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Indonesian Investment Conditions
Issues facing investors in Indonesia's oil
and gas sector
Domestic demand for oil and gas is beginning to outstrip the country’s ability
to meet its energy needs from domestic sources. Its ability to tackle this problem
is being obstructed by an historic cheap energy policy that encourages wasteful
usage of energy and discourages the very necessary investment in new productive
capacity and energy efficiency.
Fig 1 - Source: Ministry of Finance (MOF)
Indonesia Oil Consumption and
Production
Source: BP World Energy Statistics 2011
For Indonesia’s President Yudhoyono government, faces great challenges in
its efforts to create a more positive environment to attract foreign investors with
the necessary amounts of capital and technology required to gain access to the
country’s vast oil and gas potential. Due to the opposition to reforms in
Parliament, the President has had only limited success in attracting foreign
investment needed to boost production.
In addition, other factors have created additional problems for the
industry in attracting potential investment since the last Asian financial crisis
in 1997. These include uncertainty caused by confusion arising from the
introduction of regional devolution, as well as domestic terrorism in the oil
producing province of Aceh and the tourist island of Bali, exacerbated by natural
disasters helped including tidal waves, earthquakes and the recent spate of
volcanic eruptions.
However, past policy decisions made by previous governments have also
contributed to the petroleum industry failing to keep pace with demand.
This has resulted in:
1. A failure to reverse the decline in domestic oil output.
2. Indonesia, becoming Asia’ largest importer of petrol and diesel.
3. A planned decline in gas exports, due to increasing domestic demand.
4. Indonesia could become a net gas importer by 2030.
Industry executives have also raised concerns that the government has been
failing to give the sector the attention that this strategic industry deserves,
given that it contributes some $20 billion in tax revenues each year reports, about
12% of total government revenues reports the Ministry of Finance - Bureau of
Statistics.
Further, like all other government owned industries, Pertamina, the national oil
and gas company, that has been responsible for the industries development, has
found it difficult to obtain the necessary funding from government to maintain, let
alone, boost production. This has led to Pertamina finding it difficult to invest
in new technology, which would have maintained output and extended the lifespan of
some fields.
In addition, this has forced the closure of marginal fields and has led to
Pertamina being unable to conduct exploration and development of new fields in
deeper waters. It is estimated that 70% of the country's proven and probable oil
and gas reserves are located offshore.
Reforming Indonesia's Investment Climate
Action taken to attract new oil and gas investors
Recent Reforms in Indonesia
Since 2004, as a consequence of the coalition government led by President
Yudhoyono being elected, a new political, legal, social, technological,
administrative and business culture has been introduced. This has led to a
considerable number of changes throughout the operation of Indonesia’s strategic
energy industries, specifically the removal of inconsistencies in regulations and
improved transparency in negotiations between government agencies and investors. An
increasing number of foreign and domestic investors, including Indonesian owned
Medco are working with Pertamina to exploit the country’s resources.
Amongst these most recent improvements to the regulatory culture has the country’s
application to join the Extractive Industry Transparency Initiative, which is a
world industry standard for monitoring all payments made by operators and received
by member governments in the extraction of minerals, oils and gases. Once fully in
place, it should make investment in Indonesia a more transparent process for
potential new entrants and aid the government in its fight against corruption. It
should facilitate government ambitions to create a more positive pro-business
environment. In addition, fresh incentives have been introduced for development of
marginal fields and the more costly fields in deeper waters.
Amongst the new incentives being offered are more favourable exploration rights and
incentives to oil and gas investors, including improved tax treatments and better
production splits, in order to encourage exploration. As a result, investors have
been able to negotiate improved production-sharing agreements with the Ministry of
Energy and Resources.
Nevertheless, industry experts have suggested such incentives are proving
insufficient to overcome the increased costs of exploration and development of new
fields, which are increasingly located in remote and or deeper waters, far from
existing markets and existing industry infrastructure.
As a further example of the changes being made is the preparations for the
long-term partial privatisation of the state owned oil and gas company Pertamina.
Pertamina has already been changed from a state agency to a public non-listed
company, in order to make its operations more transparent for potential partners in
joint development schemes. As a result, interest in the industry has
increased.
