Tapping a Hidden Resource Energy Efficiency in the Middle East and North Africa February 2009

Transcription

1 Tapping a Hidden Resource Energy Efficiency in the Middle East and North Africa February 2009 Sustainable Development Network Middle East and North Africa Region Energy Sector Management Assistance Program (ESMAP)

2 Copyright 2009 The International Bank for Reconstruction and Development / THE WORLD BANK GROUP Energy Sector Management Assistance Program (ESMAP) 1818 H Street, N.W. Washington, D.C , U.S.A. All rights reserved Energy Sector Management Assistance Program (ESMAP) reports are published to communicate the results of ESMAP s work to the development community with the least possible delay. The typescript of the paper therefore has not been prepared in accordance with the procedures appropriate to formal documents. Some sources cited in this paper may be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this report are entirely those of the author(s) and should not be attributed in any manner to the World Bank, or its affiliated organizations, or to members of its board of executive directors for the countries they represent, or to ESMAP. The World Bank and ESMAP do not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement of acceptance of such boundaries. The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/ The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. Acknowledgments The financial and technical support by the Energy Sector Management Assistance Program (ESMAP) is gratefully acknowledged. ESMAP a global knowledge and technical assistance partnership administered by the World Bank and sponsored by official bilateral donors assists low- and middle-income countries, its clients, to provide modern energy services for poverty reduction and environmentally sustainable economic development. ESMAP is governed and funded by a Consultative Group (CG) comprised of official bilateral donors and multilateral institutions, representing Australia, Austria, Canada, Denmark, Finland, France, Germany, Iceland, the Netherlands, Norway, Sweden, the United Kingdom, and the World Bank Group. This report was produced by a team consisting of Alex Kremer (senior sector economist, task team leader), Dominique Lallement (consultant, content coordinator and main author), John Besant-Jones (consultant and chapter author), Hayat Al-Harazi (program assistant), Abdulhamid Azad (senior irrigation engineer), Kevin Blanchard (consultant), Khalid Boukantar (program assistant), Julia Bucknall (lead natural resources management specialist), Kevin Carey (senior country economist), Jean-Charles Crochet (senior transport economist), Carine Dumit (consultant), Roger Gorham (consultant), Mohab Hallouda (consultant), Grayson Heffner (consultant), Maros Ivanic (consultant), Mireille Linjouom (consultant), Will Martin (lead economist), Xiaoyu Shi (consultant), Steven Kennedy and Stephen Spector (consultants, editors), Loic Whitmore (junior professional associate), Ning Wu (consultant), and Yabei Zhang (consultant).

3 Contents Introduction Using energy wisely in a growing region 1 High and rising energy intensity: where is MENA heading? 1 The path to energy efficiency is clear 2 What to expect in an energy-efficient future: greater energy security, faster growth, less pollution 4 1 An energy-rich region s unfolding energy crisis: as demand soars, efficiency lags 5 Consumption of energy is rising in the region faster than anywhere else in the world 5 Opportunities to increase efficiency are many 5 Greater energy efficiency would pay substantial dividends 7 Energy efficiency s specific importance for women 7 2 Breathing uneasily: the health and environmental costs of using too much energy 8 Caution: overconsumption of energy is bad for your health 8 MENA pays a high price for its air pollution 8 Energy efficiency promises a healthier environment 10 3 The engine of inefficient consumption: subsidies 11 Subsidies are substantial 11 Subsidies miss those who need them most and divert investment from the most viable industries 13 Energy efficiency would improve fiscal balances across the region 13 4 The antidote to inefficiency: real-world energy pricing 15 Electricity pricing must meet several goals 15 Prices of petroleum products are held down by regulation in much of the region 16 Price reforms should take country differences into account 17 5 Readying the safety net in anticipation of higher prices 18 Designing effective social protection requires much preparation 18 Five countries of the region are planning social protection related to energy price reform 20 6 Managing efficiency: institutional and financing frameworks 22 Enabling frameworks create the conditions necessary to undertake an energy efficiency campaign 22 Implementation arrangements must make the most of a country s resources and capacities 23 MENA is building its institutional frameworks for energy efficiency 24 7 Yes, it can be done: international experience 26 Brazil, China, and Japan have achieved comprehensive results 26 Indonesia succeeded from a difficult entry point 27 In Jordan, effective communication was the key to success 27 8 Greater efficiency, sector by sector 29 Manufacturing can expect quick gains from energy efficiency 29 Construction: the keystone of long-term energy savings 30 In transportation, MENA s dubious honor: most energy intensive 30 Boosting farm profitability with energy-efficient pumps 30 Demographic trends set the context for sectoral analysis 31 9 Where and when: the art of reform 32 Policymakers must find appropriate entry points for intervention 32 Stakeholders at the national and international levels must be consulted 33

