What are the effects of oil subsidies in Ghana, and how price reforms could improve that
Introduction
Petroleum is the major index that drives business, manufacturing and transportation of goods and services to serve a competitive nation’s economy and the world at large. The tradability, specificity of assets, planned demand characteristics, the depletion premium resulting from the countries decision to consume now or later and the occurrence of externality, all plays an increasing role in the pricing and the cost of Petroleum products to a country. As the nation’s needs for economic growth increases, it also triggers the needs for reduction in unemployment and the provision of more goods and services. The need for constant supply of petroleum products at affordable price for country’s economic growth can therefore not be a question for debate.
However, the discovery of oil and gas often brings about dreams of wealth and prosperity for the developing countries. (Joseph Stiglitz Aug, 2004). In 2007 the Country’s President, John Kufuor, said that the country’s new “black gold” would enable Ghana to become an “African tiger”. “Oil according to him is money, and we need money to do the schools, the roads, the hospitals. If you find oil, you manage it well, can you complain about that? Even without oil, we are doing so well already now, with oil as a shot in the arm, we’re going to fly.” This statement is demonstration that, the recent discoveries have, raised the hope and aspiration of Governments and the average Ghanaians for a better Ghana in the near future.
Unfortunately, the discoveries have changed the perspective of Ghanaians about the need for subsidies and pricing of the petroleum products in the country. Ghanaians are expecting petroleum prices in the country to trade lower than the import parity price due to the simple reason that the country has found its own crude oil on commercial quantity. It will be interesting to note that the opportunity cost of consumption subsidies to an exporter like Ghana, is the revenue forgone by not charging international price domestically.
Additionally, if this perspective of the average Ghanaian materialises, a non stable, non neutral and inefficient pricing mechanism will emerge. This will generate into devastating political conflict and lasting economic setbacks for the country. According to the IMF country report 2009 “if Ghana uses its new-found oil wealth wisely, it stands the chance of achieving middle-income status within ten years”.
Ghana’s petroleum problem in relation to subsidy is deeply rooted in all the sectors of the economy, from households through firms to government official and high level politicians. This chronic condition has been left uncheck for several years from one political economy to another. Consequently, any action by any political administration to truly correct it will be too painful to the consumers and also politically unwise for the government.
However, having being blessed with this discoveries in recent times , a competitive pricing regime for the petroleum products must be considered seriously for the domestic market if Ghana is to really fly as an African Tiger and also achieve a sustainable economic improvement.
Subsidies and Pricing
The mechanism for defining what constitute a subsidy differs from one country’s point of view to another. According to Organisation of Economic Cooperation and Development (OECD), any government action that reduces the cost for the consumers and the producers can be described as a subsidy (OECD, 1998).
In view of Energy Information Administration (EIA), any government action designed to influence energy market outcomes, whether through financial incentives, regulation, research and development or public enterprises constitute subsidy to the economy. (US, DOE/EIA, 1992).
Similarly, the International Energy Agency (IEA) has defined energy subsidy as any government action that concerns primarily the energy sector that lowers the cost of energy production, raises the price received by the energy producers or lowers the prices paid by the energy consumers (IEA, 1999).
Finally, the International Monetary Fund (IMF) defined price subsidy as the difference between price facing the consumers or producers and the specified optimal benchmark price (IMF, 2010).
In a perfect competitive market like Ghana, the marginal supply cost of the last supplier is taken as the benchmark price. This price must also include taxes, since governments’ makes good use of taxes to internalise the externalities of energy products in the market or to correct market failures. This principle explains the reason why our crude oil is traded internationally.
Various kinds of subsidies exist in the energy industry with some such as tax allowance, price control and grants all having direct effect on the price of energy either to the producers or to the consumers. Government’s actions through regulations may also result into subsidies.
In China for example, electricity distributers are regulated to purchase 100 percent of the renewable energy produce in the industry (Nick Hodge 2010). This is a producer subsidy. Other forms of energy subsidies may lead to price controls when the producer price falls below full cost. This is especially the case of government owned energy companies. Subsidies may either be in the form of producer subsidies or consumer subsidies. Energy subsidies mainly originated from price controls. (Trevor Morgan 2007),
Reasons for Subsidies
The reason for the provision of subsidies by government is to protect the poor household from increase in the world prices and also to encourage them to consume clean energy. Taking away these benefits from them would mean subjecting the poor to hardship hence the need to provide alternatives.
