on the consumers that have availed themselves of the benefit. As the price tag on the cylinders is the free-market price, it is equally important that there is no scope for profiting through resale on the black market.

Pahal is the world’s largest direct benefit transfer scheme, and India is developing the program to gradually wean the middle-class and affluent consumers who can afford to pay full market rates off subsidies and instead target them at the poor. This is a gargantuan task that does not come without its fair share of logistical nightmares, and one that probably has more hurdles to jump in the months ahead. Nonetheless, Pahal could serve as a good example for other Asian countries wanting to gradually reduce their subsidy spending and wasteful consumption of cheaper fuel while not leaving their poor behind.

As you described above, focusing subsidies to alleviate energy poverty has been a goal of governments across the region. How might countries go about implementing these forms of subsidies?

Targeted subsidies hold a lot of promise, but need further honing. It would be worth setting up a national or even a regional task force to look into the design and implementation of targeted subsidies. Countries such as Malaysia have had some success with a “smart card” system to sell rationed amounts of discounted fuel, while others, such as Indonesia, are still learning from the pitfalls of cash transfers, which can get lost in corrupt systems. The countries stand to gain by collaborating and learning from each other.

Moving forward, what best practices could countries adopt to overcome any remaining roadblocks to implementing fuel-pricing reforms?

After looking at the effectiveness of pricing-reform strategies adopted by the countries over the years, including how well they were received by the public and their impact on the health of the national and state-owned oil companies (which either directly subsidize fuel or end up shouldering losses for selling it below cost due to government interference in price adjustments), the paper offered a few key recommendations for policymakers.

First, it is imperative for governments to lay out their plans for fuel-pricing reform clearly and as far in advance as possible, and then to stick with these plans unless there are extreme mitigating circumstances. Such policy certainty is crucial not just for the companies responsible for fuel production and supply in the country but also so that businesses can account fairly for their energy costs in their future planning. It is also vital to clearly and regularly communicate with the public through the course of the reforms and to be transparent about the fuel-pricing formulae being used to adjust prices.

Second, as governments gradually hand over pricing power to the marketing companies, there is a need for a robust and independent downstream regulator. Such a body should have a clearly defined mandate, primarily to ensure that fuel prices are adjusted in a fair and transparent manner in accordance with the approved pricing formulae or the international benchmarks being tracked. The regulator could also ensure that fuel supply is adequate in all parts of the country, people do not hoard fuel or resell it on the black market, and sellers do not engage in oligopolistic practices.

Third, governments need to resist interfering in routine price adjustments once they have adopted free-market pricing mechanism for a particular fuel. While intervening in extreme situations when prices skyrocket might be understandable, halting routine increases on a whim or for political advantage damages the long-term financial health of a country’s oil companies, adds a major layer of uncertainty to their business, and leads to long-term underinvestment in production facilities and infrastructure.

Fourth, the path to the liberalization of fuel prices needs to be planned carefully, keeping in mind the substitutability of fuels, especially in the transportation and power-generation sectors. Deregulating one fuel while maintaining price controls and subsidies on substitutes can cause unforeseen demand swings to the cheaper product, upsetting delicate supply-demand balances and inadvertently increasing the state’s subsidy burden.

Do you have any other thoughts or issues you would like to discuss?

Countries in Asia are typically torn between the twin aims of shedding fuel subsidies in order to free up funds for more productive uses, such as building infrastructure and boosting healthcare and education, while also ensuring affordable energy for their poor. Many Asian countries are also becoming more environmentally conscious and are signatories to the Paris agreement on climate change. This adds yet another imperative for their energy policies—upgrading to cleaner fuel specifications faster than the current rate of progress, pushing for energy conservation and efficiency, prioritizing renewables, and replacing environmentally unfriendly biomass with cleaner fuels. Given that the price plunge of the past two years, which has seen oil prices erode by more than 60%, is expected to last a while longer, the time to act and move decisively is now.

Vandana Hari is the founder of Vanda Insights, a Singapore-based boutique provider of research and analysis on the energy markets. She has two decades of experience in energy commodities pricing and analyzing major trends in Asia’s oil markets. Ms. Hari was a featured speaker in the panel “The Future of Energy Demand” at the 2016 Pacific Energy Summit.

This interview was conducted by Ashley Johnson, an Intern with NBR’s Trade, Economic, and Energy Affairs group.