Why the Gulf States are Stuck With Costly Energy Subsidies

At a recent meeting in the dusty capital of Kuwait, energy ministers from the six members of the Gulf Cooperation Council (GCC) gathered to discuss the cost of subsidies.

While the regional players are well known for their amply stocked foreign currency reserves, ever-increasing consumption has heightened the cost of the burden that energy subsidies place on regional state coffers.

The six men mulled over ways to reduce the increasingly weighty burden, and later emerged with the possible idea of unifying petroleum products' prices within the GCC.

Whether the plan goes any further remains to be seen. The GCC have traditionally struggled to build consensus on this kind of policy, but the fact that the meeting took place at all suggests that the governments are sufficiently concerned about the widening hole that subsidies have burned in their pockets.

The International Monetary Fund has said subsidies are so commonplace in the Middle East and North Africa region that they account for around half of the money spent on energy subsidies across the globe.

The well-established social contract in the GCC, which includes the UAE, Saudi Arabia, Kuwait, Bahrain, Qatar and Oman, sees governments dominating resource industries, which in turn have brought in monumental revenues.

While the GCC regimes have all generally piled up substantial foreign cash reserves, some of this revenue has been invested in social and infrastructure projects. A hefty chunk is also spent on subsidising essential products such as electricity, gasoline and even food staples like bread for the general population, in a bid to forestall social unrest.

Indeed, the IMF estimates that the Gulf states are spending on average 10% of their annual gross domestic product on subsidising energy products. Lower prices have in turn, according to Capital Economics, encouraged a culture of wasteful consumption of resources in the region.

The economic research group estimates that GCC countries consume around the equivalent of a third of their collective hydrocarbon output domestically, a major increase since the turn of the century.

The model is becoming increasingly painful for the Gulf's economies, Capital said in a note on Tuesday.

Firstly, profits and investment are being hit as less oil and gas is being sold at market prices, rather more is being sold at subsidised rates to domestic consumers, the group said.

Moreover, "the GCC economies lose out on additional export revenues. If energy resources were used more efficiently, this would free up greater volumes of hydrocarbon output for export," said Jason Tuvey, Middle East Economist, in a note. "This would result in the Gulf running larger surpluses and accumulating foreign exchange savings at an even faster pace."

The GCC regimes are armed with major surpluses, which effectively allows them to keep energy subsidies high. Even with the price of oil falling around 10% in 2014, the Gulf states will enjoy healthy fiscal surpluses in the near-term.

Yet, political and social upheaval in the region has served as a reminder that economic mismanagement can have dramatic political consequences.

Take the ongoing crisis in Yemen. While the Houthi movement has long antagonised central government in the country, its recent success in mobilising tens of thousands of Yemenis has come under the banner of protesting against the lifting of fuel subsidies. Popular anger was such that the protesters managed to win concessions from the government.

If the GCC were to raise energy prices, this would in turn lead to higher inflation across the region's economies. Runaway inflation has been recognised as a key factor in the mass uprisings that occurred across the Arab world in 2010 and 2011.

While the Gulf regimes may loathe to see such a big portion of state revenue go to waste on subsidies, fears over widespread social unrest are likely to overpower instincts to impose subsidy reform.