Monday, December 15, 2008

And the time bomb has been activated

Rather than telling the people that we would let the fuel price follow the world crude price, down or up, the government made a terrible mistake: capping the prices.

President SBY and Minister Mulyani just announced that the price of premium gasoline got a further cut to Rp 5,000 and diesel oil to Rp 4,800. As if that's not enough, they also put caps on the two fuels, i.e. Rp 6,000 and Rp 5,500. That is a guarantee that whatever happens next year, the prices can not exceed the set caps. Who says this is inline with market dynamics?

Studies in time series econometrics (e.g those by prominent econometrician Jim Hamilton) have found that the world crude price behave as a random walk. The standard deviations are extremely high you can only say that the price in two years from now can go down to $30/barrel OR up to $300/barrel! See the risk there? Clearly the government does not.

The capping is really, really bad. This is why I hate election time. All the bad economics are showing.


Anonymous said...

can the govt hedge by buying oil futures and lock the price?
(especially if the price is a random walk)


Aco said...

theoretically they can. but any future price will take into account the wild volatility of the price, ie hedging will be much more costly, too with higher premium.