“Electricity is the mother of all problems in Lebanon … the size of the problem is beginning to pose a danger to public finances” – M. Chatah, Lebanese former Finance Minister.
Electricite du Liban (EDL), the state’s electric utility, operates seven thermal plants fueled by gasoil, fuel oil, and natural gas. It also runs six hydro-electric power plants. The national utility enjoys a quasi-monopoly over the power sector in Lebanon. However, for reasons ranging from inefficient operation and management to a freeze-of-tariffs government policy, the electricity company has to rely on significant subsidies from the Ministry of Finance to cover its deficit. During 2011, for example, approximately USD 1.57 billion were transferred from the state treasury to EDL, 93% of which was allocated to purchase oil. This subsidy constitutes one fifth of total public expenses, and according to a 2009 social impact analysis by the World Bank “is putting macroeconomic stability at risk”.
From Financing Investments to Subsidizing Electricity Production
Yet, government transfers to EDL are not a new phenomenon. At the end of the civil war, EDL faced significant investment requirements to rebuild the severely damaged electricity infrastructure and continue expanding production capacity as demand rose with economic recovery. The Council for Development and Reconstruction (CDR – in charge of post-war reconstruction efforts in Lebanon) allocated approximately USD 1.14 billion to the electricity sector between 1992 and 2009, which corresponded to 15% of the total value of contracts signed by the CDR during that period of time.
However, results did not match financial commitment due to political and institutional friction slowing necessary reforms in the sector. EDL could not maintain a sound financial balance mainly due to insufficient revenues, which remained largely inferior to required investments. In 1994, for example, electricity was sold at one sixteenth of its production cost. And while electricity tariff saw one increase in the mid-nineties in an effort to provide EDL with additional revenues, no other tariff adjustments were approved by government as any increase in the electricity cost could not be easily justified when power supply remained highly unreliable. This left EDL with tariffs based on a price of crude oil of around 25 USD/barrel while Brent Crude was exchanged at an average of 111 USD/bbl in 2011. With tariffs unable to cover the fuel source bill, let alone infrastructure depreciation and other operating costs, government subsidies to cover the gap between expenditures and revenues appeared to be the only way to ensure continued power generation.
Fiscal Vulnerability and Exposure to Fluctuations in Oil Prices
As oil markets significantly pushed prices upwards over the past decade, EDL deficits were set on an ever-growing trend, which reached an all-time record in July 2008 with the Brent Crude selling at 133 USD per barrel. And as the fuel mix of power generation in Lebanon remained dependent on oil products (imported mainly from Algeria and Kuwait), government subsidies increased dramatically during the 2000’s as EDL remained incapable of paying its ever increasing oil purchase bills. As a result EDL’s contribution to the oil bill continued to drop, falling from 19% in 2006 to 9% in 2011, requiring increasing subsidies from the Treasury.
The close correlation between the Ministry of Finance transfers to EDL and oil prices are clearly illustrated on figure 2. The year 2008 in particular represents an extreme example of the growing vulnerability of government finances to oil prices. As oil prices jumped from the average 2007 level of approximately 72 USD per barrel to 97 USD per barrel in 2008, government subsidies to EDL jumped by 49% percent. Transfers remained high during 2008 and 2009, because of the lagged payment of purchased oil.
All in all, dependence on fuel imports, oil markets volatility, as well as EDL’s limited resources to finance its growing oil imports bill, have collectively put significant pressures on the financial resources of the Lebanese government. Subsidies to EDL now represent Lebanon’s third largest public expenditure according to the Ministry of Finance and amounted to a staggering 23% of the government budget in 2011. In fact, EDL’s financing requirements drove up Lebanon’s national debt. Between 1992 and 2006, transfers from the Ministry of Finance to EDL amounted to USD 3.8 billion, which grows to USD 7.5 billion when interest payments are factored in. And while the entire debt of the Government of Lebanon cannot be entirely attributed to the situation of the power sector, it represents a major ongoing burden at a a time when Lebanon remains in a very delicate situation with national debt representing 150- 185% of GDP over the past few years, one of the highest debt-to-GDP ratios worldwide.
Significant Opportunity Costs and Inefficient Subsidies
Lebanon’s Ministry of Finance transfers to EDL also carry a significant opportunity cost. Subsidizing EDL operations absorbs a large share of the government’s financial resources that are spent on importing oil products and natural gas. More importantly, these subsidies are hardly associated with job creation, and have almost no positive spill-over effect on the rest of the economy.
Furthermore, while one could argue that the freeze of tariffs drove down the cost of electricity in real terms , it must be noted that this subsidy has been proven to be highly inefficient. Research examining EDL’s tariff structure points out that smallest consumers and most vulnerable households do not really benefit from the scheme and that the tariff structure does not impose significantly higher costs to the largest well-off consumers.
Both direct costs – government spending and debt creation – and indirect opportunity costs make the subsidies to EDL a heavy burden for Lebanon. To put it in perspective, government subsidies to the power sector represented USD 375 per person in 2009, compared to around USD 100 to 110 per person allocated to health expenditures. The scale and inefficiency of this policy stress the urgent need for a comprehensive policy reform for the energy sector, and a political will to change the status quo.
Marie Tyl is a student at Sciences Po Paris and Universite Paris 6, currently completing a joint Bachelor degree in sciences and social sciences. Marie is on an exchange program at the American University of Beirut, and has recently joined Carboun as a Student Ambassador.
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