3.1 Price-Gap Approach
The underlying presumption of the price-gap approach is that energy subsidies decrease prices of energy goods and services, thereby, leading to increase in consumption. The “price gap” is the difference between final consumer prices and reference prices that would dominate in competitive markets where no subsidies are provided to either consumers or producers (IEA [
1999]). Theoretical underpinnings of the methodology were developed by Corden ([
1957]). Larsen and Shah ([
1992]) applied the price-gap approach for quantification of global fossil-fuel consumption subsidies. Later, the method was used by the IEA ([
1999,
2006a,
2006b,
2008]) for estimation of energy subsidies in the largest non-OECD countries.
The price-gap approach is described in detail by IEA ([
1999]). The basic idea to compare end-user energy prices with reference prices is very simple; however, practical application of the method is less straightforward since some assumptions need to be made for calculation of reference prices. End-user prices correspond to actual energy prices paid by final consumers. These prices reflect current energy pricing policy of a country and incorporate all taxes and fees as well as reductions and rebates imposed on energy products and services. Reference prices indicate the prices at undistorted market and reflect full opportunity cost of energy consumption. Either international market prices or long-run marginal cost of production could be used as a benchmark for reference prices of energy products. For traded goods, the reference price is calculated based on the export or import border price, for nontraded products, production cost forms the basis. Importantly, border price and domestic production cost should be equal to an ‘ideal’ competitive market. Domestic production cost should be estimated based at the international price even if the product could be produced domestically at the lower cost (OECD [
2010]). Internal transportation and distribution costs are also incorporated in the reference price. In addition, Value Added Tax (VAT) and other country-specific general transaction taxes should be included. These taxes “
are part of the cost of doing business” and do not influence comparative prices between energy products and other goods, and hence, economic efficiency of resource allocation (p. 76 in IEA [
1999]). However, energy taxes should not be used for calculation of reference prices since they partly offset subsidy-induced effects on final prices and consumption. Therefore, subsidies for final energy and gas consumers in Ukraine are calculated utilizing the following equation:
where
is defined as consumer subsidies for gas or electricity,
P—end-user price including subsidies,
—estimated reference price excluding subsidies and
Q—total consumption of gas or electricity. Final prices are differentiated depending on the consumer group, quantity of energy consumed (the price increases with higher energy consumption), and availability of meters. Since energy consumption data for each group of consumers (with different energy consumption and with or without meters) is not available at a very detailed (price differentiation) level, it was decided to compare actual cost, reported by the Ministry of Fuel and Energy (MFE [
2009]) and estimated reference cost for a given quantity of energy consumed. Thus, Eq. (
1) could be presented in the following way:
where
is defined as actual cost of gas or electricity consumed at the current end-user prices reported by the Ministry of Fuel and Energy of Ukraine (MFE [
2009]) and
is defined as cost in an undistorted market. Reference price and cost for gas is estimated based on the price of imported gas and adjusted for transportation and distribution costs and 20 % value added tax (VAT). A special surcharge coefficient on the gas price is also included since it works not as classical energy tax levied on energy to reduce energy consumption or emissions. On the contrary, the revenues generated by the surcharge are used for gasification of new territories and compensation of the losses of Naftogaz (holding the largest share of the oil and gas market in Ukraine) from selling gas to district heating companies. Therefore, the surcharge contributes to full costs of the product and investment needs, which should be included in prices of all goods and services. Hence, the surcharge does not distort relative prices between energy products and other goods. A special surcharge coefficient
1 is used as a coefficient on cost of gas excluding transportation and distribution tariffs and VAT. The duty aiming to compensate expenditures of Naftogaz on selling gas to households has also been included for the same reasons. Therefore, reference cost of gas,
(in Ukrainian Hryvnia, UAH) is expressed as
(3)
where
is total consumption of gas (in 1000 m
3),
(in UAH per 1000 m
3) is the price of gas at the border,
(in UAH per 1000 m
3)—cost of selling gas incurred by Naftogaz,
—special surcharge coefficient;
and
transportation and distribution tariffs (in UAH per 1000 m
3), respectively. In 2008, the price of imported gas was at 945.5 UAH per 1000 m
3 which approximately equals 179.5 USD.
