The Effects of the Energy Price Reform on Households Consumption in Iran

Abstract

Iran is an energy-rich country and one of the world’s main oil-exporters, but its own rapid energy consumption in recent years has raised concerns about the ability of the country to continue exporting oil in the future. Economic growth, massive energy subsidies, and mismanagement of the energy sector are blamed for increasing energy consumption, which has led to very high energy intensity, fiscal imbalances, unequal income distribution, and environmental degradation. In response to an urgent need to monitor energy consumption and ease fiscal pressure, Iran embarked on an unprecedented energy price reform to remove subsidies in 2010. However, the effects of energy price reform on energy consumption and the wellbeing of households depends on the demand elasticities for different energy types in different income groups. To shed light on household response to energy price reform, I use a two-stage optimization demand model to derive energy demand for households and estimate energy demand elasticities for electricity, natural gas, and gasoline for households in different income groups. The data is from household budget surveys for 2001-2008. The results indicate that due to inelastic demand for energy by households, the overall effect of price reform on energy demand will not be significant. Furthermore, the price reform will be regressive as the energy expenditure’s share of income for low income groups will increase. Also, the compensation package intended to mitigate the income distributional effects of price reform will likely lead to higher energy consumption, particularly in low- and mid-income groups. The results call for a more comprehensive energy reform policy to control energy consumption and to improve energy efficiency.

Keywords: Energy, price reform, subsidies, elasticity, households, Iran

JEL Classification: D12, Q41, Q48, R21