1he !

ournal of lnLernaLlonal ollcy SoluLlons

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1 WlnLer 2009 | volume 10

ln SepLember 2008, Lhe CrganlzaLlon of eLroleum
roduclng and LxporLlng CounLrles (CLC) announced
LhaL lndonesla had formally suspended lLs membershlp ln
Lhe oll carLel because of concerns over Lhe hlgh prlce of
oll. AL over uS$140 per barrel, lndonesla was flndlng lL
lncreaslngly dlfflculL Lo subsldlze domesLlc fuel prlces
(WaLklns, lndonesla makes offlclal lLs exlL from CLC
2008). AlLhough sLlll a neL exporLer of energy, by 2004
lndonesla had become a neL lmporLer of oll (8radsher
2008). llgure 1 lllusLraLes Lhe rapld decllne ln lndonesla's
exporLs, lLs rapld lncrease ln lmporLs, and Lhe polnL aL
whlch lmporLs began Lo ouLpace exporLs ln Lhe fuel
secLor.
-./012 3

1hls swlLch Lo becomlng a neL oll lmporLer, coupled wlLh
fuel subsldles ln place slnce Lhe 1990s, has been hlghly
deLrlmenLal Lo lndonesla. 1he sLeady rlse ln oll prlces
beLween 2004 and Lhe summer of 2008 led Lo an
lncreaslngly large proporLlon of lndonesla's governmenL
spendlng golng Lo supporL fuel subsldles (see llgure 2).
lndeed, concerns over lndonesla's ablllLy Lo hold on Lo lLs
neL exporLer sLaLus have prevalled slnce Lhe early 1990s
(8arnes 1993).
lndonesla's sLaLus represenLs a source of concern among
Lhe naLlons LhaL rely on lndoneslan oll, especlally ln Lhe
currenL envlronmenL of lncreaslng energy securlLy fears.
lndonesla possessed 3.99 mllllon barrels of proven oll
reserves as of 2007 (CLC 2007). ln 2002, Chlna naLlonal
Cffshore Corp (CnCC) and eLrochlna became prlme
lnLernaLlonal oll producers ln lndonesla. AddlLlonally,
Malaysla possesses Lhe rlghLs Lo flve oll flelds ln lndonesla
(8eng 2004). As lndonesla's reserves conLlnue Lo
dlmlnlsh, Lhese producers wlll need Lo look Lo oLher
sources for oll and energy securlLy. ConsequenLly,
lndonesla's neL lmporLer sLaLus noL only represenLs a
decrease ln energy securlLy for lndonesla, buL for Lhe
counLrles LhaL have hlsLorlcally relled on lndoneslan oll
lmporLs as well.
-./012 4

CLher naLlons face slmllar problems as a resulL of
decllnlng oll reserves. lor example, Mexlco's oll ouLpuL
has been decllnlng slnce 2004. Much llke lndonesla,
Mexlco's oll lndusLry ls domlnaLed by a sLaLe player,
eLroleos Mexlcanos (emex), whlch ls responslble for
Lhe dlscovery and developmenL of new oll flelds. Mexlco
has chosen noL Lo rely on shared exploraLlon conLracLs,
Indonesias Oil Crisis:
How Indonesia Became a Net Oil Importer
SHANNON PALLONE
unlverslLy of Callfornla, San ulego
School of lnLernaLlonal 8elaLlons and
aclflc SLudles
!"#$%" '( )*$*+,* -*.+,*/
1he !ournal of lnLernaLlonal ollcy SoluLlons


