When is it the “right time” for oil prices to fall?

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Dina Nurul Fitria Lecturer at the Faculty of Economics and Business of Pertamina University

IO – The Covid-19 pandemic which began in December 2019 has exerted a major impact on world oil prices, which have sunk below a range of USD 35 / barrel for Brent and around USD30 / barrel for WTI as of March 2020. The decline in crude oil prices, 24% (Brent) and 25% (WTI), are the largest shifts since 2015. The decline in world gas prices and the narrowing of inter-market Spreads reflects lower demand levels and reduced import needs on European and Asian markets. EIA estimates that US LNG exports will average 5.3 Bcf / d in the second quarter of 2020, down 0.5 Bcf / d from the February issue of Short Term Energy Outlook (EIA, March 2020). 

This decline in crude oil prices also affects commodity and other equity markets, which have experienced significant volatility and price declines since the last week of February, amid concerns about the economic impact of the new Coronavirus 2019 (COVID-19). In addition, the oil market in particular recently responded to the results of the OPEC and partners meetings on March 6 with plummeting oil prices which consequently affected the financial markets. 

In the Indonesian context, the financial markets were depressed due to the decline in crude oil prices and natural gas prices also adding a burden to the Indonesian Rupiah (IDR) against the US dollar (USD) exchange rate which fell in a range of IDR. 15000/ USD, and even to IDR. 17000/USD at one point. 

However, the decline in crude oil and natural gas prices in 2020 is different from the conditions in 2015. In 2020, the fall in the price of crude oil and natural gas prices on the supply side did not increase consumer demand for LPG gas and fuels. The fall in consumption is due to economic activity suffering a massive slowdown in certain economic sectors even before the shutdown, by which there would be no longer any economic activity for a while, especially in the informal sectors. While the decline in crude oil prices and natural gas prices in 2015 was upstream, there was an increase in consumption at the downstream level. 

In the general concept of price transmission, an increase or decrease in prices at the upstream level is transmitted symmetrically, with an increase or decrease in prices at the downstream / retail level, whereas price increases or decreases at the upstream level are transmitted asymmetrically to the retail level, if the opposite occurs; for example, when prices falling upstream have no effect on retail prices. This usually happens to the price of horticultural commodities and is currently seen in the price of fuel oil and LPG gas in the community. 

Fuel Price Formation 

The question then arises, is it necessary for fuel prices and LPG prices, both assignments and non-assignments, to go down? And when is the right time for fuel prices and LPG prices at the retail level to dive? 

The Government of Joko Widodo, through the Republic of Indonesia Presidential Regulation Number 191 Year 2014 Regarding Supply, Distribution and Retail Price of Fuel Oil regulates certain types of fuel (kerosene and diesel oil), Special Assignment Fuel Oil (BBM) type (Ron 88 Gasoline in the assignment area, except Java and Bali ) and General Fuel Oil types. Provision and distribution of the annual volume requirements for Specific Fuel Oil Types and The Assignment-Specific Fuel Oil Types are carried out by the Business Entity through assignments from the Regulatory Body. 

The selling price and basic fuel price (acquisition costs using market index prices, distribution costs, and storage costs and margins) at the retail level are determined by the Minister of Energy and Mineral Resources. Determination of retail prices for LPG gas and Fuel Oil, following the vertical pricing pattern from the Minister of Energy and Mineral Resources, Regulatory Body, to the Business Entity and the consumer level. Meanwhile, through a Constitutional Court Decision, the setting of retail prices of industrial fuels and general fuels is left to a market mechanism to manifest marketing efficiency. 

The base price in certain types of subsidized fuel has been determined by the government, using the MOPS + Alfa calculation method, where the MOPS for RON 88 or Premium uses a coefficient of 98.42 percent, multiplied by the exchange rate of the Indonesian Rupiah (IDR) against the US Dollar (USD) with the Bank Indonesia middle rate divided by 159 liters (conversion from barrel units), while the alpha factor is the base price and taxes and the profit margin of the Business Entity are around 5-10 percent for general fuel which follows a market mechanism. The alpha factor is determined by the Regulatory Body, which in this case is BPH Migas. 

