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: Smuggling makes fuel-subsidy cut even more imperative

Vincent Lingga, The Jakarta Post, Jakarta | Opinion | Sun, September 28 2014, 1:37 PM

Several military (TNI) and police members were embroiled in a brawl at a housing complex on Batam Island near Singapore early this week after a police raid nearby on an alleged illegal storage house of subsidized fuel leaving four TNI non-commissioned officers with gunshot wounds.

A few days earlier, a low-ranking female civil servant, also in Batam, was arrested on charges of laundering Rp 1,300 billion (US$108 million) in cash allegedly derived from the illicit export of subsidized fuel. Four others, including an employee of state-owned oil company PT Pertamina and two temporary Navy employees, have also been implicated in the contraband fuel trade case.

Earlier this month, the Supreme Court almost doubled the sentence of former low-ranking police officer Labora Sitorus to 15 years’ imprisonment for fuel smuggling, illegal logging and money laundering worth about $103 million.

These are just a few of the dozens of cases of subsidized-fuel smuggling uncovered over the past 10 years.

It is common knowledge that a lot of subsidized fuel has always been smuggled overseas; the long coastlines of the world’s largest archipelagic nation provide great opportunities for such contraband trade.

Poorly-paid officials, police, members of the military and employees of state oil company Pertamina, the sole supplier of fuel oil, are all highly prone to corruption. Most importantly, the subsidized prices of domestic fuel oil are far — almost 50 percent — lower than in neighboring Singapore and Malaysia, which are only about 20 minutes by ship from Riau Islands, including Batam and Bintan.

The customs agency, the police and patrolling naval units do reveal from time to time the interception and foiling of oil smuggling, but this is simply a ploy to mislead the public into thinking that they are doing their best to prevent fuel being smuggled overseas.

The greatest credit for the latest uncovering of massive fuel smuggling should go to the Financial Transaction Report and Analysis Centre (PPATK), which in most other countries is called the financial intelligence unit.

It was the PPATK, which routinely scours financial records for signs of illegal activity and suspicious transactions through bank accounts, that discovered the fuel smuggling in Papua and Batam.

PPATK analysts realized that the billions of rupiah flowing weekly or monthly through the bank accounts of the low-ranking woman civil servant and former police officer Labora did not comply with their earning profiles, as their official salaries did not exceed Rp 4 million ($333) monthly.

The analysis and further police investigations finally traced the suspicious transactions to a ring of subsidized fuel smuggling that had been in operation for several years.

The rings of fuel smugglers in Riau Islands, Central and East Java, East Kalimantan, Papua and several other provinces that have been uncovered in recent years could not have occurred without collaboration with Pertamina officials or Navy members or seaport officials.

Pertamina still has the monopoly on the distribution of subsidized fuel throughout the country and it must know if a significant volume originally allocated for certain areas is diverted overseas.

Smuggling and other forms of malfeasance related to the misuse of subsidized fuel once again show how imperative and urgent it is now to bring domestic fuel prices closer to international levels. As long as domestic fuel prices remain at only 50 percent of international prices, the large margin is too much of a temptation for profiteers and corrupt officials to resist.

As the country now depends on imports for almost 60 percent of its oil needs and oil imports have become the main cause of the ballooning current account deficit and the sharp rupiah depreciation, subsidized fuel smuggling could be considered an act of economic subversion.

The government therefore should be deadly serious in investigating and dealing with the brains and leaders behind oil smuggling, unlike in past cases where only the “small fry” have ended up in court.

It is not exaggeration to say that the way the new government addresses the runaway fuel subsidy will be the litmus test of its economic management and policy-making capability.

President-elect Joko “Jokowi” Widodo promised in his election campaign to abolish fuel subsidies within four years. He should deliver this promise, but time the gradual phase-out wisely to minimize the impact on inflation. Most analysts consider November or April, which are the harvest seasons, as the most appropriate time to usher in the fuel subsidy cut.

Certainly, reforming the fuel subsidy system will inflict some short-term pain, as production costs and prices of goods and services will increase. Therefore the new government should conduct a nationwide information campaign to prime the public on the benefits of the fuel reform measure.

Many ideas have been touted on how to phase out the fuel subsidy. One reform scenario calls for the indexation of the subsidized fuel prices to an agreed threshold, thereby allowing the prices to move up and down on a monthly or quarterly basis.

The second idea sets a quarterly subsidy spending limit, then adjusts the prices in subsequent quarters when international market oil prices cause subsidies to breach the ceiling.

The fixed-subsidy scheme is attractive because the automatic monthly price adjustment provides policy predictability for the market and general public, as well as protecting the economy from sharp price adjustments and their shocking inflationary pressures.

