How much can CO2 emissions be reduced if fossil fuel subsidies are
removed?
Key words: energy subsidies, CO2 emissions, fossil fuel price elasticities
JEL: Q4 Q54 Q58
Abstract
This paper analyzes consumers’ price elasticity of demand for fossil fuels, and how a reduction of
fossil fuel subsidies can lead to important reduction in CO2 emissions. The countries in the Middle
East and North Africa (MENA) have significant levels of fuel subsidies and Iran and Saudi Arabia
are the largest CO2 emitters. A fuel price policy reform by these countries can be then an
important instrument of both climate and economic policy. For example, reducing fuel subsidies
by 20 USD cents per liter in the retail prices of diesel and gasoline can lead to significant decreases
in CO2 emissions. In Iran, the reductions can be up to 65% and 50% of emissions generated from
diesel and gasoline consumption, respectively. For Saudi Arabia these numbers are around 50%
to 40% of emission reductions coming from a decline in the consumption of diesel and gasoline,
respectively.
0
1. Introduction
The goal of the 2015 Conference of Parties (COP21) or the 2015 Paris Climate Conference, is to
legalize a worldwide mandate that permits to keep global warming below 2°C. The
Intergovernmental Panel on Climate Change (IPCC (2014)) has documented that there are
multiple mitigation pathways that are likely to limit warming to below 2°C relative to preindustrial levels. Any of these pathways would require substantial CO2 emissions reductions over
the next few decades and near zero emissions of CO2 by the end of the century. 1 CO2 emissions
should concern us because, as Matthews and Salomon (2013) shows, the rises in temperature
due to CO2 emissions are essentially permanent. The crucial issue is then to determine and come
to an agreement with the realistic long-term plan that meet the goal of reducing CO2 emissions
in order to avoid their negative consequences on climate.
It is now widely recognized that any target to reduce CO2 cannot be achieved without a
commitment from the developing countries. From Chakravarti et.al (2009), EIA (2014), and Parry,
Veung and Heine (2015) we learn that the developing world now not only emits half of the global
CO2 emissions but these emissions are increasing faster than those in the developed world under
“business as usual” (BAU) standards. 2 There is however not a proper analysis about the major
potential role that removing fossil fuels subsidies can have in reducing CO2 emissions through a
reduction in the consumption of fossil fuels. We pursue such analysis here by presenting a very
simple scenario that answers the following question: how much can CO2 emissions be reduced if
subsidizing countries increase by 20 USD cents per liter their price of gasoline and diesel.
We here do not focus on greenhouse gasses (GHGs), and note that the term GHG emissions refers to a large
collection of GHGs that include CO2, methane, and many others. Methane is more potent than CO2 but the
warming it causes fades quickly. By “carbon emissions” in the paper, we only refers to CO2. Note also that the
warming effect of GHGs does not accumulate like CO2 (IPCC (2014)).
1
2
One example of the many propositions to reduce CO2 emissions is Chakravarti et.al (2009) which consists in
reducing CO2 emissions by identifying the world’s high-emitting individuals across countries, and not the countries.
In short, they suggest that once the world agrees to a global CO2 emission reduction target, the universal cap
should be imposed on the global individual emission distribution (i.e. in accordance to their income distribution),
such that eliminating all emissions above that cap achieves the target.
1
Many developing countries, especially those in the Middle East and North Africa (MENA)
region, subsidize fossil fuels substantially for socio-political reasons. Moreover, gasoline and
diesel subsidy rates have in this region been increasing over time (see Mundaca (2015)). As a
result, the demand for such fuels has increased rapidly, with resulting fiscal losses for these
governments. Mundaca (2015) finds that a country that initially subsidizes its fossil fuels, and
then eliminates or reduces these subsidies, will as a result experience higher economic GDP per
capita growth, higher employment, and greater levels of labor force participation, especially
among the youth. These effects are strongest in countries where fuel subsidies are high, such as
those in the MENA region. Our main message here is that it is urgent to move away from the 2tier world defined by the 1992 United Nations Framework Convention on Climate Change
(UNFCCC): that only the developed countries should take the lead to reduce CO2 emissions while
the other countries, in light of their relative low economic development, should be treated
differently. We think that the removal of energy subsidies should pertain all (developed or
developing) countries, and be part of any international agreement on reduction of CO2 emissions.
Taghavee and Hajiani (2014) argue that gasoline consumption in Iran has surpassed the
Iranian production level, leading Iran to import gasoline. Coady, Parry, Sears and Shang (2015)
consider that the MENA region could, with a more correct and efficient pricing in petroleum
products, reduce CO2 by 36 percent. They indicate that this figure is much above what the whole
world could attain (20 percent) with similar efficient pricing. They further indicate that CO2
emissions have increased from these MENA countries because the current demand for
petroleum products are relatively too high as a result of the current high petroleum subsidies.
Note though that detailed estimates using price elasticities are not available for countries
with very high fuel subsidies. Our goal here is to estimate fuel price elasticities for these
countries, and also to provide estimates of CO2 emissions and how they are affected by fuel
pricing. This should be useful for at least two reasons: i) to assess the amount of CO2 emissions
that can be reduced by removing subsidies; and ii) because the effectiveness of any fuel subsidy
reform largely depends on how the demand for fuels responds to price changes. It is imperative
to properly specify a demand model for fossil fuels, and estimate precisely as possible the price
elasticities of fossil fuels such as gasoline and diesel. It is also well acknowledged that low fuel
2
retail prices (i.e. high fuel subsidies) also has various other negative effects; among these are to
discourage investment in energy efficient products, and make the renewable energy industry less
competitive.
