No Hasty Cuts

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  • TEMPO.CO, JakartaThe collapse in world oil prices sparked calls for the government to reduce fuel prices. There is a risk of losses at a time of considerable global economic uncertainty.                      

    THE government should not hastily reduce fuel prices. Although the market price of oil has plummeted as a result of the collapse in demand due to the Covid-19 pandemic, the global economic pendulum could still swing in another direction. The currently low prices of crude oil and gasoline could rise in an instant.

    Demand for oil began falling when China was struck by Covid-19 in January. The slowness of oil-producing countries to reach an agreement to cut production has made market conditions increasingly difficult. Oil continues to flood the market, while demand has fallen sharply because of the pandemic. This is what led to West Texas Intermediate oil futures on the New York Mercantile Exchange being sold at a negative price, -US$37 per barrel, at the beginning of last week.

    The House of Representatives (DPR) has urged Pertamina to immediately reduce fuel prices, claiming that the people now suffering the effects of the Covid-19 pandemic need cheap fuel. However, it is the government that sets the prices of certain types of fuel, such as Premium and diesel. At first glance, the request from the DPR makes sense, but the market could be very unpredictable. Saudi Arabia and Russia have agreed to cut production in May and June. If the members of OPEC follow suit, production will be cut sharply, and oil prices could rebound very quickly.

    Hastiness would lead to complications because if world oil prices suddenly rose, it would not be easy for the government to increase fuel prices again. Inflation would soar, people’s buying power would fall and there would be the potential of triggering political unrest. Conversely, if prices were not increased, the state’s financial burden would increase – and Pertamina would eventually bear this.

    In the short term, fuel prices should not be reduced. The fuel now being sold from Pertamina’s terminals is from earlier production, when prices were still relatively high. In addition, the rupiah continues to weaken against the US dollar. Since the start of the year, the rupiah has fallen by around 19 percent. If fuel prices were hastily reduced, rather than making a profit, Pertamina could be facing losses.

    Covid-19 has had an extraordinary impact on Pertamina. It is estimated that corporate income from the upstream to downstream businesses for this year will be down by 29 to 39 percent. This will only add to the problems of Pertamina, which has suffered grievously as a result of populist government policies such as the obligation to sell fuel at one price across the country and the order to resume supplying Premium fuel.

    The state oil company has long lacked flexibility in responding to changes in the market. For example, because it has been such a long time since the capacity of refineries and oil tanks has been increased, Pertamina’s plan to buy crude oil and gasoline at the current low prices has stalled. This is despite the fact that with such low purchase prices, the company has a huge opportunity to reap profits in the future.

    This has revealed a more pressing problem: increasing national strategic energy reserves. In order for this to go ahead, Pertamina must stay in good health. Conversely, Pertamina must also be transparent in implementing its plan to borrow oil tanks and lease tankers to store imported oil. As is widely known, Pertamina’s losses are also the result of the actions of rent-seekers exploiting a range of business strategies.

    Read the Complete Story in this Week's Edition of Tempo English Magazine