The problems facing
investors
However, investors have still faced problems that have meant that
Indonesia is unlikely to reach its targets on output. These problems include issues
of consistency in governance across the country as the result of the regional
governments being granted more powers, which has led to increasing interest by
local authorities to exploit the industry as a new source of revenue. For projects
that involve several regions, this has inevitably led to delays in gaining
approvals from the various agencies involved.
Nor does it help investors, government's insistence that a certain portion of
new output should be reserved for domestic usage and sold at below world market
prices. Since such policies put many schemes economic viability in doubt.
In addition, despite government agencies being more cooperative with the
industry and the establishment of new agencies like the industry regulator BPMIGAS,
there are still problems being experienced between agencies and stakeholders.
Despite the challenges faced by investors, one example of the scale of investment
the industry is making is the speculative $1 billion investment in the exploration
for oil and gas in the Makassar Strait, off the east coast of Borneo.
However, there have been inevitable cultural misunderstandings between negotiators.
From my experience, the situation is one of rabbits amidst a jungle full of tigers.
Despite all these challenges major energy companies such as BP, Exxon, Eni,
Petronas and Santos still find investing in Indonesia worth the risk!
Is Indonesia running out of
oil?
The reasons behind its
decline
Industry
insiders are suggesting that all Indonesian crude oil production could cease by
2020, if no new fields are found.
In 2007, BP
estimated that the country had proven oil reserves of 4.37 billion barrels and
potential reserves at 4.5 billion barrels, with a similar quantity still to be
discovered. Since 1997, when Indonesian crude oil production peaked at 1.7 million
barrels a day, the country’s output has experienced a steady decline in output
since then.
Today, current
output stands at just 970,000 barrels per day (bbl. /day). Business Monitor
International forecasts that Indonesian oil production will drop to 810,000 bbl.
/day by 2019.
In the last few
years the number of new oil wells completed each year has dropped from 807 in 2004
to just 568 in 2009, reports Ministry of Energy and Mineral
Resources.
The factors
behind the decline in oil output are complex, though certainly they include issues
of geology, mismanagement and the failure of Indonesia to create a suitably
pro-business investment climate that would have attracted the volumes of capital
needed to reverse the current trend.
A vital factor
is geology, many of the country’s established maturing oil fields are located in
Sumatra, Java, and Kalimantan, where it was relatively easy to explore and develop
oil fields. The new areas where investors are looking for new oil tend to be in
remoter regions where the success rates for finding new oil finds tends to be lower
than in established oil provinces.
Nor does it help
that the country has been slow to introduce more favourable tax regimes and
production splits that take account of the greater risks involved for investors in
exploration in new potential oil territories. As a result, investment in
exploration has declined from $2.7m in 2009 to $2.3m
today.
As a
consequence, in recent months, Indonesia has begun to offer more favourable
exploration rights and has promised it will offer fresh incentives to oil and gas
investors, including improved tax treatments and production splits, in order to
boost exploration and stem from the steady long term decline in output. However,
industry investors have said these incentives are insufficient, as compared to what
other countries have on offer with similar exploration risks. It is therefore not
surprising that Indonesia likely oil output, is expected to miss the government
target of 1.05 million barrels a day in 2010.
Another question
of concern is the issue of under reporting of actual output, which is estimated to
have cost the state in lost revenues some $3billion a year reports Indonesia’s
anti-corruption agency (KPK).
In addition,
relationships between Indonesia and investors have not always been good. There have
been lengthy contract disputes, for example, the dispute between ExxonMobil and
Indonesia’s National Oil Company Pertamina, which took several years to resolve
over revenue sharing and control of the new Cepu oil and gas field in East
Java.
Pertamina, has
its own role to play, because of government reforms it has lost its position as a
traditional National Oil Company that was totally responsible for all aspects of
the Indonesia’s Petroleum sector including the strategic planning, development and
regulation of the industry. For many years, it was treated as a ‘cash cow’ for
funding economic development projects, which meant it was starved of investment.
Today, it is, because of the petroleum sector reforms, which removed many of its
strategic policy and regulatory function, Pertamina acts more like an independent
energy company, that happens to be state owned.
Indonesia's Oil
Consumption
Indonesia has
become a net oil importer, due in part to subsidised petrol
prices.
