Is it time to cut energy subsidies?

Aziz, Munich, Germany

The term subsidy has become a part of daily vocabulary (again) since new Vice President Jusuf Kalla announced that the government of Indonesia intended to cut fuel subsidies by 40% in 2005.

Otherwise, the state budget cannot be sustained without running a large budget deficit as a result of the drastic upsurge in the subsidy (Rp 70 trillion) due to the increasing oil price in the world market and Indonesia's current position as a net importer of oil. It might be hard to grasp this development since Indonesia ranks as the number 17 oil producer in the world. However, the IEA (International Energy Agency), in its World Energy Outlook Report 1999, projected at the time that within five to ten years, Indonesia would become a net importer partly because of high subsidies on petroleum products that encourage domestic consumption.

But practically every country in the world has a problem with subsidies. Fuel subsidies are a compelling issue in Indonesia because of the magnitude and the far reaching impact on the whole society in Indonesia.

Analysts have elaborated on the diminishing capacity of Indonesia's oil supply (both in reserves and production) and how the revenue collected by the central government could not fund the subsidy any longer, so that the decision cut the fuel subsidy seems reasonable, or at least understandable. It is not the best solution, many will agree, but one of the possible that is now available. The immediate reason for cutting the fuel subsidy is the strong pressure on the state budget: Either sustaining a low fuel price by running a deficit budget or increasing the fuel price to avert a larger deficit budget, but with possible side effects of higher inflation, lower competitiveness and, hopefully not, social unrest.

Nonetheless, it might be a good time to reconsider the strategy on national subsidies, in particular, the energy subsidy.

Subsidies are created on the basis of (perceived) failure of market mechanisms to allocate resources efficiently thus intervention is needed, or corrective devices, to induce markets to function more efficiently.

Further scrutiny would reveal that there are protective, stimulating and distributional components, together or separately, in every subsidy policy. Subsidizing is a very sensitive issue because it deals with public goods, and public resistance usually takes place in response to a reduction or removal of a subsidy -- sometimes it is with good reason too.

When the poor benefit from the subsidy, it will be at the minimum amount and higher income households or businesses enjoy the most, because they consume more of the subsidized fuel, unless a very specific target market is able to get the subsidies.

On the flip side, when public goods are available for free or with a minimum cost, there are three consequences that arise: Overconsumption, lack of scarcity and no sense of conservation. In the case of energy by oil-burning or coal-burning, other side effects are pollution (including greenhouse gas emissions), nitrogen enrichment in soil (could be dangerous for potable water) and global warming.

It is interesting to note that while Indonesia tries to push the domestic energy price closer to the world market price for budget reasons. Germany, for instance, has gone even further, implementing an "ecological" tax for petroleum products and electricity. This measure was taken to manage pollution and overuse of non-renewable energy. This tax simply assumes that every consumer of petroleum products is a polluter, thus each has to pay "compensation" to those who do not use these products. Money collected through this tax will be used for offsetting the reduction in pension contributions and for promoting other renewable energy sources.

Thus there are two primary drivers to manage the energy subsidy: limit the consumption of non-renewable sources (oils, coals) and switch to renewable ones as well as reallocating the subsidy to help the poor and disadvantaged through alternative routes or mechanisms. But, the question is how?

First, with Indonesia's position as a net importer, can the current level of consumption still be continued? If we want to avoid an energy crisis, it is certainly not. As the term suggested, non-renewable energy can be sustained when and only when consumption is managed under the capacity or reserves. Or new deposits are always explored, found and exploited to make up the for overconsumption.

That means new investment, whereas attracting new investment in Indonesia is now very difficult and it takes more time to realize a committed investment plan. Besides, we may want to mull over the recommendation by Extractive Industries Review (EIR), a task force commissioned by the World Bank and chaired by Emil Salim, for the World Bank to abandon financing extractive industries (non-renewable) because it does not go along with its mission to alleviate poverty through sustainable development.

On the other hand, while we are discussing this energy subsidy, the low-income households already suffer the adverse effect of the plan to reduce the energy subsidy.

But we may not be illusive to provide everything for free either. The focus must not be directed only on whether "the price is right" but on whether "the income is right".

Finally, energy subsidy reform does not come without risks either. When the domestic price increases, investment might become more attractive hence, even spurring the exploration and exploitation of petroleum energy. The alternate mechanism of the subsidy might not work as expected, especially when corruption is still imminent. There must always be caution and provision in a changing policy and implementation, but given the level of energy problems within the perspective of sustainable development, reforms must take place immediately.

It is hard, but it is harder to ignore it.

The writer is a post-graduate student in Sustainable Resource Management at the Technical University of Munich. He can be reached at aziz9672@yahoo.com