Our additional contribution to the relevant literature is in our understanding of the
demand for fossil fuels for developing countries. We remark that most studies in this literature
have been conducted to estimate the price and income elasticities of demand for fuels, and
concentrate in developed or OECD countries. Much less has been done for developing
countries. Exceptions are for example the works of Alves and Bueno (2003) for Brazil; Lin and
Zeng (2012) for China; Sita, Marrouch and Abosedra (2012) for Lebanon; Sene (2012) for
Senegal; and Taghavee and Hajiani (2014) for Iran. More crucially, even less attention has been
given in these countries to analyze one of the most important externalities caused by fuel
consumption in these countries, which is emissions of carbon dioxide (CO2).
There is large number of reviews and surveys attempting to synthesize and compare the
results of estimate fuel price elasticities are available (e.g., Drollas (1984), Blum (1988), Dahl and
Sterner (1991a,b), Goodwin (1992), Sterner and Dahl (1992), Dahl (1995), Espey (1998), Graham
and Glaister (2002), Basso and Oum (2007), Goodwin, Dargay and Hanly (2011)). I am not
however aware that such work on gasoline and diesel price elasticities and CO2 emissions, has
been done for the specific countries and Regions of the World Bank, in particular those on which
I am here focusing.
The objectives of this paper are i) to estimate the price and income elasticities of demand
for gasoline and diesel for the different World Bank regions; ii) to assess impacts of these fossil
fuel price increases (i.e. reduction of fossil fuel subsidies) on CO2 emissions for the countries in
the MENA region, in the East Asia Pacific (EAP) region, and the OECD countries; and iii) to estimate
a hypothetical demand for fuels (gasoline and diesel) and the corresponding hypothetical CO2
emissions for the countries in MENA, EAP and OECD. We specifically evaluate the effects that an
increase in fossil fuel prices by 20 USD cents per liter will have in the demand for fossil fuels in
these countries. This study focuses in the MENA countries because of the significance levels of
their fuel subsidies; the EAP region is interesting because it includes China which is one of the
3
largest emitters of CO2 even though it does not subsidize fossil fuels; and the OECD with the
United States as a member and being also an important emitter of CO2.
The paper is organized as follows. Section 2 presents basic data and some stylized facts,
while Section 3 presents my estimations of fuel demand relationships, for the different regions
of the World Bank, except the South East region because of an insufficient number of
observations. These regions are then MENA, EAP, Latin America and the Caribbean (LAC), Africa
(AFR), and Europe and Central Asia (ECA) excluding the OECD countries. In Section 4 I calculate
impacts on future fossil fuel (gasoline and diesel) demand and carbon emissions in response to a
20 cents per liter increase in the prices of gasoline and diesel for the MENA, but in section 5
similar calculations and projection are done for the countries in the EAP region, and the OECD
countries. Section 6 concludes.
2. Stylized facts and data
The data set has been gathered by the Environment and Energy Team at the Development
Research Group of the World Bank (DECEE), and contains also relevant and important political
and economic variables for this study taken from the World Bank Data Depository, IMF, Penn
World Tables, and Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ). The data are on
an annual basis for the period 1998-2012.
Figure 1. World Bank countries excluding OECD Figure 2. World Bank countries excluding OECD
Correlation between (ln) Gasoline Consumption Per Capita (Kg) and
Correlation between (ln) Diesel Consumption Per Capita (Kg) and
(ln) Diesel Prices ($ cents/liter). 1998 - 2012
QA
AE
KP
SA
LY
CY
HK
LV
LT
ME
HR
MT
AR UYAL
MY
TH PY
BG
BYBR CR
BA
RS
EC OM JO
PA
SY
XK
RO
ZA MK
TN
BW
MA
RU SV
PE
NA
DO
LKCOGT
HN
JM
UA
BO
NI
GA
AZ
PHCG
ID
VNPKCN
KZ KG
GE
MN SN
AO SD
GH KH
BJCU
IN
ZW
CM
HT TG
KE
CI
UZ
MZTZ
MM
NP ER
NG
ZM
BDLB
ET
SG
BN
BH
KW TT
IR
DZ
VE
(ln) Gasoline Consumption Per Capita
2
4
6
8
(ln) Diesel Consumption Per Capita
2
4
6
8
(ln) Gas Prices ($ cents/liter). 1998 - 2012
EG
YE
TM
KW
QA
SA BH
AE
BN
OM
LB
CY
JMZA
MT
KZRU BW
SG
LV HR
CR
PA JONA
LT
MN AR
BY
UA
CO DOBG
ME
UY
RS
TH
BR
GE
AZ SY GT
BA
RO
SV
MK
KG
ID
BO
UZ
AM
HK
HN
BJ
NG
CNTN PY PEXKAL
VNPHNI GA
CU
GH
AO
TG
LK
CG
HT
ZW MA
CM
SD
KE ZM
PK KH
SN
IN
KP
TJ
MM
CI
TZ
MZ
NPCD
ER
ETBD
TT
MY
IR
EC
YE
DZ
EG
0
0
CD
LY
VE
1
2
3
(ln) Diesel Price
4
5
2
4
3
(ln) Gasoline Price
4
5
The scatter plots in Figures 1 and 2 show negative sample correlations between fuel prices
and fuel consumption, for diesel and gasoline, taking into consideration all the countries of the
World Bank. Thus, the higher the fuel price the lower the demand for diesel and gasoline.
Figures 3a and 3b (taken from Mundaca (2015)) display the diesel and gas price gaps as
defined by Koplow (2009) 3, against the average changes in these price gaps respectively, over
the period of 1998 to 2012 for countries in the MENA region, while 4a and 4b show corresponding
gaps for the countries in the European and Central Asia (ECA) region. The price gap can be
negative (when fuel is subsidized) or positive (when fuel is taxed).
