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Sept 22 (PolicyScape360)--Policy measures to smooth fuel prices are hardly without controversy. The first hurdle to overcome is the debate on whether or not such policies are even desirable. The fact is, many economists and policy analysts hold the evidenced-backed view that governments should not subsidize fuel.
Instead, that school of thought promulgates the point that market forces should be left to dominate because efforts to keep the prices artificially low puts demand higher than they would have otherwise been. This artificially higher level of fuel-product demand actually helps to keep international prices elevated, especially in a global scenario characterized by supply shortfall.
Those who argue against price-smoothing interventions are not economically heartless or void of an appreciation of the need to assist disadvantaged groups. They, instead, make the point that the tax revenues collected should, then, be targeted towards needy households and private-sector support programs. In short, they suggest that in lieu of governments cutting taxes to keep the price (relatively) stable, there should be full “pass-through” of the international price fluctuations to the local consumers, and the taxes gained should be earmarked towards social assistance and business-support programs.
The Max-Min Rule
Of course, that’s the market-oriented, non-interventionists' vantage point. However, there are several interventionist policies that have been utilized to smooth fuel prices by controlling the international prices’ pass-through (“pass-through”).
As Federico, Daniel, and Bingham (2001) explained in their paper, “Domestic Petroleum Price Smoothing in Developing and Transition Countries,” there are three general categories: (i) rules based on a moving average of international spot prices; (ii) trigger rules, in which local retail prices only change if international prices increase or decrease beyond a predetermined band; and (ii) the maximum-minimum (max-min) rules, which sets retail price between a ceiling and a floor.
The max-min rule has been utilized in countries like Chile. There the Chilean government operated the Chilean Stabilization Fund, which had undergone several reforms and redesigns between 2000 and 2010 (see Oliveira and Almeida, 2015, p. 10). A detailed discussion on those reforms is beyond the scope of this article, but there is value in explaining its initial design. Oliveira and Almeida explained the model thus:
“The [Petroleum Price Stabilization Fund] included gasoline, diesel, LPG, and other oil products and was initially capitalized with US $200 million borrowed from the Cooper Stabilization Fund. The mechanism was based on a max-min price rule set at +/- 12.5% of reference price, which was defined by the energy authority. If prices were above the ceiling of the band, the fund would pay a subsidy equal to the difference between the two prices. In contrast, if import prices were below the floor, 60% of the difference would be taxed and deposited into the fund.”
Eventually, the revision of the program saw the subsidies and taxes both being 100%, and the price band was narrowed to 5% in an effort to make the program more fiscally sustainable. See. The thing that the non-interventionists tend to caution against is the fact that when prices are coming down internationally, the tax-recovery components of such programs work fine. However, the reverse isn’t necessarily as ideal. Sharp and steady increases in world-market prices can easily stress governments’ budgets and create sharp fiscal deficits. This is because, in order to “smooth” the price under the max-min rule when prices are high, governments are expected to subsidize either directly or indirectly. These subsidies, unsurprisingly, come at a cost.
Belize’s Version of the Max-Min Rule
Since April this year, the Government of Belize (GOB) has implemented its own max-min-based fuel price smoothing program, which is based on a Fuel-Price Stabilization Fund (“The Fund”) akin to the Chilean brand.
Unlike the Chileans, Belize’s stabilization initiative did not provide a band, but has operated a hard fix for Diesel fuel and Regular gasoline, effectively making the “reference prices” both the floor and the ceiling. Without the band, Diesel’s and Regular’s prices have been fixed at $13.41 and $13.50 for months, while the excise duties have varied as necessary to hold the prices constant.
At its lowest point, the excise duty for Diesel was reduced to $0.01. For Regular gasoline, the lowest was $0.90. Of course, these low points for the duty coincided with the period of time when international prices had peaked. For example, around mid-June 2022, the Energy Information Administration (EIA) reported that US price for Regular gasoline was over US$5.00 per gallon.
It must be understood that only a year earlier, this fuel product’s price was US$3.07, according to the EIA. That’s a year-on-year growth of approximately 63%.
In terms of the month-to-month change, the average change between May 2022 and June 2022 for the US market was about 11%.
