from Follow the Money

Fuel subsidies (and fuel shortages) in emerging economies

August 17, 2005

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If you care to head to Baghdad - and are willing to wait in line - you can fill up your car with premium gasoline for 3.3 cents a liter (around 13 cents a gallon).  Basic gasoline goes for just more than a penny a liter, diesel for even less.   The electricity grid is not exactly reliable, and with gas so cheap, it is hardly a surprise that anyone with money in Iraq seems to have a private generator.    I would not be surprised if gasoline smuggling is the leading source of private employment in Iraq.

Continues, with discussion of gasoline pricing in Indonesia and China, not just Iraq ...

All this has a cost.  The IMF estimates that giving gasoline away at low prices in Iraq rather than selling it on the international market costs the Iraqi government about $8 billion in lost revenue.   $8 billion is 27% of Iraq's estimated 2005 GDP - real money.  Some of that is revenue foregone, but there is also an explicit budgetary cost.  Iraq lacks the capacity to refine premium gasoline, and cannot refine enough diesel or kerosene either.   The IMF estimates Iraq will spend $3.6 billion - about 15% of its GDP - importing refined petrol, petrol that it basically then gives away.

If nothing else, cheap petrol in Iraq does support private economic activity of a kind.   The IMF call for higher domestic oil prices is full of understatement: "Such action will not only alleviate damaging market distortions but will also generate substantial resources for the budget - rouses which currently accrue to black market dealers and smugglers."   Read the LA Times article on oil smuggling for a bit more color.  Incidentally, one little warning for anyone who bought dinars thinking that they would do nothing but go up.   The Iraq central bank has been selling more dollars into the market that expected this year - something that it has had to do to keep the dinar from falling.

Iraq is not alone.  Indonesia has become a (net) oil importer.  But its domestic petrol prices are still those of an oil exporter.   The growing budget cost of its gasoline subsidies is one reason why Indonesia's central bank is intervening in the foreign exchange market to keep its currency from falling.   China is buying dollars like mad to keep its currency from rising; Indonesia is selling dollars to keep its currency from falling.

Speaking of China, it shares one thing with Iraq.  Gasoline lines and petrol shortages.  

The pace of increase in China's petroleum imports this year has been remarkably slow - the IEA now estimates the volume of oil China imports will increase by only 5% this year.  There is a big gulf between the rapid increase in China's industrial production (up something like 16% -- see the latest from the World Bank), the rapid increase in its GDP, and the small increase in petroleum imports.  

One explanation is that China brought a bunch of coal fired electrical plants on line, reducing the need for plants to rely on petrol for to run generators of their own.    But I suspect James Hamilton (econobrowser) is right.   A big part of the explanation is that China has not allowed domestic petrol prices to rise as fast as international prices.

Purely state owned firms that did not care about their profits presumably would keep on importing all the petrol China needs.   If that cut into their profits (after, pumping China's domestic oil, refining it and selling it is still rather profitable), or even led to losses, who cares?  The state-owned banks would certainly keep on lending to firms following state policy.  But China is changing.  The state-owned petroleum firms do seem to care about their profits - and since importing oil to sell inside China at current prices cuts into their profits, they seem to be trying to import as little as possible.

Incentives and all.  Via Econobrowser and the Oil Drum comes this gem from Petroleum World:

The IEA estimates that at the beginning of July suppliers to the Chinese domestic market were losing 20 dollars per barrel or more on every barrel of gasoil supplied.

At least that is one explanation.   Gas lines in China might be the unintended consequences of controlled domestic prices, rising international prices and more commercially oriented state oil companies.

Another explanation is that China's government has an intentional policy of keeping petroleum under-priced domestically to keep folks happy, and rationing the available supply to limit demand.  That, after all, clearly is China's approach to allocating bank credit.  Keep it cheap.  And rely on administrative controls to keep credit growth from rising too much, and "window guidance" to try to make sure that the sectors that the government wants to have credit get credit.

Americans can at least take comfort that other countries are also struggling to cope with $60 to $70 a barrel oil ...

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