The more than 55 percent plunge in oil prices since July has resolved several potentially explosive political and economic problems for the new government of President Joko “Jokowi” Widodo.
But he should not get complacent, as the condition is largely a matter of good fortune.
As the saying goes, lightning never strikes twice in the same place. This could be the only oil-price down-cycle during Jokowi’s five-year term until October 2019.
The government, therefore, should seize the opportunity for energy reform to reduce the nation’s dependence on fossil fuels and gear up the economy for weathering perpetually volatile oil prices.
As a net oil importer since 2004, Indonesia enjoys a state-budget windfall savings every time international oil prices drop steeply that creates fiscal room for a massive cut or the abolishment of fuel subsidies. Now that oil prices have fallen to below US$50 a barrel, the government expects to save almost Rp 200 trillion ($16 billion) throughout this year.
The government should not succumb to the temptation to squander the huge savings on populist programs. It should instead direct them toward more productive programs in poverty alleviation and infrastructure to improve our economic competitiveness.
The government made the right policy with its quick decision to put domestic fuel prices on a managed floating market-price mechanism early this month.
This move immediately set off a virtuous circle: it will spare the government from wasteful political bickering with the House of Representatives every time international oil prices rise sharply and has freed the government from being held hostage to the wildly volatile international oil market.
In the oil market nothing is simple. Predicting oil prices is always a mug’s game because the prices are influenced by both economic and non-economic factors.
In mid-2008, for example, international prices skyrocketed to a peak of almost $150 a barrel, but collapsed to as low as $47 later the same year. A similar down-cycle has taken place since last July.
Consequently, by its very nature oil trading is beset by uncertainty and it is not just due to the precarious geopolitics in countries where most of the world’s oil reserves are located.
But bringing domestic fuel prices closer to — or on par with — their economic costs will also remove the fuel-subsidy time bomb.
But more important is that abolishing subsidies will encourage the development of renewable energy, energy efficiency and conservation.
Energy reform will cut Indonesia’s trade deficit and, consequently, the current account deficit, which has been exerting strong downward pressure on the rupiah exchange rate.
But energy reform should not end at putting fossil fuels on a managed floating market-price mechanism.
The government should instead bolster energy diversification programs by providing fiscal incentives for investment in developing more biofuels and gas and their infrastructure, mini hydro-power, geothermal and other renewable energies.
In short, the government should launch a more concerted effort to implement the 2007 Energy Law that stipulates strategic measures aimed not only at reducing dependence on fossil fuels but at compelling the government to provide incentives for energy efficiency and conservation.
Companies should be given fiscal incentives to invest in energy-conservation programs, such as in-house management of energy efficiency; performing maintenance and housekeeping measures; replacing select equipment; or modifying entire manufacturing processes.
No one can predict how long the oil price down-cycle will last or where prices will bottom out. But the government should design a formula for determining the ceiling and floor prices for oil to cope with future price volatility.
Ceiling prices should be set at levels that will encourage fuel efficiency, but which will not impose large subsidies on the state budget. Floor prices, meanwhile, should be designed to make the development of renewable energies like biofuels, geothermal and biomass still commercially viable.
The oil-price collapse has changed almost all the basic assumptions used for predicting key economic indicators for the 2015 state budget for the better.
We are glad to learn that the proposed amendments in the 2015 state budget the government proposed to the House will allocate the bulk of savings from the slashed fuel subsidies to developing infrastructure.
The rationale is that poor and inadequate infrastructure has become the biggest barrier to investment and among the main drivers of high logistics costs limiting the competitiveness of exports.
But given the dismal record in infrastructure development over the past decade, the new government should be able to make headway on several vital projects, including roads, airports, seaports and power generation that have been stalled for several years due to arduous land-acquisition procedures.
Making a breakthrough in such high-profile projects as the multibillion dollar Batang power plant in Central Java; the access road to Indonesia’s biggest seaport, Tanjung Priok; and the access railway to Soekarno-Hatta International Airport in Tangerang will boost market confidence in the government’s capacity to develop basic infrastructure.
Fortunately, this year marked the start of the full enforcement of the 2012 Land Acquisition Law, which provides stronger legal certainty for land appropriation for infrastructure projects.
The law stipulates a clear-cut, shorter time frame for land acquisition, expedites court proceedings for appeal and mandates the appointment of an independent committee for setting compensation levels with property owners.
The acute lack of strong legal frameworks to regulate land acquisition and rampant land speculation has long been the main obstacle to infrastructure development, as the costs of land often make projects financially unfeasible.
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