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The Impact of Subsidies on the Affordability of Modern Energy Services by the Urban Poor in Ethiopia: The Case of Electricity and Kerosene

By

B. Kebede, E. Kedir, A. Abera and S. Tesfaye


EXECUTIVE SUMMARY

Estimates of the total energy consumed by households in terms of kerosene and electricity equivalents are calculated. This is done by converting all fuel used by households into energy units and computing the corresponding kerosene and electricity that can provide the same level of energy. Energy use significantly varies across income groups and between different urban areas. For example, the mean energy consumption of non-poor households is 2.3 times that of poor households. As expected, total energy consumption consistently increases with per capita expenditure deciles, with the richest decile expending 2.8 times that of the poorest one. 

The value of kerosene and electricity equivalents (including equipment used) gives energy cost estimates for households. The energy expenditure is used as a proxy for purchasing power of households. The comparison of the cost estimates with the mean energy expenditures indicates the affordability of the fuel. This comparison indicates that even without subsidy, the cost of kerosene is marginally lower than energy expenditure. This result indicates that the removal of kerosene subsidy would not significantly impact the affordability even for poor households. Similarly, kerosene subsidies do not seem to be important in improving the affordability of kerosene to the average household in different urban areas. Results for per capita expenditure deciles indicate that the effect of kerosene subsidy even on the poorest of the poor is minimal. 

A similar comparison for electricity indicates that electricity is too expensive for the average household and more so for poor households. Therefore, subsidies are not important in making electricity affordable to the urban poor. Since fixed costs are important in the use of electricity, the comparison of costs and purchasing power (with and without subsidies) is also done by amortising the cost of electric equipment over their lifespan and converting them into present values by using an interest rate. The results (without the consideration of depreciation) indicate that poor households do not have the purchasing power to cover the upfront costs of electricity services. However, if the costs are spread over the lifespan of equipment, even poor households can afford to pay for electricity without subsidy. The most important obstacle for poor households to access electricity seems to be the upfront costs. 

The results indicate that subsidies on both kerosene as well as electricity do not play an important role in facilitating access to modern energy services by the poor.  The results also indicate that the majority of the urban population can afford unsubsidised kerosene and electricity if arrangements for the amortization of fixed costs, particularly for electricity, are provided.  The above results have far-reaching policy implications.  First, the subsidies on tariff do not seem to play an important role in affecting affordability of electricity to poor households; the overall changes in the cost to energy expenditure ratios are not significant. Second, given a mechanism that can spread costs over relatively long periods of time, poor households can afford electricity even when supplied without subsidy. 

Fixed costs can be spread over longer periods of time at least in two ways.  The first is through long-term contracts with electricity and equipment suppliers that enable households to pay the costs (including interest payments) over longer periods of time.  This will spread expenses to households as well as enable suppliers to recover costs.  The second mechanism that can be used to spread costs is credit. If credit facilities are available to poor households, they can cover the upfront costs and pay their debt over longer periods of time. Results indicate that given a longer repayment period, poor households can cover the cost of electricity services.  In other terms, if a mechanism that enables households to bring their future income to the present is created, they can afford unsubsidised electricity. 

Further analysis is undertaken to determine the distribution of kerosene and electricity subsidies among urban households in Ethiopia.  Results indicate that the non-poor capture most of the kerosene and electricity subsidy. In addition, mean subsidy per household and total kerosene and electricity subsidies consistently increase with per capita expenditure deciles higher income groups capture a higher level of subsidies. When the data is controlled for household size and location, the amount of kerosene and electricity subsidies is significantly and positively correlated to household expenditure.  An increase in household expenditure by one Birr increases kerosene and electricity subsidies by 0.10 and 0.16 Ethiopian cents, which are significant coefficients. These results reiterate the findings that non-poor households capture most of the subsidies. 

The study also examines the role of kerosene and electricity subsidies in public sector finance.  The overall electricity sector subsidy is very small implying that the burden on public finance is also minimal.  However, this is as a result of cross-subsidisation, with customers in the inter-connected system subsidising those in the self-contained system. In addition, commercial and industrial customers pay higher tariffs than the long run marginal costs while domestic customer with relatively smaller consumption pay less than long run marginal costs. 

The key recommendations from the study are: 

1)       Review kerosene subsidies

2)       Amortize connection fees for electricity

3)       Re-examine the cross-subsidization policies

4)       Review the method of determining long run marginal costs


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