New drive to reduce fossil fuel subsidies

Updated 16 May 2014
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New drive to reduce fossil fuel subsidies

LONDON: Fossil fuel subsidies cost governments in emerging markets more than $500 billion every year and are a major contributor to climate change, according to the International Energy Agency (IEA) and International Monetary Fund (IMF).
The biggest subsidies are concentrated in the Middle East, North Africa, Asia and parts of Latin America, according to the IEA’s Fossil Fuel Subsidy Database (iea.org/subsidy/index.html).
Moreover energy-exporting countries accounted for three quarters of all consumption subsidies in 2012, according to the IEA and OPEC members account for more than half the world’s subsidies.
Subsidies account for 82 percent of the cost of electricity and fuel in Venezuela, 80 percent in Libya, 79 percent in Saudi Arabia, 74 percent in Iran, and 56 percent in Iraq and Algeria. By contrast, the average rate of subsidy is just 18 percent in India and 3 percent in China.
In cash terms the world’s biggest subsidies are in Iran, Saudi Arabia and Russia, all of which are major oil producers. Subsidies cost these three countries a combined total of $180 billion per year in 2012.
In September 2009, the leaders of the world’s largest economies meeting at the G20 summit in Pittsburgh committed themselves to phase out inefficient fossil fuel subsidies over the medium term.
According to the IEA, phasing out subsidies for oil, gas and electricity and aligning prices with international benchmarks would cut growth in energy demand by 5 percent and carbon dioxide emissions by 2 billion tons a year by 2020 — equivalent to the current combined emissions of Germany, France and the UK.
Raising gasoline, diesel and kerosene tariffs to market levels would save 4.7 million barrels of oil a day by the end of the decade (“World Energy Outlook 2011“).
Cutting subsidies would also dramatically improve government budgets. Of 58 countries which subsidised gasoline, diesel or kerosene in 2010, 46 were running budget deficits, and in 27 cases the deficit amounted to more than 3 percent of GDP, the IMF explained in a staff note highly critical of the burden on taxpayers.
Halving subsidies would have reduced the average deficit from 2.1 percent of GDP to just 0.8 percent (“Petroleum product subsidies: cost, inequitable and rising” Feb 2010).
Subsidies often crowd out spending on infrastructure, development and social welfare. Indonesia spends more on fuel subsidies than on education or health care.
Venezuela sells gasoline for just 6 US cents per gallon. The cost in lost export revenues is $30 billion, more than the combined value of all state spending on social programs, Jim Krane at Rice University explained in a briefing paper published this month (“Navigating the perils of energy subsidy reform” May 2014).
Governments justify subsidies on the grounds that they alleviate poverty and promote economic development, but neither claim is really true.
Most of the benefits accrue to the middle class rather than poor because middle class families have more electrical appliances and their own cars.
In Indonesia, for example, the top 40 percent of high-income families absorb 70 percent of subsidies, while the bottom 40 percent of low-income families receive only 15 percent of the benefits (“The scope of fossil fuel subsidies in 2009” Nov 2010).
Subsidies also promote wasteful consumption. Saudi Arabia’s artificially cheap gasoline and electricity have made the country one of the highest per-capita energy users in the world and threaten to restrict the amount of oil left for export.
Another problem is fuel adulteration. Most countries subsidize kerosene used in cooking and lighting more heavily than gasoline and diesel used to fuel vehicles. But the resulting price gap encourages the illegal blending of kerosene into the diesel supply. Policies aimed at providing cheap cooking fuel for the poor end up helping middle class families drive motor cars.
And subsidies promote smuggling. Diesel sells for as little as 12 US cents per liter in Iran compared with $1.20 per liter across the border in Pakistan. As a result the IEA estimates 60,000 barrels of diesel are smuggled out of Iran to Pakistan and Afghanistan every day.
To combat smuggling into Yemen and other neighboring states Saudi Arabia inspects vehicles crossing its borders to ensure they only have enough fuel in the tank to reach the nearest refueling station on the other side (“World Energy Outlook 2013“).
The theoretical case for reducing or eliminating subsidies is overwhelming, but in practice progress has been slow. The fact that subsidies are concentrated in exporting countries and typically benefit middle-income and lower middle-income groups is no accident. Subsidies have a political dimension that makes them especially hard to reform.
Cheap electricity and fuel is often an important part of the social compact between governments and the population. “In major energy-producing countries consumption subsidies that artificially lower energy prices are seen as a means of sharing the value of indigenous natural resources,” the IEA explains.
More bluntly, Rice University’s Jim Krane observes: “Fossil fuel subsidies have allowed energy exporting countries to distribute resource revenue, bolstering legitimacy for governments, many of which are not democratically elected.”
Even in energy-importing countries, like Indonesia and Pakistan, subsidized electricity and kerosene is a vital way for politicians to buy support from the urban middle and lower-middle classes — the groups most likely to form the core of protest movements.
Policymakers in most countries acknowledge the need to reduce or remove subsidies, and the approach has strong backing from the World Bank, IMF and IEA. But efforts to reduce subsidies have met with limited success.
Iran, Indonesia, Ghana, Kenya, the Philippines, Mozambique and several other countries have all pushed through substantial price increases over the last two decades.
In other cases, however, price rises have had to be rolled back following popular protests. And the fact that Iran and Indonesia remain among the world’s biggest subsidisers points to how limited the reforms have been even there in the face of tough public opposition.
To succeed reform programs need to be accompanied by a strong communications strategy which points out that most of the benefits from subsidies go to wealthy households who can afford to pay the full cost of energy, and carefully targeted social measures to compensate the poorest households.
Timing is important. Reforms are more likely to be successful if the oil price is falling, when households are less likely to notice the removal of subsidies, than when energy costs are already rising. China and Indonesia both took advantage of lower oil prices in 2009 and 2010 to reduce support.
Even if it proves impossible to remove subsidies altogether, energy prices can be depoliticized by explicitly linking the retail cost of gasoline, diesel and kerosene to international benchmarks with fixed but adjustable formulas.
“Establishing an automatic pricing formula ... can help distance the government from pricing of energy and make it clearer that domestic price changes reflect changes in international prices which are outside the control of the government,” according to the IMF.
Even so, removing subsidies remains fiendishly difficult.
“Many countries have successfully implemented reforms only to see subsidies reappear when international oil prices increase,” the IMF laments. The temptation to reintroduce price controls to help households with rising living costs is strong.
And in the biggest petro-states, including Saudi Arabia, Iran, Iraq, Russia, Kuwait, Venezuela, Libya and Algeria there has been virtually no progress toward more sensible energy pricing.
The result is a prodigious waste of energy. The petro-states are among the world’s biggest and fastest-growing oil consumers and some are now having to import natural gas for power generation to meet electricity demand. And the greenhouse emissions are enormous.
It is all ultimately unsustainable. “The state itself is teaching people to waste resources,” complains one Kuwaiti newspaper editor. But subsidy reform is probably impossible without meaningful political and social change.

