It's time to reform oil market

Bangladesh should initiate reforms in oil pricing, subsidy and market deregulation to make the most of the historically low oil price in the international market, the Policy Research Institute of Bangladesh said yesterday.

“Low international oil prices, solid economic performance and political stability provide a unique opportunity to tackle these sensitive reforms,” said Sadiq Ahmed, vice-chairman of PRI, at a seminar held at the think-tank's office in Dhaka.

Politically sensitive reforms like oil price subsidy and pricing are best done from a position of strength. Bangladesh economy is growing, the macroeconomy is stable and inflation has come down.

“In this overall positive macroeconomic environment, low international oil prices present a historic opportunity to reduce economically costly and environmentally damaging fuel subsidies.”

Oil prices began its slide in the international market in June 2014, but it was only in April last year that Bangladesh made the adjustment, and too slightly.

The government had planned for another round of cuts but has shelved the course after oil prices started showing an upward trend. 

Benchmark Brent crude was up 40 cents at $55.63 a barrel yesterday, which is still less than half of the price it was two years ago. 

When oil prices are low, subsidy removal has limited adverse social consequences, said Ahmed, a former senior economist of the World Bank.

In fact, the domestic prices of oil products in Bangladesh today are above the international price and subsidy reforms will not increase oil prices immediately. 

“The outlook for international oil prices is also positive, which will help maintain price stability in the near future.”

Reforms are more likely to be successful and durable if they are embedded within a broader agenda.

Most of the successful oil subsidy reforms were well planned with a clear strategy and long-term objectives, he said. This suggests that, for Bangladesh, instead of looking at oil subsidy reform in isolation, a full package consisting of oil market deregulation, oil pricing deregulation and reform of oil public companies aimed at improving their performance and competitiveness is the way to go.

Ahmed went on to cite the Philippines and India as examples to follow for this end. The two countries have now fully deregulated the oil market and oil prices. 

India, for example, established a number of task forces to carry out the oil market reforms that were extensively debated and discussed. In Bangladesh, petrol is taxed but diesel, fuel oil and kerosene carry a subsidy.

Diesel and furnace oil account for 65 percent and 17 percent of oil consumption respectively and contribute the most towards the subsidy bill.

MA Mannan, state minister for finance, said all governments take temporary decisions on issues such as oil price. He also said the government took steps to increase the gas price, but the move faced huge resistance from a group of people who claim they think about the poor people.

But the poor in the villages spend Tk 4,000-Tk 5,000 a month to buy wood for cooking purposes. On the other hand, people living in the cities spend only Tk 500 a month for using gas, he said. 

Wahiduddin Mahmud, a former caretaker government adviser, said time has come for Bangladesh to bring in reforms in determining the prices of oil, and also to see how the private sector can be involved in the system.  Private sector investment in the energy sector would depend on how much the sector would be liberalised.

He said the country could not benefit from gas as its price has been kept very low. On other hand, the oil price is becoming a burden for the economy.

Ahsan H Mansur, executive director of the PRI, and Sajjad Zohir, executive director of the Economic Research Group, also backed reforms in the oil sector.

Zahid Hussain, lead economist of the World Bank in Dhaka, said the demand for oil in Bangladesh would grow as the country strives to attain its development objectives. “So, it is right time to bring in reforms in the price fixing system.”

Hussain also said the benefit of subsidies is short-term while everybody loses in the long run. If the subsidies are withdrawn money could be freed up for increasing spending on the health and education sectors and infrastructure development.

AMM Nasir Uddin, a former energy secretary, said determining the mode of price of oil is completely a political issue.

Stella Kaendera, resident representative of the International Monetary Fund in Bangladesh, said the economy is growing. These reforms are necessary to boost and sustain the growth. Biru Paksha Paul, former chief economist of Bangladesh Bank, said there is scope to introduce a market-based price mechanism, which will be positive for the economy.

The PRI analysis showed that most of the subsidy goes to the middle and the rich income groups. Therefore, reforms pertaining to diesel and furnace oil would be the top most priority.

As the safety net is strengthened, subsequent rounds of reforms can include larger increases in prices for fuel products that are more important in the budgets of poor households. A part of the budgetary savings can be used to finance targeted transfers to poor households.

The PRI said improving efficiency of the state-run enterprises can reduce the fiscal burden of the oil sector. Lack of competition and weak performance monitoring leave no incentives for efficiency drive.

“Well-targeted measures to mitigate the impact of oil price increases on the poor are critical for building public support for subsidy reforms.”

Fortunately, Bangladesh is already well-advanced in undertaking necessary preparatory work towards a cash-based social security system. In 2015 Bangladesh adopted the National Social Security Strategy that calls for a substantial overhaul of the social security system including transition to cash transfers.

The preparatory work undertaken in that context can also apply to the needs for phasing away fossil fuel subsidy.

The government's control over oil prices is driven by its belief that oil is a sensitive commodity for consumer welfare, whose pricing and associated consumption cannot be left to market forces. However, studies show that untargeted oil subsidies benefit the rich much more than the poor.

In Bangladesh, the rationale for oil subsidies rests mainly on the argument that they help keep fuel consumption affordable, especially for low-income groups.

A review based on the 2010 Household Income and Expenditure Survey shows that the poor households' share of consumption of fossil fuels is extremely low: 0.1 percent for kerosene and less than 0.1 percent for natural gas and LPG, petrol, electricity, and motor oil and CNG.

At the other extreme, the rich and the upper-middle classes consume nearly 79 percent of natural gas and LPG, 88 percent of petrol, 89 percent of diesel, 94 percent of motor oil and CNG, and 35 percent of kerosene. In case of diesel subsidy for agriculture, the benefits do not reach the poorest farmers.

“These suggest there is very little empirical basis to claim that oil subsidies benefit the poor in Bangladesh. Clearly, the socio-economic rationale for having open-ended subsidies for fuel oil is very weak.”

The PRI analysis said the current Bangladesh oil pricing system does not meet internationally established principles. 

Since Bangladesh does not yet have a competitive oil market, full deregulation of oil prices may be pre-mature at this time, it said. The pricing policy should be administered by the Bangladesh Energy Regulatory Commission without any government intervention. For that end, BERC should be strengthened with greater autonomy and quality staffing to do its assigned job with proper competence.

According to the presentation, the considerable benefits in reforming oil prices and subsidies and deregulating the oil market include: mobilising foreign and domestic private investment; supporting growth and job creation; and directing government resources currently spent for oil subsidies to other priority social programmes. The PRI said the recent bounty from the lower global oil prices has provided some relief. 

But the current surpluses of BPC could well be temporary if oil prices rise again and the ad-hoc pricing regime prevails. If so, BPC could return to losses once again, with all the adverse fiscal implications.

It said the cost of the oil subsidy policy is indeed large and messy. 

A recent study of 20 countries including Bangladesh finds that a phasing out of fossil fuel subsidy by 2020 leads to an average national carbon emissions reduction of 11 percent.  

Additionally, if a part of the fiscal savings (30 percent) is used to improve energy efficiency and invested in renewable energy, the reduction in carbon dioxide emission could be about 18 percent. 

In case of Bangladesh, the CO2 reduction estimates are 8.7 percent from removal of subsidies and 13.6 percent when 30 percent of savings from fossil fuel subsidies are subsequently invested into parallel energy efficiency and renewable energy.

Fuel subsidy reform can be an effective policy tool for reducing carbon emissions.