Indonesia is
facing a widening gap between its domestic oil production and consumption, despite
government efforts to reverse this trend. Oil consumption has jumped from 1,045,000
barrels per day in 2004 to 1,564,000 in 2010. As a result, Indonesia since 2004,
has become a net importer of oil, which led it to suspending its membership of
OPEC. Today Indonesia imports around 940,000 barrels per
day.
Today, oil accounts for 30% of total domestic primary energy
consumption, and there are government plans to reduce oil’s share to just 21%,
reports the Economist Intelligence Unit. Currently, the main markets for oil are
transport 41%, industry 19% and power generation 14%. Demand for oil is expected to
increase at 2.3% per annum between 2010 - 2020.
Attempts to
reduce the growth in oil usage have faced several major obstacles including,
political opposition to abolish the country’ historic cheap energy policy that was
introduced by former President Suharto. This has resulted in certain types of fuel,
including petrol, diesel and kerosene being available at subsidised
prices.
For instance,
subsidised gasoline is sold at 49 cents per litre, while unsubsidised gasoline
sells for 80 cents per litre. In the latest government budget for 2011, Jakarta has
set the volume of subsidized fuel available at 39 million kilolitres of fuel. As a
result, Jakarta treasury estimates suggest that next year’s fuel subsidy bill will
cost Indonesian taxpayers some $20 billion.
Indonesian Refinery
Pipedreams
The problems faced by new
investors
Indonesia’s refinery
and pipeline network has for over a decade, faced an investment drought. Its state
operated refinery and pipeline network had seen little significant investment in
the years between 1994 and 2006. It was 1994, that Pertamina opened its last new
oil refinery. This lack of investment in increased capacity has resulted in the
country becoming the largest importer of petrol and diesel in Asia, mostly from
neighbouring Singapore. As a result, in 2010, Indonesia's crude oil imports cost
$162 million, and its refined product imports $27
million.
At present, Pertamina
operates eight of the oil refineries and the Ministry of Energy and Mineral
Resources the ninth. In 2009, PWC estimated total refining capacity at 1.03 million
barrels a day. The largest refineries are the 348,000-bbl/d Cilicap facility in
Central Java, the 241,000-bbl/d Balikpapan plant in East Kalimantan, and the
125,000-bbl/d Balongan refinery in West Java.
Most of country's
existing oil refineries process local heavy/sweet crudes, like Duri and Widuri,
which are waxy and have a high yield of low sulphur waxy residue (LSWR), which are
used in power stations at home and abroad. However, demand for this power station
fuel is declining throughout in its main markets at home, Italy, Korea and Japan,
due to costs and environmental concerns.
Indonesia, is seeking to
reduce its dependence on refined oil products imports, especial high value ones
like gasoil and jet kerosene. Currently, much of Indonesia’s refined oil products
is imported from refineries in Singapore, which is the ASEAN regional refining and
petrochemicals hub. Since 2006, Pertamina has been involved in an $11
billion programme to boost capacity and update technology, which could end the need
for refined product imports by 2015 and boost output to 1.5 million barrels a day.
The government today is encouraging new entrants to enter the refining
market.
Since 2006, there have been
several announcements of new independent and joint venture projects with Pertamia.
However, there have been delays in the realisation of these schemes. Developers
have faced issues, including obtaining adequate funding from the international
finance markets, concerns over the ability to obtain sufficient reliable power
supplies in a country facing power shortages, dispute’s over land acquisition
issues and delays experienced in obtaining regulatory
approvals.
Many of the proposed
projects are aimed at refining mostly Middle Eastern crude oil for export to China,
so are likely to do little to contribute to Indonesia’s ambition of reducing
imports of refined petroleum products. In addition, industry insiders are
suggesting that given the new refining capacity being built in China, the economics
of building such refineries is now in doubt. The latest scheme to be announced is
the one between Pertamia and Kuwait Petroleum to build a new 300,000 bbl/day in
West Java. It has been suggested that some of its crude for refining will come from
the Middle East.
Gas Production to Peak in
2012?
Gas could run out by
2030?
Though Coal Seam Gas discoveries could
be seen as the long term solution.