— The opinions expressed here are those of the author, a columnist for Reuters.


To dodge trade war, Chinese exporters shift production to low-cost nations

Updated 8 min 24 sec ago
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To dodge trade war, Chinese exporters shift production to low-cost nations

  • Chinese exporters long battled with rising domestic labor costs
  • China-US trade war was the final straw

GUANGZHOU, China/YANGON, Myanmar: Pressured by a labor crunch and rising wages in China, Shu Ke’an, whose company supplies bulletproof vests, rifle bags and other tactical gear to the United States, first considered shifting some production to Southeast Asia a few years ago, but nothing came of it.
When trade tensions flared into a tariff war last year, however, it was the final straw.
A day after US President Donald imposed additional tariffs on $200 billion of Chinese goods in September, Shu, 49, decided to start making vests for his US clients in Myanmar instead.
Since then, the Trump administration has further hiked tariffs on Chinese imports, raising the US taxes on Shu’s Guangzhou-made bulletproof vests to 42.6%.
With more than half of his company’s income reliant on orders from the United States, Shu was happy with his Myanmar decision.
“The trade war was actually a blessing in disguise,” he said.
With Trump poised to slap 25% tariffs on another $300 billion-plus of Chinese goods, no exporter in China will be unscathed.
In recent years, some Chinese manufacturers had already started to relocate some of their capacity to countries such as Vietnam and Cambodia, due to high operating costs at home. The trade war is now pushing more to follow suit, especially makers of low-tech and low-value goods.
A few Chinese exporters have also tried to dodge the trade war bullet by quietly transhipping via third countries.