Transparency in the formation of general fuel oil prices, particularly the determination of alpha factors by BPH Migas, is needed to avoid price conduct that leads to “power over price” which is a component of ‘administered inflation’ from general oil-based fuel. Considering the limited consumption of RON 88 premium fuel, consumers will switch to using the General RON 90 fuel and this will result in an increase in RON 90 consumption; a decline in crude oil prices is actually transmitted to a decrease in the base price and retail price of RON 90, which will be close to the decline in retail prices for RON 88. 

Despite the weakening of the Rupiah against the US Dollar, the market price index of crude oil fuels, some of which were imported, also fell. The decline in retail prices of RON 90 and RON 88 can be seen in a range of 20- 25%. And the spread or price difference between RON 90 and RON 88 subsidies is maintained in the range of IDR. 500-IDR. 1000, this also applies to kerosene and industrial diesel oil. However, for industrial diesel oil in particular, the disparity in the decline in domestic diesel oil prices with international oil prices must also be maintained; this is done to prevent smuggling of industrial diesel fuel. 

Pertamina is a Business Entity that has a distribution infrastructure throughout Indonesia for PSO and non PSO fuels, so reduction in the retail price of RON 88 subsidies and RON 90 can still be maintained within a regular profit margin of 5-10 percent. In this case BPH Migas, together with the Ministry of Energy and Mineral Resources and the Ministry of Finance, can compile a PNBP formula and Dividend Tax from Pertamina; it is done at least to protect the risk of volatility of the Indonesian Rupiah (IDR) against US Dollar (USD). 

Meanwhile, 12Kg non-PSO LPG gas and 3kg PSO need to apply efficiency, specifically by applying a closed trading system in the 3kg LPG so that it can reduce the expenditure from 3kg LPG subsidies. PT Pertamina, through quality improvement, has maintained the efficiency of LPG gas trading systems for 12 kg and 3 kg. However, there is the decline in people’s purchasing power due to a decline in community economic activity, so the decline in the price of 12kg LPG and 3kg LPG will be at the retail distributor level through the application of price incentives, which, of course, will not burden PT Pertamina’s finances on the upstream side. 

Waiting for the Right Time for Fuel Oil Prices to start their decline 

When can a reduction in fuel prices for RON 88, RON 90, Diesel Oil and Kerosene be applied? In line with the stimulus policy package for handling the economic impact of the COVID-19 pandemic released by the government, which involves an important role for Bank Indonesia, an important component for determining the alpha factor is the middle exchange rate of the Indonesian Rupiah (IDR) against the US Dollar (USD), as determined by Bank Indonesia. 

Thus, changes in retail prices of PSO and non-PSO fuels are in accordance with Minister of Energy and Mineral Resources Decree No. 1980 K / 10 / MEM / 2018 concerning Fuel Market Index Prices, starting at April 25, 2020 based on MOPS 3 months before, namely January 2020 or 25 May 2020 is based on MOPS and the February 2020 middle exchange rate, or even June 25, 2020 is based on MOPS and the March 2020 middle exchange rate. Especially considering that April – June 2020 is the fasting period of Ramadan, Eid al-Fitr and the beginning of the Academic Year, if the home learning period ends in June 2020, the decline in retail prices of fuel oil and the positive impact of increasing the efficiency of LPG gas trading systems can help alleviate community difficulties while preventing the shutdown of the productive economic sector. 

The aim of reducing PSO and non PSO fuel prices, the efficiency of PSO and non PSO LPG gas trading systems including providing price incentives to LPG gas suppliers, is intended to ease the burden for industry, MSMEs and the general public to remain productive, although they must always implement social distancing and physical distancing wherever and whenever.