Indonesia, with its vast energy resources (oil, gas, coal), has opted for a development model based on the development of this natural capital. Yet the country has so far been unable to fully exploit the advantages of its energy assets. It has even become a net oil importer. An interview with Slim Dali, economist at AFD.

©Center For International Forestry Research/Ramadian Bachtiar
©Center For International Forestry Research/Ramadian Bachtiar

Can you describe Indonesia’s current energy profile to us?

Indonesia possesses one of the largest reserves of fossil fuel resources in the world (proven reserves of oil, gas and coal represent 11, 35 and 70 years of production). However, this situation conceals disparities. It was an oil exporter until 2004, but is now a net importer under the combined effect of the depletion of national reserves and the increase in domestic needs. Conversely, coal production, which was virtually nonexistent 20 years ago, today accounts for 18% of energy consumption and 48% of power generation. In terms of gas, the production rate is not expected to decline for another decade. Finally, hydropower is an energy source with high potential: only 30% is exploited today (15 TWh).

While electrification is increasing (73% of the population in 2011) and the loss rates on grid lines remain low (11 %) in proportion to the level of development, there continue to be constraints to access the network. This explains, for example, the sharp increase in the share of self-production of electricity, which today accounts for 22% of total generation.

 

In 2012, the payment of direct compensation to energy sector operators accounted for 3% of Indonesia’s GDP. Is its policy for energy price subsidies viable?

The country’s subsidy policy in this respect is indeed considerable. Between 2001 and 2013, expenditure for subsidies of overall prices (energy and food prices) accounted for an average of 22% of the total State budget, including over half for energy (61% allocated in 2013). In return for the payment of direct compensation, operators, such as Pertamina and PLN, are obliged to apply regulated or below-market tariffs (considered as a public service mission).

Fuel for households is 30 to 50% below market prices. The industrial sector, for its part, consequently benefits from a highly competitive average electricity price. In 2012, it was the second lowest among the large Asian economies.

However, it exposes four sectors (4.5% of GDP) that are particularly at risk over prices (share of energy of intermediate consumption 10 to 40% higher): terrestrial and marine transport, non-metallic minerals and non-energy commodities.

Furthermore, this direct subsidy policy today places a burden on the structure of public spending. The dependency factor is so high that budget forecasts are prepared on the basis of scenarios including the barrel price and the expected level of extraction of domestic oil resources. In this respect, the International Monetary Fund estimates that a 10% increase in the international price of oil (or a 10% depreciation of the Indonesian rupiah against the dollar) would increase this share by 0.6%.

The subject is all the more important because these subsidies create eviction effects, particularly on government spending on development and social benefits. The redistributive aim of the subsidy policy is today also called into question, as it is estimated that 40% of fuel subsidies benefit the wealthiest 10% of households against only 1 to 10% of the poorest.

 

What objectives did the Indonesian Government wish to achieve by establishing this system of energy price subsidies?

This subsidy system made it possible to redistribute part of the wealth from the exploitation of subsoil resources. In a structural context as a net energy exporter, this type of policy aimed to accelerate the development process by promoting access to energy for the poorest and limiting the production costs of a number of companies (intermediate goods). As the country has been a net oil importer since 2004, this system is now criticized for its twofold ineffectiveness: the subsidies do not benefit the poorest populations and they strain the State budget by generating eviction effects. For example, in 2012, energy subsidies were higher than all public investment in infrastructure. Furthermore, these soaring costs pose a fundamental problem in a growth trajectory where per capita energy consumption and available income increase in parallel (in particular in terms of greater external energy dependence).

 

What reforms need to be implemented to reverse these structural imbalances?

There can be several prospects open to Indonesia to develop its current model towards a phasing-out of subsidies and a reduction of inequalities.

A recent OECD study shows that the regressive effect of putting an end to subsidies by 2020 could be offset by other redistributive mechanisms, with the aim of having a generally neutral fiscal impact. While efforts at reform have so far been rather negative in Indonesia, several options could be used: an unconditional allocation of a “compensatory energy check” per household, subsidies for agricultural products, reduction of charges on earned income. These alternatives have advantages and drawbacks and echo the reformist agenda of President Joko Widodo, who was elected in July 2014. He abolished fuel subsidies in November 2014, in particular taking advantage of the window of opportunity offered by the decline in oil prices.

The need to further reform this system has now been clearly identified by the public authorities, which play the role of both provider of funds and shareholder. But the subject is politically sensitive.

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