Chapter 3. Lessons Learned from Attempts to Reform Energy Subsidies28
- Trevor Alleyne, and Mumtaz Hussain
- Published Date:
- August 2013
Although the economics make a compelling case for subsidy reform, experience shows that political constraints have often prevented or derailed reform. Understanding the political economy behind stalled reform becomes critical for maximizing the probability of a successful reform strategy. Governments themselves may be resistant to change, given that subsidies are highly visible and broad based. Where there is commitment, challenges arise from the entrenched interests of those benefiting from the status quo. Moreover, the political feasibility of reform is shaped by an environment where electricity services are poor, social programs to compensate for subsidy removal are weak, and governments may lack credibility on the effective use of subsidy savings. Despite these challenges, some countries have made a lot of progress in managing the political challenges of reform.
This section draws lessons from the case studies on electricity and fuel reform experiences described in the supplement to this paper, with a focus on laying out elements for a successful subsidy reform. It also draws on fuel subsidy reforms in Senegal (Laan, Beaton, and Presta, 2010), India (Shenoy, 2010), Indonesia (Beaton and Lontoh, 2010) and Brazil (de Oliveira and Laan, 2010). This section, therefore, starts with a brief review of reasons behind the prevalence of energy subsidies and the difficulties of removing them. The main lessons of the case studies follow.
Why Are Energy Subsidies So Attractive and Difficult to Remove?
The prevalence of fuel and electricity subsidies can be linked to a variety of reasons, some of which are common to both petroleum-importing and-exporting countries:
- A desire to avoid the transmission of price spikes to the domestic economy. This can be an understandable response to sharp increases in world petroleum prices deemed to be temporary. Evidence shows, however, that shocks to petroleum prices and petroleum products can be quite persistent. Therefore, fuel subsidies can become long lasting.
- Energy subsidies are a readily available fiscal tool or instrument, requiring little administrative capacity. Subsidies afford governments the ability to provide relatively easily a highly visible benefit for all its citizens. This is particularly the case in low-income countries, where other mechanisms of providing (targeted) social welfare benefits to the population may be limited; and, given short time horizons, governments may lack the incentive to develop the capacity to design and administer other more efficient (and equitable) means of providing benefits.
- A desire to expand the population’s access to energy products. This would be particularly the case with electricity, which, as examined in the previous sections, can be quite costly to produce in SSA. This argument has also been used to lock in large-scale energy projects (e.g., Zambia, Cameroon).
- Energy subsidies offer a way to avoid addressing key structural problems in energy companies, particularly state-owned ones. Admittedly, structural and governance problems, both in electricity companies and fuel refineries, take time to be tackled, making transfers from the government an easy fix that in many cases tends to be protracted.
Fuel subsidies are especially prevalent in oil-exporting countries. While the rationale behind these subsidies can be similar to that of oil-importing countries, oil-exporting countries have more resources to finance them. In fact, and in contrast to oil-importing countries that may encounter severe financing problems when international oil prices are high, the governments of oil-exporting countries tend to have ample oil revenue to finance the subsidy. The availability of financing, compounded by the lower institutional quality empirically observed in oil-exporting countries (International Monetary Fund [IMF], 2012a), would explain a higher reliance on government-financed energy subsidies. In addition, energy subsidies in oil-exporting countries are sometimes the result of a desire to establish resource-based industries (with higher value added). The subsidies would allow them to kick-start those industries or make them competitive in an environment of high energy (mostly fuel) prices.
Once in place, subsidies are difficult to remove. As discussed in Chapter 1, although benefits are skewed mainly to the rich, the poor also receive significant benefits; so the removal of energy subsidies, without any support system to replace them, may not be politically feasible. In addition, the longer the subsidy has existed, the more entrenched the opposition to reducing it, especially if the benefits of the subsidy have been capitalized, for example, adoption of energy-intensive technologies and equipment, or purchase of cars, taxis, refrigerators, and televisions. As a result, in many cases, it is the urban middle class, represented by influential trade unions, that often voices the strongest opposition to the removal of subsidies. In low-income countries, these groups are likely to have significantly less income than their counterparts in more advanced countries and hence are less able to maintain consumption of the energy-intensive items once subsidies are removed.