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5 Introduction Using energy wisely in a growing region Addressing the MENA region s challenges diversifying economies to create jobs for millions of unemployed young people, bringing education and health services to those who lack them, sheltering economies from the see-saw of oil-price volatility, and improving the lot of the region s most vulnerable people those tasks call for careful stewardship of resources. The region s petroleum exporters have established stabilization funds to capture windfall revenues earned during periods of high worldwide oil prices and to conserve them for use in leaner times. Such funds have received considerable attention from economists and the press. But another form of stewardship one that can benefit the region s net oil importers as well as its net exporters has been much less prominent. Truly a hidden resource, energy efficiency has vast potential to benefit the economies of the region. The scale of the potential benefit mirrors the inefficiencies in the region s use of energy today. Addressing those inefficiencies is not an easy matter, but international experience indicates that it can be done. Political commitment, keen analysis, ample communication, and institutional depth and dexterity are all required, as we shall see in the nine short chapters that follow, each based on a longer treatment in the full version of this study. The full report is available for download at High and rising energy intensity: where is MENA heading? Since 1980, the consumption of energy has grown faster in MENA than in any other region in the world, reflecting the expansion of energy-intensive industries in the Gulf states and the growing demand for electricity and transport from growing populations. Meeting the forecast level of demand growth over the next decade will require major investments. Whether those investments will embrace energy-efficient technologies is a critical question. Energy intensity the ratio of energy use to GDP has dropped dramatically nearly everywhere in the world. Only in the MENA region has the opposite happened: energy consumption has been rising faster than GDP. After experiencing a 14 percent rise between 1990 and 2005 a rate of nearly 1 percent per year the region s energy intensity is now some 60 percent higher than that of OECD countries and 40 percent above the world s average. MENA is now the second most energy-intensive region in the world, after Eastern Europe and Central Asia. Gas flaring in oil production causes losses estimated at $1 2 billion per year, while transmission and distribution losses in the power sector cause even more. Cutting transmission losses to 10 percent across the region would provide additional capacity for a growing population, or a savings of $5.5 billion equivalent in new investments. The silver lining surrounding this cloud is that opportunities to increase efficiency are ripe for picking and likely to yield substantial dividends. By embracing energy efficiency, the region could reap gains equivalent to 0.5 to 1 percent of GDP. Increasing energy efficiency by 20 percent throughout the region would generate overall GDP gains of $11 billion (2004 prices). Almost half of those benefits would accrue to

6 four countries: Iran, Egypt, Morocco, and Tunisia. Energy efficiency improvements of 10 to 50 percent would yield GDP benefits ranging from $6 to $23 billion for the region. Conversely, the price of not acting to lower the region s energy intensity will be commensurately high. The MENA region has levels of local airborne pollution and carbon emissions that are far above those found in other middle-income countries and in the OECD. The estimated concentration of particulate matter (released in the burning of fossil fuels) is 50 percent higher in MENA cities than the world average. And pollution is growing. Four MENA countries rank among the 11 in the world where emissions are increasing most rapidly. In eight MENA countries, urban air pollution is estimated to cause 40,440 premature deaths per year from diseases such as lung cancer, cardiovascular ailments, and respiratory conditions. Pollution from particulate matter is estimated to cost the region close to 1 percent of the 2004 gross national income, or about $5.3 billion. Both the high level and the inefficiency of energy consumption in the MENA region can be traced to the region s enduring tradition of underpricing energy. In most countries of the region, all fuels and electricity are subsidized. Subsidies constitute a significant share of government spending, averaging in excess of 20 percent across the region, and over 7% share of GDP in 2006, before the world price increases. When oil prices rise, as in , governments quickly feel the pinch, because price increases are not passed through to consumers. Subsidies on electricity and petroleum products are intended to allow citizens to share in their countries natural-resource wealth, or to make essential energy services available to the poor. But they have proven to be very blunt instruments for achieving those goals, particularly that of protecting vulnerable populations. Subsidies miss those who need them most, instead benefiting wealthier citizens who tend to consume more energy. In Egypt, for example, a 2004 analysis found that individuals in the highest-income quintile received more than two-and-a-half times the household electricity subsidy received by the poor. The wealthiest 20 percent of the population received 93 percent of gasoline subsidies, because they owned most of the vehicles. Untargeted energy subsidies reduce the amount of money that can be spent on programs that really benefit the poor. They also encourage investors and firms to invest in activities that would be unprofitable if energy were not subsidized. Such activities reduce economic growth by siphoning off investment that could be put to more productive use. The path to energy efficiency is clear Awareness is growing among the policymakers and opinion leaders of the region that the present mutually reinforcing cycle of energy subsidies and inefficient consumption is not sustainable. Increasingly, they know that an integrated program of price reforms, targeted social protection, institutional strengthening, and sector-specific investment is needed to boost growth, lower costs, and improve the region s air quality. Ongoing efforts to reform energy prices in several countries testify to that growing awareness. The foundation: prices. The foundation of efficient energy use is to price energy at a level that reflects its full cost to the national economy and to allow energy prices to track changes in supply costs over time. The low energy prices now charged in most MENA countries leave ample room for upward adjustment toward economic pricing. In only a few countries of the region do prices for electricity or petroleum products 2

