Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized )8(/35,&,1*$1'68%6,',(6,1,1'21(6,$ 5HDFKLQJDQ(TXLWDEOHDQG6XVWDLQDEOH3ROLF\ Table of Contents LIST OF ACRONYMS ........................................................................................................ 6 EXECUTIVE SUMMARY.................................................................................................... 7 INTRODUCTION................................................................................................................. 8 CHAPTER 1: RECENT HISTORY AND PRESENT CONDITIONS ............................. 8 1.1 DEMAND FOR PETROLEUM FUELS IN INDONESIA................................ 10 1.1.1 THE MAIN FUEL PRODUCTS AND THEIR USES................................ 11 1.2 SUPPLY OF PETROLEUM FUELS TO MEET DOMESTIC DEMAND..... 13 1.3 PETROLEUM FUEL PRICING......................................................................... 14 1.3.1 DIFFERENT METHODS WERE USED TO CONTROL PRICES......... 15 1.3.2 HOW INDONESIA MANAGED AGAINST INTERNATIONAL PRICE VOLATILITY ......................................................................................................... 16 1.4 GOVERNMENT SUBSIDIES TO SUPPORT DOMESTIC PETROLEUM FUEL PRICES............................................................................................................. 20 1.4.1 FISCAL BURDEN OF PETROLEUM FUEL SUBSIDIES ...................... 20 1.4.2 THE TARGETING OF BENEFICIARIES OF THE PETROLEUM FUEL SUBSIDIES .................................................................................................. 22 1.4.3 ENVIRONMENTAL AND HEALTH IMPACTS OF THE FUEL SUBSIDY POLICY................................................................................................. 25 1.5 INSTITUTIONAL AND LEGAL EVOLUTION OF THE PETROLEUM FUEL SECTOR........................................................................................................... 26 CHAPTER 2: The Target Regime ..................................................................... 29 2.1 ESTABLISHED POLICY INTENTIONS.......................................................... 30 2.2 COMPARATIVE EVALUATION BETWEEN THE EXISTING PRICING AND SUBSIDY SYSTEM AND THE GOVERNMENT’S OBJECTIVES........... 32 2.2.1 EFFICIENCY................................................................................................. 32 2.2.2 COMPETITIVENESS................................................................................... 34 2.2.3 ENVIRONMENTAL IMPACTS.................................................................. 35 2.2.4 CORRUPTION............................................................................................... 36 2.2.5 EVALUATION AGAINST HIGH LEVEL POLICY CONSIDERATIONS ................................................................................................................................... 36 2.2.6 EVALUATION IN RELATION TO INTERNATIONAL EXPERIENCE ................................................................................................................................... 37 2.2.7 CONCLUSIONS FROM EVALUATING THE EXISTING PRICING AND SUBSIDY SYSTEM AGAINST GOVERNMENT OBJECTIVES .......... 38 2.3 DESIRABLE CHARACTERISTICS OF A NEW PETROLEUM PRICING REGIME ...................................................................................................................... 39 2.4 WIDER CONTEXT FOR PRICE AND SUBSIDY REFORM: MARKET OPENING AND RESTRUCTURING PERTAMINA............................................. 41 2.4.1 RESTRUCTURING OF THE PETROLEUM PRODUCTS MARKET AND OF PERTAMINA’S DOWNSTREAM FUNCTION................................. 41 2.4.2 RESTRUCTURING PERTAMINA’S DOWNSTREAM OPERATIONS42 2.4.3 OPENING THE OIL PRODUCTS MARKET TO COMPETITION ...... 45 2.4.4 REGULATION OF THE DOWNSTREAM OIL SECTOR...................... 47 2.4.5 RECOMMENDATION REGARDING MARKET OPENING AND PERTAMINA RESTRUCTURING...................................................................... 47 2.5 PROPOSED PRICING AND SUBSIDY POLICY FOR PETROLEUM FUELS IN INDONESIA............................................................................................. 47 2.5.1 SETTING THE BASE PRICE...................................................................... 48 2.5.2 DEALING WITH PRICE VOLATILITY (EXCLUDING VOLATILITY BEARING ON SUBSIDY REQUIREMENTS).................................................... 49 2.5.2 DEALING WITH PRICE VOLATILITY (EXCLUDING VOLATILITY BEARING ON SUBSIDY REQUIREMENTS).................................................... 50 2.5.3 THE SUBSIDY REGIME ............................................................................. 53 2.5.4 IMPLEMENTATION OF THE NEW PRICING REGIME AND TARGETED SUBSIDIES....................................................................................... 