ANALYSES OF PETROLEUM PRODUCTS DEMAND IN THE MIDDLE EAST.

WHAT ARE THE MAJOR DRIVERS AND WHAT POLICY OPTIONS CAN BE CONSIDERED?"

BY

HASSANA DAWUDU

Email: hassydaw@yahoo.com

August, 2011.

The Middle East is endowed with abundant oil resources, and has become a beehive of crude oil production and export activities, as well as the biggest regional consumers of petroleum products in the world (a status it has maintained over decades). The largest share of export earnings of most Middle East countries comes from oil exports, since oil is the major export commodity in this region and highest income earner, which has led to dependence on the product to a great extent, thus, making some of these countries a monoproduct economy. A tradable commodity usually attracts a FOB (Free on Board) price at the port, which is collected by the exporting country. However, the Oil sold domestically in these oil exporting countries is highly subsidized, leading to a loss in profit from foreign exchange earnings; because the oil is subsidized this leads to an increase in demand of these petroleum product. Although there are a lot of rationale for subsidizing petroleum products such as; serving as a tool for rent distribution, protecting low income earners, avoiding prices from rising unexpectedly, and serving as a tool for diversification and industrialization (Fattouh., 2010). According to Bhattacharyya and Blake (2009), subsidy can also result in a number of issues, which includes: (a) Environmental pollution; A rise in oil production and consumption naturally leads to environmental pollution (b) Loss in Oil Revenue: as there is a wide gap in oil prices in the domestic and international markets due to the effect of subsidy at home; and (c) may give wrong signals for resource allocation, among others. Thus, domestic petroleum products demand of oil exporting countries is an interesting issue especially to the host countries. Attaining estimates for demand elasticities of oil products is crucial for the economies of the Middle East countries. Price and income elasticities are required parameters in planning the necessary refining capacities to meet current and future demand and forecasting energy demand. Export elasticity is also an important parameter in refinery capacity expansion. As export volume increases less is left for the exporting country to consume, this may bring about a fall in consumption and rise in prices if demand is not met locally. These are important tools in policy making as they usually indicate the degree of price change ( say increase or decrease) needed to restrain domestic consumption wastage and to find possible market forces to achieve energy preservation. A lot of effort has continually been dedicated to the estimation of energy demand elasticities in many developed countries, the results of those estimation have been of great worth for demand management and projection. The demand for crude oil has received significant

interest, and the Concerns in these studies have been to gauge the degree and speed of consumer response to changes in fuel prices and income, and in these recent times to evaluate and recommend policies aimed at environmental protection (Al-Faris, 1996). The Middle East still remains the focal point for global oil market, it has done this by dominating the reserves representation, continual search for oil and natural gas resources and developing the findings, mounting its refineries to be the best internationally and to participate in international export markets and also to provide for the ever increasing domestic markets. It is no wonder that changes in prices for oil generally do not affect demand in the middle east, this is because the government keep the prices artificially low for domestic consumers (by means of subsidy as earlier mentioned), though high prices on the other hand will bring an influx of revenue for the region. The demand for oil in general in the region continues to rise but initial data shows that the demand growth for the year 2009 was modest. Historically, crude oil capacity for the region has expanded; by the year 2008 its crude oil capacity has expanded over four times the level it was in 1965 as reported in Energy global regional report (2010). A number of researchers have searched the importance of domestic demand for crude oil products in exporting nations. Oil being the major input for the production of petroleum products, changes in demand may have policy implications. Understanding the Changes in consumption of petroleum product demand can be done using income and price elasticity of demand; export elasticity can also be used to gain more understanding of domestic consumption. A lot of studies like that of Dahl et al (1994), Al-Faris (1996), Bhattacharyya and Blake (2009) amongst others, have concentrated on examining the relationship between changes in oil prices and domestic economic activity in major oil consuming and producing economies, other studies have examined both short and long-run price and income elasticity of demand for petroleum products in oil exporting countries. This paper intends to estimate demand elasticity in some selected Middle Eastern countries. These countries are Saudi Arabia, Libya, Iran, Kuwait, Qatar, United Arab emirate (UAE) and Algeria is included in the studies because of its close location to the region and it is also a member of OPEC; these countries were also selected because they are medium to large Middle East countries. The select countries herein are not just net exporters of oil in the Middle East but are also all OPEC members, as it is also a common denominator with

member countries of OPEC, oil and gas is the mainstay of the economy. Saudi Arabia witnessed a sharp increase in domestic demand for oil product after the oil shock 1970s as all sectors experienced growth, the consumption of oil products and the demand for them also increased- a trend which has continued till date. Algeria also saw a growth in its economy, leading to an increase in energy demand, an increase in petroleum product consumption, and an increased demand. According to the U.S. EIA, in 2010, Saudi Arabia was estimated to be producing 12 million barrels per day thereby, upholding its status of the worlds largest producer of crude oil, it is also the largest consumer of crude oil the Middle East region, with an estimated daily consumption of about 2.4 million bbl/d (EIA, 2009). The EIA (2011) puts Algerias production to have also grown in general but witnessed a drop in production from an estimated 1.42 million bbl/d in 2008, to 1.33 million bbl/d in 2009. Iran has the biggest population in the Middle East, with an estimate of 1.7 million bpd for oil product demand. Approximately 70% of the demand is for middles distillates and gasoline. Kuwaits petroleum product demand on the other hand has an estimate of 360,000bpd; Kuwait still remains a major producer and exporter of crude oil. Qatar is not only a net oil exporter but is popular for its huge natural gas reserves, it is the third producer of gas in the world, it is a home to many LNG and GTL projects it is currently the largest supplier of LNG in the world. Meeting world oil demand is the emphasis placed on these oil exporting countries, with little or no emphasis being placed on meeting domestic demand, thereby, shying away from the imperative of satisfying domestic consumption. This paper will provide a set of estimates of price, income and export elasticities of oil product export in the Middle East or gulf countries as sometimes referred to, and also shed some light on their implication for government policy making in relation to energy supply in the long run. For even better understanding of the pricing policy in the region, this research looks at subsidy in the Middle East, and found that the consumers benefited more from artificial price cut in the Middle East than the producers which in this case is the government as most of the revenue gotten from export is used to subsidize these petroleum products (Sati, 2010). The study further examines whether subsidy should be removed in the region or not and what will be the benefit? This work follows closely a similar research done by Bhattacharya and Blake (2008). The use of the double-log function model is employed for this analysis, using four select petroleum products (diesel, kerosene, gasoline and residual fuel oil). The work is divided in

to six chapters with the first chapter being the introduction, chapter two covers the literature review; chapter three covers in general the evolution of petroleum products, the composition of the oil products in all the aforementioned countries and the issue of subsidy on petroleum product in the region; Chapter four shows the sources of data and methodology used for the analysis, while Chapter five presents the findings and compares the results, and Chapter six concludes the paper.