7 come close to the benchmark prices that prevail in nearby northern Mediterranean economies. In the region s main oil-producing countries, electricity and fuel prices cover only a small portion of the economic cost of supply (in the case of electricity) and are orders of magnitude below the benchmark prices. Because raising prices brings substantial political and social risks in recent years the region has repeatedly seen rioting when energy prices were allowed to rise without compensatory measures for affected groups well-designed programs of social protection are needed to mitigate the undesirable side-effects of price increases. In particular, poor households must be protected from steep increases and fluctuations in energy prices. Preparing an effective safety net requires a good deal of preparation. Planners must find out which fuel users will be the most affected by proposed price reforms, and by how much. They must then identify the most efficient way of ensuring that affected groups will continue to have access to power and fuel. The ongoing efforts of five countries to pair social protection with energy price reforms are discussed in chapter 5. Fortunately, international experience with various forms of targeting and transfer mechanisms provides formulas for success. The next level: institutions. After the foundations of price incentives, institutions are the next level of an energy efficiency policy. So-called enabling frameworks must be set up either from scratch or from existing components. Those frameworks include laws and decrees on energy efficiency, national energy strategies and plans, apex agencies for the energy sector, and regulatory regimes. Together such frameworks provide the direction for a national energy policy, including goals and targets, specific intervention strategies, and funding and other resources. With the necessary frameworks in place, implementation arrangements must then be devised to make the most of a country s resources and capacities. Most countries with large energy efficiency programs rely on specialized agencies to deliver the services called for by the efficiency campaign. So-called programmatic arrangements may also be called for. These are often sector-specific. Examples include the rehabilitation of thermal power plants to provide both heat and power; bulk procurement and mass-market distribution of compact fluorescent lights or other energy-efficient appliances; and the largescale implementation of energy audits for buildings and industrial facilities. In the MENA region, ripe opportunities to capture savings exist in all four of the chief energy-consuming sectors: manufacturing, construction, transport, and agriculture. Those opportunities are reviewed in chapter 8. Other supporting arrangements may include the promotion of awareness of energy efficiency in civil society; the development of educational curricula; the development of private energy efficiency businesses; the promotion of professional and industrial associations focused on energy efficiency; and partnerships with scientific and academic institutions. Financing arrangements deserve special mention, because insufficient access to financing is one of the most common barriers to investment in energy efficiency. Households, managers of industrial and service companies, government bodies, and other types of consumers all have limited budgets and competing spending priorities, and all are highly sensitive to the upfront costs of investments. Getting financing to those who most need it and can best use it is critical to any campaign that depends on investments in energy efficiency. 3

8 At this time, only two countries in the MENA region have what might be deemed comprehensive institutional arrangements for energy efficiency: Iran and Tunisia. Both countries have excellent enabling frameworks and implementation arrangements at least on paper. Progress in these and other countries of the region is charted in chapter 6. What to expect in an energy-efficient future: greater energy security, faster growth, less pollution Examples of how a sustained, integrated approach to price reform, social protection, and sector-specific energy-efficiency measures has yielded results are offered in chapter 7. In addition to a summary of the comprehensive gains of Brazil, China, and Japan, we also review Indonesia s successful experience with public awareness and cash transfers, as well as Jordan s recent reform of energy subsidies. In Jordan, after careful planning and analysis of stakeholder groups, options, and budgetary needs, the government discussed its proposed plan with various interest groups, including members of parliament, local nongovernmental organizations, the business community, and labor representatives. Officials emphasized the regressive nature of the oil subsidy and the leakage of benefits to higher-income groups. A media campaign prepared the public for subsidy reform. Extrapolating from these and other experiences, the countries of the MENA region can envision a future in which energy efficiency helps them to achieve their goals for growth, competitiveness, welfare, and social development. Energy efficiency can improve energy security for countries, enterprises, and households. It is also good business, offering high returns on investments, and good environmental policy, increasing the sustainability of energy sources and reducing pollution. Realizing that vision is the topic of chapter 9, which provides a rank-ordered typology of strategies for reaching energy efficiency. In most cases, pricing reform, coupled with social protection, is the most difficult but also the highest-priority intervention, followed by developing the institutional framework for energy efficiency. Once the broader institutional and incentive environment has been thought through, the focus should shift to supporting real change in firms and households using the programmatic arrangements and public-information campaigns described in chapters

