With weak oil market, time is ripe for managed floating fuel prices

Vincent Lingga, The Jakarta Post, Jakarta | Headline | Thur, December 17 2014.

Now that steadily declining international oil prices have hit a five-year low at US$60/ barrel, compared to the $105 average assumed for the 2015 fiscal year, the government has a great opportunity to slash, or even abolish, the wasteful spending on fuel subsidies that cost almost $20 billion annually over the last three years.

When subsidized fuel prices are on par with international levels, which analysts estimate can occur when oil prices fall to as low as $60/ barrel, the government could put fuel prices on a managed float mechanism where prices will adjust according to market rates, as Malaysia did earlier this month. This mechanism was adopted in early 2002 under Megawati Soekarnoputri’s administration.

It was called a “managed float”, not a “free-float” system because the mechanism was still tied to fixed-ceiling prices, whereby the government could intervene in retail-fuel prices if oil prices increased dramatically.

But President Joko “Jokowi” Widodo seems to favor a fixed-subsidy mechanism, a move campaigned for by former finance minister Chatib Basri over the past two years. But then president Susilo Bambang Yudhoyono and the House of Representatives didn’t support that idea.

The fixed-subsidy scheme will fix the rupiah price of fuel subsidy per liter, irrespective of oil-market price developments or rupiah-rate movements.

Under this regime, the price of fuel subsidies per liter will neither fluctuate alongside oil-market prices nor rupiah-rate quotations, as it will be the price of the subsidized fuels that must rise or fall monthly following the oil-market quotations.

But whichever of the two alternative policies the government chooses, the decision should be based on the real economic costs of domestically refined and imported fuels, calculated in a transparent and credible manner. As we now depend on imports for almost 60 percent of our daily fuel needs of 1.66 million barrels and because imports consist of both crude oil and refined oil products, the production costs can vary, depending on the sources.

The problem, though, is that independent analysts and the general public tend to question the reliability of the production-cost figures used as price references by the state oil company, Pertamina, to estimate the fuel subsidies.

Under the current fuel-subsidy regime, the prices of subsidized fuels are fixed at a certain level. However, the final amount of subsidies ultimately depends on the average oil-market price and the rupiah exchange rate. Since oil prices and the rupiah exchange rate tend to fluctuate wildly, the final amount of fuel subsidies also tends to increase dramatically.

The benefits of implementing a fuel-price floating system or a fixed-subsidy scheme are quite obvious: It will relieve the government from the burden of having to haggling with the House every time international oil prices rise sharply, and it will free the government from being held hostage to the wildly volatile international oil market.

Predicting oil prices is always a mug’s game, as prices are influenced by both economic and non-economic factors. In mid-2008, for example, international prices skyrocketed to a peak of almost $150/ barrel, but plunged to as low as $47 later in the same year.

Bringing fuel prices closer to their true costs will also remove the fuel-subsidy time bomb from the government’s fiscal management.

But even more importantly, abolishing subsidies will encourage the development of renewable energy, promote energy efficiency and energy conservation. It will also help stop fuel-export smuggling, which has been rampant due to the porous coastal borders of the world’s largest archipelago.

Energy reform will also cut Indonesia’s trade and, consequently, the current-account deficit, which has been exerting strong downward pressures on the rupiah exchange rate.

Our experience during the first year of the flotation policy in 2002 showed that by allowing for automatic monthly price adjustments, the government was able to provide policy predictability for the market and protect the economy from sharp price adjustments and their shocking inflationary pressures.

The price signals conveyed by this policy will serve as a guideline for companies to conduct in-house management of energy efficiency through maintenance. It will also encourage companies to take housekeeping measures and replace equipment, which could require additional investments or the modification of the entire manufacturing process — moves that may require large-scale investments.

Cheaper oil should also create the momentum needed for the government to gradually phase out the low-quality gasoline with RON (registered octane number) 88.

Most countries have shifted to fuel with RON levels above 90, which are cleaner burning, more efficient and make engines perform better. Malaysia, for example, has long used only RON 95 and RON 97 fuels. Before Malaysia fully floated its fuel prices earlier this month, RON 95 gasoline was sold at RM2.30 (Rp 9,200) per liter, carrying a subsidy of Rp 520/liter. RON 97 gasoline (non-subsidized) was sold at the equivalent of Rp 10,200.

It would technically be impossible to stop selling RON 88 gasoline (strangely called “premium” gasoline) immediately due to the limited capacity of domestic refineries. But technical preparations for a gradual phase-out of this low-quality fuel should be made as part of the overall fuel reform program.