2 WlnLer 2009 | volume 10
leavlng Lhe naLlon ln danger of belng unable Lo keep up
wlLh developmenL needs, much llke Lhe slLuaLlon
lndonesla has found lLself ln (Mlllard 2008).
lndonesla has been an oll producer for over 100 years.
AfLer Lhe naLlon's lndependence ln 1943, Lhe Sukarno and
Lhen SuharLo reglmes managed whaL was once seen as a
pollcy success sLory for an oll-produclng naLlon. under
SuharLo's leglon of LechnocraLs, lndonesla successfully
avolded uuLch ulsease, an allmenL common ln resource-
rlch naLlons, ln whlch an abundance of naLural resources
causes currency appreclaLlon and makes alLernaLe
lndusLrles less compeLlLlve on Lhe world markeL (usul
1997).
lndonesla's success sLory, however, has suffered Lhe
same faLe as SuharLo's governmenL, falLerlng Loward Lhe
end of Lhe reglme and falllng Lo recover ln Lhe years slnce
Lhe Aslan llnanclal Crlsls of 1997. 1hls paper examlnes
how lndonesla's supply-slde pollcy mlsLakes have
comblned wlLh demand-slde pollcy mlssLeps Lo lead Lo
Lhe currenL crlsls. lL wlll also revlew and suggesL pollcy
recommendaLlons for lndonesla Lo move away from Lhe
fuel subsldy wlLhouL creaLlng larger problems ln Lhe
economy.
5 61.27 ).89:1; :7 #.< $1:=0>9.:? .? '?=:?28.@
lndonesla ls an archlpelago made up of over 17,000
lslands wlLh a land area of 1,904,000 square kllomeLers.
lLs populaLlon of 223.3 mllllon lnhablLanLs makes lL Lhe
fourLh mosL populous naLlon ln Lhe world, wlLh a per
caplLa Cu of uS$1,919. As of 2007, lndonesla's crude oll
producLlon was 838,000 barrels per day (b/d), wlLh crude
oll exporLs of 319,999 b/d and proven crude oll reserves
of 3.99 bllllon barrels (CLC 2007).
lndonesla became a uuLch colony ln Lhe early 17Lh
cenLury. ln 1883, Lhe flrsL commerclal oll was sLruck ln
LasL SumaLra's 1elaga 1ungal, and Lhe flrsL reflnery was
consLrucLed flve years laLer. Shell 1ransporL and 1radlng
dlscovered oll ln LasL kallmanLan Lwo years laLer, securlng
uuLch oll lnLeresLs ln lndonesla. 1he !apanese occupled
Lhe archlpelago durlng World War ll, leadlng some
peLroleum lnsLallaLlons Lo be burned (8arnes 1993).
AfLer Lhe !apanese defeaL aL Lhe hands of Lhe Allles,
lndonesla, under Lhe leadershlp of fuLure resldenL
Sukarno, declared lndependence ln 1943. AfLer several
years of war wlLh Lhe uuLch, lndonesla was flnally
recognlzed as an lndependenL sLaLe and Sukarno was
sworn ln as presldenL ln 1949 (klngsbury 2003). 1he
lndoneslan governmenL made oll agreemenLs wlLh
several of Lhe oll companles LhaL had been ln lndonesla
slnce colonlzaLlon: SLanvac, Shell and CalLex. A 30/30
proflL sharlng agreemenL was lnsLlLuLed and Lhe flrsL
lndoneslan oll exporLlng company, ermlna, was formed
noL long afLer. ln 1960, erLamln was esLabllshed, and
Law no. 44 on eLroleum and Cas Mlnlng revoked Lhe
concesslon rlghLs of forelgn oll companles. erLamln
purchased Shell's asseLs Lwo years laLer, and lndonesla
became a member of CLC (8arnes 1993).
Sukarno's reglme, however, evenLually succumbed Lo
economlc crlsls. 8y 1963, lnflaLlon had hlL 300 percenL
wlLh rlce prlces up 900 percenL (klngsbury 2003), due ln
parL Lo Sukarno's frequenL prlnLlng of new money. Cll
exporLs had fallen so low LhaL Lhey were only half Lhelr
level flve years earller. 1hls was largely a resulL of
WesLern naLlons halLlng oll purchases from lndonesla
because of a fear LhaL Lhe naLlon would fall Lo
communlsm (SmlLh 2007). Ceneral SuharLo was glven
conLrol of Lhe counLry, and became presldenL ln 1968
(klngsbury 2003), lnherlLlng Lhe naLlon aL a Llme when
economlc reform was Lhe flrsL prlorlLy (SmlLh 2007). AL
Lhe same Llme, ermlna and erLamln were merged Lo
creaLe Lhe naLlonal oll company erLamlna, whlch sLlll
domlnaLes Lhe lndoneslan oll lndusLry Loday (8arnes
1993). lL would be seven years before forelgn oll sales
fully recovered (SmlLh 2007).
SuharLo's reglme was dubbed OtJe 8oto, or new Crder"
and lasLed for 30 years. uurlng Lhls Llme SuharLo ruled
whaL has been labeled a reformlsL auLocracy." 1hls Lype
of reglme ls characLerlzed by compeLenL, auLonomous
leaders who rely heavlly on Lhe advlce of LechnocraLlc
ellLes. SuharLo needed Lo lmprove Lhe welfare of hls
sLaLe Lhrough economlc growLh, and used oll-secLor renLs
Lo fuel growLh ln non-oll secLors (LlferL, Celb and 1allroLh
2002). lndonesla under SuharLo ls ofLen clLed as an
example of well-crafLed flscal pollcy LhaL prevenLed uuLch
ulsease from negaLlvely lmpacLlng socleLy (usul 1997).
A0BB<;CA.=2 $:<.>;
lndonesla's supply-slde pollcles cenLer on Lhe naLlonal oll
company, erLamlna. 1o beLLer undersLand Lhe pollLlcs aL
work, lL ls necessary Lo furLher examlne erLamlna's
hlsLory. Slnce lLs esLabllshmenL ln 1968, erLamlna's
prlmary purpose has been Lo acL as Lhe premlere player
ln lndonesla's oll and gas lndusLry, funnellng revenues
from lLs efforLs Lo Lhe governmenL. AL LhaL Llme, lnLernal
sLruggles abouL Lhe company's auLonomy ended when
resldenL SuharLo made Lhen resldenL ulrecLor lbnu
1he !ournal of lnLernaLlonal ollcy SoluLlons


3 WlnLer 2009 | volume 10
SuLowo, dlrecLly responslble Lo hlm. uomesLlc
dlsLrlbuLlon conLrol was glven Lo erLamlna, as was Lhe
auLhorlLy Lo allocaLe drllllng concesslons. 1he publlc was
noL allowed access Lo erLamlna's operaLlons, and Lhe
parllamenL could noL revlew erLamlna's balance sheeLs
(Seda, eLroleum aradox: 1he ollLlcs of Cll and Cas
2003).
1hls lack of Lransparency has allowed for corrupLlon Lo
become a problem wlLhln erLamlna. AccounLable only
Lo SuharLo, erLamlna had Lhe ablllLy Lo award some of
Lhe largesL and mosL proflLable consLrucLlon and supply
conLracLs ln Lhe counLry (Seda, eLroleum aradox: 1he
ollLlcs of Cll and Cas 2003). aLron-cllenL relaLlons have
hlsLorlcally been a sLrong source of corrupLlon ln
SouLheasL Asla, wlLh favor delegaLlon playlng a key role ln
pollLlclans' ablllLy Lo remaln ln power (ScoLL 1972). WlLh
de facLo conLrol of erLamlna, SuharLo had a seemlngly
endless source of conLracLs wlLh whlch Lo reward hls
paLrons as he moved Lo a poslLlon of sLrong auLocraLlc
power (Seda, eLroleum aradox: 1he ollLlcs of Cll and
Cas 2003). lL also made erLamlna suscepLlble Lo
rampanL kolosl, kotopsl Joo oepotlsme (kkn - colluslon,
corrupLlon and nepoLlsm), maklng room for corrupLlon
wlLhln Lhe sysLem LhaL would evenLually hlnder efforLs Lo
lncrease producLlon capaclLy and ouLpuL (Seda,
eLroleum aradox: naLural 8esources and uevelopmenL
ln lndonesla, 1967-1997 2001).
ln !uly 2008, lndonesla's CorrupLlon LradlcaLlon
Commlsslon (kkn) announced LhaL lL had launched an
lnvesLlgaLlon of Lhe upsLream Cll and Cas 8egulaLlng
8ody (8 Mlgas) over dlscrepancles ln oll producLlon LhaL
ls purporLed Lo represenL 16.1 mllllon barrels of crude oll
per year. Cver Lhe pasL seven years, Lhls has allegedly
amounLed Lo 120.3 Lrllllon 8uplah (approxlmaLely uS$21
bllllon) ln revenue LhaL should have been Lransferred Lo
Lhe sLaLe. lndonesla CorrupLlon WaLch made Lhe
dlscovery and reporLed Lhe clalms of corrupLlon Lo kkn.
Such corrupLlon ls aLLrlbuLed Lo a lack of Lransparency
LhaL sLlll pervades lndonesla's oll lndusLry (Abdussalam
2008).
1urnlng Lo lndonesla's oll reserves as an lndlcaLor of
fuLure levels of oll producLlon, lL should flrsL be noLed
LhaL lndonesla's largesL produclng flelds are aglng and
producLlon ls slowlng. CurrenL ouLpuL has slowed Lo less
Lhan a mllllon barrels per day, far below Lhe 1.3 mllllon
barrels per day of lndonesla's CLC quoLa (lndonesla Lo
be ln CLC unLll year-end 2008). llgure 3 lllusLraLes Lhls
sLeady decllne (lengler and 8ulman 2008).
-./012 D