Indonesian gas
production is set to grow from 72bcm in 2009 to a peak of 89bcm by 2012, before
slipping back to 87bcm by 2019, reports Indonesia’s Ministry of Energy and Mineral
Resources. Such an increase in in output is reflected by the growing number of gas
wells being completed, which has risen from 88 in 2004 to 434 in 2009. In Current
estimates put Indonesia’s total proven gas reserves 94 trillion cubic feet (TCF),
with a similar quantity likely to be discovered.
At present, rates of
production, industry insiders have estimated that natural gas resources could be
exhausted by 2030, unless new gas fields are discovered. Much of Indonesian gas
production is located in the aging nearly drained gas fields of Northern Sumatra
and East Kalimantan.
Already new gas
fields in South Sumatra and elsewhere in the country are beginning to replace
output from these maturing fields. The most recent example of this is the recently
opened 14 TCF BP led Tagguh project in the eastern province of Irian Jaya (West
Papua), is helping to boost the country’s gas output.
Indonesia's Coal Seam
Gas
In addition, alternative
source of gas is being explored, this is the development of the country’s
unconventional gas (coal seam gas) reserves located in the country’s major
coalfields. Indonesia is estimated to have some 450 TCF of coal seam gas reserves
in its coal fields of Southern Sumatra and East Kalimantan. Indonesia is already
the world’s largest exporter of power station coal.
Several pilot
projects in the coal fields of Kalimantan have been announced. However, investors
in coal seam gas are facing similar obstacles that have hindered investors in oil,
natural gas and power generation. Even so, a BP led consortium has announced a
pilot project to develop coal seam gas in the East Kalimantan
coalfields.
Nevertheless, due to
the complex business and regulatory climate in Indonesia, development is likely to
be at a slower pace than in neighbouring Australia.
Problems Faced Supplying the Domestic Gas
Market
Java searches further afield for its gas
supplies!
Indonesian Domestic Gas Market
Despite gas output
expected to climb from 72bcm in 2009 to 87bcm by 2019, Indonesian gas exports are
set to decline. This is because of increasing domestic gas
usage.
Domestic demand is
planned to grow, because of the implementation of a government oil substitution
policy, which seeks to reduce oil usage in the Indonesian economy. Amongst the
measures undertaken has been to cut subsidies to oil prices, this has contributed
to greater demand for gas by customers in the domestic market. As a consequence,
Indonesia’s state owned power generator PT PLN is undertaking a policy of
converting its oil powered power stations to gas.
Similar developments
are taking place elsewhere in the economy, including for transport, cooking and
increased usage as a feedstock for its fertiliser industry. These changes are
expected to increase demand by 6% per annum for domestic gas from the present
annual consumption of 33bcm.
Supplying Java With Gas
Java is the economic
heartland of Indonesia and it is where most of the demand for domestic gas is
located. The island only has 8 TCF of gas reserves, insufficient to meet Java’s
growing needs. At present, Java uses some 1.0 billion cubic feet per day (BCFD),
and by 2025 this could increase to 6.5 BCFD, due to growing demand for gas, and
this increasing gas usage poses serious supply problems for the Javanese
market.
In order to meet
increasing Javanese demand and top up local production, Gas Negara the state owned
transmission and distribution gas utility opened a 1000 kilometre pipeline linking
the gas fields operated by Chevron and Pertamina in Southern Sumatra with Jakarta
in Java in 2007.
Fig 3 -
Sumatra to Java Gas Pipeline Network
Source: Gas Negara
Unfortunately, this is only a short-term solution;
Gas Negara is now looking further afield for new gas supplies to meet medium to
long-term future needs, including Kalimantan, Sulawesi and
Papua.
One measure being
implemented is the construction by state owned gas transmission and distribution
company, Gas Negara of a new LNG import terminal in West Java, due to come on
stream in 2012 with an initial capacity of 1.5 mtpa. Most of the LNG for the West
Java plant is likely to be shipped from the Bontang LNG export terminal that serves
the gas fields of East Kalimantan. However, given the rate of growth of demand for
gas in Java, and the slow pace of development of new fields, it is possible that
Java could be importing gas from further afield, for instance Tagguh or even its
neighbour Australia one day.
In addition, there
are long term proposals to link new gas fields in East Kalimantan holding proved
reserves of 25 TCF via a 750-mile pipeline to Java.
