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Indonesian households are quietly undergoing cultural and lifestyle changes in the way they prepare food for the home.

This is not about the gastronomic revolution, in which gourmet trends replicate through the fashion-mills of major cities. Rather, it is as mundane as the way people here cook and the source of energy they use.

Since the colonial era, Indonesians have used kerosene, for decades available at very affordable, highly subsidized prices. Not any more.

Starting in 2007, the government has campaigned to replace kerosene with cleaner, cheaper natural gas, resulting in billions of dollars of savings each year in reduced subsidy costs. Conversion in Java and Bali, which once represented about 70 percent of national kerosene consumption, has largely been completed, and universal conversion is expected to be complete in another year or two.

New lovers of gas are not confined to households. Electricity utilities, fertilizer companies and other industries increasingly use gas rather than oil as their energy source. This trend has pushed domestic demand upward, creating both opportunity and challenges.

A Sunset Industry

In the 1970s, Indonesia was Southeast Asia’s only natural gas supplier through state-owned energy producer PT Pertamina. For 25 years, it dominated the regional market and dictated prices.

Since the early 2000s, Pertamina has lost its grip to new entrant to the market from Australia, Brunei, Malaysia and Qatar, heralding a buyers’ market that continues today.

According to The World Fact Book 2009, Indonesia ranks 13th in proven natural gas reserves, with 2.7 trillion cubic meters, and ranks 15th in production, at 56 billion cubic meters per year. With that production rate, reserves will last for a half century.

In the coming decades, new gas-fueled power plants, fertilizer factories and other industrial concerns are expected to boost the domestic demand for gas by 6 to 8 percent per year, doubling gas consumption 2020. Most of that growth will take place in Java, which is expected to almost triple its appetite.

In the meantime, production of existing gas assets in the country is expected to peak in 2012, at about 8,000 million standard cubic feet per day, and then deplete to about half that by 2020. Without the development of new gas assets by then, our total gas demand will surpass national production and Indonesia will become a net importer of the fuel.

The challenge is how to add momentum to an otherwise dwindling industry. Developing upstream assets is very costly, and while those costs might once have been offset through recovery schemes, more recent government caps on those schemes have made for a disincentive to invest in exploration and development.

Misaligned Incentives

In 2008 and 2009, almost two thirds of Indonesia’s gas production was exported. By 2020, it is projected that exports will represent less than 50 percent of national gas production, the majority of which will come from new sources.

In an economic sense, export is more attractive than domestic sales because it commands better prices, currently $8 to $12 per million British thermal units, compared with depressed domestic prices of about $4 to $6 for the same amount.

In addition to paying higher prices, long-term off-takers are normally reputable multinational companies with strong credit ratings. Such factors are crucial for structuring financing. For domestic consumption, project financing is an uphill battle.

The nation’s financial market is still dominated by banks, whose assets represent more than 80 percent of total market capitalization. Those banks are already constrained by legal lending limits to provide financing for the two major off-takers: state-owned electricity utility PT Perusahaan Listrik Negara and fertilizer giant PT Pusri.

In 2008 and 2009 the government offered 40 oil and gas blocks for development but found only eight takers, leaving a startling 75 percent of the offer on the table.

Gas developers are facing risk from all sides, from geological uncertainties to the incoherent behavior of our bureaucrats and politicians.

While we can do almost nothing about the risk associated with nature, putting a cap on cost recovery is a sure way to push potential investors out of the door. Such a policy is squarely at odds with the need to develop new assets to feed gas-starved industries and electricity producers.

The involvement of local governments in energy development is inevitable, and this also adds complexity to the process. Despite all good intentions, reality bites in the form of weak institutional capacity — typified by the poor quality of both local bureaucrats and data — at both the central and local levels.

Gaseous State

The domestic demand for gas is expected to grow faster than the gross domestic product in the next 15 years or so. That means Indonesia needs to invest in future upstream assets to meet the fast-growing demand. This is a huge investment that requires proper incentives, an appropriate regulatory regime and market-friendly bureaucrats.

As it stands today, domestic gas prices are capped significantly below market prices. It is clear that with such a price scheme, it will be very difficult to attract the much-needed investment. We need to smartly design a regulatory regime — involving a combination of a more rational government take, more flexible cost recovery and more market-based domestic pricing — that will attract investment while still being considered fair by local communities.

Regardless of where future supply comes from, Indonesia badly needs more infrastructure for gas. For Java, key requirements include liquefied natural gas receiving terminals, the pipeline currently under construction between West and East Java and infrastructure to produce compressed natural gas for transport and piped gas for industry.

Increased use of cleaner-burning compressed gas would reduce over-dependence on diesel fuel for vehicles and liquefied petroleum gas for industry and households.

Players in the oil and gas sector certainly need to deal with the current economic and socio-political realities, factoring in the associated risk as well as the already complicated geological risk. At the end of the day, potential investors will demand returns commensurate with such risks.

Squeezing more out of investing companies (in the form of the government’s take and the cap on cost recovery) is not the smartest policy in a declining industry. The government needs to consider dropping more candies to attract the army of ants to lift the gas industry in the country.

In physics, a gaseous state refers to the state of matter found between the liquid and plasma states, marked by relatively rapid expansion and contraction with changes in pressure and temperature. In similar vein, the state of the gas industry in Indonesia can evaporate rapidly if the right investment is not attracted, or can grow rapidly if the government has the determination to put it right.

Hopefully, policy makers and legislators in charge of energy are sensible enough to resolve the issues rationally, beyond the rhetoric of sovereignty.

 

Farid Harianto is a contributing editor for GlobeAsia. The article also appears in the magazine’s April edition.