ln Lhe 1960s, lndonesla soughL Lo combaL decllnlng
producLlon by lnsLlLuLlng producLlon-sharlng conLracLs
(SC) ln order Lo lncrease exploraLlon and modernlzaLlon
of exlsLlng flelds. 1hen, as now, uncerLalnLy of pollLlcal
reglme, hosLlllLy Loward forelgn companles, and an
unsupporLlve legal framework made lL dlfflculL Lo
convlnce forelgn lnvesLors Lo lnvesL ln lndonesla's oll
resources. SCs, deslgned Lo spllL proflLs 60/40 ln favor
of Lhe lndoneslan governmenL, were enacLed Lo combaL
Lhese problems. 1hese agreemenLs dld noL always Lake
precedence, however, as erLamlna's resldenL ulrecLor
and ulrecLor Ceneral of Lhe 8ureau of Cll and Cas (Mlgas)
conLlnued Lo glve conLracLs Lo exlsLlng raLher Lhan new
companles (8arnes 1993).
1hese SCs, however, sLlll lefL room for corrupLlon and
meLhods for lndonesla Lo counL Lhe proflLs ln lLs favor.
CosLs were only recoverable on producLlon, and Lhe
conLracLor Look on all of Lhe rlsk, whlch was frequenLly
subsLanLlal. 1he conLracLor would flnance all exploraLlon,
developmenL and producLlon, meanlng LhaL ln Lhe evenL
LhaL no oll was produced from LhaL fleld, Lhe conLracLor
would bear all of Lhe cosL and lndonesla would bear
none. 1hls made lL dlfflculL for lnvesLors Lo recover Lhelr
expendlLures. Lven afLer alloLmenLs had been made for
Lhe conLracLor Lo recover Lhelr cosLs, Lhe sLaLe kepL 60
percenL of proflLs, whlle Lhe conLracLor only saw 40
percenL. LvenLually, erLamlna's share rose Lo as hlgh as
83 percenL (8arnes 1993). 1oday SCs are Lyplcally spllL
83/13, wlLh Lhe excepLlon of hlgher rlsk deepwaLer
deposlLs, for whlch Lhe SCs allocaLe 70 percenL Lo Lhe
lndoneslan governmenL and 30 percenL Lo Lhe prlvaLe
company (MonLlake 2008).

