E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) APRIL 2018 MADAGASCAR • When oil prices started rising in 2010, the Malagasy government introduced fuel subsidies to keep energy prices low. SUSTAINING THE REMOVAL OF • In 2015, as global oil prices fell, fuel subsidies were removed. The government is now focused FUEL PRICE SUBSIDIES on sustaining the removal of these subsidies Madagascar, home to nearly 25 million people, is among through ESMAP funded technical assistance for the poorest countries in the world. Close to eighty percent restructuring fuel pricing and for developing of the population lives below the poverty line, and only a strategy to communicate the rationale and fourteen percent has access to electricity. The majority of approach for revised pricing of fuels. people use inefficient energy sources such as kerosene, • ESMAP is also supporting the policy dialogue on firewood or charcoal which are also polluting and unsafe. mitigating measures to protect the poor from the impact of fluctuating prices. Madagascar is an oil importing country, and relies heavily on fuel oil for electricity generation. The state- owned utility, JIRAMA (Power and Water Madagascar), consumes three-quarters of all fuel oil imports and diesel and kerosene, which resulted in subsidies being 20 percent of diesel coming into the country. Lack of paid to petroleum companies. Between 2013 and 2015, access to affordable and reliable electricity has been a fuel subsidies averaged 0.56 percent of GDP annually, major impediment to Madagascar’s economic and social compared to an average of only 0.7 percent of GDP development. Infrastructure for energy is outdated, and spent on social priority sectors over the same period. existing generation, transmission and distribution facilities are not able to meet the growing demand. However, fuel price subsidies largely benefited the wealthiest. Over time, the payment to petroleum com- When global oil prices started to rise in 2009-10, the panies to compensate them for keeping prices low Malagasy government capped retail prices of gasoline, became unaffordable for the government, leading to the E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) accumulation of arrears and reducing available resources in 2010, the government capped prices at the pump. for pro-poor expenditures. In 2015, the Malagasy autho- Mechanisms to compensate petroleum companies rities requested technical assistance from the World were introduced, such as the reduction or suspension Bank’s Energy Sector Management Assistance Program of certain taxes and a preferential exchange rate for (ESMAP) to support them in sustainably eliminating fuel petroleum imports. price subsidies. In 2013, the government introduced a new way of deter- mining fuel prices, establishing the so-called reference THE BACKGROUND price structure. The reference price was computed monthly and was based on the import price (global oil Energy price reforms in Madagascar cannot be seen price) to which was added the cost of transport, the cost outside the country’s political upheavals. A coup d’État of distribution, taxes, and fees. The government paid in 2009 and the instability that followed diverted atten- the petroleum companies a subsidy equivalent to the tion from critical economic and political challenges. difference between the reference price and the pump The investment climate was adversely affected by the price, multiplied by the volume of fuel sold by each instability, key development partners cut ties with the petroleum company. country, the economy stagnated, and poverty worsened. In 2012, 78 percent of Madagascar’s population lived on less than $1.90 a day, up from 74 percent in 2005, and THE CHALLENGE approximately 90 percent lived on less than $3.10 a day. But over time, the subsidies became unaffordable. They It was during this period of instability that the govern- constrained the budget and impeded the government’s ment implemented the subsidy program. Madagascar’s ability to invest in priority sectors. The government started downstream petroleum sector had been formally libe- to accumulate arrears in the payment of subsidies to the ralized in 2004, but once global oil prices started to rise petroleum companies. To compensate for the arrears, further measures were put in place to compensate impor- ters/distributors including the suspension of payments to the road maintenance fund and VAT, and preferential exchange rates for oil importers. The fuel subsidy program was implemented while Madagascar continued to grapple with enormous eco- nomic and social challenges including high levels of poverty and extreme poverty. The wealthiest households, as the largest consumers of fuel, benefitted most from the fuel subsidy. As the political situation normalized in 2014 with a return to constitutional order, the government initiated the process of removing fuel subsidies. This move coinci- ded with a sharp decline in global oil prices. In 2015, the Malagasy authorities requested technical assistance from ESMAP for transition to a new regime that allowed for the permanent elimination of subsidies. E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) THE RESPONSE ESMAP grants were provided in November 2015 and in July 2016 to fund a technical assistance program and develop policy measures to eliminate pump price subsidies in a sustainable way. The ESMAP program included several components: `` First, in 2015, a stakeholder analysis of the petroleum sector was undertaken, which revealed overwhelming support for the removal of fuel subsidies. Both the government and petroleum companies wanted to end the subsidy programs. Consumers expressed concern over rising prices and questioned how prices were determined. All participants wanted to see transparency in the price structure, communication the dialogue with the government on appropriate around the reforms, and mitigation measures to social protection measures. reduce the impact of higher prices. `` A lesson sharing workshop with Mexico was organized `` Second, a desk-study of the fuel price structure was with ESMAP support in March 2018 in order for undertaken. This study recommended that a more Malagasy officials to understand the experience and in-depth assessment of the fuel price structure should steps taken by Mexico to liberalize its domestic market be commissioned to take account of the specificities for fuels. The government has requested further of the Malagasy market. exchanges with other countries which are reforming `` In 2017, an independent downstream petroleum firm their downstream petroleum sectors. was contracted to conduct an in-depth audit of the The removal of fuel subsidies was also supported through structure of fuel prices. The assessment considered a two-year