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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