9 1 An energy-rich region s unfolding energy crisis: as demand soars, efficiency lags Compared with other world regions, the countries of the Middle East and North Africa (MENA) use energy inefficiently. That is a problem because the costs of inefficiency are great, as we shall see in succeeding chapters dealing with the health and fiscal consequences of excessive energy use. But it also presents an opportunity. With the right policies, appropriately sequenced, the region could raise its energy efficiency significantly, as many other countries have done, thereby improving the health of its people and freeing up funds for other purposes. In this chapter we put the region s energy intensity into international perspective. Consumption of energy is rising in the region faster than anywhere else in the world Since 1980, the consumption of energy has grown faster in MENA than in any other region in the world, reflecting the expansion of energy-intensive industries in the Gulf states and the growing demand for electricity from growing populations. Energy demand is expected to continue to grow at a very high rate over the next decade, although not as quickly as GDP (table 1.1). Meeting the forecast level of demand growth will require major investments. Fossil fuels dominate demand in the region as heavily as they do supply. Nearly all the region s primary energy supply comes from locally produced fossil fuels, primarily oil and natural gas. Two countries Iran and Saudi Arabia account for almost half of that supply. Table 1.1. The region s demand for energy will grow through 2030, but not as rapidly as GDP Per capita energy demand (toe/capita) GDP (billions of 2004 PPP dollars) 1,970 2,640 3,661 4,870 Energy intensity (toe/thousand dollars of GDP) Source: IEA, Note: toe = tons of oil equivalent; PPP = purchasing power parity. Overall, the region consumes about 30 percent of its world-leading production of fossil fuels, and exports the rest. But six of the 19 countries in the region Djibouti, Israel, Jordan, Morocco, Tunisia, and West Bank and Gaza depend heavily on imports. Opportunities to increase efficiency are many Energy intensity the ratio of energy use to GDP has dropped dramatically nearly everywhere in the world. The OECD countries have experienced a steady decline in their energy intensity since the early 1970s. Only in the Middle East and North Africa has energy consumption been rising faster than GDP. The region experienced a 14 percent rise in energy intensity between 1990 and 2005 a rate of nearly 1 percent per year (figure 1.1). The region s energy intensity is now some 60 percent higher than that of OECD countries and 40 percent above the world s average. MENA is now the second most energy-intensive region in the world, after Eastern Europe and Central Asia. Some countries have fared better than others. Tunisia s energy intensity has experienced a steady decline since

10 Is high and rising energy intensity a bad thing? A high level of energy intensity is often (but not always) a sign that energy is being used inefficiently, just as low energy intensity is often (but not always) a sign of efficiency. Countries with low energy intensity may specialize in economic activities that do not use much energy, or they may use energy efficiently. Measuring the two effects separately requires detailed data on the subsectoral composition of the economy and of energy use. Therefore, although energy efficiency is easily measured at the micro level for example, how much energy it takes to produce a ton of cement it is generally not possible to aggregate it at the country level. For that reason, high energy intensity is used, cautiously, as a sign of possible energy inefficiency. The reciprocal of energy intensity, GDP per unit of energy, is called energy productivity. High energy productivity is the same as low energy intensity. The energy intensity of the region s economies is not explained simply by differences in their natural resource endowment. Energy-abundant countries such as Iraq and UAE are among the most energy-intensive in the region. But some energy-importing countries (Jordan, Lebanon, Yemen) have energy-intensive economies. So do some countries that are facing the depletion of their fossil fuel reserves (Syria, for example). Meanwhile, energy-abundant Algeria has a low level of energy intensity, as do Egypt and Oman. Israel, Morocco, and Tunisia fall below the world average (and even below the OECD average). The world s regions also vary in the sectoral breakdown of energy use (figure 1.2). In MENA, transportation accounts for the largest share of consumption (31 percent) and fastest growth, reflecting the rapid expansion of car ownership in oilrich countries. The share of consumption used for transport is only slightly above the world average of 28 percent, but it is well above that of Asia (excluding China) and the non-oecd countries as a whole. The ratio of transport energy use to GDP is greater in MENA than in any other Figure 1.1. Change in primary energy intensity by world region, % change in energy intensity world region. The same goes for household energy use. The ratio of manufacturing energy use to GDP in MENA is second highest after Europe and Central Asia, with its legacy of notoriously inefficient Soviet-era industries. 20% 10% 0% -10% -20% -30% -40% -50% -60% China East Asia & Pacific Europe & Central Asia Source: World Bank/ GDI database. India Middle income United States World Latin America & Caribbean Figure 1.2. Share of total final consumption by sector and region, % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% MENA Asia Excluding China Latin America Non-OECD Total World Industry Transport Other Sectors Non-Energy Use Source: IEA database. Note: Nonenergy use means the conversion of energy sources to non-energy products e.g. plastics or fertilizers. MENA 6

