Regulation of Energy Prices in Russia

Russia prices its energy commodities domestically much lower than the prices prevailing in the international market. Using a general equilibrium framework, we analyse reasons for why Russia should or should not use such a price regulation. First, being a major exporter of energy commodities and having considerable monopolistic market power, the country is able to use its supply in order to influence the international energy prices. A rational way to channel this rent to the domestic non-energy sector and to domestic consumers is through a lower, i.e., competitive, domestic price on energy than that in the world market. Second, we introduce the classic infant-industry argument with positive intertemporal spillovers through learning-by-doing linked to current production. These spill-overs are likely to be relevant for manufacturing in a transition economy, which argument creates a further reason for a deviation in the pricing of energy to domestic industrial producers from the world market prices. However, an empirical consideration of these results and the estimation of the learning-by-doing curve suggest that the first effect can in principle be sizeable, while the second is only marginal and that, overall, Russia is currently subsidising its domestic energy prices clearly too much. Further, we conclude that the country should not subsidise its domestic consumers more than its domestic industry, as it does in reality. We also derive the optimal domestic energy tax and show that it is modest in comparison to its current rate. The optimal pricing policy could therefore have a marked positive effect on the international supply of energy by Russia.