1he !ournal of lnLernaLlonal ollcy SoluLlons


4 WlnLer 2009 | volume 10
8enLler sLaLes such as lndonesla have Lyplcally been
characLerlzed as dependlng heavlly on Lhe dlsLrlbuLlon of
renLs for pollLlcal sLablllLy. 1hls creaLes a subsLanLlal
rellance on peLrodollars" Lo malnLaln auLhorlLy aL Lhe
expense of sLaLe capaclLy bulldlng (Seda, eLroleum
aradox: naLural 8esources and uevelopmenL ln
lndonesla, 1967-1997 2001). Cver Llme, Lhls decrease ln
oll ouLpuL capaclLy becomes caLasLrophlc lf Lhe naLlon
wanLs Lo remaln a neL oll exporLer.
lndonesla's currenL exlL from CLC and decllnlng
producLlon has been blamed on pollLlcal uncerLalnLy as
well, Lhls Llme as a resulL of conLlnued fallouL from Lhe
collapse of SuharLo's rule. Slnce 1998, erLamlna has
kepL lLs WesLern parLners from new lnvesLmenLs ln
lndoneslan oll producLlon, delaylng Lhe developmenL of
new oll flelds. Whlle lndonesla lnsLlLuLed a plan ln 2007
Lo lncrease producLlon back Lo 1.3 mllllon b/d by 2009, lL
has become lncreaslngly unllkely LhaL Lhls goal can be
meL, as Lhe formal parLnershlps have noL yeL been
flnallzed. 8lslng naLlonallsm also makes lL dlfflculL for
forelgn oll companles Lo do buslness ln lndonesla, as
many clLlzens are opposed Lo allowlng forelgn companles
access Lo lndonesla's naLural resources (WaLklns, ollLlcal
uncerLalnLy reduces lndoneslan producLlon 2008). lf
lndonesla does noL revlse lLs pollcles Lo creaLe a more
frlendly operaLlng envlronmenL for forelgn lnvesLors, lL
musL begln lnvesLlng heavlly ln upgrades Lo erLamlna as
well as puL money lnLo exploraLlon lf lL wlshes Lo regaln
lLs sLaLus as an oll exporLlng naLlon.
1he charges broughL by lndonesla's Supreme AudlL
Agency (8k) agalnsL 8 Mlgas and erLamlna are Lhe
flrsL sLeps ln sendlng a slgnal Lo forelgn lnvesLors LhaL
corrupLlon wlll no longer be LoleraLed. 1here are 106.93
Lrllllon 8uplah ln mlsslng non-Lax revenue and lncome Lax
from Lhe oll and gas secLor LhaL wenL unreporLed by
conLracLors. 1herefore, proceeds were never Lransferred
Lo sLaLe coffers, leavlng Lhem ln Lhe hands of local
admlnlsLraLors lnsLead. 1hls ls ln addlLlon Lo Lhe 1.17
Lrllllon 8uplah ln 2006 and 6.60 Lrllllon 8uplah ln 2007
LhaL erLamlna ls accused of Laklng ln lnflaLed fuel
subsldles (Clobal lnslghL Same uay Analysls 2008). 1hese
Lypes of acLlons send negaLlve slgnals Lo forelgn
lnvesLors. Such behavlor ln Lhe pasL has been a sLrong
lndlcaLor of wldespread corrupLlon reachlng Lo hlgh levels
of governmenL. Whlle Lhe charges are a sLarL, lndonesla
has Lhus far falled Lo follow Lhrough on any hlgh proflle
corrupLlon charges. ln order Lo regaln Lhe confldence of
forelgn lnvesLors needed Lo generaLe upsLream pro[ecLs,
Lhe governmenL musL prosecuLe raLher Lhan absolve Lhe
players of Lhe corrupLlon charges. Such behavlor ln Lhe
pasL has been a sLrong lndlcaLor LhaL corrupLlon ls
wldespread and reaches Lo hlgh levels of Lhe
governmenL.
1hus far, however, Lhe governmenL has noL slgnaled LhaL
lL lnLends Lo follow Lhrough on Lhe corrupLlon charges. ln
november 2008, ALLorney-Ceneral Pendarman Supand[l
dropped a case agalnsL erLamlna lnvolvlng Lhe sale of
under-valued oll Lo Lwo oll superLankers. 1he ALLorney
Ceneral argued LhaL a lack of comparaLlve prlce sLandards
made lL lmposslble Lo value Lhe amounL of Lhe losses Lo
Lhe sLaLe, and Lherefore Lhe case should be dropped.
1hls case was llnked Lo governmenL offlclals as hlgh as
former resldenL MegawaLl SukarnopuLrl (llLzpaLrlck
2008). Such proLecLlon of governmenL mlnlsLers ls a slgn
LhaL Lhe paLronage sysLem ls sLlll very much ln pracLlce.
E2F@?=CA.=2 $:<.>;
1he oLher half of Lhe lndoneslan pollcy puzzle leadlng Lo
Lhe naLlon's currenL lmporLer sLaLus has Lo do wlLh
demand pollcy LhaL falled Lo hold energy growLh aL a
susLalnable pace. under SuharLo's conLrol, growLh grew
ln lndonesla durlng Lhe 1990s (Plll 1996) aL a pace LhaL
earned lL a spoL on Lhe llsL of counLrles lnvolved ln Lhe
Aslan Mlracle". ln 1973 and 1974, durlng Lhe oll wlndfall
booms, lndonesla was able Lo lmplemenL a sLrong
sLraLegy for developmenL spendlng. uurlng Lhe flrsL oll
wlndfall, lndonesla puL half of Lhe money earned from oll
renLs lnLo developmenL spendlng (LlferL, Celb and
1allroLh 2002). 1he rapld growLh, however, also led Lo a
rapld lncrease ln energy demand. As llgure 4
demonsLraLes, oll has comprlsed an lncreaslng proporLlon
of energy generaLlon ln lndonesla over Lhe pasL 10 years
(CLCu/lLA 2008). Whlle clear aLLempLs have been made
Lo dlverslfy, prlmarlly Lhrough lncreases ln coal and
naLural gas use for elecLrlclLy generaLlon, and Lo a lesser
exLenL renewable such as geoLhermal, solar and wlnd, oll
has sLlll become lncreaslngly predomlnanL ln energy
generaLlon. Some esLlmaLes ln Lhe mld-1990s suggesLed
LhaL Lhese energy source subsLlLuLlons would decrease
Lhe share of oll ln LoLal energy demand by 44 percenL by
2010, lL ls now clear LhaL Lhls wlll noL be Lhe case (8arnes
1993). Whlle Lhe Aslan llnanclal Crlsls of 1997 caused a
dlp ln all of Lhese sources, LhaL decrease was soon
overLaken by a sLrong reLurn Lo growLh ln energy
demand. Calns LhaL had been made by slowed
producLlon were shorL llved, and whlle lL probably earned
lndonesla some exLra Llme before lL swlLched Lo neL
1he !ournal of lnLernaLlonal ollcy SoluLlons


