Global Gas Guzzlers

Recently I have been spending a lot of time thinking about global fuel subsidies. The most extreme example is Venezuela, where gasoline costs only 6 cents per gallon.  That’s not a typo. The price in Venezuela is less than 1/50th of what I pay in California.  It is no coincidence that gasoline consumption in Venezuela is 40% higher than any other country in Latin America, and three times the regional average.

Gasoline subsidies are inefficient because they lead people to drive too much and to own large, low-MPG vehicles. In a new EI@Haas Working Paper titled, “The Economic Cost of Global Fuel Subsidies”, I examine Venezuela and other countries that subsidize gasoline and diesel. Using the latest available data from the World Bank, I find that subsidies for gasoline and diesel totaled $110 billion in 2012. The top ten countries (below) represent 90% of global fuel subsidies.

FuelSubsidies

Many of these countries are major oil producers. Gasoline and diesel subsidies have long been viewed in many oil-producing countries as a way to share the resource wealth with a nation’s citizens. This is not the view in all major oil-producing countries, however.  Prices are at or above market in Iraq ($2.95 per gallon for gasoline), Mexico ($3.26), Russia ($3.74), and Canada ($5.00).

These subsidies impose enormous economic costs. Subsidies create “deadweight loss” by enabling transactions for which the buyer’s willingness-to-pay is below the foregone revenue from selling oil. In other words, it costs the government more to provide the subsidy than the value the subsidy creates for gasoline consumers. In Venezuela right now there is someone driving around who values gasoline at only $.50 cents per gallon. Gasoline can be sold in international markets for about $3.00, so each time this person uses a gallon of gasoline the world becomes worse off by $2.50.

The total amount of this deadweight loss depends on the elasticities of demand and supply. For a given size subsidy, the more elastic are demand and supply, the larger the deadweight loss. Estimates in the literature for the long-run elasticity of demand for transportation fuels range from -0.6 to -0.8 (Brons et al., 2008). In the main analysis in the paper I use -0.6 while noting that deadweight loss is 18% higher when -0.8 is used instead. And I assume that supply is perfectly elastic.  Incorporating less than perfectly elastic supply would decrease the estimated deadweight loss, but only modestly because fuel consumption in most countries is small relative to the world oil market.

Under these assumptions, the total global deadweight loss in 2012 is $44 billion. The top ten countries (below) are similar but not identical to the previous figure.

DWLtopten

Saudi Arabia takes the top spot with $12 billion in deadweight loss in 2012. Venezuela is number two with $10 billion in deadweight loss. In 2012, Venezuela had the cheapest fuels on the planet so even though the total dollar value of subsidies is higher in Iran and Indonesia, the subsidies in Venezuela impose more economic cost because the subsidy per gallon is so high.

Incorporating external costs increases the economic costs substantially. Parry, et al. (2007) find that the external costs of driving are about $1.00 per gallon. Under my baseline assumptions this would imply that global fuel subsidies impose external costs worth $32 billion annually. Combined with the estimated deadweight loss ($44 billion), the total economic cost of fuel subsidies is $76 billion annually.

While these calculations could undoubtedly be refined substantially, the analysis makes clear that fuel subsidies are not just benign transfers from sellers to buyers. It would be useful in future analyses to explore alternative assumptions about demand and supply, but these subsidies are extreme enough that under any reasonable assumptions the estimated economic costs are going to be very large.

Subsidy reform is difficult but not impossible.  Just last summer, Indonesia took a major step forward by increasing gasoline and diesel prices by $0.75 per gallon (more here). Prices remain well below market and Indonesia has nonetheless become a net importer of gasoline (here), but the increase should still be considered a substantial victory for economic efficiency. Moreover, the Indonesian government combined subsidy reform with increased funding for cash transfer programs, thereby mitigating any distributional impacts.

In future work it will be important to expand the analysis to include other energy markets. Coal, natural gas, and electricity, for example, are also widely subsidized. Recent analyses of the broader energy sector find that the total dollar value of global energy subsidies is almost $500 billion annually (IEA 2012; IMF 2013) and much more can be done to understand and quantify the economic costs of these policies.

About Lucas Davis

Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.
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18 Responses to Global Gas Guzzlers

  1. dzetland says:

    I understand that Iran has been pushing subsidy reform (with many bumps), so there are some moves (perhaps forced) for reform. http://en.wikipedia.org/wiki/Iranian_subsidy_reform_plan

    • Lucas Davis says:

      Iran is super interesting. Subsidy reform has been in the works in Iran since the 1980s, but it continues to be a real challenge. Most recently, plans to increase gasoline and diesel prices were suspended in late 2012 with the Iranian parliament citing concerns about inflation. There is a nice discussion of Iranian subsidies in this IMF report.

      http://www.imf.org/external/np/pp/eng/2013/012813a.pdf

  2. Nety says:

    Very interesting and useful analysis. Will look forward to seeing the future work on the other energy markets.
    Surprised that India & China did not make the list.

    • Lucas Davis says:

      Thanks for your interest. You are correct that neither China nor India made the list. You can see both countries in Figure 1 of the paper. The circles are population weighted so these two are easy to see. According to the World Bank data, gasoline prices in 2012 were $5.18 in China and $4.73 in India, so by my calculations neither country subsidizes gasoline.