Figure 3a. MENA countries
Figure 3b. MENA countries
Average Koplow's gasoline price gap and its average change
Average Koplow's diesel price gap and its average change
Subsidies (-) or Taxes (+) ($ cents/liter). 1998 - 2012
100
Subsidies (-) or Taxes (+) ($ cents/liter). 1998 - 2012
Morocco
Tunisia Lebanon
United Arab Emirates
Jordan
Lebanon Tunisia
10
United Arab Emirates
Oman
Algeria
Egypt Yemen
Bahrain
Kuwait
Saudi Arabia
Qatar
Iran
Libya
-10
Figure 4a. ECA Countries
Ukraine
Armenia
Tajikistan
Russian Federation
Uzbekistan
Azerbaijan
Turkmenistan
-4
100
Malta
Cyprus, South
Croatia
Albania
Montenegro
Serbia
Macedonia
Bosnia and HerzegovinaLatvia
Lithuania
Romania
Bulgaria
Average gasoline price gap
0
50
Georgia
Subsidies (-) or Taxes (+) ($ cents/liter). 1998 - 2012
-2
0
2
4
Average change in the diesel price gap
6
Armenia
Georgia
Ukraine
Belarus
Tajikistan
Russian Federation
Kyrgyzstan Uzbekistan
Kazakhstan
Azerbaijan
-50
-50
Average diesel price gap
0
50
Croatia
Malta Cyprus, South
Bosnia and Herzegovina
Montenegro
Serbia
Latvia
Lithuania
Bulgaria
AlbaniaRomania
Macedonia
Kazakhstan
5
Average Koplow's gasoline price gap and its average change
Subsidies (-) or Taxes (+) ($ cents/liter). 1998 - 2012
Kyrgyzstan
-5
0
Average change in gasoline price gap
Figure 4a. ECA Countries
Average Koplow's diesel price gap and its average change
Belarus
Jordan
Syria
Yemen
5
-5
0
Average change in the diesel price gap
-10
Morocco
-50
-50
Oman
Syria
Kuwait
Bahrain
Algeria
Qatar
Egypt
Libya
Saudi Arabia
Iran
Israel
Average gasoline price gap
0
50
Average diesel price gap
0
50
Israel
Turkmenistan
-4
-2
0
2
Average change in gasoline price gap
4
6
This is equal to the domestic fuel retail price minus the average U.S. retail price, minus 10 cents per liter for fuel
importers (corresponding to the average U.S. tax), and minus an additional 10 cents per liter for fuel exporters.
3
5
It is noticeable that a large number of MENA countries have had relatively higher negative
price gaps or higher average levels of subsidies to diesel and gasoline, than most ECA countries
where, in most cases, these fuels are taxed. The noticeable exceptions in ECA are Azerbaijan,
Kyrgyzstan, Kazakhstan, Turkmenistan and Uzbekistan, especially with respect to diesel.
Moreover, the MENA countries have over the period of 1998 and 2012, had not only higher levels
of fuel subsidies, but the subsidy levels have become larger over time: the average change of
their fuel price gaps have been negative. Thus, most MENA countries have not attempted to
seriously improve their fuel pricing situation over these years.
Note that Figure 5 also shows a negative correlation between diesel prices and per capita
diesel consumption for the MENA countries. This means that countries that subsidize or undertax diesel and gasoline are the most likely candidates to reduce fuel demand and CO2 emissions
(as we will show), in addition to reap economic gains as Mundaca (2015) has shown, by
subsidizing these fuels less and/or taxing them more.
Figure 5. MENA countries
7
MENA. Correlation between (ln) Diesel Consumption Per Capita (Kg) and
(ln) Diesel Prices ($ cents/liter). 1998 - 2012
QA
(ln) Diesel Consumption Per Capita
3
4
5
6
AE
SA
LY
BH
KW
IR
DZ
SY
OM JO
TN
EG
MA
2
YE
LB
1
2
3
(ln) Diesel Price
4
5
3. Fuel demand elasticities in the presence of fuel subsidies
3.1 The empirical model
For our empirical analysis of the demand for fuel i (i = gasoline, diesel) in country j at time t, we
take into account the countries of the different regions of the World Bank: Middle East and North
Africa (MENA), Europe and Central Asia excluding the OECD countries (ECA), East Asia Pacific
(EAP), South Asia Pacific (SAP), Africa (AFR), and Latin America and the Caribbean (LAC). Following
6
previous literature (Archibald and Gillingham (1980), Hausman and Newey (1995) and Basso and
Oum), I consider the translog model as the baseline model structure, except that I include the
effect of recessions:
ln Qijt =+
α ij β1, j ln Pijt × region + β 2, j ln Yijt × region + β3, j ln Qijt −1 + β 4 ln Pijt × Drecessions +
τ t + cij + ε ijt
.
(1)
In (1), the demand per capita for fossil fuel i (i = diesel and gasoline) in country j at time t, Qijt, is
a function of the real price of fuel i (USD cents per liter in 2010 USD) in country j at time t, Pijt,
and the per capita disposable income in country j at time t, Yijt. Pijt and Yijt entered multiplied by
the dummy for the region in order to obtain the elasticities of Pijt and Yijt, per individual regional
instead of the average elasticities for the whole world as is a more standard procedure. We also
include dummy variables to represent the recessions of the years between 2001 to 2003, and
2008 through 2010, entering interactively with the fuel prices for each country at time t. This is
to capture the average sensitivity of the demand for fuels to prices during recessions and across
countries. For each type of fuel i, we include time and country fixed effects which are denoted
by τit and cij, respectively; as well as the εijt is the error term. β1,j; β2,j; β3,j; and β4 are the
parameters of the model. β1,j and β2,j are respectively the short-run elasticities for prices and
income. The long-run elasticities for prices and income for each region are represented by
respectively (β1,j×region )/(1-β3,j), and (β2,j×region)/(1-β3,j). When taking into account the effect
of recessions, the long-run elasticities are equal to (β1,j×region + β4×recession)/(1-β3,j)).