3 WlnLer 2009 | volume 10
lmporLer sLaLus, Lhe Lra[ecLory made Lhe change
unavoldable.
-./012 G

8uL growLh ls only half of Lhe sLory. 1he oLher half sLems
from Lhe wldespread avallablllLy of cheap oll (8arnes
1993). As was menLloned prevlously, ln Lhe pasL
lndonesla has successfully lnvesLed oll renLs derlved from
hlgh world prlces lnLo economlc developmenL pro[ecLs
LhaL dlverslfled lLs economy away from oll and helped Lo
prevenL Lhe onseL of uuLch ulsease (LlferL, Celb and
1allroLh 2002). uurlng Lhe oll boom of Lhe pasL four
years, however, lndonesla has noL been able Lo caplLallze
on hlgh oll prlces for Lwo reasons. llrsL, lndonesla's
sLaLus change from neL exporLer Lo neL lmporLer means
LhaL Lhere ls no excess oll Lo sell on Lhe world markeL, and
Lhe naLlon musL purchase oll ln order Lo meeL lLs own
domesLlc needs. Second, ln order Lo pay for lncreaslng
fuel subsldles, lndonesla musL sacrlflce spendlng on
developmenL programs. 1o beLLer undersLand Lhls
problem requlres an ln depLh examlnaLlon of fuel
subsldles ln lndonesla.
'?=:?28.@H8 -02< A0I8.=;
lndonesla's fuel subsldy has presenLed lLs greaLesL
obsLacle Lo overcomlng demand-slde pollcy fallures Lo
conLrol domesLlc oll consumpLlon. 1he subsldy Lakes Lhe
form of a Lransfer paymenL from Lhe cenLral governmenL
Lo erLamlna ln exchange for Lhe losses erLamlna suffers
as a resulL of arLlflclally low domesLlc fuel prlces (Mello
2008). 1hls obsLacle becomes even greaLer when Lhe
hlgh volaLlllLy of oll prlces ls Laken lnLo conslderaLlon
(usul 1997). lor an exporLlng naLlon, Lhls ls generally
mosL problemaLlc ln Lerms of deLermlnlng governmenL
spendlng. lf oll proflLs are overesLlmaLed, Lhere ls a
danger of rapldly lncreaslng debL Lo meeL spendlng
needs. lf proflLs are underesLlmaLed, Lhe naLlon faces a
surplus. lor lmporLlng naLlons, however, especlally Lhose
LhaL lnsLlLuLe fuel subsldles, Lhls volaLlllLy presenLs a
dlfferenL problem. ?ears wlLh unexpecLedly hlgh oll
prlces mean LhaL Loo much of Lhe federal budgeL ls
consumed by fuel subsldles, ofLen aL Lhe expense of
programs such as publlc healLh and educaLlon. ?ears of
underesLlmaLlon of oll prlces can lead Lo a false sense of
securlLy LhaL Lhere wlll be adequaLe spendlng for
developmenL programs.
Subsldles have noL always been a facLor ln lndonesla.
lndeed, ln 2003, subsldles had largely been phased ouL.
Slnce LhaL Llme however, lncreaslng oll prlces, coupled
wlLh ever lncreaslng domesLlc demand, caused Lhe reLurn
of subsldles ln Lhe followlng year back Lo levels
approachlng 3 percenL of Cu. ALLempLs Lo abollsh Lhe
subsldles have meL wlLh slgnlflcanL reslsLance ln boLh Lhe
general populaLlon and Lhe lndoneslan parllamenL due Lo
fears of lnflaLlon and an adverse effecL on Lhe poor
(ClemenLs, !ung and CupLa 2007).
Aslde from Lhe problems subsldles creaLe ln Lerms of
balanclng Lhe budgeL, Lhey are also deLrlmenLal ln Lerms
of lnflaLlng demand. When fuel prlces are held below Lhe
Lrue markeL value, cusLomers demand more fuel aL Lhe
cheaper prlce. 1herefore, demand for energy wlll
lncrease aL a hlgher raLe Lhan lL would have lf consumers
were paylng Lhe Lrue markeL prlce. 1hls exacerbaLes Lhe
supply problem, creaLlng a need Lo lmporL addlLlonal oll
from elsewhere Lo meeL Lhe gap creaLed by Lhe oll
squeeze (SmlLh 2007).
AnoLher concern generaLed by Lhe fuel subsldy ls LhaL lL
places an addlLlonal sLraln on Lhe envlronmenL due Lo Lhe
lncreased demand LhaL Lhe subsldy generaLes. 1he
arLlflclally low prlces dlscourage Lhe developmenL of
oLher, more envlronmenLally frlendly alLernaLlves and
keep lndonesla heavlly rellanL on fossll fuels for energy
generaLlon (Mello 2008).
ln addlLlon, fuel subsldles do noL beneflL Lhe rlch and Lhe
poor equally (See llgure 3 (lengler and 8ulman 2008)).
Accordlng Lo an CLCu worklng paper, lL ls esLlmaLed LhaL
Lhe rlchesL 40 percenL of Lhe populaLlon recelves almosL
Lwo-Lhlrds of Lhe beneflLs of all fuel subsldy spendlng
(Mello 2008). More speclflcally, Lhe Asla uevelopmenL
8ank asserLs LhaL of Lhe regresslve fuel subsldy Lhe Lop
10 of lncome earners recelve 43 of Lhe fuel subsldles
and Lhe pooresL 10 less Lhan 1" (8rommelhorsLer
1he !ournal of lnLernaLlonal ollcy SoluLlons


6 WlnLer 2009 | volume 10
2008). Subsldles are generally lnLended Lo help poorer
populaLlons wlLhln a counLry cope wlLh oLherwlse hlgh
prlces.
-./012 J

ln Lhe era of SuharLo's LechnocraLs, moneLary and flscal
pollcy was hlghly regulaLed. Cll revenues were used Lo
promoLe developmenL ln Lhe agrlculLural and lndusLrlal
secLors, mosL noLably ln programs almed aL lncreaslng
rlce producLlon (Macuougall 1976). ln Lhe presenL era
where lndonesla ls no longer self-susLalnable, leL alone a
neL exporLer of oll producLs, Lhere ls llLLle surplus from oll
Lo be redlrecLed lnLo economlc developmenL pro[ecLs.
Whlle lndonesla ls sLlll a neL energy lmporLer wlLh large
revenues from Lhe exporL of alLernaLlve fuel sources such
as llquefled naLural gas and coal, Lhe pressure of Lhe oll
subsldles on Lhe cenLral governmenL's budgeL ls sLrong.
ln 2008, lL ls esLlmaLed LhaL fuel subsldles alone wlll
greaLly ouLwelgh caplLal lnvesLmenL and soclal program
spendlng. When consldered ln con[uncLlon wlLh Lhe
elecLrlclLy subsldy, lL ls posslble LhaL energy subsldles
could equal more Lhan caplLal lnvesLmenLs and soclal
program spendlng comblned. 1hls Lrend ls noL unlque Lo
2008 (see llgure 6). An examlnaLlon of energy subsldles
versus soclal spendlng over Lhe lasL Lhree years shows
LhaL Lhls has been a wldenlng Lrend (lengler and 8ulman
2008). As a resulL, lL ls dlfflculL for lndonesla Lo make
galns ln Lhelr caplLal sLock of labor, as educaLlonal
programs conLlnue Lo suffer aL Lhe hands of Lhe fuel
subsldy (Mello 2008).
ALLempLs Lo reduce Lhe subsldles have only augmenLed
Lhese problems. Whlle lL ls Lhe rlch who beneflL Lhe mosL
from Lhe low fuel prlces, as Lhey are more able Lo afford
personal vehlcles and can susLaln lncreased consumpLlon,
lL ls Lhe poor who suffer Lhe greaLesL shorL-Lerm effecLs
of a subsldy reducLlon. 8educLlons ln Lhe fuel subsldy
drlve up Lhe prlce of food and LransporLaLlon, wlLh Lhe
poor sufferlng Lhe mosL from Lhe ensulng lnflaLlon. As a
resulL, Lhere has been subsLanLlal reslsLance Lo Lhe
reducLlon ln subsldles (Mello 2008).
ln 2003, as a response Lo rapldly lncreaslng fuel prlces,
Lhe governmenL lnsLlLuLed Lwo prlce ad[usLmenLs for a
welghLed average lncrease of 160 percenL ln gasollne
prlces. 1hls broughL fuel prlces wlLhln range of
lnLernaLlonal levels, buL Lhe opporLunlLy Lo offlclally
phase ouL Lhe subsldy was lgnored, and Lhe subsldy
sysLem was kepL lnLacL (8rommelhorsLer 2008). llgure 7
(lengler and 8ulman 2008) shows Lhe relaLlonshlp
beLween lndoneslan and lnLernaLlonal fuel prlces, as well
as Lhe polnLs aL whlch Lhe subsldy was decreased. ln
addlLlon Lo Lhe lncreases of 2003, record hlgh crude oll
prlces ln 2008 necesslLaLed a Lhlrd fuel prlce lncrease of
28.7 percenL. learful of Lhe prlce lncrease's effecL on
lnflaLlon and Lo mlLlgaLe Lhe effecL on Lhe poor, Lhe
governmenL lnsLlLuLed a compensaLlon program. 1he
hlghllghLs from Lhls program lncluded cash Lransfers Lo
low-lncome famllles and an lncrease ln Lhe rlce subsldy Lo
amelloraLe Lhe paln of rlslng food cosLs (ers 2008).
-./012 K

