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Reforming Industrial Fuel and Residential Electricity Prices in Saudi Arabia

About the Project

We developed the KAPSARC Energy Model (KEM) for Saudi Arabia to understand the dynamics of the country’s energy system. It is a partial equilibrium model formulated as a mixed complementarity problem to capture the administered prices that permeate the local economy. KEM has been previously used to study the impacts of various industrial fuel pricing policies, improved residential energy efficiency on the energy economy, the feasibility of installing coal-fired power plants in Saudi Arabia, and to computationally analyze residential time-of-use electricity tariffs. In the present paper, we apply the model to look at the demand response of households in Saudi Arabia to changing electricity prices.

Key Points

The Saudi electricity sector buys fuel and sells electricity at prices administered by the government. In this analysis, we assume that fuel prices are deregulated — priced at their marginal values or international equivalents — and use a long-term static version of the KAPSARC Energy Model (KEM) for Saudi Arabia. This allows a better understanding of the economic effects of energy price reform packages by providing illustrative estimates of their impacts. We do not propose a specific package of reforms, but seek to show the different channels by which the Saudi economy can benefit.

We expand on previous KAPSARC analyses by combining the price reform of fuels used in power plants with the implementation of alternative electricity pricing schemes for households. In particular, we examine the differences between ‘lifeline’, average-cost and marginal-cost electricity pricing policies for residential customers.

Compared with business as usual (a scenario replicating the year 2015), we find:

Energy system-wide benefits of nearly $4 billion per year could be achieved by deregulating fuel input prices, valuing the oil saved at the 2015 average world oil price. Most of these benefits stem from the ability to export more crude oil than otherwise would have been the case.

The total gain to the energy system, however, increases to $12 billion per year by raising electricity prices to households to reflect the cost of supply. Much of this gain is due to the decline in electricity consumption in response to the higher prices.

Without any mitigation for the lowest income households, these consumers would pay an additional $3 billion in electricity costs. However, lifeline prices would halve this burden while maintaining greater economic gains than by only deregulating fuel input prices.

The average electricity price paid under the lifeline scenario would be a more manageable 4.0 cents per kWh, versus an average marginal-cost price of 7.1 cents per kWh, and an average cost price of 7.70 cents per kWh.

In the alternative electricity pricing scenarios we study, natural gas usage by the power utilities falls, allowing gas to flow to other industries, which would consume it to reduce their costs. We find the marginal values of natural gas falling at higher electricity prices, indicating that the supply of gas is becoming less constrained. In these scenarios, lower fuel consumption and investment costs contribute to the policies’ gains.

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