We note that the estimation of our demand equations might result in biased and inconsistent
parameter estimates since price and quantity are jointly determined through shifts in both supply
and demand. We deal with this econometric problem by instrumenting for price. An ideal
instrumental variable for gasoline and diesel demand is one that is highly correlated with the
price of gasoline and diesel but not with unobserved shocks to the demand for gasoline and
diesel. It is of course challenging to identify adequate instrumental variables for gasoline and
diesel demand. Now, if the prices of gasoline and diesel are highly influenced by the type of
governance in each country 4, the gasoline and diesel prices should be correlated with the
4
See Strand and Beers (2013)
7
effectiveness of the regulatory system and the development of the institutions in each country.
This implies theoretically that fuel prices could be instrumented by the indicators of governance
in one country. We thus use some of these indicators constructed by Kaufmann, Kraay and
Mastruzzi (2010)), as instruments. We test the validity of the instruments with the Sargan test
since we use the Generalized Method of Moments as our estimation method. We use the System
General Method of Moments (GMM) (Arellano-Bover (1995)/Blundell-Bond (1998)) for the panel
data. It is important to keep in mind that the GMM corrects for possible endogeneity and nonstationarity of the regressors or explanatory variables. In particular, diesel and gasoline prices are
most likely to be endogenous, being affected by both demand and supply conditions.
Our table with the estimates reports both of the two-step estimates (which yield theoretically
robust results, Roodman (2009)). Since we use the two-step estimator, we can obtain a robust
Sargan test (same as the robust Hansen J-test). This is crucial for testing the validity of the
instruments (or over-identifying restrictions). We test the presence of first- and, in particular,
second-order autocorrelation in the error term to shed light on the validity of the model (De
Hoyos and Sarafidis (2006). These statistical diagnostics are also presented together with the
estimated parameters. At the outset, it should be mentioned that all our empirical models, the
Sargan tests of over-identifying restrictions do not reject the null hypothesis (e.g. of correct
model specification and valid over-identifying restrictions) at any reasonable level of significance.
Thus, our econometric strategy have the valid instruments. The tests on autocorrelation indicate
that we cannot reject the null hypothesis (e.g. the cross section dependence is homogeneous
across pairs of cross section units after including time dummy variables). Hence, the inclusion of
time-dummies in our specification has removed time-related shocks from the error term in our
empirical model.
3.2 Estimation results for the World Bank regions
The results of estimating equation (1) are presented in Table 1. With respect to demand for diesel,
note in Table 1 that, without taking into account the recession effect, the long-run price elasticity
is three times the short-run values for the MENA, AFR, and EAP regions. The short-run elasticity
8
for LAC is statistically and numerically insignificant, while for ECA, the corresponding parameter
for such elasticity has the wrong sign.
When considering the effect of the recessions that have occurred between 2000 and
2013, the long-run elasticities for diesel become smaller in absolute value. This implies that
policies to reduce fuel consumption using fuel price instruments are less effective during
recessions. A likely reason for this is that diesel is an important input in different industries; and
also that diesel is used heavily in public transport where demand may be less sensitive to the
effect of both recessions and fuel price changes. The short-run income elasticities were all found
to be positive and statistically significant, and very similar among the World Bank regions in
question except for AFR. These results indicate that diesel must be a normal good. The long-run
income elasticities are also at least 3 times as large as the short-run ones for all the regions.
For gasoline, the coefficients representing the short-run price elasticities are all significant
and with correct signs, except for the LAC region. The long-run elasticities are in contrast to the
ones for diesel, at least as 8 times larger than the short-run elasticities. Note that the income
elasticities are also statistically significant for all the regions, but are less than half the size of the
corresponding ones for diesel. Consequently, the long-run income elasticities are also smaller.
Importantly, in contrast to diesel, during recessions the consumption of gasoline will be smaller
than during normal times. Thus, the expenditures on gasoline will likely decrease more when
there is both a recession and a price increase.
On the basis of these results, we can conclude that fuel price reforms, especially for countries
of the MENA region, will be highly effective in affecting fuel demands, and that the governments
should take advantage of this if they want to reduce the demand for fossil fuels, together with
all the externalities and CO2 emissions that are usually generated from fossil fuel consumption.
