Indonesia's Oil Problem

One told a decade ago that oil prices would quadruple but not seriously hurt growth in emerging economies, it would have seemed fantastic. (After all, the oil shocks of the 1970s substantially curtailed growth in Latin America). Yet this is precisely what has happened. As oil prices approach $100 a barrel, economists are wondering why.

Jon Anderson at UBS has a note out this week titled, "Why Doesn’t Oil Matter?” with a few ideas. The most interesting one is the smaller role oil plays in energy consumption in emerging economies relative to developed ones. Roughly 40% of primary energy used in developed economies comes from oil, as against 28% in emerging economies. Coal is still pretty much king in developing economies, at 49%, whereas the equivalent figure is 20% in developed economies. For India and China, the reliance on coal—mostly domestically produced—is even greater, at 67%.

But the "emerging" category conceals some radical differences across countries. Indonesia, for instance, is actually more oil-intensive than most developed countries, with oil at 47% of consumption. As a result, oil price increases hit Indonesia hard. Indonesia's uniquely high oil intensity is probably thanks to domestic production; the Southeast Asian country only became a net oil importer in 2003, and prior abundance left any notion of scarcity alien to industry and households.
Dependence on cheap oil begins in poor households, which usually use government subsidised kerosene instead of gas (which is cheaper and simpler to use). "It is a total waste to cook with jet engine fuel", quipped Jusuf Kalla, the country's vice-president, in 2007, but poor Indonesians have struggled to make the transition to gas, which they perceive as more dangerous. In 2008, a 30% fuel price hike led to widespread rioting.

The middle class is also addicted to cheap oil in the form of fuel subsidies that continue to bludgeon public finances, with roughly 10% of tax revenue—or $10 billion—spent on them. But a recent effort to remove the subsidy was derailed by a 14-hour parliamentary gabfest—an Indonesian filibuster. Prices are still much lower than anywhere else in the world—unsubsidised, private car owners would pay Rp. 5,600 per liter (about 0.62 cents per liter, or $2.35 per gallon) instead of the current Rp. 4,500 per liter. But the plan to scrap subsidies has been postponed by at least six months.

Even at the level of industry, tremendous inefficiencies reign. In Indonesian Papua, for instance, the state electric company's (PLN) entire energy generation capacity is diesel-based (diesel is a derivative of oil). In Java, higher oil prices are forcing PLN to shut down four power plants, this in a country where power demand is growing at around 9% per year. Many factories in the Jakarta area also use diesel as backup electricity, and trucks use it to transport goods, including food products, which have seen significant inflation, sparking public debate.

In short, higher oil prices are reconfiguring the entire Indonesian economy, and forcing it to confront a new world of scarcity. It is unclear what the political economy's breaking point is, but as oil prices continue their steady ascent, we may soon find out.

The Economist