Consumer subsidies are an important mechanism for governments to support or influence behavior of residents. But surprisingly, the precise definition of a subsidy is still a matter of debate. Anwar Gasim and Walid Matar from KAPSARC have developed a new set of equations to calculate implicit subsidies, which suggest that the scale of Saudi Arabia’s energy subsidies may be overestimated1.
Subsidies lower the prices of essential goods and services. When it comes to energy pricing, an example of an explicit subsidy is where a fuel is sold at a price lower than it costs to produce. But governments can also provide ‘implicit’ energy subsidies. This is when a fuel is sold domestically at a price higher than its production cost, but lower than it would have been if sold on the open international market.
“For instance, the price of Arab Light crude oil in Saudi Arabia is currently $14.90 per barrel, which is above its production cost of less than $10 per barrel but below the market price of $70-80 per barrel,” explains Matar. “These implicit subsidies represent an unrealized forgone revenue rather than a direct loss.”
This implicit nature has led to disagreements over exactly what defines a subsidy, which also makes them difficult to estimate. One popular approach is the price-gap method: this calculates the difference between the market and domestic prices of a commodity multiplied by the quantity consumed. The advantage of this approach is its simplicity, however it has shortcomings when estimating implicit subsidies, which are important in countries such as Saudi Arabia.
If the saved oil is exported, that would suppress the market price due to higher supply, and result in a lower gap between market and domestic prices.
Walid Matar
“The removal of oil subsidies in Saudi Arabia would lower domestic oil use,” explains Matar. “If the saved oil is exported, that would suppress the market price due to higher supply, and result in a lower gap between market and domestic prices.”
The KAPSARC team has proposed a set of equations to estimate implicit subsidies, but that retain the simplicity of the price-gap method.
“Our equations only add oil exports and price elasticities to the original price-gap method. The key difference is they can consider the effect of lower domestic oil use due to higher domestic oil prices on incremental exports and consequently a lower international market price.”
The team would like to further develop their modified price-gap method to include substitution effects: for example, posing questions like “what happens to fuel oil demand if only diesel prices were changed?”
Reference
1- Matar, W., An exposition of bilinear “implicit” subsidy equations. 2024. | Article
2- Gasim, A.A. and Matar, W., Revisiting energy subsidy calculations: A focus on Saudi Arabia. The Energy Journal, 44 (1), 245-276, 2023. | Article