11 Greater energy efficiency would pay substantial dividends By embracing energy efficiency, the region could reap gains equivalent to 0.5 to 1 percent of GDP. Increasing energy efficiency by 20 percent throughout the region would generate overall GDP gains of $11 billion (2004 prices). Almost half of those benefits would accrue to four countries: Iran, Egypt, Morocco, and Tunisia (table 1.2). Energy efficiency improvements of 10 to 50 Table 1.2. Energy efficiency could boost the region s GDP by up to $23 billion GDP gain (in US$ millions) from various percentage increases in energy efficiency Country / region Iran, Islamic Rep. 1,611 3,010 4,237 5,325 6,295 Egypt, Arab Rep ,406 1,983 2,496 2,955 Morocco Tunisia Rest of North Africa 584 1,089 1,530 1,920 2,268 Rest of West Asia 2,630 4,917 6,929 8,717 10,320 MENA total 5,890 11,008 15,504 19,495 23,063 Source: Ivanic and Martin, percent would yield GDP benefits ranging from $6 to $23 billion for the region. Two specific issues contribute visibly to the region s energy inefficiency gas flaring in oil production, and transmission and distribution losses in the power sector. Gas flared in the oil and gas industry of the Middle East is estimated to be the third-largest volume after Russia and Africa, with losses estimated at $1 2 billion per year. Transmission and distribution losses in the power systems are high by industry standards except in Israel and Saudi Arabia. Elsewhere, losses range from about 12 percent in Tunisia to 26 percent in Yemen. Reducing transmission and distribution losses in all these countries to 10 percent would provide additional capacity, or a savings of $5.5 billion equivalent in new investments. Energy efficiency s specific importance for women The different situation of men and women, both in the household and in business, means that energy use and energy efficiency will matter to them in different ways. World Bank studies in Tunisia and Egypt confirmed that gender affects energy use. In the household, for example, decisions on choices of fuel, household appliances, and use of electricity are male-dominated, although women are keenly aware of the relative energy efficiency of various appliances. In both countries, poor women are the hardest hit by increases in fuel prices. In Egypt s business sector, men seemed to be better informed about energy efficiency than women and were already using energy conservation measures. In Tunisia, by contrast, differences in awareness depended on the nature of the activity rather than on gender. 7

12 2 Breathing uneasily: the health and environmental costs of using too much energy The MENA region has high levels of local airborne pollution and carbon emissions, levels far above those found in other middle-income countries and in the OECD, particularly in the manufacturing sector. And pollution is growing. Four MENA countries rank among the 11 in the world where emissions are increasing most rapidly. The costs of such elevated levels of pollution are measured in their impact on health, the environment, and the economy. Improved energy efficiency could substantially reduce pollution and its costs to the regional economy. Caution: overconsumption of energy is bad for your health As elsewhere in the world, energy consumption is the most significant source of pollution in the Middle East and North Africa. Airborne pollution affects the local environment, causes disease, and lowers the quality of life today, while threatening future consequences from climate change. The burning of fossil fuels for power generation, transportation, industry and other human activities produces a complex mixture of particulate matter (PM) and gaseous pollutants. The health impacts of air pollution depend on the pollutant type, its concentration in the air, length of exposure, other pollutants in the air, and individual susceptibility, but even very low concentrations of air pollution damage the health of local people, especially children and the elderly. Figure 2.1. Pollution from particulate matter is high in the MENA region Concentrations of particulate matter (μg/m3), 2006 Urban air pollution causes premature deaths and diseases such as lung cancer, cardiovascular ailments, Source: World Bank, and respiratory conditions, including infections. The World Health Organization estimates that urban PM accounts for about 5 percent of all cancers of the trachea, bronchus, and lung; 2 percent of deaths from cardiorespiratory conditions; and 1 percent of respiratory infections. Worldwide, this amounts to about 0.8 million deaths annually, most in developing countries. Moreover, the ill effects of PM pollution extend beyond the direct effects, as they contribute to climate change and affect rain patterns. Particulate pollution can also impair visibility, damage buildings, and destroy vegetation. MENA pays a high price for its air pollution The MENA region is the second-most-polluted region in the world in terms of PM concentrations, behind only South Asia (figure 2.1). The estimated PM concentration in MENA cities is 50 percent higher than the world average. Within the region, Iraq has the highest PM concentration, followed by Egypt, 8

13 Kuwait, Oman, Libya, the United Arab Emirates (UAE), and Saudi Arabia. The bad news is compounded by the fact that emissions are increasing. Four MENA countries Egypt, Iran, Saudi Arabia, and the UAE rank among the 11 countries worldwide with the fastest increase in emissions (figure 2.2). PM s effects on health is estimated to cost the region close to 1 percent of the 2004 gross national income, or about $5.3 billion. In terms of damage suffered from PM, the region ranks second after the East Asia and Pacific region and well above the world average of 0.5 percent. Within the region, Iraq and Kuwait pay the highest costs for PM emissions 2.7 percent of GNI, more than five times the world average. But most MENA countries have PM-emission damage costs that are higher than the world average, with the exception of Morocco, Tunisia, and Yemen. Figure 2.2. Four MENA countries are among those with the greatest growth in emissions The 11 countries with the largest percentage increase in emissions, Percent Malaysia Thailand China Iran Spain India Saudi Arabia Source: IEA/OECD, Turkey Egypt United Arab Emirates Indonesia In the eight MENA countries for which cost of environmental degradation studies exist (table 2.1), urban air pollution is estimated to cause 40,440 premature deaths per year. Egypt suffers the highest damage (2.1 percent of GDP), accounting for 44 percent of the total cost of environmental degradation in the country. Table 2.1. The costs of urban air pollution in eight MENA countries Number of estimated annual premature deaths due to urban air pollution Total Disability- Adjusted Life Years (DALYs) Share of overall estimated cost of environmental degradation to the country (%) Reference year US$/year (millions) Percentage of GDP Algeria n/a 157, Egypt, Arab Rep of , , , Iran , , , Jordan , Lebanon , Morocco ,300 73, Syria ,400 95, Tunisia , Source: World Bank staff. Data from: World Bank, 2001, 2002, 2003, 2004a, 2004b, 2005a, 2005b. Note: Damage costs due to air pollution include both urban air pollution and indoor air pollution (IAP). IAP is minimal in Syria and Jordan, however, because there is nearly universal access to clean commercial fuels. Column 6 (DALYs) measures the number of person-years of healthy life lost to air pollution each year. 9