What was the corresponding change to local pump prices? Well, there was none, given the price stabilization program. Prices for both Diesel and Regular remained largely unchanged via the government’s lowering of the excise tax. Had there been full pass-through, the price for Regular gasoline would have been closer to $15.00 (instead of $13.50).
But please understand. That unchanged price did not come for free. Given that the original excise duty for Regular was $3.95, the lowered rate of $0.90 meant that for every gallon of Regular gasoline sold during that time, the government “lost” $3.05 per imperial.
Let’s put that into perspective. For the month of June, Belize imported close to 1.3 million imperial gallons of Regular gasoline. At the original $3.95, the government would have collected $5.13 million in excise tax revenues. However, at $0.90, the actual take in June would be closer to $1.2 million, a shortfall of almost $4 million for Regular.
Let’s recall that the story, in June, was fairly similar for Diesel, the excise for which was lowered to $0.01, down from $3.57 per imperial gallon. That’s a loss in tax revenues of $3.56 per imperial gallon.
Had the prices continued to climb, there would have been little to no excise-tax levers left to pull. Fortunately, the gamble paid off, and world prices for energy started to decline, with the EIA already placing Regular gasoline in the US at US$3.65 as of September 19th.
On the Way Down
The Price Stabilization Fund (“The Fund)’s capitalization is at the heart of the program. Therefore, as prices fall internationally, the max-min design of the Fund requires that it be replenished by matching increases in the excise duties charged. It is for this reason that the excise on Regular gasoline, for instance, as of September 3rd, 2022, has climbed to BZ$4.41, a figure that is roughly 12% above the $3.95 per imperial gallon that had been in place since 2017.
While clearly unpopular with average consumers who figure that prices should come down, the fact of the matter is that the Fund must be replenished for the max-min-styled program to work. In many ways, it is literally the price paid for stability at the pumps.
Loss and Recovery
One way to look at things is to say that with all the excise tax reductions between April and August, on average, GOB had forgone about $1.28 per imperial gallon of Regular gasoline. This amounts to an estimated loss in potential excise-tax revenues of about $9.1 million on Regular fuel alone for those five months.
If the goal is to replenish the Fund within the short term (hopefully before another upward price shock), even if the excise was raised to $5.23 per imperial gallon, it could take approximately an additional five months or more, all things remaining constant, before that forgone sum is recovered as it pertains specifically to Regular gasoline.
Of course, for Premium fuel, no such recovery is necessary because this product’s price was left to the ebbs and flows of the market, a fact that would make the non-interventionists proud. It is for this reason that, in recent weeks, Premium’s pump price has dipped from $17.50 to $16.60.
Was it the ‘Best’ Policy Choice?
In the end, when it comes to matters of public policy, “best” is quite the subjective term. Frankly, policies can only be judged on the degree to which they achieve their objectives and solve the identified problem.
Consequently, one must ask what “problem” was the smoothing program intended to solve. Honestly, the answer is in the very description of the program: Price stabilization and/or price “smoothing.”
Did the price-stabilization program steady prices for the relevant fuel products? The conspicuous answer is “Yes.”
With all policy options, there’s always the question of fiscal sustainability. Was it sustainable? In theory, “yes, it is.” However, it must be understood that the recovery elements for The Fund only work as long as the prices trend on the low side. Chile had learned this lesson the hard way in the early 2000’s when energy prices were relatively high.
For now, with lower international prices, the Fund must strike while the proverbial iron is hot because a blend of geopolitical and economic events could easily disrupt those trends, yet again.
Naturally, we must recall that problem definitions exist in the normative space. Someone could argue that the chief problem was not to simply “stabilize” prices, but to provide relief for the disadvantaged. That would suggest a strategy that applied the market-based logic that would have seen tax revenues directed towards social assistance programs and business-support initiatives where needed. That, too, would be a sound “redistributive” argument to make.
However, in Belize’s political space, the discussion is not between “smoothing” versus market-supported “redistributive” strategies. The rhetorical call is seemingly for both to somehow exist simultaneously. The call has been for the government to BOTH lower (subsidize) fuel prices and, at the same time, provide social assistance programs. The latter are transfer programs that are by nature costly ventures.
Fundamentally, the question of “best,” as was said before, is qualitative. But, it is possible to say that among a series of bad options, the goal was to choose the policy path that could be considered the least “bad” among the list of bad choices from which to select.