Fossil fuel subsidies and renewable energies in MENA: An oxymoron?

The Middle East and North Africa (MENA) region plays a central role in the global oil and natural gas markets. The region is home to more than 52 and 42 percent of global crude oil and natural gas proven reserves, respectively. In the past decade, the region generated 36 and 22 percent of global crude oil and natural gas, respectively. The abundance of hydrocarbons has sometimes been a mixed blessing for the economies of MENA countries, which have been reluctant to promote energy efficiency or sector diversification. Around the globe, energy intensity —energy use (kg of oil equivalent) per $1,000 GDP — became 15% more efficient between 2001 and 2018. In contrast, MENA became 8% less energy efficient according to the same measure during that period (Figure 1).

Energy Subsidies, Inefficient Use of Energy, and Declining Air Quality in MENA

Massive energy subsidies have been the hallmark of economies in the region, and are the main cause for the increasing energy inefficiencies. According to a 2019 IMF report, energy subsidies in the MENA region constitutes around 13% of the region’s GDP, with a staggering figure of $111 billion for Iran or 25% of its GDP. These subsidies are wasteful and unjust as the region’s wealthiest households are their main beneficiaries. According to another research paper that covered over 20 developing countries, only 7% of benefits from fuel subsidies reached the bottom quintile of households, as opposed to 43% for the top quintile. Thus, while energy subsidies are often justified as a poverty alleviation measure, they feature significant “benefits leak” to the wealthy.

Inefficient consumption of energy has had adverse effects on the air quality in the MENA region. Eight MENA countries —Bahrain, Egypt, Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and UAE— are home to 29 of the 100 most polluted cities in the world according to PM10 concentrations. The welfare loss associated with air pollution in MENA is estimated to be around $154 billion per year or 2 percent of its GDP. 125,000 premature deaths are also attributable to diseases associated with outdoor and indoor air pollution in the region. In Iran alone, air pollution is costing the economy around $13 billion per year, or more than 3 percent of Iran’s GDP, and some estimates put the cost as high as $30 billion. Most alarmingly, Iran’s air pollution has been causing an estimated 20,000 premature deaths per year.

Electricity Generation and Air Pollution in MENA

One industry in particular bears much of the responsibility for such high levels of pollution in the region: electricity production (EP). MENA’s population and GDP have grown by 150% and 220% respectively in the past four decades. Its EP, however, has increased by around 600%. This figure is significantly higher than all other regions, with the exception of East Asia, where EP grew by 680% increase in the same period.

This rapid growth of electricity production in MENA has led to significant environmental challenges for the region as more than 98% of its electricity is generated through fossil fuels. As a result, MENA’s electricity sector is one of the most environmentally damaging in the world. This is especially true for MENA countries where the share of heating oil in electricity production is significant: Lebanon (94%), Iraq (92%), Kuwait (71%), Saudi Arabia (42%), and Iran (26%). While natural gas has steadily become the primary fuel for electricity generation in MENA — accounting for about 65% in 2019— heating oil, which is highly polluting, is still the primary fuel used in the region’s power plants. In 2019, more than 30% of all electricity generated in the MENA region was produced using heating oil.

MENA’s Vast Solar and Wind Energy Potentials Remain Untapped

While the rest of the world has been pushing ahead with renewable energies, hydrocarbon-rich MENA economies have lagged substantially. Of all regions in the globe, MENA has the lowest share of renewable energy as a portion of total energy consumption. Renewable energy — not including hydropower — has been responsible for less than 1.5% of all electricity generation in the MENA region, significantly below the world average of more than 10%.

This is the case even though MENA has immense potential for renewable energy, namely solar and wind. Electricity generation from solar farms, solar thermal power plants, and photovoltaic cells is economically most justifiable in areas with daily direct normal irradiation (DNI) above 5 kWh per square meter. As seen in Figure 2, this is true almost everywhere in the MENA region —shown by yellow, orange, red, purple, and dark purple shadings — while at least half of MENA has DNI ratings more than 6.4 kWh per square meter. From a technical perspective, the region has the potential of producing solar power that is equivalent to 50 to 60 percent of the total global electricity demand.

