Low oil prices, high time to move off of diesel subsidies

As markets around the world adjust to the decline in global oil prices, there is at least one positive outcome for clean transportation: dropping prices have helped the governments of India and Malaysia to end their fuel subsidy programs, and kicked off reform actions in Indonesia. The currently low market price for oil means there is less of a price shock when governments remove subsidies, so this is an opportunity to advance a policy that in other conditions might meet strong resistance. The resulting rise in fuel prices may anger the public in the short run, but the long-term benefits of fuel subsidy reform will more than compensate.

Fuel subsidies hurt developing countries by diverting funding from infrastructure development, health, and education. And a subsidy that privileges diesel vehicles can have even more damaging effects on health and the environment, as it incentivizes higher-emitting diesel engines for cars and other light-duty vehicles—a problem my colleagues have blogged about for India. At the current Bharat 4 standards in many Indian cities, a diesel car will emit nearly 30 times as much fine particulate matter (PM2.5), and in rural areas, where only Bharat 3 applies, diesel cars emit 40 times the PM2.5. India’s Environment Pollution Prevention and Control Authority (EPCA) described recent air pollution in Delhi as a health emergency, and is urging the Supreme Court to impose an additional tax on diesel vehicles to help control pollution.

While India will grapple with the pollution from diesel cars for years to come, it has finally corrected its subsidy policy. India made headlines this October with the announcement that for the first time in over 10 years the country would pay no subsidy for diesel fuel. Since January 2013, India has been slowly weaning itself from national diesel subsidies, at a rate of 40-50 paise (about one US cent) a liter per month. When this transition began, the gap between Indian prices and the global market was 19% (based on a market price of Rs 57.96 and a subsidized price of Rs 47.15), and it was thought that the transition would take two years. With October’s drop in global oil prices sending down the cost of diesel, Prime Minister Modi took the opportunity to announce an end to state controls on diesel fuel prices. From the start of the diesel subsidy program in 2004 through 2013, it has cost Rs. 3.4 trillion (US $53 billion at current exchange rates). This cost was borne by state oil producers, refiners and the national government: the price control had required state refiners to sell diesel fuel at a loss, and they were only partially compensated through reduced crude pricing and government payments. Eliminating this price control gives state refiners more capital to invest in infrastructure and the ability to pass infrastructure costs on to consumers, and is hoped to curb consumers’ appetite for diesel cars.

A month after India ended their diesel subsidies, the Malaysian Ministry of Domestic Trade, Co-operatives and Consumerism announced an end to national subsidies for both diesel and gasoline, effective December 1. Using a “controlled flotation method”, the Malaysian government will allow prices to fluctuate with the market, but may step back in with subsidies if world oil prices rise dramatically. Although some opposition lawmakers advocate the return of the subsidies, the Malaysian media have praised the decision as a means to balance the budget and rein in fuel smuggling.

Indonesia is now on the cusp of a critical decision about subsidies that will have long-lasting consequences for the nation’s budget, vehicle market, and potentially its air quality. A week before Malaysia’s announcement, Indonesian president Joko Widodo took the first step in fuel subsidy reform, and raised the controlled price of gasoline by 31% to Rp8,500 per liter, and the price of diesel by 36% to Rp7,500 per liter (about 60 and 80 US cents, respectively). Before the cut, these subsidies were projected to cost US$21 billion or 13% of Indonesia’s budget; now the costs will be lower, through they may still go up if oil prices rise or consumption increases. In addition, keeping controlled price levels may hinder fuel quality improvements. The state sets a budget for annual fuel subsidy spending (although this is often exceeded), and also heavily influences budgeting of the government-owned oil and gas company, Pertamina. If state-affiliated members of Pertamina’s board have an interest in controlling national subsidy spending by keeping production costs as low as possible, they may delay high-cost investments in desulfurization technology. Given that few refineries were producing . Now, officials are considering the next step. They have indicated a move to a fixed subsidy, and perhaps an end to subsidies for gasoline altogether.

Moving to a fixed subsidy could be the right move for Indonesia. Allowing the price to fluctuate would reduce the subsidy burden when oil prices increase, and give Pertamina the ability to pass on the costs of providing cleaner fuel. However, a policy that maintains and perhaps increases the price differential between gasoline and diesel fuel, as the proposal to end gasoline subsidies while continuing to give discounts on diesel would do, risks the dangerous pollution problems that India faces now. At Indonesia’s current standards, a new diesel car could emit 25 times the PM2.5 that a gasoline car would (the ratio is lower in Indonesia than it is in India because both diesel and gasoline vehicles are allowed to emit more in Indonesia), and twice the PM2.5 that a new diesel car in Delhi would. In India, lower prices for diesel fuel led the share of diesel passenger vehicles to rise from 30% to 50% in less than three years. Indonesia has been one of the fastest growing passenger vehicle markets for several years, and giving the growing group of car owners an incentive to choose diesel could lead to the same air quality emergency that India faces today. Jakarta, the fourth largest urban agglomeration in the world, could see its air pollution rival that in Beijing and Delhi. Diesel cars may be more efficient, but when you consider the climate effects of short-lived pollution and the toll on public health, they are not the greener choice. In France, where the government intentionally promoted diesel cars for their efficiency, Prime Minister Manuel Valls has called the decision “a mistake”.

While low oil prices continue, Indonesia has the chance to smoothly transition to more ambitious reforms of the fuel subsidy system. If they choose fixed subsidies, they should aim to put gasoline and diesel on equal footing. As India and Europe have demonstrated, a government boost to vehicle sales, whether intentional or not, can be a public health disaster. From a public health standpoint, the most effective course for Indonesia is to eliminate subsidies for diesel as well as gasoline while imposing stricter emission standards on all vehicles. If price reforms are accompanied by a transition to Euro 4 emission standards for new vehicles, then Indonesia can deliver an effective one-two punch to its rising air quality and oil consumption problem.