lndonesla's fuel subsldles also creaLe leakage concerns.
Casollne ls ofLen purchased aL Lhe subsldlzed prlce and
Lhen resold offshore (MonLlake 2008). 1hls Lype of
behavlor ls noL consLralned Lo lndlvlduals seeklng proflL
from arLlflclally low prlces. lL also exLends Lo erLamlna
offlclals, who have been known Lo smuggle oll Lo offshore
1he !ournal of lnLernaLlonal ollcy SoluLlons


7 WlnLer 2009 | volume 10
buyers below Lhe markeL prlce. lL was reporLed LhaL ln
LasL kallmanLan aL Lhe Lawe-Lawe oll reflnery, erLamlna
workers were pumplng crude oll ouL Lo Slngaporean
Lankers LhaL were walLlng offshore. 1he oll was
reporLedly sold for half Lhe offlclal lnLernaLlonal prlce
(?amln 2003).
-./012 L

uomesLlcally, Lhe beneflLs of Lhe fuel subsldy are noL
experlenced by all. 8ecause Lhe subsldy ls supplled aL Lhe
fuel depoL Lo dlsLrlbuLers, Lhe dlsLrlbuLers, ln Lurn, musL
Lransfer Lhe fuel Lo Lhe ouLer lslands. 1he cosL of Lhe
LransporLaLlon ls added Lo Lhe cosL of Lhe subsldlzed fuel,
meanlng LhaL Lhe more remoLe lslands face much sLeeper
prlces Lhan Lhose lnhablLanLs who llve on Lhe !ava
malnland". uesplLe numerous pleas by local
governmenL offlclals, acLlons have noL been Laken Lo
make Lhe subsldy falrer". 1hus, noL only do Lhe rlch
beneflL from Lhe subsldy because of hlgher lncomes, Lhey
are also more concenLraLed on Lhe malnland and see
addlLlonal beneflLs from Lhelr proxlmlLy Lo Lhe subsldlzed
porLs (8umLe 2008).
lL ls dlfflculL Lo convlnce Lhe publlc and Lhe parllamenL
LhaL Lhe fuel subsldles should be abandoned. ln Lhe pasL,
cuLs ln Lhe fuel subsldy have been accompanled by rloLs
and proLesLs (?amln 2003), as consumers fear LhaL noL
only wlll Lhey be unable Lo afford prlvaLe and publlc
LransporLaLlon, buL LhaL Lhey wlll feel Lhe lncrease ln food
and sLaple lLem prlces. 1hls was a parLlcularly dlfflculL
dllemma ln 2008, as Lhe pressures of keeplng up wlLh
soarlng oll prlces had Lo be welghed agalnsL Lhe LhreaL of
anLl-governmenL proLesLs ln a pre-elecLlon year (1ong
2008). As of uecember 2008, Lhe world oll prlce had
fallen by approxlmaLely uS$100, and lL ls unllkely LhaL
lndonesla's parllamenL wlll make addlLlonal cuLs Lo Lhe
fuel subsldy wlLh Lhe now decreased budgeL pressure.
$:<.>; &2>:FF2?=@9.:?8
AlLhough lndonesla was halled as a model for developlng
oll naLlons ln Lhe decades leadlng up Lo Lhe Aslan
llnanclal Crlsls, Lhe flnanclal lnsLablllLy revealed long-
sLandlng problems wlLh supply- and demand-slde
pollcles, whlch consplred Lo shlfL Lhe naLlon from a neL oll
exporLer Lo a neL oll lmporLer. 1here are a number of
avenues LhaL lndonesla can and has been explorlng,
whlch may help decrease demand and boosL producLlon
so LhaL Lhe counLry can evenLually re[oln CLC and revlve
lLs alllng oll lndusLry, and agaln become a model for
developlng oll naLlons.
lottbet Jecteose tbe foel sobsl Jy ootl l l t teocbes
wotl J ptl ces
1he mosL radlcal opLlon on Lhe demand-slde of Lhe
equaLlon would be Lo ellmlnaLe Lhe fuel subsldy. lf world
oll prlces remaln low, Lhls could be a feaslble slLuaLlon, aL
leasL unLll prlces sLarL rlslng agaln. 1hls prlclng should
beLLer capLure Lhe cosLs of energy producLlon, and
decrease demand Lo a more susLalnable level. 1hls, ln
Lurn, should spur lndusLry Lo adapL more efflclenL
Lechnlques ln order Lo remaln compeLlLlve. 1he removal
of Lhe subsldy would also reduce budgeL consLralnLs and
allow for lncreased spendlng on caplLal works and soclal
programs (8rommelhorsLer 2008).
1he blggesL fear spurred by Lhe ad[usLmenL Lo world
prlces ls LhaL anLl-governmenL proLesLs and rloLs would
resulL as soon as world prlces began Lo rlse. lL ls llkely
LhaL Lhls unresL would be coupled wlLh a shorL-Lerm
economlc downLurn. A large splke ln lnflaLlon
accompanled Lhe 2003 subsldy decrease (see flgure 8).
1hls lncrease ln lnflaLlon, however, was shorL llved. lL ls
sLlll Loo early Lo deLermlne whaL Lhe full effecLs of Lhe
2008 subsldy decrease wlll be on lnflaLlon, however, early
daLa lndlcaLes LhaL lLs dlrecL effecL ls around 30 percenL.
PlsLory suggesLs LhaL lnflaLlon wlll recover ln Lhe long run
(lengler and 8ulman 2008).
locteose sobsl Jl es fot ttoospottotl oo ooJ fooJ
sectots wbl l e pbosl oq oot foel sobsl Jl es
ln order Lo l essen Lhe l mpacL of decreasl ng fuel
subsl dl es, Lhe governmenL coul d underLake
programs sl ml l ar Lo Lhe currenL compensaLl on
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8 WlnLer 2009 | volume 10
sLrucLure Lo hel p ease Lhe Lransfer Lo hl gher fuel
prl ces.
-. /012 M