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View Point: Shaking up and cleansing the oil regulatory body

Vincent Lingga, The Jakarta Post, Jakarta | Opinion | Sun, November 30 2014, 1:15 PM

The fastest pace and widest breadth of reform taking place under President Joko “Jokowi” Widodo’s 50-day-old government has taken place at the Ministry of Energy and Mineral Resources (ESDM) for the right reason.

The ministry administers, manages and oversees the development of natural resources (oil, natural gas and all other minerals) worth hundreds of billions of dollars in exports, import procurements, taxes and royalties every year.

In a country perceived as one of the most corrupt in the region, senior officials at the ministry and all other agencies under its jurisdiction, notably those with authority for supervision, licensing and procurement, are understandably vulnerable to corruption.

No wonder, Jero Wacik who was replaced last month by Sudirman Said, is now a corruption suspect and Rudi Rudiandini, the former chief of the Upstream Oil and Gas Regulatory Special Task Force (SKKMigas) is now in jail for graft.

 Jokowi’s first move in setting off reform at the ministry was appointing Sudirman, an anti-corruption activist and good-governance champion, as the new ESDM minister.

 Sudirman, an auditor by training, who also graduated from business management from George Washington University, has built years of experience in state and private oil companies and has demonstrated his managerial and leadership qualities in many institutions and organizations.

He was among the founders of the Indonesian Transparency Society antigraft movement and the Institute for Corporate Governance. Sudirman served for almost two years as a vice president at the state oil company Pertamina in charge of reforming its supply chains – Pertamina was at the time considered one of the most inefficient and most susceptible to corruption. But he quit in 2009, reportedly owing to intense lobbying by a strongly influential oil mafia.

 Sudirman rightly selected the oil and gas sector of the mining industry as the first target of his bureaucratic reforms, again for a strategic reason.

The hydrocarbon industry plays a central role in the economy as it is still the main source of primary energy (about 70 percent), contributing almost 6.5 percent of the gross domestic product, US$31 billion in revenues to the national budget (23 percent) and $22 billion in foreign investments a year, of which 60 percent is spent on local goods and services.

 Indonesia is already mired in an oil crisis with the supply-demand gap exceeding one million barrels a day. Crude oil and fuel imports, which last year totaled $42.1 billion, have been responsible mainly for the ballooning current-account deficit and downward pressures on the rupiah.

Worse, according to the Indonesian Petroleum Association (IPA), oil reserve replacement was at only 47 percent last year. The association estimates that annual investments in exploration alone should be tripled to over $11 billion within the next five to 10 years to prevent a widening oil deficit and another $30 billion a year investment in production development is needed, or otherwise the oil deficit could reach 2.5 million barrels per day.

But which investors would be willing to risk so huge a sum of capital if an oil company requires almost 70 types of permits from the national and regional governments, involving 284 processes and 17 agencies, and is subject to land and building tax even during the exploration stage?

According to IPA, the average time needed by oil companies to monetize proven reserves has increased from five years in the 1970s to more than 10 years in the late 1990s and 15 years in the 2000s mainly because of the arduous licensing system, bureaucratic inertia and corruption.

Thus Sudirman’s quick decision taken just a few days after his inauguration, to replace the director general of oil and gas and the chief of SKKMigas, is quite strategic.

He also immediately started preparations for the selection of officials for the levels of directors general and directors at his ministry through an open, competitive recruitment process.

The appointment of Amien Sunaryadi, a former deputy of the Corruption Eradication Commission (KPK), to head SKKMigas signals a massive shake up and reform within the regulatory body.

It plays a key role in the petroleum sector because this regulatory body oversees the management and business plans of all national and foreign companies operating in the hydrocarbon sector.

Sunaryadi’s previous experience as a senior operations officer for the Anti-Corruption Action Plan (ACAP), a cooperation program of the government and the World Bank’s Department of Institutional Integrity (DII), from 2009 to 2012, well equipped him with high managerial ability and technical competence to develop a strong institutional-integrity system at SKKMigas.

The DII has been well known for its success in establishing a strong integrity system within the multilateral development bank, which is constantly exposed to the risk of corruption and other forms of malfeasance as it operates in many developing countries.

The program was designed to build effective internal control mechanisms within projects or an institution able to explicitly identify governance-related risks to achieving project objectives, thus improving project-level governance.

The overall aim of ACAP is to improve management, monitoring and oversight within the Indonesian public sector.

Sunaryadi, an auditor by training, is believed to be able to disseminate within SKKMigas the expertise to audit business processes and eventually develop innovative ways to communicate with civil society organizations, soliciting public feedback on the quality of public services provided.

The reform of SKKMigas, combined with the recent slash of fuel subsidies to bring fuel prices closer to and eventually on par with the actual costs, would contribute greatly to mitigating the risk of corruption within the petroleum industry.

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