Figure 2. Direct normal irradiation in MENA

In terms of wind power, large areas of the MENA region have substantial resources. As seen in Figure 3, in more than three-fourth of the MENA region — areas shaded in green, yellow, orange, red, and purple — average wind speeds are greater than 5 meters per second at the height of 50 meters, which is the minimum wind speed required for the development of utility-scale wind farms.

Figure 3. Wind Speeds in MENA at the Height of 50 Meters

Subsidizing the Development of Solar and Wind Energy

Power purchase agreements (PPAs) and Feed-in-Tariffs (FiTs) are policy mechanisms intended to promote investments in renewable energy by offering long-term contracts and cost-based compensations. PPAs generally last 15-25 years and FiT compensations are above retail electricity prices in the market. As of now only five countries in the MENA — Algeria, Egypt, Iran, Israel, and Jordan — have some sort of PPAs in place to incentivize the generation of electricity through wind and/or solar sources. However, the FiTs offered by these PPAs are not attractive enough to accelerate the development of the wind and solar power generation in these countries.

For example, in the case of Iran — the second most populous country in MENA — the FiT has dropped from around 14 cents (USD) per kWh in 2017 to less than 2 cents per kWh in 2020 because of massive currency depreciations in the past three years. This has choked investments in wind and solar energy in Iran. Facing massive budget deficits — mainly because of economic mismanagement and partly because of sanctions — the Iranian government is not able to commit to a fixed FiT of 12 cents per kWh, the minimum average FiT required to make long-term investments in wind and solar farms economically justifiable. The same is true for most of the MENA countries where governments’ fiscal positions are significantly weaker than before because of lower and volatile oil and gas prices in the past decade and the massive economic shock of the global pandemic. For example, for wind energy to meet 10% of total electricity demand in MENA — around 150 Terawatt-hours as of 2019 electricity consumption figures — governments in the region must allocate around $20 billion per year to commit for an economically justifiable minimum FiT of 12 cents per kWh.

Rerouting Fossil Fuel Subsidies to Renewable Energy

At first glance, it seems the region does not have sufficient financial resources to incentivize the development of wind and solar power. However, reducing annual fossil fuel subsidies by only 5% will free adequate financial resources for the MENA governments to subsidize the minimum FiT required for development of wind farms that could meet 10% of all electricity demand in the region. Moreover, less than 40% of one year’s annual fossil fuel subsidies is sufficient to cover the capital and maintenance costs of thousands of turbines in such farms over a 20-year period.

The MENA region has ample solar, wind, and financial resources to transition its highly polluting electricity generation industry from fossil fuels —especially heating oil— to wind and solar sources. MENA governments should critically reconsider their policies around economically wasteful, socially unjust, and environmentally detrimental fossil fuel subsidies which have hindered the development of renewable energies. The reduction of fossil fuel subsidies could lead to higher energy efficiency in the MENA economies, as well as foster the development of the alternative energy economy in the region. This will improve air quality and health outcomes, while also creating hundreds of thousands of green jobs. Furthermore, this shift would reduce water consumption and pollution in one of the most water-stressed regions of the world.

While the economic, social, and environmental benefits of reducing or removing fossil fuel subsidies are indisputable, political considerations have prevented policymakers in the region from taking this important step. With Sustainable Development Goals (SDGs) and Environment, Social, and Governance (ESG) objectives gaining traction among global policymakers, business communities, and consumers alike, the policymakers in MENA will face increasing pressure and incentives to tap into the region’s vast solar and wind potential. Although investments in MENA’s renewable sector have grown by around 10 times in the past decade — from about $1.2 billion in 2008 to more than $11 billion in 2016 — much more needs to be done in this front. Substantial reforms to fossil fuel subsidies are central to this process.

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