Policymakers have also raised concerns a about a possible loss of competitiveness in the short run if energy subsidies are reduced. Concerns about a possible loss of competitiveness tend to be particularly relevant for electricity usage. Electricity prices are already quite high in SSA, increasing the costs of domestic production relative to imported products. Therefore, further increases in electricity prices would exacerbate this disadvantage. Temporary assistance to energy-intensive traded sectors may be required to allow a transition to a more energy-efficient input mix, as was done in Iran (Guillaume, Zytek, and Farzin, 2011). More fundamentally, however, subsidy reform must not only focus on raising tariffs but also on ensuring that supply and quality of service are improved. Indeed, the fear of tariff hikes may be overblown, because consumer surveys in a number of countries indicate a willingness to pay higher tariffs for better service, especially when the higher tariffs might still be lower than the costs of self-generation of power incurred by many consumers. The link between fuel subsidies and competitiveness is more tenuous. As mentioned earlier, fuel subsidies could create artificial competitive advantages that would disappear if fuel prices fall. As argued in Chapter 1, in the medium term, subsidy reform can help to boost competitiveness by freeing up resources for productive investment and eliminating distortions in price signals.
Policymakers have also worried about the impact of subsidy reform on inflation. The extent to which higher energy costs result in a persistently higher price level will depend on the strength of “second-round” effects on wages and the prices of other inputs. These second-round effects can be contained with appropriate monetary and fiscal policies that help anchor inflationary expectations. Subsidy reform helps support an appropriate fiscal policy response by reducing budget deficits and helping contain demand pressures on prices.
In petroleum-exporting countries, the task of removing fuel subsidies has proven especially difficult. There is often an expectation by the population that it should consume petroleum products at below international market prices (even where refined products are imported) as a form of distributing the oil wealth. In addition, as oil-exporting countries in SSA have lower institutional quality levels relative to other countries in the region and in the world, their citizens might not have much confidence that the government will wisely use savings from subsidy reform. When Niger became a producer of refined fuel products in 2012, it set the fuel prices below international levels. The ex-refinery prices for domestic consumption were fixed for the first six months of operation of the new refinery and were supposed to be linked to international prices after that period, but the prices were not changed.
A number of reasons make the subsidy issue so knotty. First, it is difficult to convey to the public the rationale for products to be sold at their opportunity cost and not their cost of production. However, as argued in IMF (2012b), oil assets, when extracted, ought to be converted into another asset (real, human, or financial). In this process, to make as many resources as possible available for investment, oil revenue should be maximized, which would include selling oil at market prices. The decision to subsidize oil or oil products ought to be made separately, with the costs made explicit in the budget and evaluated just like all other expenditures, and should be de-linked from whether or not the country is an oil producer. Second, in many cases, the subsidy is implicit, absorbed in the revenue of the state oil company, and thus the subsidy costs are not well understood by the population. Third, on the side of the government, the subsidy costs, although potentially high, are usually affordable.
A Strategy for Energy Subsidy Reform
Despite the difficulties encountered, the experiences of various sub-Saharan countries point to key actions that appear to be necessary for a successful reform. In designing the reform strategy, detailed research and consultation with stakeholders have been crucial. At the implementation stage of the reform, appropriate timing, a sound public communications strategy, and well-targeted compensating measures facilitated public acceptance of reforms. Finally, although many countries have experienced difficulty in sustaining reforms, a number of actions and reforms can help ensure the durability of energy reforms.
