Over the course of 2011, some African countries took steps to drawdown on expensive and unsustainable fuel subsidy programs. Recently, Nigeria joined the ranks of Ghana and Guinea by slashing fuel subsidies to align domestic fuel prices with international prices.
The argument for the removal of fuel subsidies is based on the notion that poorly targeted consumption subsidies deprive the country of scarce resources critical to other priority sectors. Globally, fuel subsidies amounted to USD 410 billion in 2010 as energy prices rebounded strongly. In 2011, fuel consumption subsidies in Nigeria, Cameroon and Ghana cost USD 7.5 billion, USD 600 million, and USD 276 million, respectively. The fuel subsidy was the equivalent of 30% of total federal government expenditure in Nigeria, and approximately 12% and 3% of federal government budget in Cameroon and Ghana, respectively. This sharply contrasts with the proportion of public spending on health in those countries.
Why remove fuel consumption subsidies?
- Fuel subsidies are regressive in their effect: According to IMF estimates 65% of total fuel subsidies in Africa benefit the richest 40% of households (2010). Only 8% of the USD410 billion in subsidies went to the poorest 20% of the population (International Energy Agency - IEA estimates, 2010). These figures underscore the inequitable distribution of subsidy benefits and the inefficiency embedded in subsidy programs, especially consumption subsidies.
- Discourage illegal fuel exports: Fuel consumption subsidies have historically been associated with rent-seeking behavior. For instance, gasoline prices in Benin and Cameroon are more than 200% higher than the subsidized price in Nigeria. This provides substantial incentive for marketers to smuggle petroleum products across borders. The wider the margin between international prices and subsidized oil prices, the larger the rents from illegal oil marketing which in turn create an incentive for smuggling.
- Discouraging investment in energy infrastructure: In oil exporting countries, consumption subsidies on petroleum products discourage private sector investment in refinery infrastructure because it is relatively cheaper to import finished oil products than to refine domestically, especially when the cost of refinery is higher than landed import tariffs. The existence of excess capacity and the inability to compete against subsidized imports creates a disincentive for private investment in oil refinery infrastructure.
- Reducing greenhouse emissions: Removal of fuel subsidies could also alleviate environmental problems by reducing petroleum consumption and associated greenhouse gas emissions. The IEA estimates that reducing subsidies by one-half in non-OECD countries could reduce greenhouse gas emissions for up to 12 percent by 2050.
Alternatives to ‘linear’ fuel subsidies
The biggest test to phasing out of poorly targeted subsidies is the ability of the authorities to withstand the social and political backlash from vested interests. Removal of subsidies is the first best solution; followed by alternative measures which have customarily been used to diminish the full scale cost of the subsidy removal could also be considered.
- Cross subsidies: Poor households benefit more from subsidies on kerosene than on other energy products, mainly because expenditure on kerosene weighs more in the budget of this category of consumers. Concessional measures could therefore target poor households by eliminating gasoline subsidies and maintaining kerosene subsidies, and/or subsidized public transportation which benefit poor households directly.
- Compensatory transfers: A proportion of the budgetary savings generated from abolishing the fuel subsidy could be directed towards new social safety-net programs or towards existing programs including cash transfers and/or lower user fees for health care, for example.