14 The inefficiency of growing energy use also caused the MENA region to contribute 6 percent of the world s energy-related greenhouse gas emissions in Those emissions were concentrated in three countries Iran (27 percent), Saudi Arabia (18 percent), and Egypt (10 percent). When analyzed by sector, emissions in the MENA region do not follow the prevailing patterns of middle-income countries or developing countries as a whole. The energy sector contributes almost 45 percent of emissions, followed by the transport sector (22 percent) and the industry sector (20 percent). MENA s manufacturing sector produces more CO 2 emissions per dollar of output than any other world region (figure 2.3). Its emissions are almost twice as high as those of other middle-income countries. Figure 2.3. Manufacturing in MENA is CO2-intense Energy consumption and CO2 emissions per dollar of manufacturing output, by region, 2005 toe/2005 US$ PPP t of CO2/2005 US$ PPP MENA ECA Lower Middle Source: WB-GDI and IEA/OECD, Income Upper Middle Income Energy Consumption/Dollar of Manufacturing Output (toe/2005 US$ PPP) CO2 Emission/Dollar of Manufacturing Output (t of CO2/2005 US$ PPP) EAP LAC Energy efficiency promises a healthier environment Improvements in energy efficiency have the potential to reduce pollution. To date, the lion s share of global progress in decreasing the carbon intensity of economic activity has come from improved energy productivity. A model known as GMAPS demonstrates the great power of energy efficiency to reduce PM concentrations in the region: An energy efficiency program that reduced per capita oil consumption by 10 percent would bring a reduction in PM concentrations of almost 6 percent. The same program would save about 2,400 lives every year in the eight countries in Table 2.1. A 10 percent cut in diesel consumption in the transportation sector would cut PM concentrations by 1.1 percent. Iraq, with the highest PM concentrations in the baseline, has the potential to achieve the highest reduction in PM concentrations in absolute terms a 23 percent reduction in PM concentrations from a 30 percent improvement in energy efficiency. 10

15 3 The engine of inefficient consumption: subsidies Energy subsidies and energy efficiency have a two-way relationship. By underpricing energy, subsidies encourage its inefficient use. Greater energy efficiency, on the other hand, reduces the cost of energy subsidies for the simple reason that less energy is used. The high level of energy consumption in the Middle East and North Africa cannot be divorced from the region s tradition of underpricing energy. In most countries of the region, subsidies for fuels and electricity constitute a significant share of government spending. In Yemen, for example, they represented more than 30 percent of all government spending for the period Petroleum subsidies alone were estimated to amount to 11 percent of Yemen s GDP ($3 billion) in While diverting a large chunk of tax revenues from investment and other spending that would have greater social and economic returns, subsidies rarely benefit the social groups or sectors that need them most. Few productive sectors depend on energy subsidies for their survival; those that do tend to contribute little to the economy. Once oil prices resume their historical upward trend, the situation can only get worse. Tunisia has shown that aggressive energy-efficiency programs pay off in several ways, one being a reduction in society s demand for energy subsidies. The gradual withdrawal of subsidies, meanwhile, encourages further steps toward energy efficiency a virtuous circle. There is some evidence that others in region are heeding Tunisia s example. Subsidies are substantial Energy subsidies exceeded 7.1 percent of the region s GDP in 2006, before the world energy price increases. The rate of subsidy ranged from 1.3 percent of GDP for Morocco to 17.5 percent for Iran (figure 3.1a). In the same year, average energy subsidies exceeded 20 percent of government spending. Shares ranged from around 4 percent in Qatar and Morocco to about 40 percent in Syria and Libya and 67 percent in Iran (figure 3.1b). As energy costs rose in , the cost of subsidies increased apace, as most countries remained reluctant to pass through to consumers the rising costs of energy. Figure 3.1. Energy consumption is heavily subsidized in many countries of the MENA region a. Energy subsidies as a percentage of GDP, 2006 b. Energy subsidies as a percentage of government spending, Iran Iraq Libya Syria Egypt Kuwait Yemen Algeria Saudi Arabia Lebanon Jordan Source: Carey, Note: Includes both on- and off-budget subsidies. Oman UAE Bahrain Tunisia Qatar Morocco Iran Libya Syria Egypt Algeria Iraq Kuwait Yemen Saudi Arabia Lebanon UAE Jordan Oman Bahrain. p g Tunisia Morocco Qatar 11