Whichever policy the new government implements, the energy reform should from the outset clearly set out the fuel-policy direction for the next five years, instead of muddling through one-off price rises.

The writer is senior editor at The Jakarta Post.

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The week in review: Past rhetoric, daunting tasks

The hot stories and the main topic of heated debates during the week after the Aug. 21 constitutional confirmation of Joko “Jokowi” Widodo as Indonesia’s new president beginning on Oct. 20 remain the complex and daunting economic challenges his government must immediately confront.

 Foremost among the tasks is the painful measure the new government has to immediately take to achieve fiscal sustainability, as it will be virtually impossible for Jokowi to deliver even a few of the promises he made to the poor segment of the population during his election campaign without slashing the huge fuel subsidy.

In fact, worries about the shortage of subsidized fuel have already hit many areas, prompting long lines of motorists at gasoline stations as the state oil and gas company Pertamina attempts to ensure that the use of subsidized fuel this year does not exceed its mandatory volume ceiling of 46 million kiloliters. 

The new government will indeed face a very austere budget. More than 85 percent of the 2015 state budget plan will be tied up by routine (operating) spending covering fixed expenditures mandated by specific laws on education, regional autonomy and health, as well as other inflexible expenditures for personnel, debt servicing and energy and non-energy subsidies.

Hence, Jokowi will either have to cut a portion of the Rp 364 trillion (US$31.14 billion) energy subsidy or step up tax collection to get more revenue to fund some of the top priority programs he promoted during the election campaign.

However, since economic growth in 2015 is expected to be stagnant at this year’s 5.3-5.5 percent range, it would be rather difficult to immediately increase tax revenues. Hence, cutting fuel subsidies could be the most feasible way of immediately generating savings to use for more productive programs.

When it comes to the huge, wasteful spending on fuel subsidies, Jokowi’s position is by and large similar to President Susilo Bambang Yudhoyono’s four months after his rise to power in October 2004, when his predecessor Megawati Soekarnoputri left behind a fuel-subsidy time bomb.

Consequently, Yudhoyono was forced to raise the price of subsidized fuel twice in early 2005 or face severe fiscal difficulties.

The dilemma is that the issue of fuel subsidies has always been socially and politically sensitive, causing street protests and political turbulence at the House of Representatives, despite it being public knowledge that more than 70 percent of the fuel subsidies are enjoyed by middle- and high-income citizens.

Yet more worrisome is the risk as to whether the new government will be able to gain House approval for a raise in subsidized fuel prices as the coalition of opposition parties still controls more than 52 percent of the seats at the House.

The biggest challenge in ushering in fuel-price reform (meaning raising prices) is related to how social safety net programs should be designed and structured to cushion the impact of the general price increase caused by higher fuel prices on low-income citizens, the most vulnerable members of society.

Even though the number of citizens living below the poverty line has decreased to less than 12 percent of the total population, the number of people living on the verge of the absolute poverty line has remained large. This highly vulnerable group could easily be plunged into dire poverty by even the slightest decline in the macroeconomic condition.

The other downside risk is that the commodity market will most likely remain weak next year due to the persistent decline in the economic growth of  China, Indonesia’s biggest trading partner. Meanwhile, Indonesia’s manufacturing sector is unable to offset the decrease in export earnings from natural resources because of an acute shortage in supply capacity and low competitiveness due to the high logistics costs caused by poor infrastructure.

Given these limitations, the new government should do its best to woo more inflows of portfolio capital to fill in the large current account deficit, as well as foreign direct capital to build new manufacturing plants and infrastructure.

The next top-priority initiative requires the incoming government to expedite negotiations with contractors in the general and oil and gas mining industries so that the pace of production and the speed of new investments can be immediately accelerated. The upstream oil industry needs a special boost because the large deficit in the international trade balance has been generated by oil imports that now account for more than 60 percent of national consumption.

The new government should go the extra mile to convince foreign investors that it is not influenced and misled by partisan resource nationalism, as the rhetoric during the past election campaign implied.

In view of the high expectations facing the new government and since bitter pills (painful measures) are included among the first action programs Jokowi must implement, it is of paramount importance for the new government to maintain the public trust by demonstrating high standards of governance and clean and efficient administration.

The first test for sustaining this confidence lies in Jokowi’s selection of the members of his Cabinet, especially his economic team. It would also help minimize the potential for protests if the new government channels the bulk of any savings from the fuel reform toward improving infrastructure in rural areas, rehabilitating wet (traditional) markets in urban centers and smoothing the distribution of goods to control the general price rise after the fuel reform.

— Vincent Lingga

Vincent Lingga - The Jakarta Post | Editorial | Sun, August 31 2014, 12:33 PM

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