Fuel subsidies are double-edged sword for UAE

Gulf state torn between raising fuel prices or shutting down loss-making petrol stations
The UAE has long subsidised fuel prices in an effort to cut living costs for residents
By Reuters
Sun 30 Oct 2011 07:51 AM

Fuel subsidies have become a double-edged sword for the United Arab Emirates, which is caught between raising petrol prices - an unattractive option at a time of social unrest in the Arab world - or shutting down petrol stations, leaving hundreds of people scrambling to find fuel in the oil-exporting country.

Heavy subsidies on gasoline are a common characteristic of the Middle East. Analysts say the region accounts for almost half of the $409bn that the International Energy Agency (IEA) estimates the world spends annually on government subsidies for fossil fuel consumption.

In the UAE, a petrol price cap is set by the federal government and petrol is sold to customers at a fraction of what retailers pay to buy it from global markets, where the price of gasoline has risen some 70 percent in the last few years along with surging crude oil prices.

The system leaves the retailers to operate at a loss. Three of the UAE's four fuel retailers - Dubai government-owned Emirates National Oil Co (ENOC), Emirates Petroleum Products Co and federally owned Emarat - have been making losses for many years. The fourth is Abu Dhabi National Oil Co, which has been largely unaffected because its upstream operations and vertically integrated supply system allow it to absorb any potential losses.

The retailers have put up with this system because they are government-owned and to some extent view themselves as state utilities. But there are now signs that they are tiring of this role.

In a rare and surprisingly frank public statement this month, ENOC, which has shut its petrol stations in the northern emirate of Sharjah since June, asked authorities to change the system.

"The current scenario, where ENOC has to bear the burden of higher international fuel prices while at the same time distributing fuel at subsidised rates, is clearly not sustainable or viable for the company," it said.

"ENOC looks forward to the support of the concerned authorities in addressing the concern."

Standard grade gasoline in the UAE is sold to the public at AED1.72 (47 US cents) per litre, less than half of the global average price of $1.21 a litre, according to the World Bank. ENOC predicted this system would cause it to suffer a loss of AED2.7bn this year.

The shutdown in June of some petrol stations by ENOC and its subsidiary Emirates Petroleum Products Co caused mayhem in the relatively poor and neglected northern emirates of the UAE. Citizens were forced to drive for kilometres to find a functioning station and then wait for hours in queues to fill their tanks - embarrassing scenes for a country which has over 7 percent of the world's oil reserves.

Some of rival Emarat's petrol stations ran dry in April after a payment problem with suppliers.

"Petrol prices are set federally so this is not a Dubai-specific issue. The issue is in federal policy and it guarantees you're going to lose money," said Robin Mills, head of consulting at Dubai-based Manaar Consultancy.

"I'm sure Dubai must be saying to Abu Dhabi, 'if you want this policy, you have to back it up'."

Since the federal government sets the price cap for fuel in the UAE, the wealthiest emirate Abu Dhabi, which owns the bulk of the country's oil, has the biggest say in deciding the policy. That can threaten to create an imbalance between costs and benefits.

Article continues on next page…

Dubai, which is slowly recovering from its 2009 debt crisis, spent just over AED5.7bn on various subsidies including energy and other transfers in 2010, according to International Monetary Fund data. Abu Dhabi spent AED22.2bn - but its budget is more than four times the size of Dubai's.

The UAE government has not yet responded publicly to ENOC's plea. Short-term solutions such as recapitalising or making cash injections into the loss-making fuel retailers could allow the UAE to avoid raising pump prices at a politically sensitive time. This approach has already been taken at least once; in June the federal government raised Emarat's capital by 50 percent to 9 billion dirhams, state news agency WAM reported.

But some analysts argue that given the wastefulness of the system and the disincentives it creates for retailers to maintain reliable fuel supplies, such solutions can only delay the inevitable: the eventual phasing out of the subsidies.

"The optimal outcome here would be not to have blanket subsidies for everyone," said a Dubai-based independent energy analyst, who declined to be named because of the sensitivity of the issue.

"And instead to have those subsidies for those who really need them: Emiratis with lower incomes or anyone who earns below a certain level."

The UAE has one of the highest per capita incomes in the world, thanks to its oil wealth; according to HSBC, the country's fuel subsidy level per capita was the highest worldwide in 2009 at $2,290.

Petrol prices in the UAE were raised three times in 2010, and sources in the Abu Dhabi government and the oil industry say bringing prices in line with global markets is the ultimate goal for the government. But it is not an urgent goal.

A source close to the Abu Dhabi government, who declined to be named, said fuel retailers had complained about the price before ENOC's public outburst.

"Is this issue more urgent today compared with yesterday? Not really, because oil prices are not as high as they were, like in 2008," he said, predicting that international oil prices would ease further in coming months, reducing pressure for the UAE to hike pump prices.

The source agreed with ENOC that fuel retailers' business model was not sustainable in the long run. But it is a model practiced in variations across the Gulf, including Oman, Kuwait, Qatar, Yemen and Saudi Arabia.

At $0.16 a litre, Saudi Arabia offers the second cheapest fuel price in the world, after Venezuela, while Qatar's heavy subsidies allow it to sell fuel at $0.19 a litre, well below the Middle East average of $0.56, according to World Bank data.

Iran was part of this group until late last year, when it removed government subsidies on items including food and fuel, causing the price of gasoline to surge between 400 and 700 percent overnight.

"Iran made a political decision to deal with the subsidy issue and has drastically raised the price of domestic fuel, and has severely reduced its [fuel] imports on the back of that," said Chris Bake, managing director of Vitol Dubai.

Article continues on next page…

Vitol, the world's biggest oil trading firm, was one of many gasoline suppliers to Iran when the Islamic republic was importing 12-16 cargoes a month, depending heavily on imports because of a lack of refining capacity and booming demand.

US-led economic sanctions on Iran, aimed at its disputed nuclear programme, prompted companies to stop doing business with it and were instrumental in the decision to phase out subsidies, because demand had to be curbed.

Iran's daily gasoline consumption has fallen from around 76 million litres per day in 2006 to around 60 million litres in early October, according to the Iranian government, despite the number of vehicles roughly doubling over the period.

"Subsidies around the Gulf and North Afria are problematic for governments," Bake said. "It is not only in the UAE, there is Saudi, Egypt. They are funding massive deficits on the back of subsidies. It is an issue that has to be dealt with."

Subscribe to our Newsletter

Subscribe to Arabian Business' newsletter to receive the latest breaking news and business stories in Dubai,the UAE and the GCC straight to your inbox.