Subsidized energy and its effect on energy consumption in Saudi Arabia

Abstract

As the top exporter of crude oil, the Kingdom of Saudi Arabia (KSA) supplies almost a fifth of global oil demand. At home, it has been able to keep fuel prices well below international benchmarks via subsidies. Their current price of gasoline, at $0.16 per liter, is eight times lower than the world average and the price of diesel, at $0.07 per liter, is eighteen times lower than the world average. These subsidized fuel prices are often criticized for their ability to cause overconsumption of energy. However, the extent to which subsidized prices affect fuel consumption remains unknown. Thus, it is also unclear how much fuel consumption would change in the event of a subsidy reform. In order to quantify the potential benefits of a subsidy reform, the purpose of this study is to estimate the price elasticity of demand for fuel products in KSA. Using data from 1990-2010 from the Saudi Arabian Monetary Agency (SAMA) and the U.S. Energy Information Administration (EIA), I first employ Granger causality tests to demonstrate evidence for unidirectional causality from energy price to energy consumption. Then, I use ordinary least squares (OLS) to estimate the price elasticity of demand over this time period. Finally, I use the coefficient obtained by OLS to estimate the changes in energy consumption that would follow from hypothetical price increases. I find that KSA could decrease its gasoline consumption by 10% if it raised the price to the level of other countries of the Organization of the Petroleum Exporting Countries (OPEC). This finding indicates that there are significant benefits to an energy subsidy reform in KSA in terms of restraining domestic consumption. Restraining domestic fuel consumption would help to preserve the Kingdom’s export capacity and reign in environmental pollution.