The Asia-Pacific Journal | Japan Focus Volume 8 | Issue 47 | Number 1 | Nov 22, 2010

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Snakes and Ladders for Japan in Indonesia's Energy Puzzle　インドネシアのエネルギーの謎における日本にとっての蛇と梯子

David Adam Stott

Snakes and Ladders for Japan inIndonesia’s Energy Puzzle

David Adam Stott

‘Possibly the most important(challenges) are Indonesia’sdeclining oil and gas productionand the fast increasing domesticrequirements for oil and gas; thepers is tent e lec tr ic i ty andpetroleum subsidies and pricecontrols; and the limited clarity inIndones ia ’s energy sectorgovernance, co-ordination anddecision making regime.’

International Energy Agency (IEA),Energy Policy Review of Indonesia(2008)[1]

The Asian liquefied natural gas (LNG) industryis undergoing a major realignment. Whilstregional LNG demand continues to increase,Indonesia has relinquished its position as theworld’s biggest exporter and is redrawing itsenergy export policy to reflect evolvingpriorities and changing circumstances.Indonesia became a net importer of crude oil in2004, a costly encounter with reality for acountry accustomed to domestic energysubsidies. A consequent lack of investment inenergy infrastructure has resulted in bothindustrial output and overall quality of lifebeing compromised by electricity shortages.The central government has responded byphasing out exports from its biggest LNG

processing plant and prioritising supplying thedomestic market. At the same time, Jakartacontinues to promote foreign investment in newgas projects, albeit amid high levels of policyuncertainty.

Nevertheless, Japanese firms are behind movesto double the number of LNG processing plantsin Indonesia to six within the next five years.Japan keenly feels any change in Indonesia’sgas export policies since it is the world’slargest importer of LNG and Indonesia’sbiggest customer. As long-term contracts withIndonesia expire, Japanese buyers have beenscrambling to secure replacement LNGsupplies from the archipelago and elsewhere.Despite all the maneuvering, Indonesia remainsattractive to Japanese energy firms due to itsrelatively proximity and its sheer size.

Five specific LNG projects are being affectedby Jakarta’s energy policy reforms. This paperwill firstly analyse the reasons for the policychange before presenting an overview of thesefive schemes. In doing so, other related aspectsof Indonesian energy policy - such as fuel andelectricity subsidies, the prospects forunconventional gas and the general foreigninvestment climate - will be assessed. Inessence, this paper will seek to address theissues cited above by the IEA by focusing onLNG ties with Japan.

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Most of Indonesia’s LNG plants are locatedfar from its population centres. Sengkang,

Senoro and Abadi have yet to startproduction.

Indonesia’s energy reforms

LNG processing plants are where natural gas isliquefied and compressed for transport, and areusually located near the natural gas fields, fromwhere the gas is transported to the plantthrough pipelines or by freight transport.During processing, impurities in the gas areremoved, and it is then cooled to minus 162Cand kept in cryogenic storage. At suchtemperatures, natural gas becomes liquid and615 times smaller in volume. The coolness alsoensures that is not explosive and does not burn.The LNG is then sent by specially constructeddouble-hulled ships to an LNG receivingterminal, where it is reheated and subsequentlydistributed to the buyer.

Indonesia became the world’s biggest LNGexporter from two processing plants – the ailingArun facility in Lhokseumawe, Aceh provinceand the Badak plant in Bontang, EastKalimantan province – built under long-termsupply contracts with Japanese buyers andopened in the late 1970s. The country’s thirdsuch plant, the Tangguh facility in West Papuaprovince, opened in May 2009. Prompted bybecoming a net oil importer in 2004, theIndonesian government now wants to replacecostly oil with gas-fired power generation, andthe expiry of these long-term LNG salescontracts will help them to do so. Natural gas

that has long been destined for export willinstead be sold domestically, bolsteringIndonesia’s energy security and reducingreliance on oil imports. Since most of thecountry’s LNG exports end up in Japan,Japanese utilities will be the biggest victims ofthis policy reversal. Indonesia presentlysupplies about 20% of Japan’s total LNGimports, although this share has been steadilyeroded as Qatar, Malaysia, Australia and Russiacatch up. Nevertheless, Indonesia’s geographicproximity to the large LNG export markets ofJapan, South Korea, Taiwan and, increasingly,China, guarantees its attractiveness toNortheast Asian developers and buyers.

