Complex Made Simple

Saudi is being clever with its energy subsidy program – see how

Oil and gas are essential pillars of the Saudi economy, but the Kingdom is also aware that diversification is important for its economic sustainability.

That gave rise to Saudi Vision 2030, which is mainly aiming to reduce the Kingdom’s dependence on oil and diversify its revenue sources.

The Aramco IPO aimed at revenues of $100 billion, selling other types of assets – including stakes in the stock exchange and football clubs among others – as well as reforms for visa issuance, property and business ownership, lifting ban on Saudi women drivers, removing VOIP restrictions and finally setting up a $2.7bn company to invest in entertainment are all signs of the implementation of the Vision.

Read: This is what you need to know about the upcoming VAT

However, one reform has remained a sticky point: Fuel subsidy programs.

These have cost the kingdom more than $107bn, or 13.2 per cent of the country’s total GDP annually, according to Geopolitical Monitor, an international intelligence publication.

Has Saudi found a smart way to deal with them?

Energy subsidies

Energy subsidy reform is a key part of the Saudi Vision 2030.

Under the plan, the government would increase fuel costs at the pump to levels in line with international prices, according to a September 2017 statement by Petrol World, a global b2b trade media brand in fuel downstream.

Read: 5 ways VAT will impact Saudi companies

“This could result in a hike of about 80 per cent for octane-91 grade to about 1.35 riyals per liter (0.36 cents),” it said.

However, the Kingdom recently announced that it delayed its plan to phase out energy subsidies, without fixing a specific date for that move.

Removing energy subsidies is sensitive in Saudi Arabia, as many nationals have become accustomed to generous benefits by the Kingdom, in both low fuel and utility prices.

Now a neat plan has emerged: As part of its introducing Value Added Tax (VAT) in 2018, the Saudi government included combustible fuel while it rethinks its subsidy programs.

It aims to apply a five per cent VAT on gasoline from January 1, 2018, as reported by the Kingdom’s tax authority, according to a Twitter feed on Sunday.

Read: GCC VAT: Which 3 major business sectors must urgently do now?

Impact of the move

The new move is essential for the Kingdom to generate more revenues, but can’t happen without having negative repercussions.

Tariq Qaqish, Managing Director of the Asset Management Division at Mena Corp Financial Services in Dubai, was quoted in media as saying: “Not only the transportation and logistics sectors will be affected significantly; any company that is involved in production and needs to transfer their end products to consumers will be affected.”

Reuters recently reported that past austerity steps didn’t yield the expected results, such as in December 2015, when an initial round of energy price hike caused rising unemployment among Saudis.

Read: VAT in Jan 2018 but ‘Excise Tax’ is imminent

That means that further austerity will be hard to introduce without risking a sharp economic slowdown, which would deter the private investment that the reforms aim to attract. A prolonged recession could turn public sentiment against reforms, it said.

This is why the government decided to delay price hikes until the beginning of the year, but as with similar past decisions, this date could also be delayed.

“The government delayed the next round of price increases because it wanted to ensure that an increase won’t slow industrial activity,” according to Bloomberg News.

“The government is assessing how much to raise prices to avoid hurting the economy,” it said.