  3. Great article, Lucas. My wife is from Venezuela, so I have spent a lot of time down there. For economists, it’s a fascinating example of how not to run a country. With respect to your article, incremental negative externalities that result from inefficient fuel use are also important to factor into the deadweight loss. Last time I visited Venezuela, we went to Morrocoy National Park to relax on the beautiful archipelago of while sand beaches. Unfortunately, my experience was ruined by the hundreds of small, loud, smelly and inefficient boats all over the place. It’s convenient that these boats can pull up to the beach and mix you a fresh Pina Colada made from local produce, but when they leave their dirty generator running all day, it ruins the experience.

    • Lucas Davis says:

      Interesting! It is remarkable how people respond to prices. When a good is very cheap, people find all kinds of clever ways to use (and overuse) it.

  4. Reminds me of some natural gas issues I once ran into in Trinidad – where gas was subsidized for electric generation, and where the subsidy went (by customer class) once it got to the electric utility was not particularly transparent.

  5. mark cooper says:

    The pricing of oil and oil products has a lot more to do with political economy than economics. This is readily apparent in Figure 1.
    The world price of oil vastly exceeds the economic cost of production because a cartel underinvests in exploiting the natural resource, restricts supply and administers prices through production quotas. Any calculation of the welfare economics of the oil market should start from the recognition that the primary affront to efficiency is the cartel manipulation of the oil market. The ten nations that have the largest subsidies, don’t subsidize oil consumption, they choose not to impose their cartel tax on their own people.
    The European nations that have the highest taxes, have very little oil. The high tax on consumption recaptures some of the surplus that would be transferred to the cartel members.
    There are a number of nations in between who are not members of the cartel and are both big consumers and big producers of oil (U.S., Canada, Russia, Mexico). Eschewing hefty consumption taxes keeps consumers happy (relatively) and allows oil companies to enjoy excess profits.
    We must not confuse the cartel tax with a tax that internalizes the social cost of oil. Transferring massive amounts of wealth to cartel members, whose interest is not in reducing the external costs of oil but in maximizing their long run rents is not a very efficient way to address the social cost of oil

    • Lucas Davis says:

      Thanks for your comment. I have less confidence than you do about OPEC’s ability to influence market prices. In the short-run, OPEC is not a very effective cartel and the market is large enough that any single country (even Saudi Arabia) is limited in what they can do. In the long-run, you could make the argument that the cartel is restricting investment and thereby capacity. This is much harder to measure empirically. Even here though, one would want to model seriously the fact that non-OPEC oil production is 60% of current world production, and increasing quickly (e.g. Brazil, Canada, U.S., Kazakhstan). How much lower would oil prices be if the market were truly competitive? I’m not sure. This is a hard question. But I’m not convinced that oil prices would be much lower. I’m not even convinced that this is the “primary affront to efficiency” in this market. I wouldn’t be surprised if, at the end of the day, these consumption subsidies impose more economic cost than market power.

  6. Robert Coe says:

    You note that “Gasoline and diesel subsidies have long been viewed in many oil-producing countries as a way to share the resource wealth with a nation’s citizens,” but apparently disagree with this strategy. Sharing resource wealth is important. If subsidizing low prices is not a good way to do it, please suggest what practical method or methods you think would best accomplish this goal.

    • Lucas Davis says:

      I would prefer lump sum transfers. Lots of places do this. In Alaska, every man, woman, and child receives an annual payment from the “Alaska Permanent Fund” just for living there. Last year it was nearly $900. Other places (e.g. Indonesia, Iran) have begun substituting energy subsidies with conditional cash transfers to low-income households.

  7. India no longer subsidizes gasoline; but it does provide enormous subsidy for diesel (considered as the fuel for poor – in rural India). However the Govt. has tried very hard in past couple of years to deregulate diesel prices, and have raised prices for 11th time in this year alone; the last revision was announced just days back. http://profit.ndtv.com/news/industries/article-diesel-price-hiked-by-50-paise-a-litre-petrol-price-unchanged-373666

  8. Juan Cristobal Nagel says:

    Prof. Davis, thanks for the WP. I’ve reposted a comment on it over at Caracas Chronicles, a Venezuela-centered public policy blog.

    http://caracaschronicles.com/2013/12/03/deadweight-loss/

    Feel free to weigh in.

    • Lucas Davis says:

      I enjoyed reading your post tremendously. You do a much better job than I did at explaining deadweight loss. I particularly like this section…

      The problem is waste. … The gap between the $5 in value the transaction could’ve generated and the 3 cents it actually did generate isn’t actually transferred to anyone – it’s welfare that’s destroyed. Analytically, that’s the real welfare loss, that is where the waste occurs, and that is what Lucas Davis tries to measure.

      • Juan Cristobal Nagel says:

        I appreciate that, we worked hard on trying to get the analogies right. Thanks for your interest on this topic.

  9. Great fun! I think Fuel Subsidies are such a multidimensionally bad idea, you could spend a large portion of your career just tracking all the different kinds of damage they do. One that I’ve been toying with recently is macroeconomic: in Venezuela, the chasm that the gas subsidy leaves in the state oil company’s accounts is so big it’s actually started to have macro effects. Why? Because the Central Bank is now monetizing PDVSA’s debt, leading to a terrifyingly quick expansion in the money supply that’s fueling unprecedented levels of inflation. Really!

    details -> http://caracaschronicles.com/2013/11/30/pero-tenemos-free-gas/

  10. David Foster says:

    Thanks for your article. While the subsidies may be highest in Venezuela, I suspect that the distortions (due to those subsidies) among economic classes is even greater in Nigeria and possibly even in India. As always, the subsidies are provided in the name of “helping the poor” but in those countries most of the poor that I met were still struggling to buy their first bicycle.

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