Fuel Subsidy Reform Is Credit Positive for United Arab Emirates and Abu Dhabi: Moody’s
Hydrocarbon revenues comprised 75% of the UAE’s consolidated revenues in 2014
UAE fuel subsidies equal $730 per resident per year, compared with $2,810 in Qatar and $2,522 in Kuwait
Last Wednesday, the United Arab Emirates Ministry of Energy announced gasoline and diesel price deregulation starting 1 August, effectively phasing out fuel subsidies. Fuel prices will be linked to global oil prices and adjusted on the 28th of each month.
The global credit rating agency Moody’s rates these measures as credit positive for the UAE and Abu Dhabi, the wealthiest of the seven emirates. Abu Dhabi accounts for 94% of the UAE’s oil production and the new reform is expected to bolster government finances dented by the downturn in global oil prices. The announcement about the pace of the subsidy phase-out is expected on 28 July.
Despite progress in diversification, hydrocarbon revenues comprised 75% of the UAE’s consolidated revenues in 2014. Given our forecast for Brent crude oil prices to average $60 per barrel in 2015, versus $101 in 2014, we expect a 27% drop in consolidated government revenue.
In 2015, the UAE will likely face a fiscal deficit of 2.3% of GDP, its first deficit since 2010, and a decline from a 10.3% surplus in 2014. Phasing out fuel subsidies will partly offset the negative effect of lower oil prices, according to Moody’s.
The report also said that the increases in gasoline prices will reduce the economic cost of subsidies the UAE public sector has provided to domestic consumers. According to the International Monetary Fund, post-tax1 petroleum subsidies in the UAE would have cost the government $7.0 billion in 2015 (1.9% of GDP) under the current system, a decline from $10.2 billion in 2013 (2.5% of GDP).
Per capita, UAE fuel subsidies equal $730 per resident per year, compared with $2,810 in Qatar and $2,522 in Kuwait. The International Energy Agency estimated the energy subsidization rate (i.e., the subsidy as a percent of full cost) for the UAE at 65% for 2013, compared with 78% in Qatar and 77% in Kuwait.
Fiscal gains from subsidy reform are likely to be moderate this year and accelerate when oil prices increase, and the credit rating agency expect they will next year. Total subsidies and transfers made up around 22% of all consolidated expenditures in 2014. Although details of the pricing formula have not yet been disclosed, Moody’s estimate that removing fuel subsidies will reduce the UAE’s consolidated fiscal deficit by 0.4% of GDP this year and contribute another 0.6% of GDP to the fiscal balance in 2016, which they expect will return to a small surplus.
Fiscal savings from the subsidy reform will increase if, as expected, oil prices rise to $75 by 2018. Linking retail prices to global prices also makes public finances more predictable because the public sector will no longer absorb increases in global oil prices.
The inflationary effect will likely be moderate: fuel consumption is less than 4% of the UAE’s consumer basket and gasoline prices are already higher in the UAE than in the rest of the Gulf ($0.47 per liter in the UAE versus $0.16 in Saudi Arabia, see Exhibit 1). According to the Ministry of Energy, deregulation will lower diesel prices, which were kept high to cover some of the cost of gasoline subsidies.
Further price increases should limit growth in domestic fuel consumption (which has been 8.1% a year on average over the past five years) and support export volumes. Rising fuel consumption has been eating into oil exports and the share of oil consumed domestically has increased to 23.5% in 2014 from less than 20% before 2009 (see Exhibit 2).