I have just returned from Algiers where, after a brief Eid al-Fitr break, people have started to come to terms with yet another embarrassing revelation: the proliferation of cross-border smuggling of petroleum products. Their indignation was bluntly echoed by the Minister of Energy, Youcef Yousfi, who was reported to have said: “Fuel smuggling is gangrene on the national economy; enough is enough!” However, the minister’s outrage can hardly be taken as a sign that the time has come to reform subsidies.

In an attempt to convey some of the scale of the smuggling, Mr Yousfi has indicated that, in 2012, 1.5 billion liters of road transport fuels found their way illegally into neighboring countries (MEES, 9 August). This amounts to a little more than half the imports by volume, which contributed 20% of domestic supply. The loss to the Algerian economy – calculated on the basis of the volume-weighted average import price of gasoline and diesel oil – represents some $1.3bn. Equally disturbing are the statistics compiled by Mr Dahou Ould Kablia, the Minister of Interior, who suggested that the volume of gasoline supplied to Tlemcen – an Algerian city which has turned into a smuggling hub into Morocco – is higher than that supplied to the capital city. This is a huge aberration considering that Tlemcen’s population is only about one-third that of Algiers. It is also an unfortunate irony given the fact that the land border with Morocco has been closed to people and merchandise since 1994.

ARBITRAGE OPPORTUNITIES

Smuggling has flourished due to the failure to secure borders, clamp down on illegal trade and reform heavily subsidized petroleum products prices. The immediate consequences are costly shortages and widespread corruption. Subsidies are obviously the root problem. With gasoline prices at the pump in a ratio of 1 to 3 compared to Tunisia and 1 to 5 compared to Morocco, arbitrage opportunities are huge. As the ratio is 1 to 8 compared to southern Europe, further opportunities are as broad as the smugglers’ imagination and resources. Still, the government seems to have concentrated its efforts on the symptom by deciding to enhance border policing even if this involves stretching thin the country’s security assets.

The government’s failure to reform subsidies is at odds with its projected budgets. These are expected to be strained by spending commitments on much needed health, education and other essential public goods; all increasing at a time of declining oil and gas production and significant drop in hydrocarbon exports. In a context of lingering regional turmoil and an uncertain, forthcoming presidential election, reforming subsidies present a major political dilemma.

On the one hand the government realizes that it would be doomed if it increases prices by any significant amount. On the other hand, it cannot ignore those who believe that it would be damned if it did not. The latter includes international policy agencies such as the IMF and the World Bank. Both have repeatedly highlighted the magnitude of energy subsides, underlined their economic inefficiency and social inequity and articulated the most compelling arguments for their phasing out, at least progressively and in a targeted manner. They have been relayed by local business thought leaders, some of them having assumed government positions in the past, as well as young economists currently federated within NABNI (Notre Algérie Bâtie sur de Nouvelles Idées) initiative, all trying to initiate and inform a hardly existing public debate on a broad subsidies reform agenda.

We have recently contributed further evidence to the discussion under the title “Algeria’s Natural Gas Policy: Beware of the Egypt Syndrome!” (APICORP’s July Economic Commentary in MEES, 28 June). Our focus on natural gas is motivated by its dominant role in the energy balance of the Algerian economy. Essentially, naturally gas represents 50% of primary energy production, fuels 98% of power/water generation and contributes 39% of the rest of energy consumption, as both an energy source and a feedstock for petrochemicals. It further represents, when including natural gas liquids (NGLs), 56% of hydrocarbon export volumes.

As with the prices of other energy products, those of natural gas are regulated and founded on the obsolete premise of abundant and cheap resources. Occasional price adjustments have been too modest to keep up with unrelentingly escalating costs, not to mention their far distance to opportunity costs when benchmarked to prices fetched by Sonatrach on international markets. Primary gas prices are passed through into equally low – frozen for long periods of time – tariffs to the industry, public distribution and the electricity and water utility customers. Over time, subsidies of both intermediate and final consumption have significantly increased the risk of unsustainable consumption patterns, already apparent in the way domestic consumption is strengthening to the detriment of exports.

CHEAPEST IN MENA

Not surprisingly therefore, Algerian natural gas is the cheapest within the MENA region, where pricing policies are in flux. Maximum wholesale prices currently range from $0.50/mn BTU in Algeria to $3.75/mn BTU in Iran – the biggest holder of reserves in the region. Even if the latter price level may not be enforced immediately, following a freeze on energy subsidy reforms and the moderate stance adopted by Iran’s new president, it is unlikely that Tehran will backtrack on the core principles of policy. Equally less prone to policy reversal despite political uncertainties is the case of Egypt where prices are set to double for the energy-intensive industry – up to $6/mn BTU – in order to reflect soaring upstream costs. MENA rising cross-country trend is challenging the long-held view that the size of resource endowment should be a key determinant of domestic prices.

Countries that have embarked on meaningful reforms had to first overcome the political economy of subsidies and rethink the social contracts built on them. Both are necessary but not sufficient. Governments most likely to succeed are those that opt for phased price increases and targeted measures to protect the poor, preceded by extensive consultation on reform plans and a sustained public information campaign. The longer the Algerian government holds back and delays this process, the more difficult reform will be and the higher and more severe the economic and political costs.

* The author is a policy-oriented energy economist. The opinions are his own and not of the institutions he is currently associated with. Comments and feedback may be sent to [email protected]