x Abu Dhabi, UAEThursday 27 July 2017

The road to hell is paved with good intentions

It is a bitter irony for citizens of many energy-exporting nations that they often live shrouded in darkness.

It is one of the bitter ironies of life for citizens of many of the world's largest energy-exporting nations that they often live shrouded in darkness. While many in the developed world barely think twice about flicking on the lights thanks to energy supplied from Iraq, Iran, Angola or Nigeria, millions in those countries have no such luxury. The reasons differ in each case, but can often be explained by bad government policies based on good intentions. And there is a lesson here for the Emirates.

Soon after their inception, governments that depend almost entirely on revenues from exploiting natural resources naturally act on a moral obligation to pass on this blessing to their citizens. To encourage the widest possible distribution of their resource wealth, public servants fix the price of energy, whether petrol, kerosene, cooking gas or electricity, at rates far below those prevalent in the world market.

Bargain energy brings first-world luxury to the doorstep of these emerging economies. Symbols of wealth and modernity - the car and the air conditioner - come within the reach of the masses. Industries flock in to take advantage of low operating costs. But the distorting effects on the national economy soon emerge. Cheap fuel means people have no incentive to conserve energy or use public transport. It is no coincidence that these countries often suffer from some of the world's worst traffic jams. Low prices are an incentive to smuggle fuel to territories where prices are higher, increasing demand and costs to the state. And, of course, there is no incentive to develop alternatives.

In Iran and Venezuela, for example, subsidies on fuel and power are so large and growing so fast that they drain money away from spending on health care, education and infrastructure. In Iran, the government has had to impose fuel rationing to limit the damage to its budget. In Venezuela, fuel subsidies of US$12 billion (Dh44bn) last year were at least double the government's total investment in its oil and gas industry. Both countries now need export prices close to $100 a barrel just to balance their budgets, partly because spending has become so inflated by subsidies.

They cannot raise pump prices at home because, rightly or wrongly, many of their citizens believe they deliver little else; a withdrawal of subsidies is perceived as another cynical attempt by a wasteful government to consume more of the national cake. The result is simply a withdrawal of service in the form of blackouts, rationing and queues at petrol stations. Cheap natural gas and power have equally deleterious effects, and these are clearly at work in the Emirates today. Low gas prices have attracted many energy-intensive industries to the country, but now the talk in the industry is of an imminent gas shortage. For a country with the world's fifth-largest reserves of gas and only four million inhabitants, this is hard to believe.

The shortage is more precisely a price crisis. The government's price for gas is less than $1 per million British thermal unit (btu), versus a free market price of $15. This explains why companies are not queuing up to offer more of the stuff. Qatar has politely declined to discuss increasing gas supplies through the newly constructed Dolphin pipeline to Taweelah, and another supply line from Iran to Sharjah has stood empty for two years because of a disagreement over price.

The lack of new energy supply has become so acute in Dubai, whose oil and gas resources are drying up, that it has signed up to import liquefied natural gas in tankers from Qatar at a price up to 20 times higher than the nation's domestic rate. We can only assume the difference will absorbed by the public purse since power prices are only inching up. The solution is not an energy shock in the form of a total liberalisation of the UAE energy market, but a gradual reduction of subsidies on fossil fuels combined with more spending on conservation and investment in alternatives. This will soften the blow of higher energy prices while encouraging a more sustainable energy future.

Abu Dhabi has already joined the hunt for alternatives with its Masdar initiative to build the world's first zero-carbon city. A factory to produce solar cells is due to break ground in the desert later this month which will create power at almost 10 times the cost of domestic gas. Subsidies in this case will open doors to a new technology that might one day take over from fossil fuels. The Emirates is faced with the same dangers as all energy exporters, but does not have to repeat their painful experience. They can deliver a lot more than cheap fuel for the masses. The first step is to start reducing subsidies and raise the price of domestic energy closer to the market rate.