Indonesia's oil subsidy problems<\/p>\n
Gabriel Andris Thoumi
\nYogyakarta<\/p>\n
Here are some important global oil facts:<\/p>\n
U.S. uses 25 percent of the world's daily oil production of 80
\nmillion barrels of oil. World oil supplies are at their historic
\npeak of maximum production due to depletion setting in. The
\nplanet is operating at anywhere from 95 percent to 99 percent
\ncapacity production. Since 1965 world trend is oil extraction
\nrates are declining. Over the next ten years China's and India's
\n2.3 billion humans will rapidly expand oil demand.<\/p>\n
Indonesian oil facts are equally worrisome:<\/p>\n
Indonesia's state run oil and gas company PT Pertamina
\ndecreased its fuel reserves to 21 days. Indonesia's 2005
\ngovernment fuel subsidy may be Rp 150 trillion which is 450
\npercent over forecast. The 2005 government fuel subsidy may be
\n275 percent greater than its education budget. Indonesia may have
\nto decrease its 2005 fuel subsidies by Sept. 30.<\/p>\n
Indonesia's 2005 domestic auto and motorcycle sales are
\nexpected to grow 38 percent and 26 percent respectively.
\nIndonesia's fuel subsidies are regressive because the poor and
\nmiddle class subsidize the rich. Indonesia's refining capacity
\nhas decreased from 1.6 million to 1.1 million barrels per day
\nfrom 1995 to 2005.<\/p>\n
Starting September 2004, Indonesia is the only OPEC country
\nto import oil. Average wealthy Indonesian uses about 39 barrels
\nof oil a year while average poor and middle class Indonesian uses
\nabout six barrels of oil a year<\/p>\n
However, the Indonesian government has no nationally-defined
\nfinancial market risk management plan for its fuel subsidy even
\nthough it applies this technology to the banking sector.<\/p>\n
Firms all over the world face a similar situation with regards
\nto financial market risk exposures as do governments. Since
\nhedging can have a material impact on a firm's ability to execute
\ntheir business strategy, firms use forecasting tools to determine
\npossible outcomes to attempt to hedge market risk.<\/p>\n
Market risk is the risk that exchange rates and commodity
\nprices will move causing a firm an unexpected financial loss or
\ngain. Compared with companies, at the national level, the
\nconsequences of a poorly designed hedging policy are much higher.<\/p>\n
The key concept that many governments fail to understand is
\nthat some of the macroeconomic financial market risks can be
\ntransferred to the international financial markets by hedging.
\nEven though there may be a cost associated to hedging certain
\nrisks, the benefits for the country, particularly in terms of
\nallowing the execution of the economic agenda, may heavily
\noutweigh the costs of inaction.<\/p>\n
After having learned the lesson from the 2004 fuel subsidy
\ncost problem, the Indonesian government allocated Rp 76.5
\ntrillion to subsidize domestic fuel for 2005. However, this
\nsubsidy assumed an average global oil price of US$45 per barrel
\noil, a Rp 9,300 exchange rate against the U.S. dollar, and a
\ndomestic consumption rate of 59.6 million kiloliters oil.<\/p>\n
To make matters worse, Indonesia's domestic fuel demand has
\nincreased 10 percent over the first half of 2005 . This was
\nexpected given that domestic automotive sales have increased 38
\npercent year-over-year June 2004 to June 2005 and domestic
\nmotorcycle sales are expected to increase 26 percent in 2005
\ncompared to 2004.<\/p>\n
Early last March, the Indonesian government decreased its fuel
\nsubsidy by 29 percent, but domestic oil fuel prices remain among
\nthe lowest in the world. In comparison, this translates into
\n$0.70 per gallon premium gasoline and $0.68 per gallon automotive
\ndiesel whereas current levels are above $2 in most U.S. states.<\/p>\n
However, these savings from lower subsidies are offset by the
\nrupiah's depreciation and by the expected increase in national
\noil consumption and international oil prices. According to Anton
\nGunawan, Citibank's chief economist in Jakarta, every Rp 100 that
\nthe Indonesian rupiah depreciates against the dollar has a Rp 1
\ntrillion negative impact on a government deficit target of $2.2
\nbillion.<\/p>\n
Since Indonesia's government has to import oil to cover
\nincreased national demand and it is having limited success with a
\nvoluntary national fuel conservation plan, it has now delayed
\ncash transfers to the state run oil and gas company PT Pertamina
\nto force energy conservation. For example, on July 2, PT
\nPertamina reduced daily fuel supplies to West Java Province and
\nJakarta by 5 percent. Before this, each region received about
\n16,500 kiloliters fuel per day. Now roaming fuel shortages are
\ncommon, particularly on the weekends.<\/p>\n
At current prices, economists estimate Indonesia's 2005 fuel
\nsubsidy bill be between Rp 138 trillion and Rp 150 trillion based
\non $60-$80 per barrel oil. About 25 percent-30 percent of
\nIndonesia's national budget is expected to be used for the 2005
\noil subsidy.<\/p>\n
The Indonesian government fears a decrease in fuel subsidies
\nwill threaten stability and increase the possibility of street
\nviolence.<\/p>\n
The second national budget revision session of the Indonesian
\nHouse of Representatives is scheduled for late August with the
\nmain agenda item being further decreases in fuel subsidies.<\/p>\n
If Indonesia continues to base its national fuel subsidy
\nbudget on single-point estimates, it is important for policy
\nmakers to understand the potential variation of those estimates.<\/p>\n
By using quantitative and qualitative market risk management
\ntechniques, they will have some control over the Indonesia's
\nmarket risk exposures. A comprehensive evaluation of effective
\nfinancial market risk implementation strategies is needed in
\norder to make the final decisions.<\/p>\n
With fuel prices at record levels and a falling rupiah,
\ninflation fears are being felt in Indonesia with the central bank
\nrepeatedly warning that it will tackle inflation effectively.<\/p>\n
If the Indonesian government starts moving towards a proactive
\nmacroeconomic financial market risk hedging policy, it would be
\nable to forecast its fuel subsidy needs. This means moving from a
\ncrisis management strategy to an effective financial market risk
\nmanagement strategy by considering preemptive risk analysis tools
\nso that Indonesia can limit its dependency on its economic growth
\nto the fluctuations of international oil prices. Could an
\neffective financial risk management program in Indonesia reduce
\npoverty?<\/p>\n
The writer studies international business development while at
\nthe MBA program at the Ross School of Business University of
\nMichigan after a five year professional banking career. He is
\ncurrently researching Indonesian problems related to market risk
\nand oil subsidies.<\/p>",
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