Other reasons why governments will introduce subsidies may include the need to make renewable energy competitive in the market and also to reduce the high percentage of income spent on energy and also reduce significant amount of time spent collecting fuel wood for cooking and subsequently reduce greenhouse-gas emission. Issues of high inflation are sometimes also considered as a reason for introducing subsidy. Energy for lightning helps students study and this may increase the level of education of the poor if subsidies are provided.
Trend of Subsidies In Ghana
This report estimated the trend of energy subsidy in Ghana in accordance with the definition of energy subsidy by IMF, 2010 report. Since Ghana is an exporter of crude oil, the marginal supply cost to the country is the price prevailing in the international market. This price is further adjusted for by transportation, distribution, and marketing cost, but also including various taxes and levies for internalising the cost of externalities generated by consuming fossil fuel.
In estimating the subsidies, the benchmark price is taken as the US dollar price plus adjustment of $0.3 for the optimal tax level. Basic economic principles suggested that, taxes on petroleum products should be higher than those imposed on other consumer goods due to the environmental issues and also the level of revenue require by governments for development (Crawford, Keen and Smith, 2008).
The US equivalent retail price is calculated by multiplying the local currency retail price in Ghana cedi by the end of period exchange rate. The magnitude of the consumer subsidies are estimated based on the difference between the benchmark price and the domestic retail price (tax inclusive). The report, estimated the subsidies on Gasoline and Diesel only.
It is interesting to note that, between 2000 to 2008 inclusive, gasoline and diesel constitute about 81 percent of the petroleum products used. Kerosene and Liquefied Petroleum (Gas) LPG which are mainly used for domestic cooking and lighting constituted about 9 percent, whiles Residual fuel Oil and Aviation Turbine Kerosene (ATK) amounted to the remaining 10 percent. Similarly between 2009 and 2011, LPG, Kerosene and Pre-mix fuel constitute about 12 percent whiles gasoline, gas oil and aviation fuel constitute about 78 percent of petroleum products consumed in the country.
The total consumption subsidies estimated by Africa Centre for Energy Policy (ACEP) during the period under review (2000-2008) amounted to US$ 3billion. This translates to annual average of about US$ 428million. In 2007, there were eventually no subsidies due to 30 percent average increase in the domestic retail price of the products, whiles the US retail price increase by only 8 percent average for the two products. During 2007, the country suffered a serious energy crisis as a result of severe drought, leading to a significant shift in the energy mix. As a result the country move from predominantly, hydro to Combined Gas Cycle Turbine (GGCT) power generation, at the time of rising price of crude oil. The Government was forced to increase the price of fuel leading to the elimination of subsidies in 2007. In 2008, there was a total subsidy of more than US$ 600 million which was equivalent to 1.8 percent of the 2008 GDP of US$ 34.93 billion. This amount was about 92 percent higher than the 2006 figure of US$320 million.
According to National Petroleum Authority (NPA) the cost of subsidy from 2009 to 2012 is over GHS1.5billion and the projection for 2013 by NPA, if the chronic condition remained is also about GHS2.4billion .These values put together far exceed the cost of building Akosombo Dam today. The evidence of this subsidy means that government still regulates the domestic prices per litre of fuel, therefore an, increase in the world market price of crude oil is not transferred to the final end users.
In Ghana, the problem of inflation, affordability, equity and fairness to the poor in society are the main issues that comes out for discussion anytime there is need, to increase the retail price of fuel as a result of increase in the world market price. The public and civil society groups react negatively to any approach to increase the fuel price. As a result all the political administrations in the past have failed to solve this chronic petroleum problem within our society.
Recently we witnessed a short term solution with half heated measures like hedging which was introduced in April, 2010 by the current administration to address the problem. This solution unfortunately has worsened the problem beyond remedy because the judgement was wrong. It is important for Ghanaians and generally politicians to note that hedging without the elimination of subsidies will not reduce the impact of price volatility on petroleum products. It will only encourage planning.
