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Economist view - UAE Petrol Prices

Posted by: Matthew Birchley
25/08/15

ECONOMIC THEORY

In Theory, the Unleaded Petrol price increase at the pumps will greatly benefit the UAE Government, which is why Suhil Al Mazrouei, Minister of Energy, has been advocating the changes as a way to promote “rationalised consumption”. The Minister believes the increase will push people to the most fuel-efficient cars, and to other solutions, including public transport. 1 solution I will investigate is a new car pooling application that has been extended to all UAE Residents, and which can make great sense. More of that later in the article, and in a future Blog.

Why will the move strengthen the UAE public coffers ? The simple reason is that demand for petrol at the pumps is certainly Inelastic, and this means, as simple illustration, a 20 % price increase will lead to a reduction in demand much smaller than 20 %. If demand was perfectly elastic, such a price increase of 20 % would simply depress demand by 20 %, and overall expenditure on unleaded petrol would stay flat. Table 1 shows 2 different demand curves, below, the Relatively Inelastic line could be that of Petrol, and the Relatively Elastic line could that be of Air Travel for Leisure (as opposed to Business).

Table 1 - Elasticity of Demand

UK ECONOMIC EVIDENCE

We know from the UK, that when unleaded petrol prices started to sharply increase, and as a consequence of this inelastic demand curve, Consumers started substituting petrol in their basket of Household Expenditure for groceries. In other words, reduced expenditure at the High Street supermarkets, as people were forced to prioritise filling their cars as a way of ensuring they were able to afford to drive to work. This simply meant the demand curve for Petrol was more inelastic than the demand for groceries, and it also saw some Consumers shift to Low Cost Retail chains, who were focused on the lowest possible price for their Customers.

CAR POOLING AND THE USE OF TECHNOLOGY

1 clear advantage the UAE has over the UK is its readiness to embrace the very latest Technology, and already the Roads and Transport Authority (RTA) has launched a new, and upgraded smart app, Sharekni, that is all about encouraging car pooling.

The service portal, www.sharekni.ae, is much improved, and is open to all, and the people of the UAE are very Tech savvy, such that the take up of this type of initiative is likely to be immediate, and high volume. I will be looking in more detail of practical experiences on this website in future blogs. 
My Employer, Subsurface Global, is based since more than 5 years at Masdar City, a Green City of the Future, and Dr Ahmad Belhoul, Chief Executive of Masdar was quoted in the National, a leading Abu Dhabi Newspaper as follows : “We support initiatives such as this to promote energy efficiency and a more sustainable energy future for the UAE”. Dr Belhoul goes on to talk about smart choices, such as electric vehicles, and renewables, and significant improvements in emissions as a result of these smart choices.

WHAT NEXT FOR THE UAE?

Reading the National, Consumer reaction rightly praises the Government for the brave steps it is taking, in the knowledge that Consumer behaviour will be forced to react accordingly. Every month, the prices will fluctuate, with a Fuel Committee setting prices against International Levels on the 28th of each month, for the following month. 
Could the Government encourage Consumers to change the shape of the Demand Curve in Table 1, such that the Inelastic Demand in Table 1 becomes much more Elastic over time ? It is entirely possible, if people make wise decisions to drive more Economic Cars, with smaller engines, and if this sees advancement towards the smart choices Dr Belhoul is advocating.

There can be positive Externalities, or benefits to the wider society as a result of this : These would include less busy roads, with people switching to Public Transport, using the new car share application, simply not travelling, or travelling less often – All of these would have benefits to the wider society,  not always easily quantifiable, but including less congestion, quicker journeys, less pollution, potentially safer roads, fewer road deaths, and acting as a signal to neighbouring Countries, including Saudi Arabia, that the reduction in Energy Subsidies makes sound Economic Sense.

In Saudi Arabia, as an example, the annual expenditure on Energy Subsidies exceeds the annual Budget on Education, the IMF quoted the cost at USD 106.6 Billion in a May 2015 Report, quoted by Bloomberg on 22 July. So, if the UAE can start to change the shape of its demand curve for fuel, then this will send out strong signals to many Countries in the Gulf.

Plus, with the lower Oil Price currently seen, this makes Budgetary sense for all oil-producing Countries in the Gulf, who seek to find economies in their Annual Budgets.

CHANGING THE SHAPE OF THE DEMAND CURVE

The likelihood is that the Demand Curve can change shape IF the price increases are material, and sustained. Consumer reaction at the August 1 price increase was to praise the UAE Government as forward-looking, and from an Economics perspective, it is clear that this can make good sense in the long-term. 
Dubai has a fine Infrastructure, including a fabulous Metro system that is inexpensive, and many GCC Countries are planning, and building comparable Mass Transit Systems, all of which underpin the Economies, and the vital Tourism for the Region. Undoubtedly, there can be improvements in Public Transport as a reaction to these changes in the fuel price, and indeed we saw recently the RTA opening the Tram in Dubai, plus confirmation of new Metro Lines that will be built.

This Author will be investigating Car Pooling, and will report back to you on the practicalities, and here is a thought to finish on : The RTA Sharekni service portal even has the ability to provide details about the best-rated driver when looking for a car share. This is the kind of concept that David Ricardo, the Author of the Law of Comparative Advantage some 200 years ago, would have applauded – You find a best-rated driver, book your journey, and use the time as a passenger productively, to read, or to work, to sleep, or to talk with your fellow passengers.

MA Birchley at Masdar City. July 2015

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