Indonesia post $100 per barrel:The impact of oil & gas prices on public finances

Wolfgang Fengler and Tim Bulman

World Bank Institute:Oil Price Volatility, Economic Impacts, and

Risk Management in Asia

Wednesday, June 4, 2008

The World Bank Group in IndonesiaPoverty Reduction & Economic Management

Outline

Indonesia during high and volatile oil prices

Energy subsidies, the budget and the lessons of the 2005 price adjustments

Challenges and options going forward

Indonesia post US$ 100 per barrel: Four “confusing facts”

1. Since 2004, Indonesia has become a net importer of oil but it remains a net exporter of energy

2. Despite record high oil prices - oil and gas revenues have been hardly increasing

3. High oil prices remain positive for Indonesia's fiscal position - but negative for the central government

4. Although fuel subsidies are rising rapidly, electricity subsidies have been increasing even faster

Outline

Indonesia during high and volatile oil prices

Despite high oil prices revenue from oil and gas has hardly increased ...

Indonesian Government Revenue

0

200

400

600

800

1,000

1994 1997 2000 2003 2006

Total central gov't revenues

Non-oil and gas central gas revenuesOil and gas central gov't revenues

Source: Ministry of Finance (constant 2007 rupiahs)

Tril

lion

Rup

iah

… because production has been falling sharply

Indonesian Crude Oil (Production and Price)

600

900

1200

2000

2001

2002

2003

2004

2005

2006

2007*

2008*

150,000

400,000

650,000

Source: Ministry of Finance

IDR /

barrelKbpd

Price(RHS, adjusted for

exchange rate)

Output (LHS)

Indonesia’s has adjusted gasoline prices but is still trying to catch up with world prices

Rp p

er liter

0

2000

4000

6000

8000

10000

2000 2002 2004 2006 2008

Sources: U.S. Department of Energy; CEIC; World Bank staff calculations

US price

Indonesia

Link with world prices Mar-05:33% increase

Sep-05:88% increase

May-08:33% increase

Gasoline prices in Indonesia remain among the lowest in the world

0

0.5

1

1.5

2

2.5

3V

enezuela

(C

ara

cas)

Indonesia

(early M

ay)

Mala

ysia

(K

uala

Lum

pur)

Indonesia

(end M

ay)

Chin

a

Vie

tnam

Tim

or

United S

tate

s

India

(B

angalo

re)

Thaila

nd

Phili

ppin

es (

Cebu)

Cam

bodia

Japan

Sin

gapore

South

Kore

a

Hong K

ong

United K

ingdom

Germ

any

Turk

ey

US

$/L

itre

Administered price

Automatic/market price

Gasoline prices in selected countries, US$/Litre - May, 2008

Energy subsidies will reach a new record high in 2008

Energy Subsidies in Indonesia

0%

1%

2%

3%

4%

5%

2004 2005 2006 2007 2008

0%

4%

8%

12%

16%

20%

Source: Ministry of Finance and World Bank staff calculations

APBN

APBN-PPercent of central gov't

spending (RHS)

Percent of GDP (LHS)

% o

f G

DP

% o

f c

entr

al g

ovt

sp

end

ing

Fuel and electricity subsidies represent significant share of national budget

Personnel13%Material

5%

Capital9%

Interest10%

Transfers to regions

29%

Other spending10%

Fuel subsidy13%

Electricity subsidy

6%

Other subsidies

5%

Source: Ministry of Finance

Subsidies24%

Outline

Energy subsidies, the budget and the lessons of the 2005 price adjustments

High and volatile oil prices undermine the budget process

Rules on transfer of funds to sub-national governments create an incentive to under-project oil prices

Indonesian Government Oil Price Projections

US

$ p

er

ba

rre

l

0

30

60

90

120

2001 2002 2003 2004 2005 2006 2007 2008

* May 2008 projection. Source: Ministry of Finance

Projected

Realized *

Energy subsidies:Crowding out productive spending

Energy Subsidies & I ndonesian Government Spending

US$, billions

0

30

60

90

120

2005 2006 2007 2008(initial)

2008(revised)

Other Sub-national transfersEnergy subsidy Capital investmentSocial spending

Sources: Ministry of Finance, World Bank staff calculations

Energy subsidies dominate 2008 central government spending

US$ billion

0

7

14

21

Subsidies Capital invest't Social programs

Electricity*

Fuel*

* Assumes ICP oil at US$95. 2008 APBN-P; 2008 APBN for social program expenditure. Source: Ministry of Finance

