Indonesia: The Gordian Knot and the fuel subsidy in Indonesia - GlobeAsia - Shamim Razavi

Last Updated: 21 October 2014
Article by Shamim Razavi

In his latest opinion piece for business magazine GlobeAsia, Senior Foreign Counsel Shamim Razavi discusses the fuel subsidy challenges faced by Indonesia's new government.

This article has been reproduced with permission of GlobeAsia.

Loosening the Gordian Knot

In the city of Gordium on the Anatolian plateau there was a legendary knot with folds and layers so intricate the two ends of the rope could not be seen. An oracle had foretold that whosoever was able to loosen this knot would rise to become King of all Asia and so many a would-be-ruler had tried his hand at the puzzle and failed.

It took a young Macedonian by the name of Alexander to ride into town, sword in hand, and slice the Gordian Knot in two, thus fulfilling the prophecy and going on to sack and then rule Persia and beyond.

Somewhere in the government files being handed over to the new administration will be one titled "Fuel Subsidy" and I wouldn't be surprised if it bears a subtitle 'Gordian Knot'. The ends of this particular knot are similarly out of reach – to raise the amount of government resources devoted to the subsidy above the current 20% of the national budget on one end of the rope, or to increase the price of gasoline at the pump on the other end – and a tug on either would result in some further tightening of the knot.

We saw just such a tightening in August with subsidised fuel being sold during restricted hours – a move which led to hoarding of fuel, queues at petrol stations and a speedy reversal of the move. Yet something will need to be done soon, with the 2014 budget allocation for subsidised fuel set to run out in mid November, leaving the country facing a full month and a half of fuel use with no subsidy at all, with a crippling effect on transportation and logistics across the country.

The knot tightens daily, and President-elect Jokowi has undertaken to tackle the problem as a priority during his term in office.

The source of the problem is deep seated and linked to the decline of Indonesian-sourced gasoline which in turn led to the need to import gasoline and exposure to fluctuating fuel prices in the international market. Many solutions have been attempted and are ongoing – such as the incentives for oil and gas exploration companies to find and exploit new reserves – but clearly more needs to be done.

The cash payouts distributed among the country's poor under the outgoing administration were a good example of creative political thinking. In 2008 President ,SBY oversaw an increase in fuel prices by 33%, the impact of which he softened with the Direct Cash Assistance (Bantuan Langsung Tunai) scheme, where direct cash payouts were distributed to those who would most keenly feel the increased fuel price – the poor. Indeed, this political gambit was effective and set a new baseline for the level of fuel subsidy, but at the same time it merely deferred a comprehensive solution to another day.

One of the most positive aspects of the Direct Cash Assistance scheme was its prioritisation of the poor. The $15 billion fuel subsidy is more than twice the sum devoted to education, health, and welfare combined, and so any solution to the problem will have a positive impact on the lot of the poorest in our midst.

Changing the basic assumption

What if it were possible to change the basic assumption that there is an ever dwindling – and increasingly expensive – supply of gasoline to power our cars? What if we can increase supply of fuel without requiring either an increase of subsidy or an increase of fuel prices?

The research for alternative fuel sources has shown that this is possible. It has evidenced promising results, and its use in several countries has shown that it is effective. Many types of alternative fuel are now used all over the world, such as ethanol, natural gas, electricity and liquid hydrogen.

Indonesia, for example, has started to use natural gas to fuel public buses. Although the number of public buses that are powered by natural gas are very limited and only available in few major cities, it demonstrates that the use of alternative fuel is in fact a feasible option.

The effectiveness of alternative fuels depends to a large degree on whether or not the source of the fuel is a resource that is widely and easily available in that country. Take for example, Brazil, the world-leader in biofuel industry: Brazil's biofuel industry is mostly sourced from sugarcane ethanol, and this successful Brazilian ethanol industry is sustainable in Brazil not only due to its advanced agro-industrial technology but also due to its abundant areas of arable land. One downside of sugarcane-sourced ethanol is the impact on food prices – meaning that once again the poor suffer disproportionately from the drive to fuel our cars.

Indonesia's solution has been more effective. Crude Palm Oil (CPO) has been used for some time now to produce ethanol which is blended into the various biofuels available at the petrol station forecourts. As CPO is mainly an export commodity and not used for human consumption, the impact on local consumers and the local economy has been largely positive – making for a sustainable source of fuel ethanol. Of course, ethanol has another key advantage which makes it a clear winner in Indonesia – it burns clean, with almost none of the particulates that cast the familiar pall of smog over our cities. Coupled with recent government incentives for biofuels, and with the ability to be blended into gasoline without the need for any adjustments to vehicle engines, ethanol might be one of the solutions to the subsidy puzzle. As the world's largest producer of CPO, Indonesia looks set in coming years to consume ever more ethanol sourced from CPO.

Coal to ethanol

Another option which might be even better suited to Indonesia – and which this columnist has worked closely on in recent months – is the conversion of coal to produce fuel ethanol.

The technology involved in this process is more innovative and complicated than that involved in the production of ethanol from CPO but has the important advantage of taking one of Indonesia's most abundant but under-utilised sources of hydrocarbons – coal – as a source of fuel ethanol.

Furthermore, the process can take low grade coal (for which there is a very limited market) as a feedstock, thus maximising a resource that has very little practical application otherwise and directly satisfying the recent desire to see Indonesia not export unimproved raw minerals but rather to refine and improve its raw materials within the country.
Indeed, under the Mining Law of 2009, Indonesia's government has indicated its intention to restrict the export of low grade coal – making the domestic use of this coal to produce ethanol an unusually attractive option.

Pertamina's role

In the midst of its transformation from a 'national oil and gas company' to become a 'world-class energy company', Pertamina has displayed a real commitment to boost renewable and cleaner sources of energy.

Their prime focus so far has been, among others, geothermal energy, coal-bed methane, waste energy from municipal waste and solar energy and they also announced in 2012 an MoU to explore bringing coal-to-ethanol technology to Indonesia – all bold technological solutions that could put Indonesia one step ahead given the current fuel price and subsidies quandary that it is facing.

While no single alternative fuel solution will on its own solve the fuel subsidy issue, and other elements which reduce consumption as a whole must play a part, the makings of an innovative solution that challenges many of the basic intractable assumptions can be discerned. It may take vision and courage of the Alexander the Great variety, but the Gordian Knot may yet be sliced through once again.

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