Undertake Comprehensive Research
The implications of energy subsidies are typically not well known, particularly by the general public. As argued by Victor (2009), subsidies survive in part because the groups that bear their burden are unaware of the cost they are paying. Moreover, a lack of information makes it difficult to pursue an informed debate. Developing a reform plan requires being able to explain the rationale for presumably taking away a benefit that has been enjoyed by a significant and politically powerful segment of the population. To properly make the case for reform, research will be important to determine the cost of subsidy, including the nonfiscal costs; how benefits are distributed; and the likely effects of removal. Household income and expenditure surveys and national accounts data should be critical information sources, as well as willingness-to-pay analyses (particularly for electricity consumption). In Uganda, a World Bank report noted that average coping costs for intermittent power supply (i.e., including the costs of self-generation) as well as residential consumers’ willingness to pay for improved service was quite high, providing reform planners with valuable information on the public’s possible tolerance for tariff increases. The results of the research should be disseminated publicly to improve understanding of the rationale for reform.
Availability of information on size, distributional incidence, and economic impact of energy subsidies has an impact on reform prospects. In Ghana, the government commissioned an independent poverty and social impact analysis (PSIA) to assess the winners and losers from subsidies and subsidy removal in 2005. This was an important foundation for persuasively communicating the necessity for reform and for designing policies to reduce impacts of higher fuel prices on the poor. By contrast, in Nigeria, the National Assembly did not support the removal of the gasoline subsidy in December 2011, claiming a lack of firm data underpinning the size and incidence of subsidies. In addition, lack of information on the state of the refining industry and on the management of the fuel subsidy mechanism made it difficult for the government to persuasively refute the argument that government investment in refineries and/or stopping subsidy abuse was preferable to removing subsidies. Despite many attempts at reforming fuel subsidies, Indonesia’s objectives in reforming them are not clearly laid out in any one source. In Niger, little was known about the size and distributional impact of fuel subsidies until the authorities published estimates of the fiscal cost of fuel subsidies in the 2010 budget and the IMF Fiscal Affairs Department conducted a PSIA.
Transparency on the size of energy subsidies is particularly helpful to kick-start any reform. In Nigeria, the government used the fact that fuel subsidies (4.7 percent of GDP in 2011) exceeded federal capital expenditure to call for reform. In Niger, the realization that oil tax revenue shrank from 1.0 percent of GDP in 2005 to 0.3 percent of GDP in 2010 contributed to triggering reform. In Ghana, the large size of the debt of the state-owned refinery (7 percent of GDP at the end of 2002) led the government to raise fuel prices in 2003, and the large size of the fuel subsidies in 2004 (2.2 percent of GDP, more than the budget of the Ministry of Health) led the government to further raise fuel prices in 2005. In India, the publication of a study revealing that around 40 percent of the subsidized kerosene (with a fiscal cost of $3.5 billion) was diverted to the black market and did not reach the intended recipients forced the government to take action.
Consult a Broad Range of Stakeholders
In planning a reform, it is important to identify main stakeholders and interest groups, and develop strategies to address their concerns. Close consultation with main stakeholders, inviting them to participate in the formulation of the subsidy reform strategy, could help build consensus for reform. In Namibia, the National Energy Council, chaired by the Minister of Mines and Energy, established the National Deregulation Task Force in 1996 to examine fuel price deregulation through a broadly consultative process, culminating in the publication of the White Paper on Energy Policy in 1998. In Niger, the authorities also opted for a consensual approach, co-opting all relevant stakeholders. They established the Commité du Differé to discuss the best way to approach the reforms and their subsequent implementation. In Kenya, consultation with unions allowed the electricity reform process to proceed without the retrenchment of staff in the utilities. In addition, early in the reform process, tariff increases required intense negotiations with large consumers, whose cooperation was secured only with the commitment by the government to use extra funds to expand electricity supply.
