A number of factors distort and limit the choices available, to the detriment of Indonesia’s economic development. This is the energy challenge that Indonesia must address.
Influencing the development of the energy sector is a well-entrenched energy subsidy. Indonesia has subsidised energy consumption since the early days of the republic, and much has been said about how subsidy expenditures may aggravate fiscal imbalances and crowd out public investment on infrastructure as well as on energy. A 2012 IMF Country Report (No 12/278) on Indonesia’s economy argued that while the cost of capital is declining, investment in infrastructure (including in energy-related infrastructure) remains relatively weak. Public investment is hovering at about 3 per cent of the country’s GDP, among the lowest in Southeast Asia. Progress with public-private partnerships to promote investment in infrastructure has also been slow.
Underpriced energy also distorts resource allocation by encouraging excessive energy consumption. And since the subsidy comes in the form of a price subsidy, most of the benefits are likely to be captured by higher-income households, which tends to exacerbate income inequality.
With a large proportion of the country’s energy consumption limited to oil, coal and, increasingly, natural gas, the development in alternative energy forms is lacking. This is also partly due—especially for oil—to the energy subsidy. But history also plays an important role. Indonesia’s significant reserves of these three resources meant, like many other countries, it first began to exploit them not only for domestic consumption but more importantly for export, as a source of foreign exchange. Recently, Indonesia has become a net oil importer. Ideally the government should be removing fuel subsidies at once to promote efficiency as well as to encourage development of alternative sources of energy. Instead the government has left the subsidy in place, halted oil exports, reduced natural gas exports and redirected some coal exports for domestic use.
It is also important to note that Indonesia is an archipelagic country of around 17,500 islands, some 6000 inhabited. It is inevitable that the market for electricity, for instance, will remain segmented. Even the four main islands, Java, Sumatra, Kalimantan and Sulawesi, where most of the country’s population of around 250 million is concentrated, are unlikely to ever be connected by a single power grid. As such, the pattern of population distribution is quite different from the distribution pattern of the country’s energy resources. The province of Papua, for example, is sparsely populated but has considerable hydropower potential. Papua is also separated from the rest of the country by a deep sea, making it impossible to send electricity from Papua to other parts of the country.
To address the country’s energy challenge, the government has recently set quite an ambitious target: by 2025 the share of oil consumption will drop to 20 per cent from almost 50 per cent in 2011, while during the same period the share of renewable and new energy will increase from 5.7 to 17 per cent of the domestic primary energy consumption. The rest will come from coal (33 per cent) and natural gas (30 per cent). Geothermal energy is included in the renewable energy mix. Currently the country generates around 1.2 GW of electricity from geothermal resources, substantially below its potential which, according to the Ministry of Energy and Mineral Resources, is around 28 GW.
In addition, Indonesia’s reserves of unconventional gas (coalbed methane) are even larger than its natural gas reserves. The resource is yet to be exploited. The government has also set targets to exploit other renewable energy resources, such as biofuel and biomass.
The ability to meet these targets depends on a number of factors.
First, it depends on the government’s willingness to overhaul the country’s energy pricing policy. In addition to fuel price subsidies—and despite the acute shortages of electricity faced in some parts of the country—Indonesia’s electricity price is among the region’s lowest, and does not reflect its relative scarcity. This undoubtedly discourages investors to enter the industry.
Further reform to the energy sector is also needed. The vertically integrated state-owned electricity company PLN (Perusahaan Listrik Negara) continues to dominate the sector. It owns over 75 per cent of the country’s generating capacity and most of the distribution systems. Moreover, it retains a monopoly on the transmission system and functions as its system operator. It also has the ‘right of first priority’, implying that independent power producers can only serve areas that have been declined by PLN.
Second, achieving Indonesia’s energy targets also depends on the government’s ability to improve the country’s investment climate. Indonesia needs a huge amount of investment in its energy sector, including energy-related infrastructure like gas pipelines. But various impediments have discouraged investors from entering Indonesia’s energy markets (as documented in, among other reports, the World Bank’s ease of doing business index, where Indonesia ranks 120 overall).
In the meantime the government is offering investors in the renewable energy sector some forms of fiscal incentives. Such incentives, however, will only work as intended if all the relevant impediments are properly addressed; there is no point in subsidising biofuel, for instance, while subsidies on gasoline remain intact.
It is perhaps more important for the government to instil confidence among potential investors that it is committed to ensuring regulatory certainty, a step that would enable investors to properly assess investment risk. An incentive is rarely necessary when there is regulatory certainty and market mechanisms are able to function properly. Incentive schemes in the form of tax exemptions or subsidies should be viewed as a last resort and only ever provisional in nature. Open-ended incentive mechanisms exemplified by the current fuel price subsidy are not the way to go.
For Indonesia’s energy options to reflect the country’s resource potential, and facilitate rather than inhibit Indonesia’s economic growth, these obstacles must be overcome.
Dr Raymond Atje is a Senior Fellow at the Centre for Strategic and International Studies, Jakarta.
This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Indonesia’s choices’.