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The catch-22 oil price situation

Jakarta | Fri, April 1, 2016 | 01:47 pm
The catch-22 oil price situation Indonesia faces a Catch-22 situation. Whether it decides to raise or lower oil prices, it will still not be the right move to make. (Shutterstock/-)

For the past decade, the declining price of oil per barrel has been a trending topic worldwide. The impact of the situation has transformed the global economy, and quite alarmingly so when the price plunged to below $30 per barrel. While some people may covet the lower price, nevertheless more are distressfully concerned that the excessive price decline will bring not benefit but disaster.   

Many factors have contributed to the fall in global oil prices, but it is mainly the abundant availability of supply that is to blame for the price decline. On further exploration, there are three driving factors that affect oil oversupply – technology, economics and politics.

The fracturing technology that produces shale oil in the US has the ability to multiply oil production and increase the volume of oil reserves, thus changing the course or direction of the development of global energy. With oversupply in oil production using this technology, the US has the option of flooding the global market with its oil. This action by intent is meant to suppress the rise of terrorism, especially the Islamic State (IS), which many believe is funded through the sale of oil. The abundant oil supply in the global market is expected to cull and suppress terrorist aggression, but to date, the effectiveness of this method remains questionable.

Vested interests also play a major role in the decline of oil prices. Saudi Arabia and other oil producing countries, members of OPEC, hesitate to reduce their oil production in response to the oversupply in oil. They argue that reducing oil production is no easy matter and would result in the loss of oil market share. Besides that, the measure would not necessarily curb the fall in oil price.

The slowdown in China’s economy has also worsened the situation.  Currently, China is the world’s largest economy. For years, China’s economy has grown aggressively, but recently it has shown significant slowdown, leading to a reduction in oil demand. To put it in another way, reduction in oil demand increases the accumulation of oil supply, causing the oversupply in oil.

Concerns have heightened with the lifting of the Iranian embargo. Iran is one of the largest oil-producing countries in the world. The end of the economic sanctions will provide Iran with the opportunity to produce and export oil, adding to the oversupply, and prices will most likely drop even lower.

Initially, the oil price drop was received well as it was expected to stimulate global economic growth, which has recently slowed down. This situation should be profitable for developing countries and oil importers in pushing up their economic growth and development levels. On the contrary, the extreme drop in oil price impacts the economy negatively, as it hits the real sector.

The extreme price decline has had undesirable consequences. Several oil companies have experienced the impact of the oil price slump. Schlumberger is the first multinational company to respond to the situation by laying off its employees. No fewer than 10,000 employees around the world will lose their jobs in the near future.  Several other multinational companies are preparing to do the same.

Inevitably, the oil price drop is also hitting the Indonesian economy. The price decline, which is expected to allow the Indonesia’s economy to breathe, poses another challenge, as this condition threatens the real sector related to the oil industry, such as coal mining, putting it in a dangerous position. Chevron Indonesia pioneers the first and initial response to this condition. Employees by the thousands are being prepared for redundancy.

Unrealistic conditions

The existing oil price no longer makes sense. Many question its economic level, and yet there is no definite answer, given the ongoing dynamics. The response of several global and domestic    companies serves as an indicator of the feasibility of the price. In economic theory, if the price drops and stands below the average of the total cost, it will affect the company’s activities and operations in both the short and long terms. Cost efficiency may not be effective in overcoming the resultant ongoing problems.

Indonesia faces a Catch-22 situation. Whether it decides to raise or lower oil prices, it will still not be the right move to make. The current price has made some industries no longer attractive. The price affects these industries in that they can no longer cover the emerging costs, and this destroys the Industry’s structure. Tax relief, as an effort to solve the problem is no longer a valid action. The government should fully intervene to anticipate the emergence of a more distressing situation. The continuing uncertainty remains the greatest challenge.

Energy independence

The bitter truth facing Indonesia is its position as a net oil importer, without any power to determine the oil price. Energy independence ultimately has to be achieved as soon as possible; the longer Indonesia depends on oil, the deeper the country will fall into the depths of uncertainty.

It is not a simple matter for Indonesia to be free from the trap of dependency. While Indonesia’s energy portfolio is for the time being sufficient, the fact remains that Indonesia still depends on oil. Energy sustainability must be implanted and internalized in the people’s mindset. It is of utmost necessity to raise public awareness not to depend on fossil fuel, especially oil.

A firm decision by the government on the discontinued dependency on fossil energy should become the foundation to resolve the problem, and it should avoid decisions that provide only short-term benefits. It is of absolute necessity for the nation to develop renewable energy, which Indonesia has huge potential in.  Based on the most recent data from the Energy and Mineral Resources Ministry, the potential for micro-hydro energy is 450 MW, biomass stands at 50 GW, solar is 4.80 kWh / m2 / day, geothermal energy is 28 GW, wind is 3-6 m / s, with 3 GW for nuclear energy, and biofuel making up the rest of potentially available energy. The oil price today makes it impossible to rely on investors as renewable energy development partners. Currently, renewable energy development is costly, making it economically unattractive given the continued decline in oil prices.      

The nation should fully undertake the responsibility to develop energy, including the provision of its funding. The government has rightly highlighted the controversy of energy sustainability, but failed to follow through on implementing the steps due to weak legal support or meager protective coverage by the law. The government should quickly move to fill the existing gaps and immediately advance the program and acquire the necessary funding, especially since they can no longer use any available existing funds. This is imperative for the sake of the sustainability of national energy.

 

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The writer is a Faculty Member of Prasetiya Mulya School of Business and Economics.

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