Inefficiency at root of fuel price hikes

Parulian Sihotang and Alex Russell, Department of Accountancy and Business Finance, University of Dundee, United Kingdom

Public anger and discontent at the government's New Year's Day announcement of fuel price rises of up to 22 percent, effective as of Jan. 2, 2003, was predictable and is potentially destabilizing for the government.

Of course, it is not only the hike in fuel prices that is stirring the blood, for electricity and telephone tariffs are also set to rise by 15 percent on average.

The government's policy of supporting people and business via state subsidies was rendered unviable by the 1997 economic crisis, and it is not surprising that the International Monetary Fund (IMF) has forced the country to make price increases to help reduce the huge state budget deficit. Indonesians resent the interference of the IMF in their affairs and view it as being akin to the loss of sovereignty.

The government needs to demonstrate leadership at this time of crisis. And stamping out corruption, collusion and nepotism (KKN) should be the first step, for it is clear that inefficiency and KKN, particularly throughout the Indonesian petroleum sector, are major contributing factors in the miserable game.

Anecdotal evidence of KKN and inefficiency is legion, and is no doubt what prompted the World Bank (WB) to fund a study which discovered that the Indonesian oil and gas sector suffered an estimated annual loss of US$1.4 billion in economic efficiency. This loss was due to the subsidies for the five BBM products -- motor gasoline, kerosene, automotive diesel oil (ADO or Solar), industrial diesel oil (IDO) and fuel oil. In addition, the study predicted that the amount the government would have to provide for subsidies until the end of 2005 would be about $36 billion.

The same study also predicted that, if the subsidies were gradually removed, the government's expenditure would be reduced by about $22 billion over a five-year period, and the value of its additional foreign exchange earnings (due to reduced consumption of fuel) would be about $11.5 billion. In addition, the study claimed that, following the removal of subsidies, there would be a net reduction of about $5 billion in environmental damages resulting from particulate matter and nitrogen oxides.

Further, if the lead in gasoline were phased out, there would be an additional $6 billion reduction in environmental damages currently resulting from lead poisoning.

In the light of this evidence, it is hardly surprising that the government has decided to end the subsidies. But if this is all that is undertaken, then the decision effectively represents a tax on all users of petrol. As mentioned above, public reaction has been swift and violent at the thought of bearing the whole cost of the lost subsidies.

To counter this anger, the government must take all possible steps to eliminate KKN and inefficiency in the industry by rigorously implementing austerity measures, minimizing waste caused by inefficiency and corruption, and dealing firmly and quickly with conglomerates alleged to have been partly responsible for bankrupting the economy.

Clearly, a more efficient oil industry freed from the ravages of KKN will produce oil products at a much lower cost. And since the oil subsidy is the arithmetic difference between the cost of the petrol delivered at the pumps and the government-set selling price, the cost to be borne by the public will be much reduced following such improvements.

How can efficiency be introduced? In the oil industry, the government should accelerate both the macro and micro restructuring and redesigning that has been widely reported. As far as up-stream activities are concerned, the Boston Consulting Groups (BCG) claims that restructuring and redefining would net efficiency gains of about $25 billion on a present-value basis over a four-year period.

These savings would be the result of: 1) introducing faster approval processes, shorter discovery/production cycles and increased production rates ($6 billion); 2) improving industry- wide performance through sharing facilities/equipment, lowering costs and adopting new tendering/procurement processes ($16 billion); and 3) increasing recoverable reserves ($3 billion).

Within the downstream sector, the World Bank Report 2000 claimed that Indonesia's petroleum refining and marketing sectors were essentially inefficient due to monopolistic operations. Many of the Indonesian refineries are not competitive by international standards. Use of fuel within the refineries is unacceptably high, product losses exceed international norms, and staffing levels are excessive.

For example, Pertamina has nine refineries with a total processing capacity of about 1 million barrels a day, and most of them are inefficient. Operating costs of a typical Indonesian refinery are nearly double those of corresponding refineries in Southeast Asia ($2.56 per barrel here compared with $1.31 in neighboring countries).

The margin surplus for a hydrocracking type refinery in Singapore is $1.41 per barrel, compared to a loss of $0.89 per barrel for a similar refinery in Indonesia (WB, 2000).

This evidence of huge sector inefficiency excludes the hundreds of project contracts within the industry characterized by KKN.

So, as there are comparable international average cost figures available for all aspects of Indonesia's oil and gas operations, the government should set the oil and gas industry the task of matching or bettering these costs. In this way, the government will be perceived by the public as being serious about eliminating KKN-induced waste and inefficiency in the industry.

The role of auditors in policing the gathering and processing the cost data should also be clearly defined, which will almost certainly require some investment for the training of suitable auditors.

The Indonesian economy stands at a crossroads and the government must not fail the people.