Energy Subsidies: Lessons Learned in Assessing their Impact - UNEP

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Energy Subsidies: Lessons Learned in Assessing their Impact and Designing Policy Reforms between 2000 and the end of 2005, based on current international prices, would have amounted to about $36 billion. Figure 7.1: Gasoline Subsidies in Indonesia, 1970-2001 (billion rupiahs) The loss in economic efficiency in terms of the fall in the aggregate welfare of consumers and producers resulting from these subsidies has been large. 64 The net economic cost in 1999 is estimated at about $1 billion. The losses for kerosene alone were about $700 million. On current trends losses would reach almost $2 billion per year by 2005. These costs are manifested in various ways. Cheap oil has encouraged excessive consumption and undermined incentives to conserve it. Over-consumption has also reduced the country’s export potential, reducing foreign exchange earnings. Indeed, if subsidies are not reduced, Indonesia will become a net oil-importing country by 2010. Furthermore, subsidies have led to smuggling of oil as neighbouring country prices are at least 80% higher than domestic prices. Oil subsidies have also undermined the development of the domestic gas industry. This study has not quantified the costs resulting from relative price distortions. However, such costs are thought to be substantial, as a result of distorted consumption patterns and the subsequent misallocation of resources. Such distortions are particularly costly in the refining sector. For example, major investments in refineries have had to be made to boost production of automotive diesel to meet surging demand. Oil products are subsidised primarily for social reasons. They are intended to make energy more affordable for low-income groups. In practice, however, high-income groups and large manufacturers have been the principal beneficiaries of these subsidies. The biggest subsidy goes to kerosene, the main consumers of which are households. 64 See Chapter 2, Section 2.2 for a discussion of welfare losses caused by subsidies. 94
Oil Subsidies in Indonesia 7.4 Economic and Fiscal Benefits of Subsidy Reform Removing oil subsidies would enhance Indonesia’s growth prospects through greater allocative efficiency and fiscal benefits, although there would be significant adjustment costs in the short term. Higher energy prices would raise the cost of living and producer costs. The cost of living would rise directly and indirectly, through the effect of increased fuel-input costs on the price of consumer goods. The net increase may be slightly higher for producer costs. However, the increase in prices is not expected to have a major impact on the inflation rate, which has been high in the past few years. Eliminating oil and other energy subsidies would improve the national budget balance substantially. In addition, removing subsidies would provide Indonesia with a hedge against exchange-rate fluctuations. This is crucial, since about two-thirds of the recent rise in the external debt was due to the fall in the value of the rupiah. If the subsidies were not reduced, the Government would need to spend about $36 billion between 2000 and 2005. The value of lost foreign exchange earnings due to over-consumption of fuels would be about $16 billion. 7.5 Environmental Benefits of Reform Eliminating subsidies would also bring significant environmental benefits. Measures to combat pollution and the harmful effects of energy use adopted over the years in Indonesia have been overwhelmed by rising energy use encouraged by subsidies. Subsidies have led to over-consumption of oil products, particularly transport and industrial fuels, resulting in serious environmental consequences. Chief among these are increases in emissions of particulate matter, lead and nitrogen oxides, which are responsible for respiratory illnesses – the sixth leading cause of death in Indonesia. Pollution is especially bad in Jakarta. Emissions of climate-destabilising carbon dioxide have also increased. These environmental problems provide grounds not just for eliminating subsidies, but for levying taxes on oil products – especially automotive fuels. Fuel taxes would need to be applied nationally to avoid arbitraging of products among regions. A comprehensive study of fuel taxation is needed. 7.6 Social Benefits of Subsidy Reform Only a small amount of the subsidies to oil products currently reaches the poor in Indonesia. The poor, defined as those people living on less than $2 per day [to be checked] represent almost 20% of the population and the near poor, those living on between $2 and $3 per day [to be checked] another 10 to 12%, according to 1998 data. But they consume only about 10 million barrels of kerosene out of about 65 million consumed each year. This is because the poor use kerosene mostly used for lighting. Only half of the urban poor use kerosene for cooking, the rest use fuelwood. About 20 million barrels were used in the non-household sector in 1998, and the remaining 35 million were consumed by middle- and high-income households. In 1999, only about $260 million, or roughly 15% of the total kerosene subsidy of about $1.75 billion, reached the poorest 30% of the population. Thus, removing subsidies would, at the aggregate level, affect high-income households more than the poor. However, experience in other countries has shown that the poor suffer more in 95
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© Copyright 2003 UNEP This publica
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Acknowledgements Acknowledgements T
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United Nations Environment Programm
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Contents Contents Foreword 1 Acknow
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Contents 8.2.3 Renewable Energy Sou
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Executive Summary Executive Summary
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Executive Summary Summary of Findin
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Executive Summary employment in dom
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Abbreviations and Acronyms Abbrevia
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Energy Subsidies in OECD Countries
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Designing and Implementing Energy S
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Energy Subsidies: Lessons Learned in Assessing their Impact - UNEP

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