ln addlLlon Lo cash Lransfers Lo low-lncome households
and lncreased food subsldles, Lhe lndoneslan governmenL
should conslder lnvesLlng funds ln Lhe publlc
LransporLaLlon sysLem. An lnvesLmenL Lo creaLe a more
efflclenL sysLem wlll make mass LranslL a more aLLracLlve
alLernaLlve Lo prlvaLe vehlcles, provldlng Lhe proporLlon
of Lhe populaLlon Loo poor Lo purchase expenslve fuel
wlLh a more aLLracLlve alLernaLe form of LransporLaLlon.
1he governmenL should also conLlnue Lo prlorlLlze lLs
kerosene Lo llquefled peLroleum gas converslon program
so LhaL Lhe poor are less rellanL on heavlly subsldlzed
kerosene as a prlmary fuel source. Such shlfLs wlll have
poslLlve exLernallLles ln Lhe form of decreased emlsslons,
as well as lncreased efflclency ln household energy
generaLlon (MlnlsLry of Lnergy and Mlneral 8esources
8epubllc of lndonesla 2007).
1he World 8ank has mapped ouL varlous scenarlos for
showlng ways ln whlch gasollne prlces could be
normallzed wlLh world prlces (llgure 9) (lengler and
8ulman 2008). 1he graph does noL, however, lnclude Lhe
laLe 2008 world prlce decrease of approxlmaLely uS$100
per barrel of crude oll. A gradual opLlon, such as closlng
Lhe gap by 8 percenL per monLh, would allow some of Lhe
exLra money Lo be spenL on alLernaLe subsldlzed
programs, and some Lo be redlrecLed Lo secLors such as
publlc healLh and educaLlon ln order Lo lncrease Lhe
human caplLal of lndonesla's labor force.


uecteose cottoptl oo ooJ eocootoqe opstteom
Jevel opmeot by fotel qo l ovestots
Whlle worklng Lo conLrol demand-slde pollcy problems,
Lhe governmenL should slmulLaneously move Lo lncrease
lncenLlves for forelgn lnvesLmenL Lo sLlmulaLe oll
exploraLlon and Lhe growLh of upsLream developmenL
pro[ecLs. 1he flrsL sLeps should be ln Lhe arena of legal
reform. lorelgn lnvesLors musL be convlnced LhaL Lhelr
rlghLs wlll be proLecLed lf Lhey are expecLed Lo bear Lhe
welghL of exploraLlon cosLs. 1he pasL seven years have
been puncLuaLed by corrupLlon scandals, conLracL
dlspuLes and run-lns wlLh local governmenLs who are
unhappy wlLh forelgn companles developlng lndoneslan
resources. 1hls hlgh degree of rlsk and uncerLalnLy ls
unaLLracLlve Lo forelgn lnvesLors who, under SCs, musL
Lake on all of Lhe rlsk and can only recoup Lhelr cosLs lf
proflLs are made (MonLlake 2008).
-./012 N

8ecenL corrupLlon lnqulrles are an early sLep ln bulldlng a
more secure lnvesLmenL envlronmenL for forelgn
companles. lL ls lmporLanL, however, LhaL cases be seen
Lhrough. lf charges conLlnue Lo be dropped, a slgnal wlll
be senL Lo forelgn lnvesLors LhaL corrupLlon exlsLs hlgh
enough wlLhln Lhe governmenL LhaL Lhey wlll have no
proLecLlon from Lhe law. 8llaLeral and mulLllaLeral pollcy
dlscusslons, such as Lhe recenL 2
nd
lndonesla - u.S.
Lnergy ollcy ulalogue (MlnlsLry of Lnergy and Mlneral
8esources 8epubllc of lndonesla 2008) are key for
esLabllshlng LrusL wlLh forelgn lnvesLors.



