Fuel subsidies wasted

Fuel subsidies wasted

The steep oil price hike since May -- to as high as US$50 per
barrel now -- has finally forced the Indonesian government to
revise upward from $22 to $36 per barrel the average oil price
used to estimate oil tax revenues and the cost of fuel for the
current fiscal year. However, the contingency measure Minister of
Finance Boediono proposed to the House of Representatives on
Tuesday does not, by any means, bring about fundamental changes
to basic energy policy.

The government, instead, has decided to abandon its sensible,
fuel-economic, 2002 policy to float domestic fuel prices on
market quotations in Singapore to encourage efficient use, slash
subsidies, target price support only to poor consumers (kerosene
for household use) and, most importantly, minimize smuggling
overseas. Consequently, fuel subsidies for 2004 will balloon to
more than Rp 63 trillion ($7.08 billion), much more than total
central government spending on its personnel (civil servants, the
police and the military).

Since the government maintains domestic fuel prices way below
actual production costs -- applying a blanket subsidy on all
kinds of fuel -- the bulk of the subsidies may end up benefiting
mostly private car owners (middle and top-income consumers). Most
devastatingly, fuel smugglers will receive even stronger
incentives, as their profit margins will skyrocket.

True, part of the subsidy will go on kerosene, which is widely
used by poor people. But corruption will continue to divert quite
a significant portion of this cheap fuel to industrial users and
smugglers.

Until last year (when Indonesia was still a net oil exporter),
any increase in international crude oil prices would give the
government net additional revenues. However, starting this year,
as the country is already a net oil importer of about 36,000
barrels a day, an oil-price hike immediately cuts into central
government income as additional revenues are much less than
additional spending on subsidies.

The problem is that fuel subsidies are borne by the central
government alone, while a larger portion of the additional
revenues from higher oil export prices must be shared with local
administrations, in line with the 1999 law on fiscal relations
between the central government and regional administrations.

It would be political suicide for the present government to
adjust domestic fuel prices to international market quotations,
especially as the incumbent president, Megawati Soekarnoputri,
will also compete in the Sept. 20 runoff. Moreover, raising fuel
prices now could affect political stability in the run-up to the
presidential election.

However, by doing virtually nothing to stop profligacy in the
use of oil or to target better the bulk of subsidies to the poor
is simply to plant a time bomb for the new government. The
subsidy amounts to a future tax that has to be paid sooner or
later.

The verdict among most energy analysts now is that the era of
cheap oil is already over; they point out that the steep oil
price rise since late May is not speculative in nature. Nor is
the trend primarily a supply shock. The plain truth is that the
world is consuming almost all new supplies gushing out from the
ground. OPEC producers no longer have enough spare capacity to
meet the insatiable global thirst for fuel, especially the
steadily high demand from China's economy, which keeps growing by
7 percent to 8 percent per year.

Worse still, analysts say, the cushion of extra supply is so
thin at a time when troubles are popping up in major oil-
producing countries, such as Iraq and Russia. Years of
underinvestment by the oil industry in everything from drilling
to refining have left producers with little to fuel the world.

As long as Indonesia depends on a dwindling supply of oil, the
threat of an economic downturn will remain. Therefore, the new
government will have to make radical changes in the way oil
energy is used: That could be achieved immediately by curtailing
fuel subsidies in the draft 2005 budget and targeting such
subsidies only to kerosene for household use.

Improving energy efficiency and conservation takes a long time
but it could be done if consumers were forced to pay the real
economic cost of fuel.

Indonesia is endowed with a wide variety of energy resources
such as oil, natural gas, geothermal steam, coal and hydropower.
These alternative resources will become more commercially viable
now, as the era of cheap oil seems to be over. This would be
especially true if the government made the investment climate in
the energy industry much more attractive and competitive to other
countries.

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