Overview of Indonesia’s Downstream Oil and Gas Sector

Energy & Mining | Overview: Indonesia’s Downstream Oil and Gas Sector

Growing energy demand and manufacturing activities are creating investment opportunities in Indonesia’s downstream oil and gas sector. While in the past most oil and gas would be exported, strong economic growth and rapidly rising household spending mean the sector is increasingly focused on the home market. The Indonesian government is pushing to expedite the industry’s reorientation, which presents challenges and opportunities for businesses.

Business success in the sector, however, hinges on the ability of Indonesia’s upstream producers to provide sufficiently large and sufficiently reliable supplies of crude oil and natural gas

A draft assessment by the Ministry of Energy and Mineral Resources published in February 2013 projects that Indonesia’s national electricity demand will grow at an annual rate of 10.1% until 2031 (See Indonesia’s Electricity and Power Generation Sector). The government’s plan to rely more on cleaner-burning gas and less on coal to fire new power plants is set to create stronger and stronger demand for gas. Vehicle ownership in Indonesia is also rising fast, with a record 1.1 million cars sold in 2012 (GAIKINDO). Together with the need for hydrocarbon feedstock in the country’s growing petrochemical and fertilizer industries, this provides a compelling case for downstream investment in petroleum and natural gas.

Business success in the sector, however, hinges on the ability of Indonesia’s upstream producers to provide sufficiently large and sufficiently reliable supplies of crude oil and natural gas (See Indonesia’s Oil and Gas Sector – Upstream Challenges). More money has gone into exploration and production in recent years, but it remains to be seen whether this is enough to reverse the trend of falling oil production and fluctuating gas output. Assuming downstream companies can secure a dependable stream of oil and gas, business opportunities are plentiful. Easier access to financing can give foreign companies an edge over local ones on capital-intensive projects, with the following areas meriting particular attention:

LNG infrastructure: The gas industry’s shift towards domestic demand necessitates new infrastructure for liquefied natural gas (LNG). Once a leading LNG exporter, Indonesia will require increasing LNG imports, as domestic production alone is unable to accommodate rising demand. This creates a need for new import terminals (See Indonesia’s Gas Industry; Prioritising Domestic Demand and New Opportunities). New liquefaction plants will also be needed if domestic gas production increases as planned. Finally, both foreign and domestic LNG needs to be distributed and re-gasified at destination. As expiring long-term export contracts make more gas available for domestic use, getting gas from the site of production to the place of consumption will require substantial investment in pipelines and receiving terminals; including floating storage and re-gasification units (FSRUs). Timing is a crucial factor, as all components of the LNG supply chain must be well integrated to work at optimal capacity.
LPG infrastructure: In the case of liquefied petroleum gas (LPG), Indonesia’s imports already far outweigh exports. Accommodating the growing domestic market will require years of investment into building and operating new facilities and networks. Additional domestic LPG production capacity is required as the government pushes for the use of LPG in households and automobiles to lessen Indonesia’s dependence on oil. Distribution and storage offer business opportunities as well.
Petroleum refineries: The government has been lethargic about adding oil refining capacity for the best part of the last two decades, which has created a substantial domestic supply gap and dependence on refined petroleum imports. The Energy and Mineral Resources Ministry has stated that Indonesia needs at least 750,000 barrels per day (bpd) in new refining capacity in addition to the current 1 million bpd (in practice refineries run below full capacity). Transportation fuel demand is rising quickly, as is feedstock demand from the petrochemical sector, which is forecast to outperform the overall economy over the coming years. Pertamina has entered into agreements with Middle Eastern companies and is seeking further cooperation with foreign firms on more refineries. Incentives to compensate for high upfront costs have been one of the main sticking points in negations, but as demand increases, so too does the pressure on the government to accommodate investors with more attractive arrangements to offset some of the capital risk.
Petroleum storage and trading: Growing domestic consumption of petroleum products and Indonesia’s proximity to Singapore, Asia's oil trading hub, open up opportunities for storage and trading. Chinese oil and gas major China Petroleum & Chemical Corporation (Sinopec) announced in October 2012 that it had begun work on Southeast Asia's largest oil storage terminal in the Batam free trade zone to support its trading business. Due to its political importance, storage of oil and gas is heavily regulated. For instance, storage operators are required to allow other companies to use their facilities in remote areas with hard access to petroleum.