Timing: Establishing a Timetable and Deciding When to Launch the Reform
Various factors need to be taken into account in deciding the pace and timing of a subsidy reform. If subsidies are large or if subsidies have been in place for a long time, a phasing in of reforms is likely to be more palatable and provoke less intense negative reaction. In these circumstances, a gradual approach may be necessary to (1) allow firms that have invested in relatively energy-intensive technologies time to adjust; and (2) avoid a sharp increase in prices, to better manage inflation expectations. A gradual approach would also tend to be preferred the less developed the available instruments for delivering mitigating measures to the most needy; or the worse the government’s track record on spending quality (hence the need for time to build credibility). For electricity, the complex nature of the reform process requires that it be gradual. In Kenya, subsidies were eliminated over the course of about 7–8 years through a combination of tariff increases, improvements in collections, and reductions in technical losses. Similarly, in Uganda, the reform process has been underway since 2001. In Namibia, fuel subsidies started to be scaled back in a gradual manner over several years beginning in 2001, a full three years after the adoption of a consensual white paper on deregulating fuel prices. Moreover, the reform was introduced when oil prices were stable and low, giving consumers and government space to adjust in a relatively shock-free environment. In Brazil, the government pursued a gradual approach to the removal of subsidies during the 1990s to minimize opposition from the interest groups that had benefitted from the policies. The phased removal of subsidies followed a political agenda, with the first products to lose subsidies (asphalt, lubricants, gasoline for airplanes) generally used by politically weak stakeholders, and the politically more difficult subsidies (for liquid fuels used for transport and by industry) removed last.
The credibility of the government, its policies, and its commitments are critical for a reform’s timing. Fast-paced reform is preferable where a country has sufficient credibility (e.g., Ghana’s 2005 fuel price adjustment). Where government is strong or soon after elections, a big bang approach with a large initial adjustment may be feasible. In cases of serious credibility shortcomings, it would be advisable to initiate programs to improve governance, spending quality, and public financial management in advance of subsidy reform. Similarly, in an environment of frequent power supply disruptions, the government needs to find ways of improving performance ahead of the tariff increases. In the initial stages, better service for current customers should take precedence over expanding the network through an inefficient state utility, which could lead to even weaker supply. In Nigeria, where the federal government traditionally suffers from a large credibility gap, the attempted one-step fuel price deregulation in January 2012, initially raising prices by 115 percent, had to be scaled back following widespread protests. On the other hand, an increase in electricity tariffs in that same year, which has followed an improvement in service quality, went through without any major public reaction.
Financing constraints and changes in external conditions can also play a role in the timing of the reform. A gradual approach may not be feasible or advisable if the costs are unmanageable. Similarly, power crises or mounting quasi-fiscal costs can provide the impetus for reform (e.g., in Kenya). A number of countries, faced with the untenable costs of subsidies in 2007–08, were forced to raise prices, regardless of protests. By contrast, there have been examples where countries have taken advantage of other opportune moments, such as a period of low international prices, to push ahead with rapid reform. In late 2008 when international prices had collapsed, Vietnam introduced market-based pricing, while Ethiopia eliminated fuel subsidies.
Launch an Intensive and Extensive Public Communication Campaign
A comprehensive public information campaign well ahead of the implementation of the removal of energy subsidies is needed to clearly explain the rationale and objectives of the reform. It is important to be able to address concerns of key interest groups; detail the planned use of the savings; and outline mitigating measures. Beyond the narrow fiscal implications of subsidy reform, the broader positive impacts on growth, productivity, and increased public resources for physical and human capital formation should be emphasized.
- In Nigeria, the communication campaign in 2011/12 included public statements by the president; presentations in budget documents highlighting the cost of fuel subsidies and the need to mitigate the impact of fuel price increases, including through priority spending (rehabilitation of existing refineries and building of new ones); and the Subsidy Reinvestment and Empowerment (SURE) program (Box 4). A brochure on SURE was widely distributed. It summarized the government’s case for subsidy removal; the resources that would accrue to federal, state, and local governments; and the social safety nets and critical infrastructure projects on which the federal government would spend its resources. However, information on the SURE program was released only about six weeks before the subsidy reform. In addition, while the SURE program outlined a detailed list of federal infrastructure and social programs to be funded by subsidy savings, the state and local governments, which would receive approximately half of the subsidy savings, were silent on the intended use.
- In Ghana, the communication campaign in 2005 included the State of the Nation address to parliament, radio broadcasts of the same message by the minister of finance, advertisements in national papers comparing Ghanaian prices with its West African neighbors, interviews with government and trade-union officials, and the posting on the internet of the PSIA providing an independent confirmation that the policy to reform fuel subsidies was in the best interests of the citizens of Ghana.