Inflation is mainly a monetary issue, and with good monetary and fiscal policy mix, the inflation component in the fuel price should be reduced. Again inflation cannot last for so long if not fuel with expansion in monetary supply. Also countries like Ghana that persistently keeps fuel prices below the benchmark price are the ones with higher inflationary figures.
With the argument of fairness and affordability for the poor, it has been established by research that fuels and all kinds of petroleum products are mostly used by the affluent in the society compare to the rural poor household. (OGJ, Dec. 10, 2007). Therefore the direct benefit of subsidy excludes the poor in the society.
Interestingly, our politicians and successive governments have promised heaven, yet refused to acknowledge how essential, subsidies and other imposed inefficiencies corrode employment and lead to stagnation in economic growth. Unfortunately contradictions like this arise when politicians push political agendas at the expense of national interest.
Effect of Petroleum Subsidy in Ghana
Considering the fact that the opportunity cost of these subsidies, is the revenue forgone by not charging the international prices domestically, there is a high probability therefore of a shift in the allocation of scarce economic resources to finance the increase in crude oil price in the country. For-example, according to the IMF, 2009 Country report, the rising oil import contributed to the widening of the external current account deficit from 9.9 percent of GDP in 2006 to 19.3 percent of GDP in 2008.
Consumption subsidies on the other hand increases domestic consumption and trigger an increase in demand for import. This may increase the energy dependency ratio and worsen the balance of payment and the energy security in Ghana. The country currently has a very high level of energy insecurity; the lights are 20 percent of the times not on. Our vehicles are often seen waiting several hours in long queues for fuel. The unreliability of supply of LNG for homes keeps running from bad to worse. The country’s fossil fuel consumption keeps increasing with increasing energy intensity of about 0.2.
Surprisingly, 2000 and 2011, the country’s petroleum product consumption increases from 1487.40 kilotons to 2733.40 kilotons representing a percentage increase of 84 percent. LPG has seen the highest increase of over 376% with gas oil following with over 115 percent with gasoline and premix fuel coming with 54 percent and 48 percent respectively. Kerosene has actually seen a drop of over 7 percent during these periods. This trend if continue with the current level of subsidy is likely to reduces further the price elasticity of demand for the product and this will further increases the rate of consumption which will finally worsen the frequent physical shortages the country is witnessing.
Similarly in 2008, the overall balance of payment recorded a deficit of US$941 million compared with a surplus of US$413 million in 2007. All these may be due to the size and effect of subsidies in 2008 compare to 2007. Petroleum subsidies disturb the pricing mechanism of the energy source and set in motion a disequilibrium position and therefore deter new investment flow into the sector. It also limits access, and may hinder the growth of alternatives in the country. The current level of renewable penetration in the country’s energy mix is less than 0.01 percent but the renewable energy law makes provision of 10 percent by 2020. With the persistent level of petroleum subsidy, the introduction of renewable into our energy mix for the purpose of energy security will not be competitive.
Furthermore consumption subsidies may also lead to wasteful consumption and inefficient use of energy. This may put pressure on government resources and may lead to unsustainable budget deficits in the country. For example according to IMF country report, 2009 ” the percentage of the budget fiscal deficit to GDP in 2008 was about 14.5 percent. Contributing to this may be the high energy and energy related subsidies”. It again worth noting that in 2008 the energy subsidies on gasoline and gas oil alone amounted to over US$600 million as estimated by Africa Center for Energy Policy (ACEP).
Finally, subsidies on petroleum products encourage higher consumption which may increase externalities, by increasing carbon dioxide (C02) emission. Subsides, may also lead to faster depletion of fossil fuel reserves. It has been established by empirical studies that, the emission reduction resulting from cancelling all subsidies on fossil fuels is very high. (Trevor Morgan, 2007). It is interesting to note that, not all energy subsidies have negative consequences. When the presence of energy subsidies leads to internalising the cost of externalities, there will be no environmental effect or cost from the use of subsidies and also when the social benefits or the environmental improvement exceeds the cost of subsidies, a positive effect can result, an example is the case of renewable.
Why the need for Reform
Although consumption subsidies are often justified as protecting the poor from higher prices, thereby encouraging the poor to consume a cleaner energy at affordable price, in Ghana only a very small share of either the total or indirect benefit actually reaches the poor, with a substantial leakages to the higher income household (David Coady et el, 2010). In Ghana less than 10 percent of the Petroleum products are used for lighting and cooking, with the more than 80 percent used by the transport sector. Given that the direct benefit for cooking and lighting goes to the poor, one can say that the current system is very regressive and does not benefit the poor directly.