16 Electricity prices in the region generally do not cover the long-run marginal cost of supply. All MENA countries subsidize the retail prices of gasoline and diesel fuel, many heavily (figure 3.2). In 2006, retail diesel prices in 15 of 19 MENA countries with available data were lower than prices in the United States, and gasoline prices in 12 of the 19 countries were lower than in surrounding Mediterranean countries (Italy, France, Greece, Portugal, Spain, and Turkey). Figure 3.2. Low energy prices in MENA leave ample scope for reform to encourage efficiency a. Electricity prices, average residential, 4th quarter 2007 b. Diesel prices, 2006 US cents/kwh countries US cents/kwh countries Note: Red bar indicates benchmark for electricity =derived value from ex. tax tariffs in the northern Mediterranean countries (France, Greece, Italy, Portugal, Spain, and Turkey), where costs are reflected in pricing. Rising world fuel prices have widened gaps between world prices and domestic prices, and increased subsidy rates. The total cost of subsidies for nearly every kind of fuel increased between 2000 and In Egypt, for example, the cost of subsidies (at current prices) swelled from 2.4 billion Egyptian pounds in 2001 to 3.0 billion in The way in which energy is subsidized varies from country to country. In energy-producing countries with large foreign private-sector involvement, such as Egypt and Yemen, the key subsidies are embedded in production-sharing agreements for domestic oil and natural gas. In energy-importing countries, the government sets the domestic wholesale or retail price of products below the market price, and then compensates the importing companies (public or private) or the refineries. Electricity subsidies are effected in two steps: through the sale of oil or gas to power companies at subsidized prices, and through the tariffs charged to various types of consumers. Utilities may or may not be compensated for the losses they incur from the mandated tariffs. Subsidies miss those who need them most... Energy subsidies are commonly justified as a way of ensuring that the poor have access to electricity and fuel or that they share in their country s natural resource wealth. But when subsidies are untargeted, the greatest benefit goes to those who consume the most energy namely firms and wealthier households. In Egypt, for example, a 2004 analysis found that individuals in the highest-income quintile received more than two-and-a-half times the household electricity subsidy received by the poor. The wealthiest 20 percent of the 12

17 population received 93 percent of gasoline subsidies, because they owned most of the vehicles. Similarly, they received 65 percent of natural gas subsidies because the gas network reached only the wealthiest urban neighborhoods. In Yemen, a 2003 study found that the richest 10 percent of households received 40 percent of all subsidized diesel, while the poorest 20 percent received only 2 percent. The kerosene subsidy is an important exception to this pattern; it is the fuel of poor households. Untargeted energy subsidies reduce the amount of money that can be spent on programs that really benefit the poor. In Yemen, the petroleum subsidy benefits only about 23 percent of the poor but costs the government 10 times as much as specific and targeted poverty reduction programs. Much of the cost of lowering energy prices is achieved by raising the prices that consumers pay for other goods and services. Although taxes on income, profits, and capital gains affect mostly the rich, the same is not true of sales taxes, which are a major source of government revenue in most MENA countries. And fuel subsidies represent a high share of sales taxes. In Algeria, Egypt, Iran, and Jordan, for example, energy subsidies add at least 20 percent to the rate of taxation on goods and services.... and divert investment from the most viable industries The region s industry, viewed as a whole, is not particularly dependent on energy subsidies. Most energy subsidies to industry reduce the costs of production for economic activities that would take place anyway; the subsidies simply transfer wealth from the taxpayers to producers and consumers. But the overall situation conceals important differences between sectors. Some industries do depend on energy subsidies to survive they would be unprofitable without energy subsidies. According to wellestablished economic theory, the value of the inputs used by those industries exceeds the value of the outputs they produce or contribute to the economy. In other words, energy subsidies are encouraging investors and firms to invest in activities that reduce economic growth, thus diverting investment away from value-adding activities. Energy efficiency would improve fiscal balances across the region The governments of energy-exporting and energy-importing countries feel the weight of energy subsidies and understand that they are not unsustainable. 1 They also know that long-term increases in oil prices will exacerbate the situation. Better energy efficiency would assist the region s fiscal management in three ways. By reducing energy consumption, energy efficiency programs cause budget outlays for subsidies to shrink. The savings can be redirected to other uses, such as improving the lot of the poor. Properly administered energy efficiency measures stimulate GDP by raising competitiveness and encouraging investment in value-added activity. A larger GDP produces greater tax revenues. Energy efficiency measures allow households to spend less on energy, thereby reducing the claims on the government for social safety net support. 1 Of the eight MENA countries that are running a significant budget deficit, four are net exporters (Egypt, Iran, Syria, and Yemen) and four net importers (Jordan, Lebanon, Morocco, and Tunisia). 13

18 Tunisia has shown how improved energy efficiency can reduce spending on subsidies. Energy efficiency gains led to a remarkable decrease in the energy intensity of the economy between 1990 and Renewed efforts undertaken in response to the steady increase in oil prices led to a 13 percent decrease in the country s energy intensity between 2000 and The efficiency gains achieved during are now generating annual fuel savings of 390 thousand tons of oil equivalent 0.7 percent of the country s total energy consumption and a potential annual budgetary saving of $40 million per year. Other countries in the region have higher subsidies and higher levels of energy intensity than Tunisia, so their potential fiscal savings are greater. 14