Getting fossil fuel price increases or reductions in fossil fuel subsidies, may need drastic
reforms and planning. Mundaca (2015) however finds that there is a significant positive effect of
subsidy reductions on economic growth and employment in the MENA countries. Mundaca
(2015) find that these countries might experience a reduction in GDP in the very short run (as
9
TABLE 1. PRICE ELASTICITIES OF GASOLINE AND DIESEL CONSUMPTION. GMM ESTIMATES
Dependent variable: (ln) fuel consumption per capita. 1998 – 2012 a
Elasticity with respect to
Elasticity with respect
Elasticity with respect to
Elasticity with respect to
(ln) diesel real price
to real income
(ln) gasoline real price
real income
Short-run
Long-run
Short-run Long-run Short-run
Long-run
Short-run
Long-run
MENA
-0.1850***
(0.0608)
ECA
0.2425***
(0.0636)
LAC
0.0364
(0.0386)
-0.1019***
(0.0348)
AFR
EAP
(minus 5 HIC)
-0.1779***
(0.1000)
-0.6351
w/recession:
-0.5046
0.2123***
(0.0275)
0.7288
-0.0888***
(0.0387)
0.2415***
(0.0265)
0.8290
-0.1270***
(0.0247)
0.2429***
(0.0284)
0.1112***
(0.0199)
0.8338
0.0242
(0.0164)
-0.2270***
(0.0303)
-0.3498
w/recession:
-0.2194
-0.6107
0.2343***
w/recession:
(0.0330)
-0.4803
0.0380***
(0.0064)
0.3817
0.8043
-0.1184***
(0.0346)
-0.7345
w/recession:
-0.8420
-1.0504
w/recession:
-1.1580
0.0882***
(0.0182)
0.7295
0.0902***
(0.0166)
0.7461
0.0886***
(0.0178)
0.0786***
(0.0169)
0.8295
-1.8776
w/recession:
-1.9851
-0.9793
0.0874***
w/recession:
(0.0388)
-1.0868
-0.0130***
(0.0045)
ln(fuel price)*
recession
0.7087***
0.8791***
(ln) fuel consumption
(0.0299)
(0.0165)
p.c.(t-1)
st
z = -3.9204
z = -3.5735
H0: No 1
Prob>z = 0.0001
Prob>z = 0.0004
autocorrelation
z = 0.42495
z = -0.2331
H0: No 2nd
Prob>z = 0.6097
Prob>z = 0.8157
autocorrelation
chi2(88) = 72.0548
chi2(88) = 69.9403
H0: over-identifying
Prob>chi2 = 0.8911
Prob>chi2 = 0.3153
restrictions are
correct. Sargan Test
1100
1132
# of observations
a
Standard errors in parentheses. *** Significant at the 1% level; ** significant at the 5% level; *significant at the 10% level
10
0.7328
0.7229
subsidies are removed). But as the economies adjust and reallocate resources more effectively
in response to the new and higher energy prices, and with the help of enhanced public spending
in infrastructure and public services with the freed resources from subsidy reductions,
employment and GDP per capita can increase substantially in subsequent years. Finding a
mechanism for these fossil fuels price reforms to occur faster may indeed be a key goal of all
stakeholders in the very near future.
4. How will reduction of fuel subsidies and carbon emissions in the MENA region reduce fuel
demand and CO2 emissions? Projections
In this section we present a scenario predicting how much CO2 emissions can be reduced by
increasing the gasoline and diesel prices by 20 cents per liter in the MENA region. This exercise is
worthwhile since we know from the analysis in the previous section that the long-run elasticities
are statistically highly significant both for diesel and gasoline. As mentioned, these estimates
have important implications for fuel taxation policy and reforms: the higher the elasticities, the
larger the likelihood that the policies will be effective and have greater effects. As Figures 3a and
3b above indicate, the fuel subsidies are not only very high in the MENA countries but also have
been increasing over time. This is much in contrast to the countries of the ECA region (see Figures
4a and 4b). That implies that there must be distinct tax burden on fuel consumption across
countries. Besides, these tax policies explain the differences in the domestic fuel prices.
It is crucial to put a special attention to the countries of the MENA region because of its
prominent feature of its energy markets. That is, their high fuel subsidy levels. For example,
according to the World Bank (2014), even after reforms, energy subsidies in Egypt, Tunisia and
Yemen still account for more than 5 percent of their GDP. This number is even higher for Algeria,
Iran, Iraq and Saudi Arabia, more than 10 percent of their GDP. Reforming energy prices in the
MENA region, by letting energy consumers face prices close to their optimal levels, is then likely
to lead to measurable benefits for these countries. Mundaca (2015) found that an increase of 20
USD cents per liter in the gasoline and diesel prices, through removal of fossil fuel subsidies,
increases the GDP per capita growth rate by about 0.46 percent and 0.24 percent, respectively.
Moreover, the same study finds that the governments in the MENA countries direct
predominantly their savings from reduced subsidies toward health expenditures, education
11
expenditures and public investment in infrastructure. These channels are undoubtedly important
requirements to spur higher long-run economic growth.
We use our estimated elasticities to calculate the equilibrium diesel and gasoline
consumption for each country of the MENA region, and CO2 emissions by country when the
respective fossil fuel price increases. For these calculations we assume the same long-run price
elasticity for all MENA countries for each of the fuels. Consider then the consumption for fuel i
(i=gasoline, diesel) in MENA country j at time t, Qijt, is determined by its domestic per capita
income Yjt, and its domestic price of fuel i at time t, Pijt. We can assume that fuel prices in these
countries rise by 20 USD cents/liter for a sufficiently long time to be able to calculate what would
be the annual average demand for fuel I in the next 15 years. 5 To do that it is necessary to take
into account our estimated long-run elasticities for each country of the MENA region. We call this
the estimated hypothetical demand (HQijt) for fuel i in country j at time t, which will be obtained
from the following relationship, following Sterner (2007) and others:
 P + 20 
HQijt = Qijt  ijt
 P 
ijt


β1, j /(1− β3, j )
.
(2)
Figures 6a and 6b show the considerable impact that tax reforms (i.e. an increase of 20 USD
cents per liter in the diesel and gasoline price) would have for each individual MENA country with
respect to reductions in fossil fuel consumption. Figures 7a and 7b show the impacts on CO2
emissions (i.e. the environment) as a result of such price increase in fossil fuels. It is important to
notice that these records indicate the annual average actual and hypothetical fossil fuel (diesel
and gasoline) consumption. The hypothetical fossil fuel consumption of each country of the
MENA region are again the quantities when all countries in the region had increased permanently
their prices by 20 cents per liter. For example, for Iran and Saudi Arabia, the average annual
reduction in diesel consumption would be more than 60% and 50%, respectively. This means that
the actual average annual fuel consumption could be reduced from around 14 million tons to 8
million tons of diesel in Iran, and from 12 million tons to 9 million tons of diesel in Saudi Arabia.
