Bearing the consequences of Indonesia’s fuel subsidy

Author: Fitrian Ardiansyah, ANU

Indonesia’s decision at the end of March to reject an increase in petrol prices, thus delaying the reduction of fuel subsidies, is likely to have significant costs for the country and its people, impacting on the economy, the environment and Indonesia’s energy security.

Under the Suharto regime, Indonesia’s central government subsidised the price of a variety of energy products, including low-octane gasoline, with the aim of ensuring that energy was cheap and readily available. As long as the price of oil was low and the value of the rupiah relatively high, the subsidies remained modest.

But the decision to maintain fossil fuel subsidies in the wake of the Asian financial crisis of 1997 has severely affected the state budget. This is because Indonesia has been a net importer of both crude oil and refined products since 2004. With the skyrocketing demand for oil — especially in the transport and power sectors — and soaring global oil prices, the Indonesian economy has been placed under considerable strain.

Heavy oil and electricity subsidies cost the government US$9.78 billion in 2010, as shown by several studies, and are estimated to increase to US$18.55 billion (17 percent of government expenditure) in 2012, according to the Ministry of Finance’s Directorate General of Budget. The latter figure could be even higher since it reportedly underestimates the actual global oil price.

This pressure on the state budget also has other unwanted effects, namely, reduced allocations for poverty alleviation. For instance, Armida Alisjahbana, the state minister for national development planning, argued that a great deal of financial assistance to the poor, including funds allocated to the People’s Temporary Direct Aid (BLSM), village infrastructure, and improvements in family health programs and public transportation compensation, will have to be delayed or cancelled.

Indonesia’s low petrol prices — due to high fuel subsidies — have also contributed to a higher number of people purchasing private vehicles. According to the Asian Development Bank, the number of vehicles in Indonesia is projected to more than double between 2010 and 2035. The economic costs associated with managing this traffic congestion, and its health effects, are expected to be enormous.

Furthermore, a 2010 World Bank report revealed that, although the intention behind fuel subsidies is to enable poor people to consume fuel, the initiative disproportionately benefits the rich. The Coordinating Ministry for Economic Affairs even admitted in 2008 that indiscriminate fuel subsidies have been an ineffective way to target welfare transfers, with the wealthiest 40 per cent of households capturing 70 per cent of the subsidies.

Another unwanted consequence is the fragile security of Indonesia’s energy supply. Given the country’s low petrol prices, a 2009 study indicated that consumption of fossil fuels in the transport sector increased from six million tonnes of oil equivalent (Mtoe) in 1980 to 25 Mtoe in 2005, or 48 per cent of national fuel consumption. This rapid consumption of fossil fuels, particularly oil, is worrying. For instance, 2012 data from the Energy and Mineral Resources Ministry shows that, with a production capacity of 0.5 billion barrels per year and increasingly limited oil reserves, Indonesia’s remaining oil will likely be exhausted within 20 years.

If no new reserves are found, Indonesia must urgently seek alternative energy sources, including from renewables. But developing renewable energy is a daunting task, especially while fossil fuels are comparatively cheap.

Agus Purnomo, the special advisor on climate change to Indonesia’s president, argued in 2009 that cutting fossil fuel subsidies is the key to bolstering the renewable energy sector’s competitiveness. Money previously used for subsidies could help seed investment in renewable energy development, enabling Indonesia to move toward a sustainable energy growth path.

But since fossil fuels are still heavily subsidised, their consumption is still leading to a heavy increase in greenhouse gas emissions and other air pollutants. This clearly contradicts President Susilo Bambang Yudhoyono’s pledge to reduce the country’s greenhouse gas emissions.

Despite these unwanted consequences, removing fossil fuel subsidies is still too sensitive an issue. Simply sweeping the subsidy away has proven to be a high political risk that no party is willing to take. If this situation continues — with constant uncertainty as to whether the Indonesian political elite will act to dispose of fuel subsidies — Indonesia and its people will continue to bear the consequences.

Fitrian Ardiansyah is a doctoral candidate at the Australian National University, and the recipient of the Australian Leadership Award and Allison Sudradjat Award.

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