1he !ournal of lnLernaLlonal ollcy SoluLlons


9 WlnLer 2009 | volume 10
kepol te lettoml oo to l ovest mote beovl l y l o
opstteom Jevel opmeot
erLamlna has developed a repuLaLlon for belng dlfflculL
Lo work wlLh, holdlng up pro[ecLs due Lo dlspuLes over
revenue sharlng and pro[ecL conLrol (MonLlake 2008).
ollcles LhaL requlre Lhe sLaLe-owned oll company Lo
lncrease lnvesLmenL ln upsLream pro[ecLs wlll spur Lhe
dlscovery of new oll flelds and allow for producLlon
capaclLy lncreases.
AddlLlonally, pollcles LhaL supporL lmprovemenLs Lo oll
producLlon Lechnology should be encouraged so as Lo
lncrease Lhe efflclency of exLracLlon ln currenL and
poLenLlal new oll flelds. Such pollcles wlll force
erLamlna Lo become more compeLlLlve wlLh forelgn oll
companles. lf lndoneslans wanL oll exLracLlon ln lndonesla
Lo be performed solely by lndoneslan enLlLles, erLamlna
musL lnvesL ln lmprovemenLs LhaL wlll allow Lhem Lo work
auLonomously from forelgn companles. lf Lhls ls noL
feaslble, Lhen all efforLs should be dlrecLed Lo lmprovlng
Lhe forelgn lnvesLmenL cllmaLe Lo encourage exploraLlon
parLnershlps.
":?><08.:?8
?ears of supply-slde pollcy fallures LhaL prohlblL upsLream
exploraLlon growLh have comblned wlLh demand-slde
pollcy mlssLeps ln Lhe form of hlgh fuel subsldles Lo
creaLe an envlronmenL ln whlch lndonesla can no longer
susLaln lLs own oll needs. A pollLlcal envlronmenL marred
by paLronage and renL-seeklng behavlor has made lL
dlfflculL Lo combaL corrupLlon, even afLer SuharLo's fall
hlndered rampanL cronylsm.
lf lndonesla ls Lo regaln lLs sLaLus as an oll-exporLlng
naLlon, lL musL look Lo aggresslve subsldy reforms, as well
as reformaLlon of Lhe legal sysLem Lo encourage forelgn
dlrecL lnvesLmenL. 1hese acLlons, whlle holdlng Lhe
poLenLlal for shorL-Lerm problems lncludlng hlgh lnflaLlon,
should sLablllze ln Lhe long run and allow for greaLer
dlverslflcaLlon ln governmenL spendlng.
lncreased spendlng on soclal programs and caplLal
expendlLures ls necessary for lndonesla Lo reallze lLs
growLh poLenLlal. lundlng freed up by subsldy removal,
comblned wlLh renewed lncome from oll exporLs of
producLlon galns could comblne Lo pay for programs LhaL
promoLe educaLlon and lncreases ln oLher facLors of
producLlon. ln addlLlon, by forclng erLamlna Lo be
compeLlLlve on Lhe world markeL, Lhe sLaLe-owned oll
company should see galns derlved from lncreased
efflclency and Lechnology. WlLhouL Lhese changes,
lndonesla faces an lncreaslng gap beLween lLs energy
demands and energy supply LhaL are unllkely Lo be meL.
lndonesla's experlence holds Lwofold lmpllcaLlons for Lhe
resL of Lhe world. 1he flrsL reflecLs a LhreaL Lo energy
securlLy for naLlons LhaL rely on lndonesla Lo meeL Lhelr
own oll lmporL demands. Chlna, already concerned wlLh
growlng energy supply needs, ls mosL suscepLlble Lo Lhls
LhreaL. ln addlLlon, Lhe experlence of lndonesla can be
seen as a warnlng Lo counLrles such as Mexlco, who are
slmllarly rellanL on oll renLs ln Lhe face of dlmlnlshlng oll
reserves. lndonesla's nexL sLeps ln pollcy reform wlll
provlde a case sLudy of elLher success or fallure for oLher
governmenLs Lo use as guldance ln oll pollcy declslon-
maklng.

6.I<.:/1@BO;
Abdussalam, Andl. "AnLl-grafL commlsslon Lurns
aLLenLlon Lo oll secLor." Aototo News, !uly 11 2008.
8arnes, hlllp. loJooeslo. 1be lolltlcol cooomy of
oetqy. Cxford: Cxford unlverslLy ress, 1993.
8eng, har klm. "no rellef ln lndoneslan Cll Slump."
Aslo 1lmes Oolloe, SepLember 4, 2004.
8radsher, kelLh. "luel Subsldles for Some Make Cll
More Lxpenslve for All." 1be lotetootloool netolJ
1tlbooe, !uly 28, 2008.
8rommelhorsLer, !orn. Asloo uevelopmeot Ootlook
2008 upJote. loJooeslo. !akarLa: Asla uevelopmenL
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ClemenLs, 8enedlcL, Pong-Sang !ung, and San[eev
CupLa. "8eal and ulsLrlbuLlve LffecLs of eLroleum rlce
LlberallzaLlon: 1he Case of lndonesla." 1be ueveloploq
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LlferL, 8enn, Alan Celb, and nlls 8or[e 1allroLh. 1be
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Moooqemeot lo Oll xpottloq cooottles. ollcy 8esearch
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lengler, Wolfgang, and 1lm 8ulman. "lndonesla posL
$100 per barrel: 1he lmpacL of oll and gas prlces on
publlc flnances." 1be wotlJ 8ook Ctoop lo loJooeslo.
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llLzpaLrlck, SLephen. "Cannlng of corrupLlon lnqulry
damages lndonesla's credlblllLy." 1be Aosttolloo,
november 22, 2008.
Clobal lnslghL Same uay Analysls. "Supreme AudlL
Agency 8eporLs Masslve CorrupLlon ln lndonesla's
Lnergy SecLor." Clobol loslqbt, CcLober 23, 2008.
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Chlcago ress, 1996.
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ModernlzaLlon: 1he Case of lndonesla's new Crder."
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Mello, Lulz de. loJooeslo. Ctowtb letfotmooce ooJ
lollcy cbolleoqes. Lconomlcs ueparLmenL Worklng
aper no. 637, CLCu Lconomlcs ueparLmenL, 2008.
Mlllard, eLer. "Mexlco Lnergy 8eform Leaves narrow
Wlndow for rlvaLe lnvesLmenLs." uow Iooes
Newswltes, March 27, 2008.
MlnlsLry of Lnergy and Mlneral 8esources 8epubllc of
lndonesla. Mlolstet Opeos 1be 2oJ loJooeslo - u5
oetqy lollcy uloloqoe. CcLober 20, 2008.
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hLLp://www.esdm.go.ld/news-archlves/oll-and-gas/47-
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lLs oll." 1be cbtlstloo 5cleoce Mooltot, !uly 16, 2008.
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ers, Slaran. "CovenmenL LxplanaLlon Cn 1he
8educLlon of luel Subsldy and CLher 8elaLed ollcles."
!akarLa: ress 8elease, May 24, 2008.
8umLe, !ongker. "eople on ouLer lslands cuL off from
fuel subsldy." 1be Iokotto lost, AugusL 3, 2008.
ScoLL, !ames C. "aLron-CllenL ollLlcs and ollLlcal
Change ln SouLheasL Asla." 1be Ametlcoo lolltlcol
5cleoce kevlew, 1972: 91-113.
Seda, lranclsla S.S.L. lettoleom lotoJox. Nototol
kesootces ooJ uevelopmeot lo loJooeslo, 1967-1997.
hu 1hesls, Madlson: unlverslLy of Wlsconsln-Madlson,
2001.
Seda, lranclsla S.S.L. "eLroleum aradox: 1he ollLlcs
of Cll and Cas." ln 1be lolltlcs ooJ cooomlcs of
loJooeslo's Nototol kesootces, by LdlLor 8udy .
8esosudarmo, 179-190. Slngapore: lnsLlLuLe of
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1he !ournal of lnLernaLlonal ollcy SoluLlons


11 WlnLer 2009 | volume 10