Choice destination
Nine months on, Shu’s firm, Yakeda Tactical Gear Co, is relying on his new Myanmar factory, which started operations in December, to produce new orders for its US clients.
The 220 workers at his original Guangzhou plant, in China’s Pearl River Delta manufacturing powerhouse, now mostly supply clients in the Middle East, Africa and Europe.
In Yangon, meanwhile, Shu’s Myanmar factory turns raw materials imported from China into backpacks, kit bags and pouches for rifles and pistols — all labelled “Made in Myanmar” — almost all of which are exported to the United States.
“Our factory is receiving many orders. The products are being exported to the US and Europe. So, I believe our future will be improved from working in this factory,” said Marlar Cho, 36, a supervisor at the factory.
The factory manager, 40-year-old Jiang Aoxiong from eastern China, said they were constantly rushing to keep up with orders, despite its 600-strong workforce.
Though international criticism of Myanmar’s handling of the Rohingya crisis has crimped Western investment, the Southeast Asian nation has become the choice destination for some Chinese firms, drawn to its cheap and abundant labor.
The former British colony, located on China’s southwestern border, exports some 5,000 products to the United States duty-free under a US trade program for developing nations — another big plus.
In the 12 months through April, approved Chinese projects increased by $585 million, the latest data from Myanmar’s Directorate of Investment and Company Administration shows.
The infusion of Chinese capital has helped fuel expansion in Myanmar’s fledging industrial sector.
In May, firms saw the fastest rise in workforce numbers since 2015, while production scaled a 13-month high, the latest Nikkei Myanmar Manufacturing Purchasing Managers’ Index survey showed.

Stay or go?
ACMEX Group, a tire maker based in China’s coastal Shandong province, already had some experience with offshoring when the trade war began.
About two years ago, it started manufacturing some tires in Vietnam, Thailand and Malaysia to take advantage of lower labor and raw material costs and avoid US anti-dumping duties.
With fresh tariffs in the trade war, the company plans to boost the proportion of tires made abroad to 50% from 20%, and build its own factories instead of outsourcing to existing factories, Chairman Guan Zheng said.
“The time is ripe now,” he said, adding that supply chain infrastructure had improved.

HIGHLIGHTS

• Guangdong bulletproof vest maker moved production to Myanmar

• Shandong tire maker moved capacity to Thailand

The experience of companies like ACMEX and Shu’s Yakeda Tactical Gear underlines how the trade war has put Chinese exporters on the back foot, needing to either diversify their client base, increase domestic sales or move production to a third country.
But all those options require time and money, which are not necessarily available to China’s legion of small exporters grappling with thinning profit margins.
Even locations such as Vietnam and the Philippines have grown too dear for some.
While China has encouraged the relocation of some heavy industry overseas to ease overcapacity and support its ambitious Belt and Road infrastructure plan, Beijing is less supportive of a broader move to shift manufacturing offshore.
Liang Ming, director of the Institute of International Trade at the Ministry of Commerce’s Chinese Academy of International Trade and Economic Cooperation, rejected the idea that Chinese firms were leaving China in droves.
“Few companies are actually moving. If they move, they risk losses if there is a China-US deal,” Liang told reporters earlier this month, adding that any relocation back to China would be expensive.
As trade pressures intensify, analysts say China will loosen policy further in months ahead to shore up economic growth.
Investors are also watching to see how much Beijing allows the yuan to weaken to offset higher US tariffs. The tightly-managed currency has depreciated about 2% against the dollar since trade tensions worsened in early May.
Trump and Chinese President Xi Jinping are due to meet in Osaka at a G20 summit at the end of this week in a bid to reset ties poisoned by the trade war.
And though costs and labor may be cheaper, some Chinese firms with experience of offshoring say there are downsides too.
Factory manager Jiang complained about lower worker productivity in Myanmar compared with China, flooded roads during the rainy season, and power cuts of eight to nine hours every day.
“If there is no trade war between China and the US, we definitely would not have come to Myanmar to open our factory,” he said.