Last week in an effort to get on top of its surging budget deficit the Egyptian government decided to cut its $20 billion fuel subsidies, resulting in fuel prices rising by almost 80% overnight. For countries from Egypt to Indonesia rising oil prices have made costs balloon but in the face of precarious government finances also provide an incentive for change. The cost of fossil fuel consumption subsidies rose from around $300 billion in 2009 to almost $550 billion in 2012. Meanwhile the recent volatility in many emerging market currencies which saw their value decline versus the US dollar also had the effect of raising the cost of importing fuel.
Although energy subsidies tend to be introduced with the intention of alleviating poverty, promoting economic development and in the case of oil producers providing a visible benefit of the country’s oil wealth. However, cheap fuel has a number of side effects including encouraging over-consumption, discouraging investment in energy infrastructure, threatening security by increasing the reliance on imported fuel and disproportionately benefiting the middle class and rich. On a global basis the effects are also damaging. All this over-consumption also results in increased carbon emissions. According to the International Energy Agency, eliminating fossil-fuel subsidies would reduce global carbon emissions by 6% by 2020.
Energy subsidies also dampen the global demand responsiveness to high fuel prices. Eliminating fuel subsidies will result in lower oil consumption overall (as over-consumption is discouraged) and will mean that the oil market will balance more rapidly as demand will be quicker to respond in the face of surging demand or supply cuts. All of which should mean that the outlook for long-term oil prices will be lower. Any progress is likely to be gradual however with politicians loath to antagonise their urban elite while fearing the angry reaction of ordinary citizens who rarely believe they will be compensated.