The Winding Road to Fuel Price Hikes

In the midst of a global financial crisis, Indonesia enjoyed an impressive 6.5 percent growth rate in 2011. Yet, there have been some concerns over the sustainability of this growth in the long term.

One factor is related to the government’s policy on resource management, particularly the fuel subsidy policy.

With global oil prices exceeding US$100 per barrel, the Indonesian government’s finances will be stretched. Between 1990 and 2010, world energy consumption increased by 45 percent.

The process of economic rebalancing from West to East will potentially create energy supply problems and there is a strong indication that energy prices will continue increasing for the foreseeable future.

Indonesia’s decision on fuel subsidies will have economy-wide implications on growth through inflation rates and budget allocations to other important sectors including education, infrastructure development and poverty reduction programs. Data suggests that in 2011 fuel subsidies topped Rp 165 trillion ($18 billion).

To date, the Indonesian government and House of Representatives are still mulling the best option to deal with the increased demand for fuel and increased fuel prices.

There are three main options being considered: fuel-to-gas conversion, subsidy cuts (therefore price increases), and fuel consumption restrictions. Energy and Mineral Resources Minister Jero Wacik said that “a decision [on which of the options is being chosen] will be made by April 1, 2012” with price increases seeming to be “unavoidable”.

Fuel-to-gas conversion may become the best option in the long term. Compressed Natural Gas (CNG) is said to burn cleaner than fuel, emitting 40 percent less carbon dioxide for the same amount of energy produced.

Unfortunately, the Indonesian government does not seem to have a clear blueprint on how such conversion can be applied on a large scale. The national infrastructure to support the use of CNG is still extremely limited.

Consumers also do not have sufficient monetary incentives to make the switch given the ongoing fuel subsidy availability and the cost of converter kits. State-owned aerospace firm PT Dirgantara Indonesia, currently developing a converter kit to allow drivers to switch between CNG and gasoline, revealed that the kit is expected to be priced at Rp 12 million. Furthermore, there are only 10 filling stations in Greater Jakarta that carry liquefied gas.

Given the complexities of fuel-to-gas conversion, many parties have put pressure on the Indonesian government to immediately cut fuel subsidies. This is also considered to be the preferred option to fuel consumption restrictions.

The government initially planned to restrict private cars in Java and Bali from using subsidized fuel, starting on April 1.

However, the infrastructure to supply alternative fuels was not ready. Along with the difficulty in monitoring, consumption restriction could potentially lead to a supply shortage, which would eventually lead to price increases; while a subsidy cut or price increase would only cause decreases in fuel usage without leading to concerns among consumers or industry about whether their demand could be met.

Three alternatives being discussed are to reduce the fuel subsidy for a liter of gasoline by Rp 500, Rp 1,000 or Rp 1,500.

The market price of Premium, subsidized gasoline with an octane level of 88, is Rp 4,500 per liter while the production cost is Rp 8,200 a liter.

The government is said to be able to provide subsidies at Rp 3,000 a liter as long as national consumption is capped at 40 million kiloliters.

National Development Planning Minister Armida Alisjahbana warned that the likely effects of fuel policy would be sensitive to assumptions on macroeconomic indicators and changes in the global economy being used in impact simulations.

The state budget is developed based on an assumption of oil prices at $90 a barrel which is no longer relevant to the current price level.

It is important to highlight that even if the government decides to increase the fuel price by Rp 1,500 a liter, Premium will still be a subsidized fuel.

It is quite obvious that difficulties in making a decision about cutting fuel subsidies do not only reflect problems in simulating the economic impact but also involve political dimensions.

Increasing fuel prices was not indicated in the state budget, making the government “unable” to take such a decision.

However, the government can negotiate with the House to include this option in the 2012 revised state budget, which only makes the decision-making process even more problematic.

As is widely known, increasing prices is never a popular policy in Indonesia. The majority of Indonesians are still under the impression that increased fuel prices will hit the poor hardest.

The government has a huge task to ensure that the cash assistance to compensate the poor will be effectively allocated to those in need and the money is not associated with the ruling Democratic Party.

In addition to poverty-reduction programs, the government should also make it clear that the money that can be saved from cutting fuel subsidies can be allocated to infrastructure development.

This helps ensure national connectivity and helps less-developed regions to catch up with more-developed regions particularly on the island of Java.

Improvements in public transportation services are also crucial to not only help Indonesians cut their fuel consumption but also to contribute to the global environment. The most important thing is that the public should be made clear that the government is able to do the job.

Given the above issues, what Indonesians can expect to take place in April 2012 will probably be a maximum Rp 1,500 increase in the fuel price and some other “small” changes. For example, the government may now require its senior officials’ vehicles to use nonsubsidized fuel.

Previously, these officials have been “recommended” to use non-subsidized fuel as stated in Presidential Instruction No. 13/2011. Some government-owned vehicles may also convert to gas.

Despite the fact that decisions on the fuel subsidy cut have not been made, overall Indonesia is moving toward the suggested direction.

In Indonesia, the proportion of energy subsidies was cut from 20 percent in 2005 to 10 percent of total government expenditure in 2009.

Targeted subsidies could better reach subpopulations who are at greater risk of poverty than universal energy subsidies.

However, immediate action is needed as the continuing provision of subsidies removes the existence of economic incentives to improve efficiency.

This article is prepared by Risti Permani, a postdoctoral fellow at the School of Economics, University of Adelaide, and was published by the Jakarta Post on Tueday 27 March 2012.

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Filed under Energy, Indonesia, Infrastructure, Poverty

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