With respect to gasoline, the reductions would be of similar magnitudes, from 15 million tons to
5
Our empirical study uses 15 years of data.
12
8 million tons for Iran; and from 14 million tons to 8 million tons for Saudi Arabia. That implies
average annual reductions of around 49% and 42% in the demand for diesel and gasoline,
respectively in these countries.
Figure 6a. Diesel demand. MENA countries
Figure 6b. Gasoline demand. MENA countries
Road Diesel Consumption (mill. tons): Current and Hypothetical using
Road Gasoline Consumption (mill. tons): Current and Hypothetical(using
diesel prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
gasoline prices ($ cents/liter) + 20 cents/liter). 1998 - 2012
Iran
Saudi Arabia
Egypt
Algeria
United Arab Emirates
Morocco
Syria
Libya
Qatar
Tunisia
Jordan
Kuwait
Yemen
Oman
Bahrain
Lebanon
Iran
Saudi Arabia
Egypt
United Arab Emirates
Libya
Kuwait
Algeria
Lebanon
Syria
Yemen
Oman
Jordan
Qatar
Bahrain
Morocco
Tunisia
-70
-60
-50
-40
-30
-20
-10
0
10
20
-70
-60
Hypothetical average consumption
Average actual consumption
-50
-40
-30
Hypothetical % change in diesel consumption
-10
-20
0
10
20
Hypothetical average consumption
Average actual consumption
Hypothetical % change in gasoline consumption
One can also observe from Figures 6a and 6b that the other countries in the MENA region,
even though their demands are relatively smaller, they will also have a significant reduction in
their demand for fossil fuels. The explanation for these large effects is the fact that most of these
countries in the MENA regions subsidize heavily fossil fuels and consequently their retail prices
are now extremely low. One can see these in Figures 3a and 3b above.
Figure 7a. CO2 emissions from Diesel. MENA
Figure 7b. CO2 emissions from gasoline. MENA
Carbon Emissions from Diesel Consumption (mill. tons) using
Carbon Emissions from Gasoline Consumption (mill. tons) using
gasoline prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
diesel prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
Iran
Saudi Arabia
Egypt
United Arab Emirates
Libya
Kuwait
Algeria
Lebanon
Syria
Yemen
Oman
Jordan
Qatar
Bahrain
Morocco
Tunisia
Iran
Saudi Arabia
Egypt
Algeria
United Arab Emirates
Morocco
Syria
Libya
Qatar
Tunisia
Jordan
Kuwait
Yemen
Oman
Bahrain
Lebanon
-70
-60
-50
-40
-30
-20
-10
CO2 from actual diesel consumption
0
10
20
30
40
-70
50
-60
-50
-40
-30
-20
-10
CO2 from actual gasoline consumption
CO2 from hypothetical diesel consumption
0
10
20
30
40
50
CO2 from hypothetical gasoline consumption
Hypothetical % change in CO2
Hypothetical % change in CO2
It is now critical to notice that the effects of a reduction in fuel subsidies by 20 USD cents per
liter are likely to be significant and sizable also CO2 emissions in each of these countries in the
13
MENA region. Figures 7a and 7b show the annual average current and hypothetical (with 20 USD
increase) CO2 emissions.
The percentage reduction of CO2 can lie on the range between 65% to 15% depending on the
fossil fuel and the country in question. Here the largest emitting countries are Iran and Saudi
Arabia as a result of their high demand for diesel and gasoline. The region as a whole has emitted
on average on an annual basis, around 330 million tons (MtCO2) from consumption of gasoline
and diesel together. But they can reduce these emissions by reducing subsidies.
According to the EIA (2014) the MENA region’s total CO2 emissions have increased by
approximately 200% from 1990 to 2012, and an average of 40% of these emissions come from
the consumption of all petroleum products. Again, keep in mind that these countries have
currently too low fossil fuel prices so that a reduction of their subsidies (or increase in their prices)
by 20 USD cents per liter in their fossil fuel prices will have a significant impact on CO2 emissions.
For example, a 20 cents per liter increase in the retail prices of diesel and gasoline (or reducing
subsidies by that amount), can lead to significant decreases in CO2 emissions. In Iran, the ranges
can be cutbacks of up to 65% and 50% of emissions generated from diesel and gasoline
consumption, respectively. For Saudi Arabia these numbers are around 50% to 40% of emission
reductions coming from the consumption of diesel and gasoline, respectively.
We should now recall that under the Kyoto Protocol’s first commitment period (2008-12),
participating industrialized countries were required (as a group) to curb domestic emissions by
about 5% relative to 1990 over this period. Notwithstanding the extensive participation (192
countries), the Kyoto Protocol is limited in its potential to address global emissions. This is
because the United States remains outside of the Protocol’s jurisdiction, and developing
countries do not face emissions targets. Thus, the Kyoto Protocol framework is inadequate to
deliver the global goal of limiting global temperature increase to less than 2°C above preindustrial
levels. More recently, shares of developing country emissions surpassed those of industrialized
countries, and have kept rising very rapidly (IEA (2014)).
Now, our results here are important to consider in the upcoming climate policy meetings,
that is the 2015 Conference of Parties (COP21) in Paris in December 2015. We here document
14
that reductions in fuel subsidies (leading to increases in fuel prices) can have considerable effects
on fuel consumption and overall carbon emissions. There is therefore no reason why while the
different binding commitments are discussed and negotiated, and much before the final contract
is signed to reduce greenhouse gas emissions, policy makers should disregard the implications of
eliminating energy subsidies on these emissions. We think it is urgent that while countries are
now working to reach a new agreement to be finalized at COP21 and to be applied from 2020,
they should be starting making a commitment to reduce energy subsidies. If commitments to
both eliminate subsidies and the emissions are made, it will be a meaningful international climate
agreement to extend mitigation obligations to all countries, both developed and developing,
emphasizing those which implements high levels of energy subsidies.