19 4 The antidote to inefficiency: real-world energy pricing Consumers take their cues from prices. If energy prices are artificially low, consumers will have less incentive to conserve energy and will be tempted to use it for purposes that produce relatively little value, thereby decreasing the value of national economic output. In other words, they will use energy inefficiently. Indeed, in the absence of the right economic signals they can hardly do otherwise. By contrast, a system of economic pricing under which consumers pay the full cost to the national economy of the energy they use induces consumers to use energy efficiently. The low energy prices now charged in most MENA countries leave ample room for upward adjustment toward economic pricing. But the necessary adjustments involve more than just raising prices. They also involve using rate structures to sharpen price signals and maintaining flexibility in the price-setting process to accommodate changes in supply costs and demand patterns. If done right, energy pricing to improve energy efficiency at the micro level can produce major economic benefits at the macro level. Here we consider the virtues of economic pricing for electricity and petroleum products. Electricity pricing must meet several goals Electricity pricing should satisfy three principles: efficiency, flexibility, and transparency. The aim is to reach the best practical fit between price and cost structures, even if the fit is not perfect. Efficiency requires that prices cover the costs of investments and efficient operations for electricity supply. Prices should fully cover both economic costs and suppliers financial costs. Flexibility requires that electricity prices should change in line with changes in supply costs over time, but not to the extent of being volatile. Transparency requires that electricity price schedules should be publicly accessible and easily understood. The costs of supplying each service in each market segment should be clear. We analyzed October-December 2007 prices for residential and industrial electricity users in MENA countries against benchmark values in France, Greece, Italy, Portugal, Spain, and Turkey (see figure 3.2a). We excluded taxes on electricity consumption and converted prices to U.S. dollars at the prevailing exchange rates. The countries of the region fall into four groups, differentiated by their tariff rates. Djibouti stands out as having by far the highest rates, around $0.30/kWh for residential use and $0.20/kWh for industrial use, which reflects the high cost of operating small diesel generators. Israel, Morocco, Tunisia, and West Bank and Gaza had the next-highest tariffs: from $0.08/kWh to $0.17/kWh for residential use; $0.04 /kwh for off-peak industrial use; and $0.19/kWh for peak industrial use. West Bank and Gaza clearly covered their economic costs because they applied a substantial markup to the cost of electricity imported from Israel. Algeria, Jordan, Lebanon and Yemen had rates of $0.06/kWh to $0.10/kWh for residential use, and $0.06/kWh to $0.10/kWh for industrial use. Iran had residential tariffs in this range, but much lower 15

20 industrial tariffs. Syria had industrial tariffs in this range, but much lower residential tariffs. These rates were substantially below the economic costs of electricity supply in every country. The remaining eight countries (Bahrain, Egypt, Iraq, Kuwait, Libya, Oman, Qatar, and Saudi Arabia) had extremely low electricity prices that covered only a small portion of the economic cost of supply. These countries are also MENA s major oil and natural gas producers, with the exception of Algeria, which has somewhat higher rates. The electricity tariffs in Egypt, Iran, Oman, and Qatar were far below even the lowest of the benchmark values. Because electricity tariffs cannot be frequently changed (for administrative, social, and political reasons), changes in electricity tariffs generally lag behind changes in generating costs. In many MENA countries, years pass between fuel price changes and electricity tariff adjustments (figure 4.2). Volatility in supply costs greatly complicates decisions about how much to increase electricity tariffs, but doing nothing is the worst Figure 4.2. The costs of electrical energy from various fuels have increased in MENA since 2004 Cost in nominal U.S. dollars of energy supplied to power users from natural gas, gas oil, and heavy fuel oil, January 2004 April 2008 US$cents/kWh supplied solution of all and ultimately far more fraught with complication. 5 0 Jan-04 Apr-04 Prices of petroleum products are held down by regulation in much of the region The prices that end users pay for fuel are tightly regulated in MENA countries. The justification for this control is the great effect these prices have on the general level of domestic inflation and on household budgets especially low-income households. A wide variety of petroleum products are produced, traded, and consumed in the region ranging from jet fuel and kerosene at the light end of the oil barrel to residual heavy fuel oil at the heavy end. Many products are used industrially; automotive diesel and gasoline are used in transport; and kerosene and light diesel oil are used in households. We assessed prices in the region in the fourth quarter of 2007 against economic costs for the following three products: kerosene for the household sector; diesel for the transportation, commercial, and industrial sectors; and gasoline for the transportation sector. The results resembled those obtained for electricity. 16 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Gas turbine Gas Oil Steam turbine HFO CCGT Nat. Gas Jan-08 Apr-08 Source: Computations based on historic fuel prices from the World Bank s Development Research Group. Note: HFO = heavy fuel oil.