Iraqi Oil & Indonesian Planning

While Alex Tabarrok notes this Foreign Affairs article ($) on how to deal with Iraqi oil, those on the ground are getting exports back online:

Prices fell this week after Iraq restored full crude exports of two million barrels a day from its southern Basra fields and restarted deliveries at 450,000 bpd, half capacity, from its northern Kirkuk fields for the first time since May.
But the high price of oil caught some government planners by surprise. Hence our next Statsmerkw�rdigkeiten award goes to the government of Indonesia, which continues its incredibly distorting "buy-high, sell-low" energy subsidy:
The steep oil price hike since May -- to as high as US$50 per barrel now -- has finally forced the Indonesian government to revise upward from $22 to $36 per barrel the average oil price used to estimate oil tax revenues and the cost of fuel for the current fiscal year....

The government... has decided to abandon its sensible, fuel-economic, 2002 policy to float domestic fuel prices on market quotations in Singapore to encourage efficient use, slash subsidies, target price support only to poor consumers (kerosene for household use) and, most importantly, minimize smuggling overseas. Consequently, fuel subsidies for 2004 will balloon to more than Rp 63 trillion ($7.08 billion), much more than total central government spending on its personnel (civil servants, the police and the military).

Since the government maintains domestic fuel prices way below actual production costs -- applying a blanket subsidy on all kinds of fuel -- the bulk of the subsidies may end up benefiting mostly private car owners (middle and top-income consumers). Most devastatingly, fuel smugglers will receive even stronger incentives, as their profit margins will skyrocket.

True, part of the subsidy will go on kerosene, which is widely used by poor people. But corruption will continue to divert quite a significant portion of this cheap fuel to industrial users and smugglers.

I understand the desire to help the (very truly) poor by keeping kerosene prices affordable, and clearly the result of this policy was highly unexpected. But that's the point that has to be noticed; this example demonstrates that inflexible policies that require a static world (or that require prices to remain within an historical corridor), can fail miserably when price-flexible dyamic markets perform their economic function... Simply put, the Indonesian government thought it could spend freely on subsidies, and didn't see this coming:
Until last year (when Indonesia was still a net oil exporter), any increase in international crude oil prices would give the government net additional revenues. However, starting this year, as the country is already a net oil importer of about 36,000 barrels a day, an oil-price hike immediately cuts into central government income as additional revenues are much less than additional spending on subsidies.


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This page contains a single entry by Kevin published on August 25, 2004 3:07 PM.

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