program of World Bank lending over 2016 the appropriateness of costs, benchmarking them and 2017. against costs in comparator countries. The study was used to inform the government’s dialogue with petroleum companies on the reference price structure. OUTCOMES `` To support the reforms, a communications strategy ESMAP support resulted in the provision of high quality is being developed to explain how fuel pump prices and timely advisory services to the government related are determined and the benefits of removing fuel to the removal of fuel subsidies, developing a com- subsidies. In January 2017, the government took the munications strategy, and supporting the dialogue on initiative to communicate to journalists how the fuel mitigating measures. reference price structure works. Since March 2016, fuel pump prices have been adjusted `` In parallel, an analysis has been undertaken to examine on a regular basis. In January 2017, a price smoothing how the purchasing power of poor households formula was introduced as an interim strategy. In March has been directly or indirectly impacted by the 2018, the government negotiated a new fuel price struc- removal of the subsidies. A supporting study on ture, which included a higher tax for petroleum products mitigating measures is being prepared to strengthen and lowered margins for the petroleum companies. E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) The burden of fuel subsidy removal has fallen largely on Madagascar’s poor live in rural areas and by design cannot the wealthiest households. Comparing changes in fuel benefit from a program that serves urban areas. Second, prices before and after the fuel subsidy removal (i.e. even within urban areas, the poor do not use public between January 2016 and June 2017), the purchasing transport. Less than four percent of urban households power of the wealthiest fell by 1.2 percent, compared in the bottom quintile and less than 10 percent in the with a decrease of 0.5 percent in the fourth quintile, and second quintile use public transportation while one in four between 0.3-0.4 percent in the bottom three quintiles. households in the top quintile uses public transportation, The decline in purchasing power is the result of both with the top quintile accounting for over 90 percent of direct effects, i.e. the rise in fuel prices, as well as indirect all public transport-related expenditures. effects, i.e., a rise in prices of goods and services that Following an independent technical audit of the fuel utilize fuel, such as transport and electricity production. price structure, the government has negotiated a new Factoring in both the direct and the indirect effects, the price structure with petroleum companies to reduce top quintile bears 73 percent of the burden of price the distributor margins, which were assessed as being increases resulting from the removal of the subsidy. The high compared with similar countries. Following the bottom three quintiles bear 13 percent of the burden, issuance of the new fuel price structure in March 2018, which emanates from kerosene consumption and higher the government has agreed to review the reference price of food transportation. price structure once more within 6 months to consider Up until 2017, the government implemented a miti- additional information on the petroleum companies’ gation mechanism in the form of a subsidy to urban financial performance. However, the policy objective transport companies to stabilize urban bus fares. The of setting fuel prices without recourse to a fuel subsidy scheme allowed up to 7,000 registered buses in seven remains. To avoid undue volatility of pump prices, the main cities to purchase 30 liters of diesel per day at a government and petroleum companies have agreed to subsidized price. maintain the price smoothing mechanism. However, this program did little to mitigate the impact of fuel price increases on the poor. First, 91 percent of LOOKING FORWARD The government has taken important steps toward removing fossil fuel subsidies. Moving ahead, it needs to continue its commitment to the policy objective of permanently removing fuel subsidies, while implementing mitigating measures to protect the poorest from the direct and indirect impacts of higher petroleum prices. Experience in other countries has shown that many fuel subsidy reforms fail due to governments’ inability to stick to the plan when the situation is affected by factors such as fluctuation in oil prices or change in the political landscape. Due to Madagascar’s history of instability, the government is cautious about taking measures that can trigger public protests. With the presidential elections scheduled for the end of 2018, there may be pressure to waver on the reform momentum and to keep fuel prices low. Therefore, it is E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) important to introduce a solid strategy that can ensure While the government has committed to increasing social the permanent elimination of subsidies in the face of oil priority spending, it is important that these resources price fluctuations and political change. should be targeted to the poorest. Further analytical work on ongoing and planned social protection measures is expected to help reinforce this dialogue. NEXT STEPS Moving forward, ESMAP will focus on supporting the provision of further independent advisory services to • ESMAP’s $20 million Energy Subsidy Reform the government on the fuel price structure, drawing Facility (ESRF) was set up in 2013 to help on experiences from a broader range of countries and countries remove fossil fuel subsidies while on the expansion of mitigating measures. It will also protecting the poor. ESRF provides technical support a more intensive communication campaign to assistance to governments, develops tools for assessment and decision-making, and facilitates explain how the pump prices are determined and how knowledge-exchange for a global community of the subsidy removal will lead to policy change and the reformers. benefit of consumers. ABOUT ESMAP The Energy Sector Management Assistance Program (ESMAP) is a global knowledge and technical assistance program administered by the World Bank. It provides analytical and advisory services to low- and middle-income countries to increase their know-how and institutional capacity to achieve environmentally sustainable energy solutions for poverty reduction and economic growth. ESMAP is funded by Australia, Austria, Denmark, the European Commission, Finland, France, Germany, Iceland, Italy, Japan, Lithuania, Luxembourg, the Netherlands, Norway, the Rockefeller Foundation, Sweden, Switzerland, and the United Kingdom, as well as the World Bank. ESMAP | 1818 H Street, NW | Washington DC 20433 | 202.522.3018 | www.esmap.org