- In Niger, the government conducted public information campaigns on radio and TV stations in 2010, highlighting the regressive nature of fuel subsidies and the priority social spending on which savings from fuel subsidy reform would be spent.
In electricity subsidy reform, the authorities should emphasize that the goal of reducing subsidies is to facilitate an increase in supply and expansion of access. Thus, the communication strategy should place the tariff adjustment or cost recovery issue in a wider context of how government plans to address various problems in the power sector, including costly generation, inefficiencies of state utilities, corruption, etc. At the same time, consumers need to be convinced that that these reforms, geared to improving financial viability of state utilities, will lead to better electricity services and access. Finally, media and public education campaigns that educate on billing, collection, and energy saving could help mitigate the impact of the price increases.
- In Uganda, the government’s communication campaign surrounding the 2012 electricity tariff adjustment was very effective, pointing out that it could no longer afford costs of more than 1 percent of GDP to subsidize electricity to which only 12 percent of the country had access. Some newspapers agreed that the tariff hike was a pro-poor measure, especially because lifeline tariffs were to be maintained. In addition, while the chairman of the Uganda Manufacturers Association pointed out that the new tariff would automatically increase production costs, he also acknowledged that the new tariffs would be bearable if power supply was reliable (i.e., validating the earlier research about willingness to pay).
Box 4.Increased Fiscal Space from Energy Reform and Its Uses
The fiscal space resulting from the reduction of energy subsidies can help improve the overall fiscal position, but also can be mobilized to introduce more productive, efficient, and equitable government spending. Two oil-exporting countries, Nigeria and Iran, offer alternative approaches. The former relies on using the fiscal space more effectively through productive public spending aimed at building, physical and human capital, while the latter focuses on replacing subsidies with (more efficient and equitable) universal transfers.
Nigeria. The main plank in the 2012 fuel subsidy reform was the Subsidy Reinvestment and Empowerment (SURE) Program. The SURE envisages channeling the federal government’s share of the savings from the fuel subsidy reduction into a combination of programs to stimulate the economy and alleviate poverty through critical infrastructure and safety net projects. The infrastructure projects financed by SURE are being selected in line with the government’s Vision 2020 development strategy in the power, roads, transportation, water, and downstream petroleum sectors. The social safety net programs to mitigate the impact of subsidy removal on the poor identified by SURE are focused in the areas of urban mass transit, maternal and child health services, public works, and vocational training. In 2012, the SURE program facilitated the completion of a major north-south national railway project and improved maternal and child care services in 500 primary health care centers.
Iran. The main objective of the 2010 fuel subsidy reform was to replace price subsidies with across-the-board cash transfers for households as a means of distributing some of the country’s oil wealth to its citizens, while reducing incentives for excessive energy consumption and smuggling. Bank accounts were opened for most citizens prior to the reform and compensating cash transfers deposited into these accounts prior to the implementation of price increases. About 80 percent of the revenue from the elimination of the subsidy was redistributed this way. The decision not to target these transfers was to avoid triggering public discontent among the biggest energy users. The remaining balance of the subsidy savings was to be set aside to provide support for enterprise restructuring with a view to reducing their energy intensity. Seven thousand energy-dependent enterprises were selected to receive some form of targeted assistance to restructure their operations.
Improve Enterprise Efficiency
Successful subsidy reform, especially in the electricity sector, will be heavily dependent on enhancing the efficiency of state enterprises. This includes strengthening firms’ governance, improving demand management and revenue collection, and better exploitation of scale economies. Performance targets and incentives (e.g., improved revenue collection, reduced power outages) should be set to increase accountability of managers of state enterprises. In Kenya and Uganda, reducing line losses and increasing collection rates were instrumental in eliminating quasi-fiscal deficits and helped reduce the need for higher tariff increases. In Cape Verde, the electricity power company is allowed to keep resources from overperformance, which can then be used for investment. Introducing competition by permitting independent private producers to be involved in electricity generation can strengthen sector performance.
