Subsidising Natural Resources in the Gulf

If there has been one non-living subject that has been taboo in the Gulf monarchies then it is the domestic pricing of natural resources.  For years international economists and monetary agencies have prescribed cuts to fuel and utility consumer subsidies as a way out of the Gulf Cooperation Council states’ growing energy demand. Until mid-October however, the “s-word” had only been uttered behind the closed doors of ministries and government agencies grown increasingly worried about domestic energy security and the cost of maintaining it.

A surprise public statement from Dubai’s ENOC (Emirates National Oil Company) last Saturday (16 Oct) broke the silence by implying high subsidies had driven it to the verge of bankruptcy. The exceptional announcement, accompanied by read-between-the-lines messages typical of states not known for their transparency,  precipitated a wave of media articles and tweets. ENOC had already topped the headlines in June of  this year for the very same issue, but the company didn't admit the problem at the time. Saturday’s announcement was clear: “ENOC looks forward to the support of the concerned authorities in addressing the concern.”

In the UAE, the federal government (in this case read Abu Dhabi) sets the gasoline prices. They are currently at US$0.47 per litre, the highest price in the GCC, but not high enough to satisfy Dubai’s ENOC, which lacks refinery capacity and imports gasoline from international suppliers for sale in all emirates but Abu Dhabi. Due to rising international fuel prices, ENOC says it expects a whopping loss of US$735 million for the current year alone. Meanwhile, Abu Dhabi’s national oil giant ADNOC has been opening new stations in the emirates of Ras Al Khaimah and Ajman. Some sources have even suggested it would entirely take over the five smaller emirates from ENOC and its subsidiary EPPCO.

So, one could easily conclude that this is a classic takeover scheme, with a more powerful company taking over a weaker one to create a monopoly. It is also symptomatic of much more. Here are a few of the most important wider political issues the latest Dubai crisis reflects:

Power struggle or passing the bill: The UAE, due to its federal structure and constitutional guarantees for Abu Dhabi over the sovereignty of its natural resources, is an exceptional case in the GCC. In addition to its emirate-level social contract, which includes highly subsidised power, water, gasoline and a number of direct and indirect welfare benefits for nationals, Abu Dhabi also bankrolls most of the federal budget and provides the northern emirates with most of their cheap electricity and water. In Dubai, which is becoming increasingly oil-scarce, the economic crisis has not cooled down resource demand growth, leaving the local government struggling with both gasoline and power supply. Refinery capacity is lagging and cheap gas supplies from Qatar are not expected to increase any time soon. Dubai’s plans for power supply in the next decade do not seem too convincing either, relying mostly on natural gas, growing the share of renewables to 1%, and investing in “clean coal” (the economic feasibility and environmental safety of which are controversial).

Some prefer to see the ENOC case in light of a broader Abu Dhabi-Dubai power struggle, as I myself suggested in an earlier post. Others have pointed out that Dubai might actually be on the gaining side, as the expected shift of gasoline provision from ENOC and EPPCO to ADNOC will effectively place the subsidy bill on Abu Dhabi’s shoulders. Less responsibility obviously equals less leverage, so in the end both might end up losing.

Resource availability differentiation: There is no doubt that some Gulf monarchies, like Qatar and the emirate of Abu Dhabi, could in theory afford to uphold the domestic illusion of limitless resources for many years, even decades to come. But there are some, like Bahrain, Oman and the all the other UAE emirates, that really should have begun raising their gasoline and utility prices many years ago. At current production rates, Bahrain’s and Oman’s proven oil reserves will run dry in 7 and 17 years, respectively. In order to meet its increasing electricity and water demand, Bahrain has signed deals to import natural gas from as far as Russia. Oman is importing gas from Qatar. The understanding that subsidy reform equals increased calls for public representation, however, continues to stick. Bahraini officials have recently declared "the era of cheap gas is over”, calls that have been accompanied by announcements of gas price rises for the industry only. Most residential users of electricity in Bahrain continue to pay only 0.8 US cents per KWh and in Oman they pay 2.6 US cents, while households in the US pay 11.6 cents and in Britain roughly double of this.

