Indonesia has an ambition to reduce its dependency on fuel oil. In its General Planning for National Energy (RUEN), the government set a target to reduce the proportion of fuel oil in Indonesia’s energy mix to 25 percent by 2025, from 46 percent in 2015. Should the government manage to fulfill the target, it will have a positive effect on Indonesia’s economy.

As a net oil importer, Indonesia is more vulnerable to external shocks, such as the high volatility of the international crude oil price and exchange rate. Only by achieving the energy mix target can Indonesia significantly diminish the impact of these shocks in the future.

Yet, achieving the target is not as easy as it seems. The government’s current policy on the domestic fuel oil price tends to incentivize consumption, as the pegged fuel oil price is set relatively low compared to its market price. This policy has meant that fuel oil consumption has consistently increased, despite the increasing trend in the international crude oil price recently. So far, the lack of adjustment of the domestic fuel oil price has not led to any changes in people’s behavior toward fuel oil consumption.

Although the government announced the energy mix target in 2014, the portion of fuel oil in Indonesia’s primary energy supply has continued to increase due to the incentive for fuel oil

Data from the Energy and Mineral Resources Ministry shows that from 2013 to 2017, Indonesia’s primary energy supply grew 0.77 percent based on the compound annual growth rate (CAGR) to 1.64 billion of barrel oil equivalent (boe), from 1.6 billion boe previously.

Meanwhile, the fuel oil supply grew by 3.09 percent (CAGR) indicating an increase in the proportion of fuel oil in Indonesia’s overall primary energy supply.

Indeed, zooming into our analysis, the electricity sector has been able to reduce its dependency on fuel oil. In the 2013 to 2017 period, the proportion of fuel oil as an energy source in this sector declined noticeably. The proportion of fuel oil in the energy mix of the electricity sector was 11.6 percent in 2013. However, the figure then declined to 6.3 percent in 2017 following the government’s move to boost the development of many coal-based power plants. Moreover, in the same period, the proportion of coal in the energy mix of the electricity sector increased to 64.1 percent from 54.8 percent.

On the other hand, the proportion of fuel oil in the total energy mix of other sectors, such as industry, household and transportation, has tended to increase in the past five years. The proportion of fuel oil consumption in the industrial sector rose to 21.57 percent in 2017 from 18.79 percent in 2013. In the household sector, the figure rose to 16.16 percent from 15.41 percent over the same period. Transportation, meanwhile, has been stable at 99 percent every year.

There are at least three main reasons why Indonesia must reduce its dependency on fuel oil.

First, the high volatility of the world oil price will create instability in Indonesia’s economy. While the public has not felt the impact of the current fluctuations of the global oil price, the government remains at risk of increasing the state budget deficit by raising energy subsidies. It could also pose an increasing financial risk for state-owned oil and gas holding company Pertamina, if the government does not provide subsidies to support the company.

Second, the increasing level of domestic fuel consumption will put pressure on the trade balance, which will ultimately weaken Indonesia’s exchange rate. With the government deciding not to raise the fuel oil price until at least 2019, Indonesia’s oil and gas balance deficits are currently likely to widen. Consequently, it may be negatively affecting the overall trade balance, thus depreciating the rupiah exchange rate.

Finally, as the government has decided to peg the fuel oil price without any adjustments for certain periods, there is potential for an unexpected inflation surge if and when the price needs to be adjusted. Indonesia experienced this kind of inflation surge in 2014, when the domestic fuel price was raised by Rp 2,000 (13 US cents) per liter, causing inflation to soar to 7.9 percent year-on-year.

Most importantly, to overcome Indonesia’s dependence on fuel oil, the government should gradually stop incentivizing fuel oil consumption in the form of pegging fuel prices when there is an upward trend in the global oil price, for example. This kind of policy has surely increased domestic fuel oil consumption, as there has been no change in consumer behavior.

In addition, the government must implement several measures aimed at altering consumption patterns to reduce reliance on fuel oil. For example, the government can create a disincentive mechanism for the use of fuel oil by imposing a high tax on fuel-powered vehicles. On the other hand, vehicles using alternative energy should enjoy incentives, such as cheaper taxes or even tax holidays within a certain period. In addition, the government can continue providing safe and comfortable public transportation, so that people will be discouraged from using private vehicles.

Another way to reduce fuel oil dependency in the transportation sector is to accelerate the program for converting oil fuel (BBM) to gas fuel (BBG). Currently, the program is hampered by certain problems, such as the absence of pioneers in the private sector willing to support the move. Private sector actors believe there is insufficient demand for alternative energy-powered vehicles.

As a solution, the government should first provide infrastructure to support the fuel-conversion program, so that private sector actors are attracted to enter the market and support the development of alternative energy vehicles. In order to create demand for such infrastructure, the government could require the use of alternative energy for public transportation. As the provision of public transportation must follow government regulations, it is much easier for the authorities to enforce public transport providers to use alternative energy.

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The writer is an industry analyst at Bank Mandiri.

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