Cutting fuel subsidies

Cutting fuel subsidies

The state oil monopoly Pertamina disclosed on Monday that a
number of industrial companies in the Greater Jakarta Area
allegedly bought subsidized automotive diesel oil through
gasoline stations. Pertamina detected this abuse after learning
that many gas stations near industrial centers had run out of
stocks much sooner than they used to, even though there were no
reasons for panic buying. It also discovered in its sales records
that many industrial companies, though remaining in production,
suddenly stopped using their monthly fuel allocation from
Pertamina or sharply cut down their fuel procurement.

This abuse was one of the widely predicted risks when
the government, afraid of a worsening social and political
crisis, postponed a 20 percent across-the-board fuel price rise
in April, opting instead to discriminately increase fuel prices
to as high as 50 percent of market prices for industrial users
and 100 percent for merchant and fishing ships plying
international waters. Fuel prices for transportation and
household use remained unchanged.

Even though most analysts and Pertamina itself have been
aware of the high probability of abuse of the discriminative
pricing measure since its introduction, we still feel disgusted
at the names of big companies being included among the alleged
abusers. Their circumventing of the discriminative pricing policy
might not lead them to criminal charges, but many of them are
publicly listed companies that are supposed to profess good
corporate governance. Such companies deserve public humiliation.

But the positive point about the discovery is Pertamina's
ability to detect possible abuses early on. Hopefully, the
company will grow on the job, developing shortly a more effective
system of managing and supervising fuel distribution at different
prices so as to minimize these abuses.

Pertamina has estimated that the April discriminative pricing
measure will cut fuel subsidies by Rp 3 trillion. Even though
abuses may account for as much as 10 percent of the fuel used by
industrial users, the bottom line is still quite positive.

The dilemma though is that the government has to gradually cut
fuel subsidies, which in the current budget are estimated at Rp
41.3 trillion (US$3.75 billion at current prices) or almost 14
percent of total expenditure, have been rising steadily because
of changes in the basic assumptions used in their estimate
calculations.

The original subsidy estimate assumed that the international
crude oil price would average $24 per barrel and the rupiah rate
Rp 7,800 per US dollar for the whole year. However, international
oil prices have always been above $24 and the rupiah rate higher
than Rp 9,000 per dollar since the outset of the budget in
January. This has certainly inflated the amount of subsidy due to
the widening gap between Pertamina's fuel production costs and
the government-set prices. One should also remember that
Indonesia, despite being a net oil exporter, imports about 20
percent of its fuel needs due to a lack of refining capacity.

Some estimates put total fuel subsidies at Rp 66 trillion for
the whole year if the rupiah rate averages Rp 9,600, much higher
than the original projection of Rp 7,800, and average
international oil prices hovering at $28 per barrel. But
projecting the rupiah rate amid the heightened political
uncertainty is like shooting at a moving target.

There are only a few options available to cut the mushrooming
fuel subsidy and each has its price, carrying with it a political
risk or the risk of being abused. An across-the-board price rise
could create political volcano, recognition of which forced the
government to annul such a measure in April. Discriminative
pricing measures, such as the one imposed on industrial users in
April, are vulnerable to abuse as Pertamina has recently
discovered.

Still the government has to choose one of these painful
options, the one with the least cost or smallest risk. Subsidies
are a future tax that has to be paid, and the longer such
spending is allowed at uncontrollable rates, the more devastating
will be its impact and the more painful its cure.
A blanket subsidy for all kinds of fuel may end up with the bulk
of the subsidy being enjoyed by the middle classes and the rich.

As Pertamina gains experience in managing the discriminative
pricing policy, the combination of this measure and an across-the
board price increase, but at a moderate rate, deserve serious
consideration. But this measure should be supplemented with the
distribution of direct subsidies to the poor, as the government
is doing with the Rp 800 billion saving resulting from the 12
percent fuel price rise last October.