2 Average 2008 values of other price components provided by the National Electricity Regulation Commission (NERC [
2009]) and Ministry of Fuel and Energy ([
2009]) are used in estimates. Since Ukraine less actively participates in electricity trade (about 4 % is exported according to NERC [
2009]) with other countries compared to other types of energy, long-term production cost is a more appropriate benchmark for estimation of subsidies than the export border price. According to NERC ([
2009]), the wholesale market price (for suppliers) reflects all operational costs and incorporates surcharge for some investments. However, current tariffs are not high enough to compensate for depreciation and investment needs in nuclear, hydro, and most thermal power plants (IEA [
2006b]). According to the Energy Strategy of Ukraine (MFE [
2006]), the electricity sector requires around 196 billion UAH (37 billion USD) of investment during the period from 2006 to 2010, which means approximately 39 billion UAH (7 billion USD) annually. MFE ([
2009]) reports that about 5 billion UAH (0.95 billion USD) of capital investment have been utilized by the energy sector from all sources (including surcharge) in 2008. Hence, investment deficit amounted to around 34 billion UAH (6.5 billion USD) or 0.27 UAH/kWh (0.05 USD/kWh) for approximately 125 billion kWh of electricity consumed in 2008 (MFE [
2009]). Therefore, prices should be increased by about 0.27 UAH/kWh in order to reflect long-run production costs. This approach is especially relevant because the government perceives optimization of the price and tariff policy as one of the most important mechanisms of investment in the energy sector (MFE [
2006]). In addition, the wholesale price should be first adjusted to eliminate cross-subsidization of households by industrial consumers. The price used in calculations is reduced by 23.7 % (proportion of cross-subsidization) (NERC [
2009]). Therefore, reference cost of electricity
(in UAH) is calculated as follows:
(4)
where
—total electricity consumed (in kWh),
—wholesale price for suppliers (in UAH/kWh),
—investment deficit (in UAH/kWh),
and
—transmission and supply tariffs for electricity (in UAH/kWh). Average 2008 prices and tariffs in the electricity sector published by National Electricity Regulation Commission (NERC [
2009]) are used in the estimates.
Despite the fact that price-gap metric is widely applied for cross-country studies (e.g., Burniaux et al. [
1992]; IEA [
1999]; Larsen and Shah [
1992]), due to its relative simplicity and low level of data requirements, it has a number of important limitations described by Koplow ([
2009]) and IEA ([
1999]).
3.3 Data
The most recent input–output table for Ukraine, available for 2008 is used in this study (SSCU [
2010]). In the columns of the table, industry sectors are classified according to Ukrainian statistical classification of economic activities, which was developed based on classification of economic activities in the European Community (NACE). Classification of commodities and services (in rows of the table) is in line with state classification of commodities and services based on European Classification of Products by Activity (CPA).
The table consists of 38 sectors, 6 of which refer to energy goods and services, 11 manufacturing industries and construction, 16 service sectors, 2 transport sectors and communications, 3 sectors capture activities in agriculture, fishing and forestry. Table
2 illustrates interindustry transactions between sectors (
Z), final demand for each industry’s outputs (
x) is reflected in the column vector
y and
refers to primary inputs required by each sector. Value added part of the table incorporates wages for employees, profits, taxes, and subsidies on production. In addition to final deliveries to households, government and nonprofit institutions, the “use” section of the table provides data on gross capital formation and net exports.
Table 2
Schematic representation of the IO table
Selling sectors | 1 ⋮
i
⋮
n
| Interindustry transactions Z |
y
|
x
|
|
Value added | | | | | |
Total outlays | | | | | |
The table is augmented by additional columns in physical units to account for effects on GHG emissions, employment, total energy and gas consumption by each sector utilizing the data published by the State Statistics Committee of Ukraine ([
2009a,
2009b,
2009c]) and GHG emissions inventory of Ukraine (MENR [
2010]). Since the level of detail for each examined variable is different, the table has been aggregated to complement the data on environmental and socioeconomic factors. In particular, the table was aggregated to 13 economic sectors to complement GHG emissions data available and to 28 sectors to study effects on energy consumption and employment.
3.4 Limitations
It is important to note that obtained results should be treated with caution because of the data caveats associated with this study and inherent limitations of the methods used. First of all, the accuracy of obtained results depends on the quality of the data used in the model. National income accounts always have a “
residual error,” which is the difference of GDP estimates according to two of three possible conventions (Perman et al. [
2003]). Secondly, input–output models embody a number of simplifying assumptions, which should be considered carefully while interpreting obtained results. However, those assumptions are transparent and mathematically traceable. One of the most important shortcomings of the input–output analytical framework is that technical coefficients and the coefficients of physical factors, e.g., GHG emissions and energy inputs do not change as a result of energy subsidy induced price changes. In other words, there are no substitution responses to increased prices of energy inputs. At the same time, price elasticities of demand are incorporated in the study design to allow for adjustment of quantities of goods consumed to price changes. Ho et al. ([
2008]) argue that this approach could be intrinsically inconsistent since the response of final consumers to higher prices is taken into an account while producers are not able to switch to less energy intensive inputs. Therefore, an assumption is made that all additional costs to producers are passed on to final consumers. In addition, Perman et al. ([
2003]) note that, in reality, higher energy prices would result in consumption of less energy per unit of output and less energy-intensive intermediate inputs, which in turn would decrease prices. Thus, the input–output price model sets up the upper margins to price changes which would eventually occur. Moreover, there are some other important limitations of using input–output analysis. In particular, price changes would also affect investment decisions and labor inputs, which are not taken into account (Ho et al. [
2008]). Nevertheless, assumptions of the approach are consistent with the short-term time framework adopted in the analysis. In other words, the impacts of subsidy reform are estimated before the economy has adjusted for price changes assuming that there is no time for structural changes and substitution of labor and capital for energy as well as cross-substitution of fuels. Technological change and cross-substitution between energy and nonenergy factors of production could be explicitly modeled with (CGE) models, which on the other hand introduce other model-immanent problems (see, e.g., Clarete and Roumasset [
1986]; Scrieciu [
2007]). Other methodological limitations are highlighted in the analysis section since they are important for interpretation of estimates obtained.