Develop Mitigating Measures
Measures to mitigate the impact of energy price increases for the poor are critical to building support for subsidy reform. A conditional cash transfer targeted to the most needy income groups appears to be the most appropriate instrument. However, this may not be feasible in the short run because of a lack of bureaucratic/administrative capacity. In the power area, a central element of protecting the poor must be better targeting of lifeline-and volume-differentiated tariffs, and mechanisms to assist lower-income customers to finance connection costs.
- In Namibia, even though fuel prices track international prices, cross-subsidies in transport and distribution costs equalize fuel prices between cities and rural areas where most poor people live.
- In Niger, following negotiations with civil society organizations and the transport sector, the government provided a direct subsidy to the transport sector in 2010 to mitigate the impact of fuel price increases on the poor, at a fraction (0.1 percent of GDP) of the cost of the fuel subsidies (0.7 percent of GDP).
- In Ghana, fuel price increases in 2005 caused much less social tensions than previous increases thanks to mitigating measures including cross-subsidies in favor of kerosene and liquefied natural gas (LNG), the fuels consumed most by the poorest income groups; an increase in the daily minimum wage; a price ceiling on public transport fares; elimination of school fees for primary and secondary education; and other measures.
Box 5.Mitigating Measures—Other Countries’ Experiences
Gabon increased gasoline and diesel prices by 26 percent in March 2007.
- – National Social Guarantee Fund cash payments to the poor were resumed, while conducting a new and improved census of lower-income households.
- – Assistance to single mothers via the existing program in the Ministry for the Family was increased, as was funding for a microcredit program targeting disadvantaged women in rural areas.
- – Households with monthly electricity and water bills of less than the expenditure thresholds for subscribers who already received the social rates were eligible for free electricity and water up to a limited quantity.
- – School enrollment fees were waived for pupils enrolled in public schools and school text books given free of charge to all primary school pupils.
- – PRSP investments related to the expansion of rural health services, electrification, and drinking water supply were accelerated.
- – The mass public transport network in Libreville was expanded (27 buses).
Mozambique increased fuel prices by 38 percent in 2008.
- – Budgetary allocations to a range of social protection programs were increased substantially (Direct Social Support, Social Benefits Through Work, Income Generation and Community Development).
- – The level of cash benefits received by beneficiaries of the Food Subsidy Program was increased, with the minimum benefit increasing from 70 MT to 100 MT and the maximum benefit from 140 MT to 300 MT.
- – The number of branches of the National Institute for Social Protection was increased from 19 to 30 to expand the program.
- In Nigeria, the government kept the price of kerosene unchanged when it increased fuel prices in January 2012, and the SURE program included the expansion of several social safety net programs, such as maternal and child health services, cash for public works, women and youth employment programs, vocational training, and urban mass transit schemes.
- Lifeline (below cost) tariffs for electricity consumption exist in both Kenya and Uganda. In Kenya, the lifeline tariff, which applies to households consuming less than 50 kWh a month, is cross-subsidized by rates imposed on larger consumers. In Uganda, the lifeline tariff applies to poor domestic consumers for power consumption up to 15 kWh a month. Kenya also introduced measures to expand access, such as a rural electrification program and a revolving fund for deferred connection fee payments (financed by donor funds).
Box 5 contains examples of mitigating measures implemented in other selected countries when governments increased fuel prices as part of their plans to reform fuel subsidies.
Cross-subsidization of energy products or other mechanisms that imply substantially different subsidies (or taxes) across products should be approached with caution. As discussed above, this policy has some merits for electricity. The case of fuel products is more complex. Many countries that instituted subsidy reforms did retain subsidies on fuel products principally consumed by the poor, for example, kerosene and LNG. However, different levels of subsidization/taxation across fuel products create incentives for fraudulent fuel adulteration or other unintended consequences. In Ghana, mixing subsidized kerosene and liquefied natural gas with transport fuels became common practice when the price of subsidized kerosene fell significantly below that of diesel, creating shortages of kerosene. In Brazil, during the 1970s and 1980s, the LNG subsidy stimulated its use in industry and transport sectors as well as for heating swimming pools and saunas, even though such uses were prohibited. By artificially reducing prices for LNG and diesel, at some point Brazil became a net exporter of gasoline and a large importer of diesel and LNG.