Ira Miriawati, head
of oil and gas utilization in upstream oil and gas regulator BPMigas has observed
that current domestic gas price is around $1.2 to $6 per MMBTU, while exported
liquefied natural gas can fetch somewhere between $10 and $12." Unfortunately, for
Indonesia, such domestic pricing makes it uneconomic for investors to implement
many of the increasingly expensive schemes they are
proposing.
Nor does it help that
the government is increasingly insisting that a certain portion of output in new
schemes be reserved for sale to the domestic market at below world market prices.
Such insistence in reserving a portion of new output has delayed the go ahead for
two years of a project off the coast of Sulawesi, when the government proposed that
all the output from this scheme should be reserved for the domestic
market.
Such a proposal would
have made it uneconomic for the investors Pertamina, Medco and Mitsubishi Corp, it
was only this June that agreement was finalised that permitted 72% of the gas
produced would be reserved for the profitable export trade, to
proceed.
Indonesian Gas Exports
Government plans to cut gas exports to meet
growing domestic demand!
Figure 4 Indonesian Gas Exports in
bcm
Source BP
2010
In 2005, Indonesia
was the world’s leading LNG gas exporter, today it is the third largest behind
Malaysia, with Qatar in first place. Today, gas exports share is 48% of total gas
output. It is expected that gas exports are set to climb from 35.67 bcm in 2009 to
46.0bcm in 2012, before dropping to 24.2bcm by 2019.
Fig 5 - Indonesia to Singapore gas
pipeline network
Source:
Singapore Petroleum Company
At present, most of
the exported gas is delivered to neighbouring states and the North Asian markets by
LNG tanker, though Singapore and Malaysia import gas via pipeline direct from
fields in Central Sumatra and the offshore fields in the Natuna Sea. There are
tentative plans to build an international gas pipeline network linking Indonesian
gas fields with its neighbours that would allow Indonesia to export gas to Southern
China!
One of the reasons
for the short-term increase in exports is due to the new BP led Tagguh project in
the eastern province of Irian Jaya (West Papua), which came on-stream in 2009. This
new field has estimated reserves of 14.4 trillion cubic feet of gas, and an LNG
export terminal able to process at least 7.6 million metric tons of LNG a
year.
Tagguh cost the
consortium behind it to develop some $3.5 billion. Much of this gas is destined for
delivery over the next twenty years by LNG tanker to markets in China, Korea and
Taiwan. Apart from Tagguh, Indonesia has two other LNG plants, the country’s first
LNG plant at Bontang in East Kalimantan, with a capacity of 22 million tonnes a
year and the other at Arun in Northern Sumatra, with a capacity of around 12
million tonnes a year. However, output has declined at these plants, due to
declines in supplies from the aging gas fields they depend
on.
Fig 6- Tangguh LNG Project
Figure 4 BP's new
Tagguh LNG project in Bintuni Bay, Irian Jaya
Future Gas Field Investment
Investors have
announced four new gas fields that will include LNG plants to meet the needs of
markets both at home and abroad that are due to come on stream over the next
decade. These are the Kutai Basin, off East Kalimantan, the Masela field in the
Timor Sea, the Natuna Sea block off the east coast of Peninsula Malaysia and the
Senoro and Matindok fields off the coast of Sulawesi.
Tangguh LNG is the third LNG
hub in Indonesia. In March 2005 the Government of Indonesia gave the go ahead for
the Tangguh LNG project in Bintuni Bay of West Papua.
Conclusion
Investing in Indonesian oil and
gas
Indonesia's oil and gas
future lies offshore in the remoter deeper depths of its seas. However, to unlock
the country’s oil and gas resources, the country's government, needs to further
improve its investment climate, if it is to attract the degree of investment
required to boost long-term oil and gas production. Unless it attracts the
investors its requires, Indonesia could become as big an importer of natural gas in
the future as it is a net oil importer today.
Source:PricewaterhouseCoopers Indonesia recently
released the
Indonesia Oil & Gas Concession and Infrastructure Map.
Given the often complex
and different business, legal and cultural environment. Many foreign investors gain
the impression that they are rabbits in an Indonesian jungle full of tigers, but
careful and prudent investment can be well rewarded!
For further information:
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- Energy Economist August edition
2010
see page 23:
Peak coal approaches for Indonesia
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