Regulations & Politics

Indonesia’s oil and gas sector is regulated by Oil and Gas Law No. 22 of 2001, with Government Regulation 36 of 2004 outlining further rules for downstream businesses. Energy and Mineral Resources Ministry Regulation 7 of 2005 provides more specific guidance on permits. Separate licenses are required for core activities in processing, transportation, storage and trading. Gas pipeline projects generally need to conform to the government’s gas transmission policy. BPH Migas is the downstream regulator, but in some cases approval needs to be sought separately from the Ministry’s Directorate General of Oil and Gas. Specific rules allow BPH Migas to intervene in operations to support competition and distribution across the archipelago. For example, the agency may require storage or gas pipeline operators to allow other parties to use their facilities. Local services companies and suppliers enjoy priority over foreign ones, and companies are obliged to employ local staff wherever feasible.

The Indonesian government aims to spur downstream development through so-called clusters; industrial estates that facilitate close integration of related processes. The cluster strategy is part of the government’s economic development roadmap, with a view to accelerating growth particularly outside Java. The Industry Ministry is tasked with ensuring clusters have access to electricity, water and transport infrastructure. A petrochemical and fertilizer cluster is in the early stages of development in West Papua’s Bintuni Bay, near the BP-operated Tangguh LNG plant, which is currently undergoing a $12 billion USD expansion. New projects in the downstream hydrocarbon sector are often considered strategically important and therefore qualify for income tax holidays. This includes oil refineries and petrochemical projects worth 1 trillion RP or more. In addition, tax allowances are granted for projects upwards of 50 billion RP, while import duties on capital goods may also be waived.

Risks & Concerns

The fact that specific incentives and conditions are negotiated on a case-by-case basis means discussions are long and their outcome uncertain. This is particularly true for large-scale projects and adds to a number of more general complaints investors have when doing business in Indonesia, such as a cumbersome bureaucracy and problems with land acquisition.

Investment concerns also pertain to uncertainly about future policies. The downstream oil and gas sector has not so far drawn the nationalistic sentiment seen upstream, but the sudden disbanding of upstream regulator BP Migas after nationalistic-minded groups pushed for a Constitutional Court review in 2012 is not forgotten. While there are no signs that BPH Migas is headed for the same fate as its upstream counterpart, investors may be cautious about committing large sums before the 2014 general elections.

As the only Indonesian oil company with substantial experience in the downstream sector, Pertamina runs all of the country's refineries. This monopolistic market structure may be one of the reasons private investors have been slow to embrace opportunities in refining. Cooperation with Pertamina is virtually a precondition in the refining business, and the national company’s strong presence could be intimidating for private players, with Pertamina also dominating the retail market. State-controlled Perusahaan Gas Negara (PGN), meanwhile, has a commanding position in gas transmission and distribution.

Uncertainty about future pricing in the heavily regulated petroleum and natural gas markets complicates long-term planning. Since pricing is intertwined with controversial subsidies, more guidance is needed as to how the government seeks to exit the policy of artificially cheap energy. LNG producers must understand how this might affect tariffs paid by utility company PLN. Policies to secure supplies for domestic power plants and industries, specifically in remote areas, also need to be transparent and consistent, as does the government’s grand design of the country’s LNG infrastructure. Without clarity on these matters, entering the market entails significant demand risks for operators of plants, terminals or pipelines.

Fortunately, political and regulatory risks are constrained by market forces. Demand is increasing for the whole range of downstream products, such as gas for power stations and plastics for the packaging industry. As it strives to maintain strong GDP growth and foreign direct investment to support the Rupiah, the Indonesian government has little choice but to ensure a sufficiently attractive investment climate in the downstream oil and gas sector.

Global Business Guide Indonesia - 2014

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Indonesia Energy Snapshot

Contribution to GDP: 3.44% (2016) Oil & Gas Imports: $1.22 billion USD (Jan 2016)
Proven Oil Reserves: 3.69 billion barrels (2016)
Proven Gas Reserves: 2.85 trillion cubic metre (2016)
Proven Coal Reserves: 28 billion tonnes total reserves (2015)
Proven Potential in Geothermal Energy: 27 GW
Proven Potential in Hydropower: 75 GW
Other Energy Sources: Coal Bed Methane, Biomass, Waste, Ocean Current, Solar, Wind.
Current Energy Mix: Petroleum 41%, Coal 30%, Natural Gas 23%, Renewables 6% (2014).