By the close of March, the pricing war in the oil market between Saudi Arabia and Russia set off by COVID-19’s impact on the world economy had plunged the global benchmark Brent crude oil price to its lowest point in 22 years. At a time of economic uncertainty, Egypt, which is bound by an agreement with the International Monetary Fund to eventually lift all fuel subsidies, could still have slashed the price of petroproducts to allow for downstream market relief for customers at an exceptional time.
However, on April 10, only two days before Russia and Saudi Arabia agreed to cut production to stabilize prices, Egypt’s Automatic Fuel Pricing Committee issued a statement announcing only a slight reduction in fuel prices, far below the 10 percent maximum stipulated in the decision to commission the pricing committee in December 2018.
The prices of 80-octane, 92-octane, and 95-octane gasoline were cut by 25 piasters per liter, while the price of mazut, a fuel for industrial use, was cut by LE350 per ton. The price of the all-important diesel fuel was held steady.
The global benchmark Brent crude oil price plummeted from US$68.91 per barrel at the close of trading on January 6 to US$22.74 per barrel at the end of March, the lowest level since 2002.
For the first time, the committee’s statement included an acknowledgement that the price of some petroproducts was higher than the cost of production and that pricing will be independent from the reduction in production costs in order to accrue financial savings in the state budget.
The statement also said that the committee will designate a portion of those savings to deal with the expected rise in costs of production in the coming period — or in the event of an increase in oil prices on the global market — and to face the increasing burdens of the COVID-19-driven crisis.
The decision left some scratching their heads. Why would Egypt pass up a chance to alleviate the indirect impact of fuel price hikes on things like food costs? The five fuel subsidy cuts Egypt implemented through mid-2019 had had a significant impact on inflation. Between July 2014 and May 2019, general inflation rose by more than 100 percent, while cost of fuel price-sensitive products such as fruits and vegetables rose by more than 203 percent.
According to market observers and sources with knowledge of the government’s economic policy that spoke to Mada Masr in the days following the decision, however, Egypt was prioritizing something else: reducing a state budget burdened by diesel fuel subsidies in order to prop up key fiscal indicators that will allow the government to borrow at reasonable interest rates in the future.
Amr Adly, a professor of political economy at the American University in Cairo, believes that the committee would have lowered fuel prices to the maximum extent allowed in order to appear credible, if it were not for the exceptional circumstances presented by the global economic impact of COVID-19.
Adly adds that the committee’s honest announcement about the discrepancy between the selling price and the cost of production highlights the committee’s role as a “tool for the managed liberalization of the economy.”
“It is the same case for government banks that implicitly function as a right arm for the central bank,” Adly says. “The central bank uses them in times of necessity and intervenes behind the scenes. A prime example of this is when government banks issue savings bonds at higher interests than what is available on the market. And it has been the same with the foreign currency exchange rate since the flotation of the pound. The value is somewhat still controlled by the central bank, which means that it is only partially liberalized. This has been the same situation for petroleum since it was liberalized,” Adly says.
According to Adly, a macroview of the government’s decision to cut fuel prices only slightly shows that the government is currently prioritizing the reduction of its budget deficit rather than driving economic growth. Generally, reduced fuel prices are seen as a factor in stimulating growth, as they encourage the expansion of economic activity.
Adly believes that if reducing the budget deficit is the government’s current priority, it means that the government is seeking, in all possible ways, to prevent the deterioration of financial indicators in order to be able to borrow at reasonable interest rates at a time when other resources for foreign currency, like tourism, are depleted.
The committee’s decision to exclude diesel from the cuts is another indication of the focus on the state budget, given that diesel is currently the heaviest burden on the government’s fuel subsidy bill.
Yasser Omar, a member of Parliament’s Planning and Budget Committee, says that according to government data presented to Parliament during the discussion of the state budget, diesel takes up almost 50 percent of fuel subsidies in the budget. Butane receives the second-largest allocation of fuel subsidies, followed by Octane 80.
In addition, according to a prominent ex-government official in the Ministry of Petroleum and Mineral Resources, Egypt’s diesel consumption is double its production, which means that Egypt imports half of its diesel fuel.
“Diesel costs the state budget a large portion of its fuel subsidies because it is the most used petroleum product in Egypt, far exceeding the volume of domestic consumption of all other types of fuel,” the source says.
A report published in mid-2018 by the Ministry of Petroleum and Mineral Resources showed that Egypt’s annual consumption of diesel fuel exceeds 15.4 billion liters, whereas the annual consumption of Octane 80 and Octane 92 combined is 9.6 billion liters.
Omar says the financial savings the state will be taking in by keeping the price higher than the production costs will manifest as a lower allocation toward fuel subsidies when the fuel bill is settled in the closing state budget.
The state budget for the current fiscal year allocated LE52.9 billion in subsidies for petroproducts, a 40 percent decrease from the previous fiscal year. And according to Omar, fuel subsidies in the coming fiscal year are supposed to decrease by more than 47 percent, to come in at LE28 billion.
“But even before the Automatic Fuel Pricing Committee was established, when there was a decision to increase fuel prices, it was customary for the government to raise the price of diesel by a higher rate than most other petroleum products, because diesel was always subsidized more heavily than other fuel types,” says Mohamed Saad, a financial analyst at Shuaa Securities.
Maintaining the price of fuel in order to offset the heavy cost of diesel subsidies in the state budget has come at the cost of improving inflation rates, according to Dina Armanios, a professor of economics at Cairo University.
“There is what we call the direct impact of fuel pricing versus the indirect impact of fuel pricing. The direct impacts of fuel prices — whether they increase or decrease — are what we see in transportation costs. As for indirect impacts, these are the extended effects along the production chains that consume fuel in all sectors. For example, there is the transportation component in food production, especially fruits and vegetables that need to be transported by diesel trucks. Agricultural production also has an energy component, since farm tractors primarily depend on diesel,” she explains to Mada Masr.
“The indirect impact of gasoline pricing is much weaker than that of diesel pricing, because gasoline is primarily used in private cars. Gasoline prices directly affect transportation, specifically private transport, on a much smaller scale when compared to diesel, which is the main fuel for buses and mass transport at large,” Armanios adds.
In March, the annual inflation index came in at 4.6 percent and the monthly index at 0.6 percent, figures that are fairly moderate compared to previous rates, such as those seen in mid-2017 after Egypt started implementing the terms of the IMF loan agreement.
The establishment of the Automatic Fuel Pricing Committee was linked to the US$12 billion IMF loan agreement. According to the agreement, Egypt should eliminate fuel subsidies by applying a mechanism that ensures the continuous and flexible adjustment of the retail price of fuel based on changes in production costs, in a manner that “protects the state budget from changes in the global price of fuels.”
The new system is different from the policies that Egypt adopted to reduce fuel subsidies from mid-2014 to mid-2019, which relied on issuing successive decisions to increase fuel prices at extremely high rates that exceeded 650 percent for 80-octane gasoline and 513 percent for diesel fuel.
Since its establishment in 2018, the Automatic Fuel Pricing Committee has issued four pricing decisions, two of which maintained prices and the other two reduced prices.