Regressive fuel subsidy

0%

10%

20%

30%

40%

50%

1 2 3 4 5 6 7 8 9 10 Poor Household consumption decile RichSources: SUSENAS 2007 and World Bank staff estimates

Share of fuel subsidy received directly by households

Regressive electricity subsidy

Share of subsidized electricity connectionsby household consumption level

The inflationary effect of fuel subsidy cuts was significant but short-lived

-30

0

30

60

90

120

150

2004 2005 2006 2007 2008

Core

Food

Headline%

30% 120%

Source: BPS

30%Fuel prices

rise:

Impact of subsidy cuts on GDP and household consumption

GDP & Private ConsumptionReal, annualized seasonally adjusted

(quarterly percentage change)

0

2

4

6

8

10

2004 2005 2006 2007 2008

%

GDPPrivate consumption

Sources: BPS, World Bank staff estimates of seasonal factors

Price increase30% 120%

High subsides are related to increasing borrowing costs

Bond Yields and Fuel Price Gap

4

8

12

2003 2004 2005 2006 2007 2008

0

20

40

US-Indonesian petrol price differential

(US cents/ litre; RHS)

Domestic 5-year bond yields

(%; LHS)

Sources: CEI C; US Department of Energy; World Bank staff calculations

% USc/L

Minimize the costs:Transitory compensation

Challenges and options going forward

Outline

Indonesia 2009-2014: Fuel subsidies remain the defining policy issue

If oil prices stay at current levels, fuel subsides will remain the defining policy issue of the next government (2009-2014)

There are three broad options: (i) Keeping subsidies unchanged (or only modestly adjusted)

(ii) Gradual closing of gap between domestic and world market prices

(iii) Radical adjustment: Increase of fuel prices to market rates

Indonesia 2009-2014: Options for fuel subsidy adjustment

Advantages Disadvantages

Option 1: No or limited change to energy prices

Limited social and political upheaval

Fiscal risks and lost opportunity for public investment

Option 2: Gradual closing of gap to world market prices (2 scenarios)

Certainty of removing subsidies Gradual increase of fiscal space

Continuous increase of energy prices over a prolonger period Subsides remain high until 2010/2011

Option 3: Radical adjustment

Realistic pricing of energy Maximizing fiscal space

Social and political upheaval Substantial economic downturn (short-term)

Indonesia 2009-2014: Fuel subsidies adjustment scenarios

A Scenario for Gasoline Prices Rp per litre

4,000

7,000

10,000

13,000

16,000

2008 2009 2010 2011

Economic cost

Close 8% of the gap per month

Close the gap by Dec. 2010

Increase the price 50 Rp/mth

Source: World Bank Staff scenario

No change

Immediate deregulation

Thank you

Terima-kasih

Policy ‘solutions’ that are not an option:

Scaling back other spending Borrowing to fund fuel subsidies Rescheduling foreign debt Imposing a windfall profit tax on oil

companies Improving the efficiency of SoEs

Legacy of uncertain investment climate means Indonesia not benefiting from today’s high prices

Government receives 85 percent of production profits Domestic market obligations at nominal prices Uncertainty re: relevant rules and how they would be

applied Overhang of institutional uncertainty means

Indonesia getting less than the potential benefit of high oil prices

GoI Policy Measures

Optimalize non-oil tax revenue [Rp 20 trillion] Cut line-ministries’ spending [Rp23 trillion] and use the

contingency fund [Rp8,3 trillion] Increase bond issuance: Gross Rp157 trillion. But higher

yields Increase program loans from multilateral and bilateral

institutions [Rp25 trillion] Increasing oil lifting : 916 927 thousand KL Energy savings (Kerosene to LPG conversion program, cut electricity

consumption, cut domestic fuel consumption, increase efficiency of Pertamina, restrict access to subsidized fuel via ‘Smart Card’, Energy savings in government buildings, private offices, malls, hotels

Policy responses to high and volatile oil prices: The way forward

Maximize the benefits Create investment-friendly environment

• Encourage exploration• Enables full exploitation

Minimize the costs Move from subsidizing energy to compensating declining real

incomes Take energy price decisions out of the political boiler

• Rules that gradually move retail prices towards the economic costs, not political discretion

• Build public confidence in gov’t spending• Compensate the poorest for the transitory income loss• Spending programs that benefit the middle classes

Cut energy usage