Is it time to cut energy subsidies?

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