Without a credible and enduring reform, it won’t be possible for the industry to do new investment to replace old capacities in the power sector and hence provide more access to the poor. The Kyoto Protocol calls for reduction or elimination of energy subsidies that encourage greenhouse-gas emissions for annex 1 party’s obligation and general commitments for other nations. (Kyoto Protocol 1997).
Challenges to Reform
Governments provide subsidies to protect the poor household from increase in the world prices and also to encourage the poor to consume cleaner energy. It can benefit the intended purpose provided the right group or the targeted group is included and the untargeted group is excluded. Eliminating this benefit would mean subjecting the poor to more hardship. This can result to increase use of traditional fuel which may cause more harm to the environment.
Other challenges include; the difficulties in identifying the exact group to benefit by directing the assistance to them if a targeted reform are implemented. Estimating the right size of the subsidies and public reactions to the reform with Governments persistent use of centrally administered pricing system as political tool to win votes are all some of the challenges in Ghana.
Approaches to Reforms
To provide regular supply of petroleum products and also to insulate Ghanaians from price volatility, Government will need to introduce some reforms, but is important that the selection and implementation of the right reform strategy should take into consideration the political will of Government and the Opposition parties in general. The right orientation of the political economy in Ghana is a partial index to the success of any reform in the petroleum and in general the energy sector. The current economic condition of the country is also need to be taken into account before applying any of the reforms. The education of the public about the need for reform and the experience and core competence of the implementers and the packaging of the assistance are equally important in addressing the current issues of petroleum subsidy in the country.
Since the selection and implementation of the right reform strategy depends on the political will of Government and the people. The Africa Centre for Energy Policy (ACEP) is of the view that the application of the following reforms in the country will go a long way in addressing the endemic petroleum subsidies in the country.
There is currently a private sector participation of crude oil in the petroleum industry in Ghana. The ongoing reform allows the private sector to procure crude oil as well as import of the refined products through tendering mechanism supervised by the National Petroleum Authority (NPA). The system seems not to be working due to political interference by governments. In order for the system to work effectively for the benefit of the silence majority, ACEP is proposing the following reforms to address the problem.
Firstly, ACEP is of the view that government must encourage competition in the procurement of crude into the country without any political interference. This can be achieve through a pre-qualification mechanism to select the oil marketing companies that are financially stable to undergo open and competitive tendering in the importation of the petroleum products. We strongly of the conviction that by allowing competition, the ex-pump price of the product is likely to fall and reflect the true industry picture.
Secondly, automatic pricing reform where the burner tip price of the product is adjusted regularly in accordance with the international crude price must also be encourage with the NPA acting as the regulator. Public agitation against automatic pricing would be limited through education and Governments control would also need to be limited.
Thirdly the application of different tax structures to different petroleum products must also be encourage with adequate measures to ensure that the target groups actually benefit from the tax elements. It is important for government to provide more fuel related activities like mass transportation and other social activities for the poor and increase expenditure on social activities. Some build-up elements within the ex-pump price must be re-examine. For example government will have to consider the elimination of exploration levy and TOR debt recovery levy from the price build- up.
Conclusion
Providing Energy subsidy in view of ACEP should be a strategic process. It should be dynamic and responsive to changes. Subsidies should provide avenue for extension of services to areas that lack access, due to high level of poverty. It should attract new business investment into the area. It should encourage the people to increase their productivity level and provide benefit to the rural poor. In designing a credible subsidy regime, care must be taken by the Government of Ghana not to exclude those that, the subsidy is intended to protect (errors of exclusion) as we are currently experiencing under the subsidy regime for kerosene. Similarly it should not include those that are not anticipated to benefit (errors of inclusion). The misuse of the lifeline rates in the electricity sector in the country is a clear demonstration of lack of inclusion and exclusion mechanism. Subsidies must be provided for granting access and other capital expenditure rather than operational expenditure and also for consumption purpose. Production subsidy is the way forward but not consumption subsidy.
By John-Peter Amewu
Africa Centre for Energy Policy (ACEP)