5. Estimation of fuel demand elasticities and CO2 emissions for the OECD countries and EAP
countries. Projections
IEA (2014) reports that China, United States, India, Russia, Japan, Germany, Korea, Canada, Iran
and Saudi Arabia emit two-thirds of global CO2 emissions. We shall therefore extend our
suggested scenario of increasing 20 USD cents per litter in the diesel and gasoline prices in order
to reduce future CO2 emissions to the EAP region (which includes China) and the OECD countries,
excluding Mexico. In contrast to the other OECD countries, Mexico uses fossil fuels subsidies.
Therefore, we here argue that for the EAP and OECD countries, this increase of 20 USD cents per
liter of diesel and gasoline should be interpreted as a “post-tax” or environmental tax, as defined
in the IMF, to take into consideration the negative externalities from energy consumption. See
Perry and Small (2005), Clements et al. (2013) and Parry et al. (2014) for further details.
We have already estimated the demand for fuel for the EAP region, and presented the
results in Table 1. To estimate the possible reduction in CO2 for the OECD countries, we also need
to estimate the price elasticities of the demand for diesel and gasoline for these countries. This
enable us to estimate and make some projections for the fossil fuel demands and CO2 emissions
for the OECD countries. The empirical results are presented in Table 2.
15
Table 2. OECD (except Mexico). PRICE ELASTICITIES OF GASOLINE AND DIESEL CONSUMPTION
GMM ESTIMATES
Dependent variable: (ln) fuel consumption per capita. 1998 – 2012 a
Elasticity with respect to
(ln) diesel real price
Short-run
Elasticity with respect
to real income
Long-run
0.00412
(0.0136)
Short-run
Long-run
-0.05663
(0.04444)
Elasticity with respect
to
(ln) gasoline real price
Short-run
Long-run
-0.01744***
(0.00345)
-0.31128
Elasticity with respect
to
real income
Short-run
Long-run
0.0120
(0.0137)
ln(fuel price)*
0.000872
-0.00119
recession
(0.0464)
(0.01158)
(ln) fuel
0.95756***
0.94396***
consumption p.c.(t-1)
(0.06008)
(0.0206)
st
H0: No 1
z = -3.0433
z = -3.1853
autocorrelation
Prob>z = 0.0023
Prob>z = 0.0014
H0: No 2nd
z = -0.6147
z = -1.4419
autocorrelation
Prob>z = 0.5388
Prob>z = 0.1493
H0: over-identifying
chi2(98) = 21.6523
chi2(74) = 18.292
restrictions are
Prob>chi2 = 0.9999
Prob>chi2 = 0.9999
correct. Sargan Test
Observations
407
419
a
Standard errors in parentheses. *** Significant at the 1% level; ** significant at the 5% level; *significant at the
10% level
When we estimate equation (1) for the OECD countries and do not find that recessions
(occurring between 1998 and 2012) has affected the response of fossil fuel consumption to price
changes of diesel and gasoline. See Table 2. Moreover, we do not find significant estimates for
the demand for diesel. In contrast, our estimates for the demand for gasoline are significant. Our
short-term elasticity for gasoline is 0.017 and it falls in the range of the EIA’s estimates of the
price elasticity of motor gasoline in the short term for the U.S.A. See also Lin and Prince (2013).
Thus, a 10% rise in the gasoline price leads to a 0.17% decline gasoline consumption over time,
and in the long run about 3.1%.
We also use equation (2) to estimate or project the equilibrium diesel and gasoline
consumptions and CO2 emissions for the countries in the OECD and EAP region, assuming an
increase of 20 USD cents/liter in fossil fuel prices. These estimates for the EAP region are shown
in Figures 8a, 8b, 9a and 9b. China is of course the largest emitter of CO2 in this region. All the
countries together in this region have emitted annually an average of 332 MtCO2 and 267 MtCO2
16
from diesel and gasoline consumption respectively. China has emitted at least 50% of all the
emissions in the whole region. It is true that the percentage reductions in these emissions will
not be of the same magnitude as for the countries of the MENA region. This is because most
countries in the EAP, fossil fuels are not subsidized or at least not in the same magnitude as in
the MENA region. Still, by considering an increase of a mere 20 USD cents per liter of fossil fuels
as an environmental tax (ex-post tax in the IMF terminology), can have a no negligible decrease
in CO2 emissions: average annual decreases from 10% to 35% depending on the type of fossil fuel
and country.
Figure 8a. Diesel demand EAP countries
Figure8b. Gasoline demand. EAP countries
Road Diesel Consumption (mill. tons): Current and Hypothetical using
Road Gasoline Consumption (mill. tons): Current and Hypothetical(using
gasoline prices ($ cents/liter) + 20 cents/liter). 1998 - 2012
diesel prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
China, P.R.
China, P.R.
Korea, North
Indonesia
Malaysia
Thailand
Indonesia
Thailand
Malaysia
Philippines
Philippines
Vietnam
Vietnam
Singapore
China, Hong Kong
China, Hong Kong
Singapore
Burma (Myanmar)
Burma (Myanmar)
Mongolia
Cambodia
Brunei
Brunei
Korea, North
Mongolia
Cambodia
-40
-30
-20
-10
0
10
20
30
40
50
-40
60
Hypothetical average consumption
Average actual consumption
-30
-20
-10
0
10
Average actual consumption
20
30
40
50
60
Hypothetical average consumption
Hypothetical % change in diesel consumption
Hypothetical % change in gasoline consumption
Figure 9a. CO2 emissions from diesel. EAP
Figure 9b. CO2 emissions from gasoline. EAP
Carbon Emissions from Diesel Consumption (mill. tons) using
Carbon Emissions from Gasoline Consumption (mill. tons) using
diesel prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
gasoline prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
China, P.R.