58 2.5.5 CONCLUSION............................................................................................... 58 CHAPTER 3: THE TRANSITION ............................................................................... 60 3.1 IMPLEMENTATION OF THE TARGET REGIME....................................... 61 3.2 DURATION OF THE TRANSITION................................................................. 64 3.2.1 PRICES AND SUBSIDIES............................................................................ 64 3.2.2 MARKET OPENING .................................................................................... 65 3.2.3 RESTRUCTURING OF PERTAMINA ...................................................... 65 3.2.4 INSTITUTIONAL ARRANGEMENTS ...................................................... 65 3.3 COMPONENT 1: DESIGN OF THE TRANSITION FOR PRICES AND SUBSIDIES.................................................................................................................. 66 3.3.1 ADJUST PRICE (S) FROM THEIR SUBSIDIZED LEVELS TO ALIGN WITH IMP............................................................................................................... 66 3.3.2 TRANSFER FROM SUBSIDIZING PETROLEUM FUEL PRICES TO DIRECTLY SUPPORTING THE LOW-INCOME TARGET GROUPS ........ 68 3.3.3 MOBILIZING THE SUPPORT OF CIVIL SOCIETY............................. 69 3.3.4 SECONDARY ADJUSTMENTS.................................................................. 71 3.4 COMPONENT II: DESIGN OF THE TRANSITION FOR MARKET- OPENING .................................................................................................................... 72 3.4.1 LICENSE NEW ENTRANTS....................................................................... 72 3.4.2 GRANT PUBLIC SERVICE OBLIGATION (PSO) STATUS TO NEW ENTRANTS............................................................................................................. 73 3.4.3 EXTEND “MFN TREATMENT” TO NEW ENTRANTS........................ 73 3.4.4 ENABLE RETAIL OUTLETS TO CONTRACT WITH MARKET ENTRANTS............................................................................................................. 73 3.4.5 PROVIDE ACCESS TO PERTAMINA STORAGE FACILTIES AND PIPELINES.............................................................................................................. 74 3.5 COMPONENT III: DESIGN OF THE TRANSITION FOR PERTAMINA RESTRUCTURING.................................................................................................... 74 3.5.1 PERTAMINA RESTRUCTURING – ACTIONS TO BE TAKEN BY GOI ................................................................................................................................... 74 3.5.2 PERTAMINA ADJUSTMENTS – ACTIONS BY THE COMPANY ...... 75 3.6 COMPONENT IV: INSTITUTIONAL ARRANGEMENTS AND STRENGTHENING ................................................................................................... 76 3.7 CONCLUSION...................................................................................................... 77 BIBLIOGRAPHY......................................................................................................... 78 ANNEX 1 ....................................................................................................................... 80 The Application of Various Pricing Policies and Mechanisms in Indonesia since 1999 ............................................................................................ 80 Annex 2......................................................................................................................... 92 Fuel Subsidy Delivery Mechanism.................................................................. 92 Annex 3......................................................................................................................... 95 Lessons of international experience for Indonesia .............................. 95 Annex 4....................................................................................................................... 100 Potential Replacements for Direct Subsidization of Low-Income Kerosene Users...................................................................................................... 100 Annex 5....................................................................................................................... 103 Potential for Rapid Switching from Kerosene to LPG and Coal Briquettes.................................................................................................................. 103 Annex 6....................................................................................................................... 106 Indonesia Fuel Pricing—Four