Sunday, June 26, 2005

Iraqi Fuel Shortages: the real cause

Several of the Iraqi bloggers commented this past week that long lines have returned to gas stations in Iraq. What they haven't really talked about is why. One of my Iraqi friends tells me that gas stations have resorted to a simple measure to control lines: if your license plate ends in an odd number, you can only buy gas on odd-numbered days, and likewise for even numbers on even days. Despite this, lines for gas stations are half a mile long, and it can take 6 hours or more of waiting in line to get the gas tank filled up.

One might easily wonder how, in a country so rich in oil, that there would be a such a shortage of gasoline. The answer is simple: government subsidies.

Gas stations in Iraq are mostly government-owned, and the fuel they sell is heavily subsidized. According to one of my friends in Baghdad, a litre of gasoline in a government-owned gas station sells for 100 dinars, and on the black market for 350 dinars. When you convert these to US dollars and gallons, this equates to $0.25 per gallon at the official gas stations, and $0.88 per gallon on the black market, both well below the fair-market cost of the gasoline.

Let's do a little math here: a barrel of crude oil costs about $60 on the open market now, and a barrel contains 42 gallons, so crude oil costs $1.40 per gallon on today's market. If you consider that it costs about $0.30 per gallon to refine the crude oil into gasoline, and another $0.10 to transport it and run the gas station, you are left with a cost of $1.80 per gallon of gasoline. And yet, Iraqis are only paying $0.25 per gallon at the fuel pumps. Meanwhile, here in America, we pay over $2 per gallon of gasoline, and in parts of Europe, it is over $5 per gallon.

These artificially low fuel prices in Iraq are a legacy of Saddam Hussein. After Saddam was overthrown by the US invasion, the American administration did not want to infuriate Iraqis by having them see a sharp spike in gas prices, and so they continued Saddam's policy. For a period of over nine months in 2004, American taxpayers paid $200 million dollars per month to import gasoline from Kuwait and Saudi Arabia to meet Iraq's demand and ease the fuel lines. And now, since the reins of government were handed over to the Iraqis, these imports and subsidies have been paid for by the Iraqi government.

One might argue that in a country rich with oil, it does not actually cost anything to give the oil away to the people, however, this is a fallacy. Oil and gasoline are both commodities - in other words, it doesn't matter where it comes from, it has the same value. So, if you have a commodity like oil or gasoline and choose to give it away rather than selling it for fair-market value, you are giving up the revenue you would have made from selling it. And, I am sure Iraq could sorely use this revenue for rebuilding, education, and fixing the electrical grid.

One major problem that is caused by subsidized gasoline is smuggling. You don't have to be terribly ingenious to figure out that if you can buy gasoline at a regular gas pump at $0.25 per gallon in Iraq, and sell it for $2 per gallon in Turkey, you can make a decent living smuggling gasoline out of Iraq. And, every gallon of fuel that is smuggled out of Iraq is a gallon less that is available at the local gas pumps. Some analysts have figured that this smuggling problem is the main reason for the current fuel shortage in Iraq.

Another problem with subsidized fuel is that it artificially inflates demand, and can allow demand to reach unsustainable levels. Prior to the Iraq war, Iraqi demand for gasoline was 15 million litres per day. Today, thanks to an influx of automobiles and electrical generators, the demand is 23 million litres per day. And, many of these consumers are driving cars they could not afford to maintain if fuel was selling at market prices.

Unfortunately, the basic nature of subsidies does not provide much of an incentive for the Iraqi government to fix the supply situation, since every gallon of subsidized gasoline they sell is another dollar of government money down the toilet.

The Solution

The true solution to this problem is to stop subsidizing gasoline, and to allow the free market to determine fuel prices. This will ensure a steady fuel supply, and free up taxpayer funds that can be used for other purposes (healthcare, fixing infrastructure, etc.). Unfortunately, this solution would probably not be very popular, and would probably need to be rolled out in stages to avoid shock waves rippling through the already fragile Iraqi economy. But, sooner or later, this will probably need to be done, or this problem will remain with Iraq indefinitely, and as the demand for gasoline continues to rise, the subsidies on it will increasingly sap tax dollars away from more important projects.