China, P.R.
Korea, North
Indonesia
Thailand
Malaysia
Indonesia
Thailand
Malaysia
Philippines
Philippines
Vietnam
Vietnam
Singapore
China, Hong Kong
China, Hong Kong
Singapore
Burma (Myanmar)
Burma (Myanmar)
Mongolia
Cambodia
Brunei
Brunei
Korea, North
Mongolia
Cambodia
-50
-30
-10
10
30
50
CO2 from actual diesel consumption
70
90
110
130
150
170
-50
CO2 from hypothetical diesel demand
-30
-10
10
30
50
CO2 from actual gasoline consumption
70
90
110
130
150
CO2 from hypothetical gasoline consumption
Hypothetical % change in CO2
Hypothetical % change in CO2
With respect to the OECD countries in which the United States in the largest emitter of
CO2, we notice that a rise in the prices of gasoline and diesel of a meager 20 USD cents per liter
17
can lead to reductions of CO2 emission of less than 10%. These estimates for the OECD countries,
although modest (it is only suggested a 20 USD cents per liter), could be taken into account when
negotiating the next climate agreements in Paris 2015.
We must however remark that for the OECD countries, it is perhaps crucial to consider
higher fossil fuel price increases than the one we assume as an environmental tax, if these
countries want to contribute significantly to the reduction of CO2 emissions. In addition, as
Schipper (2008) argues, it is also important to bring into play technology that decreases the fuel
required for a given car horsepower and weight markedly to achieve CO2 emissions. It is however
also necessary to downsize and down-weight both the power and weight of new cars. Schipper
(2008) further suggests that “… as long as the numbers of cars and the distances cars are driven
keep creeping up, technology alone will have a difficult time offsetting all of these trends to lower
fuel use and CO2 emissions ...”
Figure 10. Gasoline demand. OECD except Mexico Figure 11. CO2 emissions from gasoline. OECD except
Mexico
Road Gasoline Consumption (mill. tons): Current and Hypothetical(using
Carbon Emissions from Gasoline Consumption (10 mill. tons) using
gasoline prices ($ cents/liter) + 20 cents/liter). 1998 - 2012
gasoline prices ($ cents/liter) + 20 cents/liter. 1998 - 2012
United States
Japan
Canada
Germany
United Kingdom
Italy
Australia
France
Korea, South
Spain
Poland
Netherlands
Sweden
Greece
Switzerland
Turkey
Chile
New Zealand
Israel
Austria
Czech Republic
Belgium
Denmark
Portugal
Finland
Ireland
Norway
Hungary
Slovenia
Slovakia
Luxembourg
Estonia
Iceland
United States
Japan
Canada
Germany
United Kingdom
Italy
Australia
France
Korea, South
Spain
Poland
Netherlands
Sweden
Greece
Switzerland
Turkey
Chile
New Zealand
Israel
Austria
Czech Republic
Belgium
Denmark
Portugal
Finland
Ireland
Norway
Hungary
Slovenia
Slovakia
Luxembourg
Estonia
Iceland
-10
0
10
Average actual consumption
20
30
40
-10
Hypothetical average consumption
10
30
50
CO2 from actual consumption
Hypothetical % change in gasoline consumption
70
90
110
130
CO2 from hypothetical consumption
Hypothetical % change in CO2
6. Conclusion and Policy Implications
We find that the long run price elasticity for diesel is three times the short-run values for
countries in almost all the regions of the World Bank. The long-run elasticities for gasoline are
however and in contrast to the ones for diesel, at least as 8 times larger than the short-run
elasticities. On the basis of these results, we can conclude that fuel price reforms will be highly
effective in reducing the demand for fossil fuels. This is especially noticeable for the countries of
18
the Middle East and North Africa (MENA) region which predominantly subsidize fossil fuel
consumption.
It should be also noted that, contrary to diesel, the consumption of gasoline appears to
be more responsive to increases in prices during recessions. In such a case, the public most likely
redirect its expenditures from gasoline to other (likely more essential) goods. In contrast, diesel
is an important input in different industries, and it is also used heavily in public transport. For
these reasons, the demand for diesel will be less sensitive to the effect during recessions.
This study has then aimed to show that it is possible to achieve important reductions in
fuel consumption and consequently CO2 emissions by reducing fuel subsidies (i.e. increasing
domestic prices). Such fuel policy reform can be used as a significant instrument of climate policy.
This is especially crucial for countries in the Middle East and North Africa (MENA) region.
Assuming a scenario with an increase in the price of diesel and gasoline by 20 USD cents per liter,
the reductions in the consumption and CO2 emissions can be up on the range from 65 percent to
15 percent depending on the country (in the MENA region) and type of fuel. For a large number
of countries in the MENA region, such reductions can be above 35 percent. Iran and Saudi Arabia
are the countries that could experience the largest reductions in their CO2 emissions. Currently,
these two countries are some of largest emitters of CO2 in the world. This is a long-run issue, and
it is now the time to think how to implement energy reforms in the MENA countries and use the
savings in subsidies for increased infrastructure investments, so as to attain higher economic
growth (Mundaca (2015) shows such effects). This is crucial for these countries which are
currently experiencing low growth rates and other economic difficulties.
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