Retail Pricing Policies for Energy in Developing Countries |
Russell J. deLucia and Michael C. Lesser
Overview
Retail prices for energy commodities are generally determined by both market and regulatory forces. Government policy on energy pricing is designed to satisfy several objectives, including economic efficiency, equity of income distribution, demand management, security of energy supply, protection of particular sectors or groups, and increased government revenues. Because of frequent conflicts among these multiple objectives, pricing policies must be analyzed comprehensively. This paper describes various pricing objectives and presents the elements of different methods of analyzing policies on energy pricing.
Analysis
The Multiple Objective.
Economic Efficiency-Economic theory suggests that to maximize economic efficiency, and therefore national welfare and income, the price of a good should be equal to its marginal social cost. (This is known as first-best pricing, as opposed to the read world of second-best prices.) Marginal social cost at the wholesale point is based either on the border price for imported fuels or on the marginal production and delivery cost plus a depletion premium for domestic fuels. The border price of an energy good is defined as its international price plus costs of transportation, insurance, and freight. The depletion premium or economic rent reflects the value of the nonrenewable resource in the ground. Marginal social cost can also incorporate an adjustment for the scarcity value of foreign exchange, a security premium (for example, the cost of stockpiling), and the costs of local processing and transportation. If imported crude oil is refined, the lower boundary for marginal cost is the border cost of crude oil plus an allocation of refinery costs to each product according to the relative border price of these products. The retail marginal cost may include additional factors such as the costs of externalities (for example, environmental damage and traffic congestion) and the recovery of transportation system costs.
Revenue Generation-Many governments use fuel pricing to generate revenues. Prices are regulated to achieve this objective through import duties and sales taxes, which raise wholesale and retail prices, respectively. Commonly, some fuels are taxed, and others are subsidized. Fuel taxes can also be justified to meet goals of energy conservation. Regardless of rationale, the impact of higher taxes, which distort fuel prices away from efficiency prices, should be analyzed when policies on fuel pricing are set.
Promotion or Protection-Subsidies and cross-subsidies on fuel prices lower the retail prices below efficiency levels. These policies are designed to protect particular groups or to promote particular sectors (for example, subsidizing kerosene for low-income users or fuel oil for industrial users). There are several problems with using fuel prices for this purpose. First, subsidies have a direct impact on the national budget. Second, subsidies and price differences can have unintended effects such as providing a subsidy to the wealthy. For example, gasoline is used by both high- and low-income groups and kerosene may be used as much by high-income rural groups (for lighting) as it is by low-income urban groups (for cooking). Third, distorted prices can induce unintended capital investment or a misuse of fuels (for example, overpriced gasoline leads to overinvestment in more expensive diesel vehicles). Fourth, under-priced fuels "leak" across borders and may be sold locally at inflated prices, particularly if supplies are scarce. More effective policy would offer exporters tax credits rather than subsidies or would give farmers subsidies on inputs that are less likely to leak across borders or to other sectors.
Price Discrimination-Price discrimination by consumer and producer groups is relatively easy to administer in the natural gas and electricity sectors because the delivery systems can be controlled and monitored. In general, the price that users are willing to pay differs by type of customer. In the case of natural gas, the fuel is most valuable to users whose alternatives are higher-cost fuels and feed-stock. Therefore, in these cases, appropriately designed discriminatory prices can meet both efficiency and revenue objectives.
Policy Analysis
Policy analysis can be conducted either in a static framework for a particular base year or, preferably, in a dynamic framework for about 10 years. The objective is to quantify the interrelationships and tradeoffs among the multiple objectives of pricing policy. These estimates can pertain to the impacts of various measures on output, employment, household cost of living, prices, government revenues, balance of payments, profits, and welfare or efficiency losses. Sector-specific impacts such as refinery imbalances can also be assessed. The major elements of a pricing study include
Analysis of pricing policies for energy,
Economic analyses (international and domestic),
Analysis of energy use, and
Impact analysis.
Analysis of Pricing Policies for Energy-The first step in a study of fuel prices is to understand current government policies and how taxes and duties are incorporated into wholesale and retail prices. If retail prices differ from efficiency prices, the analysis should determine whether the differences are an effective way to attain the government's objectives. In a pricing study in the Philippines, some of the scenarios developed to address the goals of the policymakers were
Efficiency (world prices of fuels, shadow price of foreign exchange, security premium, and transportation system cost recovery),
Modified efficiency with resource constraint (definition of constraint (for example, constant share of GDP) and constant tax per litre of product),
Demand management (adjusted prices to eliminate refinery imbalances and to promote energy conservation), and
Tradeoffs between efficiency, revenue, and household impacts (economic losses associated with distortions in fuel prices and tradeoffs between household impacts, revenue, and demand management).
Economic Analyses (Internationl and Domestic)-Analysis of pricing policies requires projections of macroeconomic variables (for example, world prices of energy, foreign exchange rates, the GDP deflator, and the growth rate and sectoral composition of GDP). Other economic parameters that are needed are the shadow exchange rate and the investment and social discount rates.
Analysis of Energy Use-Energy analysis should begin with an examination of energy use by end-use sector and fuel type. To understand the effects of pricing policies on energy use and sectoral output, the relationships among these factors must be characterized. Analytic tools that can quantify these relationships include econometric models (to relate energy demand to prices and output), input-output (IO) models (to capture intersectoral effects and direct and indirect energy use), and engineering process analysis (based on such factors as generic process analysis and plant visits with energy audits).
Impact Analysis-Several types of impacts must be considered: ยท Sector level (sectoral changes in costs and output can be estimated using IO models),
Welfare losses, including decreases in producer profits and decreases in consumer surplus (decreases arise when tax-inclusive prices induce producers and consumers to switch to a more expensive mix of other inputs or goods),
Households (the impact of changes in fuel prices on households can be measured by changes in the cost-of-living index for each household group),
Revenues and subsidies (revenue impacts are the differences between future government revenues under alternative scenarios of prices for fuel),
Financial feasibility of supply companies (impact of different pricing policies on cash flow and return on capital),
Balance of payments (for each pricing scenario, the value of imports and exports), and
Refinery balance (differences in net revenue from refinery operations).
Overall Analysis of Pricing-The selection of a pricing policy should be based on informed discussions that include quantitative estimates of the tradeoffs and relative impacts of a range of pricing scenarios, including the "status quo," an efficiency scenario, and other relevant scenarios.