Investor confidence in Indonesia’s oil and gas sector remains increasingly shaky, and one needs to only pick a single example among a number of recent ones to see why. At the end of May, PetroChina had access to 14 of its oil and gas wells in Sumatra, producing 433 barrels of oil and around 11 million standard cubic feet of gas daily, blocked by a local government hoping to secure energy supply. The Chinese oil giant said that the East Tanjung Jabung administration had requested five million standard cubic feet of gas per day last year, and had withheld PetroChina's land permit when the request wasn’t complied with quickly.
Indonesia today is struggling to attract investment to reverse declining oil output amid ballooning domestic energy demand. It is also facing international criticism for unstable regulations, its nationalist stance on resources and the occasionally unusual obstacles investors have to overcome, be it lockouts like the above, or as Exxon Mobil did in January, when a senior Indonesian official asked for the U.S. energy group to replace its country manager after delays at one of its major oilfields, fuelling concerns about the state meddling in the sector.
At the same time, it needs foreign investors urgently, as it seeks to raise oil and gas production. In May, Indonesia opened a rights tender for 21 oil and gas exploration blocks, including 17 offshore blocks, most of which will require overseas investors to carry out exploration, given the prohibitive costs for domestic companies. “Investors have voiced concerns that the government is unable to provide sufficient and reliable oil and gas data, which has created reluctance on the part of investors to participate in oil and gas tenders,” says Emir Kusumaatmadja, partner at Mochtar Karuwin Komar. “Another obstacle is the oil and gas regulatory framework, which consists of overlapping regulations among technical departments and between central and local governments. Complicated and excessive licensing procedures are a result. Also, in 2010, the government issued a regulation limiting recoverable costs, somewhat to the detriment of the cost-recovery scheme.”
It is hard to imagine that Southeast Asia's largest economy was once a significant producer of oil. In 1995, the annual oil production target peaked at 1.6 million barrels per day (bpd), but for 2014, the Indonesian government first set an oil production target of between 900,000 and 930,000 bpd, which it subsequently reduced to 860,000 bpd. In March 2013, the output was 840,000 bpd, compared to the target of one million bpd. At the same time, domestic demand for oil and gas has been ballooning. It is no surprise that much like their Southeast Asian counterparts such as PTT and Petronas, Indonesian oil and gas giants Pertamina and Medco are also pursuing overseas oil and gas opportunities in the Middle East, Southeast Asia and Australia.
Kusumaatmadja says that the Indonesian government has put forward certain fiscal incentives to draw the investors in. “For instance, goods and equipment for upstream oil and gas activities are now exempted from customs duties and value-added tax,” he says. “In addition, it has been reported that the government is currently looking for further incentives for oil and gas investors.”
However, he believes the government can do even more. “Since oil and gas is a high risk capital intensive business, investors are hoping more fiscal incentives will be offered, especially for the exploration stage,” he says. “During exploration, there is no guarantee that oil companies will discover oil or gas; and even if they do so, there is no guarantee that the reserve will be commercially viable for development. At the same time, however, they still have to pay a high amount of tax, including land taxes, among others. Therefore, more fiscal incentives could make investors more willing to conduct exploration activities. In addition, the government could simplify licensing procedures to make them less time-consuming and costly in order to facilitate smoother and more profitable operations.”
Indonesia subsidy cut is right plan for wrong time
By Andy Mukherjee
Indonesia’s overhaul of energy subsidies is the right plan, but its timing is highly suspect. Hiking state-controlled diesel and gasoline prices by 22 and 44 percent respectively will lift prices when investors are already jumpy: $4.7 billion in financial capital left the country in the last quarter. To prevent higher inflation from spooking investors further, the central bank will have to raise interest rates. That means sacrificing GDP growth.
For the past five years, the government has refrained from raising energy prices, choosing instead to absorb the subsidies – $20 billion last year – in the budget. But with the fiscal deficit ballooning, lawmakers agreed to a price increase, while also handing out $910 million to poor families.
The decision will automatically boost prices. Morgan Stanley economist Deyi Tan reckons inflation will rise by 3 percentage points to around mid-8 percent. It will also prompt domestic investors to demand additional yield as compensation for keeping their wealth at home. In 2005, when Indonesia made two hefty upward adjustments to gasoline and diesel prices, locals took almost $10 billion out of the country, precipitating a mini-currency crisis. That precedent will make Indonesia’s central bank extra careful this time around, especially as markets anticipate the possibility of the Federal Reserve scaling back its asset purchase programme. The central bank last month raised its benchmark interest rate by a quarter of a percentage point.
For Indonesia’s authorities, higher interest rates and lower growth will be an acceptable price. The alternative is a sharp fall in the rupiah, so that foreigners find local assets to be attractively priced in their home currencies. But that avenue is littered with potholes. For one, it will add to inflation by increasing the cost of imported goods. At the same time, private borrowers’ cost of servicing overseas debt will increase.
A somewhat slower pace of expansion won’t be a calamity in an economy that has chalked up real GDP growth of more than 6 percent for 10 straight quarters. But the combination of a sharp slowdown and higher interest rates could cause bank loans to start turning sour, delaying any recovery. By resisting much-needed reforms for so long, the government has made the pain of eventual adjustment a lot worse than it should have been.
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