Kuwait City, August 7, 2016 - Kuwait's partial deregulation of gasoline prices represents a politically and economically bold move on energy subsidy reforms, for a country where, on a per capita basis, subsidies are amongst the highest in the world. Energy subsidies in Kuwait represents a major burden on public finances in Kuwait, with estimates ranging from 1.3 percent of GDP to 5.7 percent of GDP, when environmental, health and other externalities are taken into account. Because of the size, they result in major distortions, with extremely high levels of energy consumption, much higher than those driven by demographic and growth trends, and in comparison to other high income countries.
The adoption of an automatic mechanism should be viewed as the first stage of a transition to a fully liberalized pricing and supply regime, which has typically been a more effective approach to avoiding subsidies and protecting the budget. The current environment of low oil prices presents an opportunity to reform energy subsidies with minimal impact on consumers while generating fiscal savings at a time when fiscal pressures are increasing. The decision to remove subsidies is also strategically aligned with the Kuwait’s vision to further diversify the economy and enhance its competitiveness. In the medium and long run, subsidy reforms is expected to encourage a move towards more labor-intensive industries, which is expected to lead to job creation for nationals, a particularly important consideration for Kuwait, where foreign labor has been subsidized.
The impact of higher transport fuel retail prices depends on the short run and long run responsiveness of consumers to the price shocks. International experience shows that consumption of transport fuel is less responsive to price increases than other fuels, such as electricity. While rising retail prices will increase the cost of running a car, Kuwait remains relatively cheap compared to markets in Europe. On a per liter basis, the new retail gasoline price is still less than half of the cost of gasoline in the Europe and still the lowest in the GCC countries. Accordingly, car ownership and use may still increase at least in the short run. International experience suggests that the impact of transport fuel subsidy reforms is more effective when undertaken in conjunction with complementary policies, which Kuwait is also actively pursuing, such as strengthening public transport, which benefit all segments of the population, especially the poor, and improve economic efficiency in other important ways, by reducing congestion and air pollution.
Last but not least, energy subsidy reforms provide a significant opportunity to significantly reform the energy sector and remove the inefficiencies along the value chain. The high subsidies that have been maintained over the years have created significant distortions along the entire value chain, driving extensive use of crude oil in electricity generation, when natural gas would be technically more efficient, use of inefficient power plants and inefficient equipment and appliances, in particular air conditioning, which in turn fuels electricity demand growth. Accordingly, in the case of Kuwait where fuel and power consumption is one of the highest in the world, the impact of energy subsidy reforms would be further enhanced by the introduction of supply and demand side efficiency reforms, together with broader reforms to attract renewable sources of energy.