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p. 20 of 30 BACK | NEXT Introduction Regional Energy Context Energy Policy Issues Structural Reform Energy Efficiency Energy Pricing Background Power Subsector Hydrocarbon Subsector Rural Energy Energy and Environment Rural Energy Development Regional Cooperation and Energy Development Conclusions and Recommendations

Bank Policy Initiatives for the Energy Sector : Energy Policy Issues : Energy Pricing

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Hydrocarbon Subsector

52. The Bank will continue to actively encourage the DMCs to adopt market-related prices for hydrocarbons. In respect of petroleum, most DMCs maintain domestic prices higher than border prices due to added taxes that promote energy efficiency as well as environmental benefits, while in some DMCs consumers of kerosene and diesel are subsidized by consumers of other oil products, notably gasoline. The oil subsector on the whole provides net revenues to the state in most DMCs; however the mechanisms in some DMCs to insulate the economy from too frequent price changes through oil price stabilization funds periodically lead to state subsidization. The Bank will continue to emphasize that it would be in the best interests of DMCs to quickly phase out such funds. It is, however, recognized that full price liberalization in the short-term may not be easy to achieve, especially considering the continuing gap in energy demand and supply and the public desire for equity in energy pricing.

53. In most DMCs, administered price regimes are in place for natural gas. The Bank's approach to natural gas pricing is that it should approximate the realistic market prices of alternative fuels. In the DMCs where natural gas reserves are abundant in relation to present and forecast rates of consumption, the price of natural gas could be somewhat lower than the market price of alternative fuels, but in no case should it be lower than the sum of the (i) LRMC of extraction, transmission and distribution; and (ii) the depletion premium.¹ To attract private sector oil and gas companies to invest in the exploration activities in DMCs, the well-head prices should be high enough to cover costs of risk capital and provide reasonable profits. Natural gas transmission and distribution companies should also be able to earn a reasonable return on their investments after servicing their debts. The difference between market price of alternate fuels and LRMC of extraction, transmission and distribution of natural gas represents the economic rent which is significant in DMCs with low LRMC (such as Bangladesh and Malaysia) and there is a good case for the government to capture the rent by way of taxes. In appropriate cases, governments could share the rent with gas producers by allowing a higher well-head price to attract the private sector to invest more in this activity. The rent may also be shared with consumers in countries with surplus natural gas to promote interfuel substitution and environmental benefits. Transparent regulation equitable to both the suppliers and consumers and based on promulgated tariff criteria (such as return on equity) by an independent regulatory body is a necessary key element to encourage private sector development of the natural gas industry.

54. Pricing of coal would in most cases follow the same principles indicated for oil, as the domestic pricing of coal can be structured on the prices of internationally traded coals. In respect of all forms of energy and especially in respect of fossil fuels, there is a good case to tax energy consumption to compensate for the adverse environmental costs their use imposes on society. The resulting higher price would also encourage more efficient energy use.

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