There is another key distinction to be made, namely between the different resources subsidised. Petrol subsidies are likely to stay around longer in all of the GCC states, with only moderate price rises in the horizon. Electricity and desalinated water, however, are different. They are mostly produced by burning natural gas. All GCC governments except Qatar will be forced to either continue bearing a higher price for believing that low prices will mean political stability, or devise a new power and water pricing regime that covers  existing budget losses, incentivises the average consumer not to waste, and directs badly needed investments to this sector.

Effects of the Arab Spring: The ENOC announcement also needs to be understood in the broader context of the soft counterrevolutionary measures that GCC states have been employing since regimes began falling in the region. Merill Lynch recently estimated that domestic spending in the six states has increased by US$150 billion. Saudi Arabia is spending US$43 billion on its poor and Qatari nationals recently received a 60% pay rise. In March, Abu Dhabi announced US$1.55 billion to be invested in the expansion of the northern emirates’ power  and water electricity sector alone. In August, Dubai, in a highly popular move among industries and businesses, announced a freeze in utility tariffs for the “next few years”. All these mixed signals can only mean one thing: leaders in the UAE are worried about the Arab Spring, but do not seem to agree on the role that natural resource prices play in it and how much should be sacrificed for the sake of boosting economic growth.

Unjust subsidies: It is a fact that GCC nationals are part of a social contract that includes high resource subsidies. At the same time, one cannot escape the moral problem that wealthy people tend to benefit more from flat rates, like prices and taxes, than do the poor. At the pump, it is hard to make a mechanism that distinguishes between those included and those excluded in the ruling bargain, or the rich and the poor. Electricity and water provision, however, is an easier area to target – and also the one where the gas crunch will be felt the most.

In the GCC states, nationals generally are wealthier than the large bulk of non-national residents and hence consume more. Slab tariffs have been introduced at least in Dubai, Bahrain and Oman, but their impact on curbing wasteful consumption is hard to measure. The new, higher tariffs in Dubai have reportedly driven some businesses to take measures, but the raises have so far exempted Emiratis.

Many innovative pricing mechanisms are currently being whispered by energy economists to government officials’ ears all over the GCC. These range from separate financial compensations for nationals to truly redistributive, pro-poor mechanisms. The Arab Spring has certainly made governments reluctant to make sudden moves, but at the same time these know that in the coming years prices will have to change. Except in Qatar.

In Qatar where gas is plenty, industries are large and the national population is a little over 200,000, the question is more of a moral kind than economic or availability-related: is it OK that a gardenless house uses 14,000 litres of (desalinated) water each day in a country that is classified as extremely water scarce and at a time of heigthened awareness on climate change? (The figure is from a Qatari-led study from 2003.) As I recently pointed out in a talk at Georgetown University in Doha, if we can afford to consume, does it always mean we should, especially when there are environmental impacts involved?

Towards alternatives: “Subsidy” is apparently a word disliked by many citizens of the Gulf region’s states for the negative connotations it carries. It is therefore a good start that at least a frank debate that uses this very word has now been opened. Other policy instruments, most importantly energy efficiency, however, also deserve increased attention. The good news is that when the inefficiency-inducing subsidies are gradually removed, efficiency will rise too.

Another area for GCC states to work more on is economic diversification away from oil dependency. A global oil demand peak will not be ENOC’s problem, but neighbouring Abu Dhabi, Saudi Arabia and Kuwait have a reason for concern. As Kenneth Pollack wittily noted in a recent seminar at Brookings Center Doha, a new oil shock would be likely to drive Americans “to electric cars faster than you can say ‘Prius’." Given the magnitude of this task, however, and the changes that economic diversification will most likely imply for the existing social contracts, maybe a subsidy reform is not such a bad place to start with after all.