Time is right to deregulate UAE fuel prices

The recent announcement that fuel prices in the UAE will be deregulated as of next month should not be a huge surprise to observers.

There has been an increase in rhetoric about reducing subsidies in the GCC over the past few months, as regional budgets face sharply lower oil revenues compared with a couple of years ago, when oil prices were over $100 per barrel compared with around $55 currently.

Over the past year, Oman and Kuwait have taken measures to reduce subsidies on a range of products, while Bahrain recently considered cutting budget subsidies on fuel and food and replacing them with cash transfers for Bahraini nationals.

In the UAE, recent comments by the Minister of Energy Suhail Al Mazrouei suggested that the issue of fuel subsidies in particular was under review, and that the ministry was likely to recommend a reduction in subsidies on petrol and diesel in the coming months, as the UAE’s fuel prices are among the lowest in the world.

According to an official statement on deregulation, the fuel committee will review local fuel prices against average international levels every month, and make adjustments accordingly. At this stage, the expectation is that diesel prices in the UAE may be slightly lower in August than they are currently, which should benefit the transport and logistics sectors – one of the key drivers of overall economic growth in the UAE. As the price of crude oil (per litre) is currently below the cost of petrol at the pump in the UAE, we think there is unlikely to be a sharp rise in petrol prices in the near term either.

On a macroeconomic level, reducing subsidies on fuel should benefit the budget directly, helping to offset the decline in oil revenue and possibly freeing up resources for spending elsewhere, such as on infrastructure. A recent report by the IMF showed that the GCC spends 3.4 per cent of its GDP on fuel subsides, substantially higher than other regions, except for the oil-importing countries in Mena, which spend even more. In contrast, advanced economies spend less than 0.1 per cent of their combined GDP on fuel subsidies.

According to the IMF, the UAE would have spent more than Dh46 billion on fuel subsidies this year (not taking into account the recently announced changes), more than 10 per cent of the total budget. This is just the direct cost of subsidising fuel, natural gas and electricity, and does not reflect the cost to the environment in terms of global warming, local air pollution or the costs of congestion, road accidents and road damage, which the IMF estimates at an additional combined Dh48bn this year.

Unsurprisingly, the IMF has long been an advocate of fuel subsidy reduction, arguing that in addition to the fiscal costs, inefficiencies and the skewed incentives they encourage, subsides are not a particularly equitable way to support low-income households, as they benefit the wealthy as much as – if not more than – the poor. Given the current relatively low price of crude oil and related products, it would seem to be an opportune time to reform state subsidies of fuel without causing a sharp spike in inflation or the cost of living in the near term.

Ultimately, rationalising fuel subsidies and moving to a more flexible pricing system should encourage consumers to switch to more fuel-efficient cars and increase the use of public transport. It should also encourage greater investment in public transport, renewable energy and energy efficiency.

Even if the deregulation of fuel prices leads to a small rise in petrol prices at the pump next month, the authorities have indicated that the cost of petrol represents 3 to 4 per cent of average incomes in the UAE, which suggests that the immediate impact on households should be limited.

Khatija Haque is the head of Mena research at Emirates NBD. Our regular columnist Tim Fox is away and will return within the next fortnight.

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