LAUNCESTON, AUSTRALIA, June 18: It’s taken Asian countries far too long to realise that fuel subsidies are unsustainable and poor economic policy, but there are encouraging signs that change is gathering momentum.
Indonesia’s parliament voted in favour of measures on Monday that will see gasoline prices rise by 44 percent and diesel by 22 percent.
While these increases by no way end the price support for fuel, it does go a long way to scaling back one of the most generous systems in Asia.
Indonesia has joined China, the region’s biggest oil consumer, and India, the third-largest, in moving toward market-based pricing for transport fuels.
While scaling back subsidies carries obvious political risks for governments, the benefits are widespread and enduring.
The top priority for most governments in lowering subsidies is to improve their fiscal positions, which in turn will allow them to boost social spending in order to alleviate hardship from the higher fuel costs.
Indonesia spent about $20 billion on fuel subsidies last fiscal year, an amount that is putting pressure on the country’s budget deficit target and current account deficit.
Indonesia raised interest rates last week to support the rupiah, but the real culprit is the current account deficit and that is partly driven by fuel subsidies.
But repairing balance sheets isn’t the main benefit from an energy markets perspective.
Lowering, or eliminating subsidies, encourages efficiency and improves economic output per unit of fuel.
It also allows demand to adjust far more quickly to price shocks, which in turn should lessen the volatility of global oil prices.
In 2008 when oil surged toward $150 a barrel, consumers in much of Asia were unaffected as the retail fuel prices remained largely steady.
If they had been exposed to the run up in fuel prices, it might have led to demand destruction earlier, which in turn may have resulted in a milder global recession.
In fact, it was after the 2008 oil price spike and subsequent collapse that Asian nations started to re-examine the concept of large subsidies on fuel, which were justified as helping the competitiveness of the economy and easing the burden on the poor.
While it’s unlikely that Indonesia’s trimming of subsidies will have much short-term impact on Asia’s product markets, over time the nation should consume less fuel per capita than it otherwise would have, had the government support continued.
Indonesia by itself isn’t enough to make much impact on global, or even Asian, oil and product markets, but if the process is replicated across Asia, the impact is enormous.
Even with the sharp jump in prices, Indonesia will still have fairly generous fuel subsidies.
Gasoline will cost about 66 cents a litre and diesel 55 cents. This is well below the Singapore prices of 73.5 cents and 76 cents respectively, on a free-on-board basis, meaning they exclude the costs of transportation from the refinery, any taxes and retail margin.
However, major consumers China and India are now a lot closer to having market prices for their fuels, following several years of reforms.
China’s gasoline currently costs about $1.08 a litre and diesel about $1.12, while India’s most recent adjustment on June 16 took gasoline to $1.14 and diesel to 86.6 cents.
This means that only diesel in India enjoys any substantive subsidy, the rest being fairly close to the cost of production and distribution.
However, countries such as Malaysia, and to a lesser extent Vietnam and Bangladesh, still retain fuel subsidies.
Subsidies were an election issue in Malaysia’s recent vote that saw the ruling party return with a reduced majority. The opposition said it would lower them if elected in order to free up revenue for other priorities.
But the end, or substantial reduction, of subsidies across Asia still isn’t enough to set the region’s fuel demand growth on a more sustainable trajectory.
It will require the imposition of taxes or government mandates to encourage improved efficiency.
In Australia and Singapore, retail gasoline and diesel prices are roughly double the Singapore free-on-board price, with taxes making up about one-third of the total cost.
This still leaves fuel cheaper than in most of Europe, but more expensive that in the United States.
Higher prices would go some way toward moderating Asia’s demand growth outlook, which accounts for the bulk of the expected global total.
The International Energy Agency (IEA) forecasts Asia-Pacific demand to rise by 500,000 barrels per day (bpd) in 2013 to 29.9 million bpd, while the rest of the world is expected to boost consumption by a combined 300,000 bpd.
By 2016, Asia-Pacific oil demand is expected to be 3.4 million bpd higher than it was in 2012, according to the IEA.
Removing subsidies and ultimately levying taxes on fuels would be the best way of slowing that figure down.
The boost to government revenues, economic efficiency and the reduction in pollution would far outweigh the cost of establishing other assistance to genuinely poor households.
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