Develop Mechanisms to Promote Durability of Reform
The experience of countries undertaking energy subsidy reform demonstrates that reforms can be fragile, even when all the key actions discussed above have been followed. In Ghana, the 2005 reform successfully eliminated gasoline subsidies, but when oil prices soared in 2007 and 2008, the government abandoned its policy of adjusting domestic to international prices and froze its price ceilings between May and November 2008. Energy prices became a campaign issue during the 2008 elections and the then opposition having won the election, fulfilled its election promise by reducing fuel taxes, bringing fuel prices significantly below levels in neighboring countries. When Niger became a fuel producer in 2011, it reduced fuel prices below international levels.
The durability of the reform will be enhanced by the development of a more efficient social safety net framework and by demonstrating clear progress toward achieving the announced goals of the subsidy reform. Unfortunately, achieving these objectives may not be possible in the short run. However, a number of policies can help to improve the prospects for the durability of the reform during this transition period.
Monitor and disseminate information on the use of subsidy savings. In Nigeria, a commission has been established, including representatives from the civil society, to monitor and audit the amount of savings generated by the gasoline subsidy reduction and its use to advance the targeted projects of the SURE program.
Be transparent in accounting for subsidy costs. Where subsidies are not fully eliminated, maintain transparency on their costs. In Niger and Mali, the authorities have introduced an explicit accounting of fuel subsidies in the budget. Moreover, it would be important to establish a ceiling on the possible size of the subsidy to reduce fiscal risks.
Implement an automatic price adjustment mechanism. If full deregulation of prices is not feasible in the short run, energy prices should be determined by transparent price formulas and an adjustment mechanism to changes in international fuel prices. Ghana published the price formula for determining fuel prices, including the weights of the individual components (e.g., cost of crude, refiner’s margin, excise duty, etc.). Appendix 2 discusses in more detail the various technical issues that ought to be considered in formulating a fuel-price adjustment mechanism. It may be useful to incorporate some smoothing mechanism to mitigate the impact of very sharp increases in international prices that might trigger calls for the reintroduction of subsidies.
Depoliticize the price setting framework by establishing an independent authority to manage energy pricing. In Tanzania, the creation of a specialized regulatory entity, not only to issue licenses and technical regulations (e.g., on the quality requirements of fuel products), but also to keep the public constantly informed about prices and to review the proper functioning of the market (e.g., to investigate concerns about potential price collusion practices) seems to have played an important role in sustaining fuel subsidy reforms. In South Africa, prices are adjusted on a monthly basis according to a transparent automatic formula based on international prices, freight, insurance, and other costs, as well as exchange rate movements. Price information is regularly published on the Department of Energy website, and no political interference is apparent in the frequency and parameters of adjustment (Kojima, Matthews, and Sexsmith, 2010). In Kenya, the independent Energy Regulatory Commission (ERC) regulates electricity tariffs, publishes tariff adjustment calculations on its website, issues licenses, and sets performance targets for KPLC (e.g., revenue collection, average waiting period for new connections, system losses). According to the World Bank (2010b), the negotiations for tariff-setting and power purchase agreements are transparent; and the regulatory framework in the sector is robust and resistant to political interference. Ghana established a semi-independent National Petroleum Authority to administer the pricing framework. However, although this system worked well for a number of years, it did not survive the populist pressure for the reintroduction of subsidies that reemerged at the time of the sharp rise in fuel prices in 2007–08. That experience shows that, notwithstanding the implementation of appropriate supporting mechanisms, the key ingredient for a successful subsidy reform is an unwavering political will, that is, the price-setting regime and independent regulatory authority will be only as robust as the political will behind them.