Whilst several new LNG projects are in variousphases of development, the Bontang LNG plantremains the jewel in the crown of Indonesia’soil and gas industry. Despite being surroundedby ageing gas f ields, upgrades to theprocessing plant and continuing explorationhave ensured that Bontang is still the source ofaround 90% of Indonesia’s LNG exports toJapan. Indeed, the combined processingcapacity of all of Indonesia’s new LNG projectswill still fall short of Bontang’s annual output,at least in the initial stages of these newprojects. Therefore, it was with dismay thatJapanese customers greeted Jakarta’s decisionto phase out exports from the East Kalimantanplant, especially since Japan is the largestbilateral lender to Indonesia, having providedloans totalling US$22.3 billion, whichaccounted for 43.2% of the Indonesia’s totalexternal debt in 2009.[2] To understand thispolicy change it is necessary to examine certaineconomic, demographic and geographicrealities in Indonesia.

To keep pace with economic expansion andpopulation growth, Indonesia requires evergreater amounts of oi l and gas. Sincerecovering from the Asian Financial Crisis of1997-98, the country has achieved consistenteconomic growth of 5-6% per annum, driven bya steadily expanding services sector. As the

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role of manufacturing and services in theeconomy increases, so does the country’senergy requirements. The service sector,encompassing trade, finance, transport,communication and construction, grew at about8% per annum for several years before theGlobal Financial Crisis. Despite the Crisis, thissector still managed to grow 5.9% in 2009,almost double the growth rate of agriculture,mining and manufacturing. Consequently, theservice sector accounted for 51.9% ofIndonesian GDP in 2009, up from 48.9% in2006.

The result is a dramatic increase in domesticgas demand. Government statistics report thatindustrial gas consumption rose from 3,541million metric standard cubic feet per day(mmscfd) in 2005 to 4,233 mmscfd in 2009. Thecountry’s fertiliser, ceramics and electricityindustries are the biggest contributors to thisrising demand, projected at 2.8% per annum to2020. As investment in both production anddistribution infrastructure has failed to keeppace with this extra demand, industrial andresidential consumers have experiencedincreasingly scarce gas supplies.

To cover shortfalls in gas output from Acehprovince, for several years gas has beendiverted from Bontang so that Pertamina cansupply a national fertiliser manufacturer andtwo small Japanese-owned fertiliser plants. Theexpiry of long-term sales contracts withJapanese uti l i t ies al lows the centralgovernment to formalise this process andconsolidate fertiliser supplies, thus boosting

the agricultural sector. Government policymakers also see Bontang amelioratingelectricity shortages and fostering economicgrowth by furnishing manufacturing industrieswith affordable gas supplies. Therefore, moreof the Bontang output will instead be deliveredt o t h e W e s t J a v a F l o a t i n g S t o r a g eRegasification Terminal (FSRU) beingconstructed in Jakarta Bay to receive the LNG,which in turn will supply electricity to thecapital and its hinterland. In October 2010,Japanese firm Inpex signed a preliminary salesagreement to supply 11.75 MT of Bontang LNGto the West Java terminal between 2012 and2022. BPMigas has also stated that theTangguh plant could supply 0.5 to 0.7 MT perannum to the West Java FSRU. The centralgovernment is also planning a further two LNGreceiving terminals to supply Surabaya andMedan, the country’s second and third citiesrespectively.

Electricity shortages are a major concern asstate electricity monopoly PLN struggles tocope with increasing demand. The countryneeds some 260-290 billion kilowatt hours(kwh) to avoid rationing and rolling blackouts,but in 2009 electricity output was only around170 billion kwh, and demand is constantlyrising. It is estimated that every 1% of futureGDP growth will require a simultaneous 2.5%rise in electricity output. Given that theIndonesian economy grew at an annual rate of5.7% in the first quarter of 2010 and 6.2% inthe second quarter, to sustain such growth thecountry needs to bolster its electrical poweroutput by at least 15% each year.[3] Indeed, in2008 shortages prompted a group of Japanesefirms, backed by the Japanese Embassy, tothreaten to leave Indonesia unless electricitysupplies were improved. The Jakarta JapanClub cited a survey of its 414 membersthroughout the archipelago which put thesefirms’ combined losses due to power cuts atsome US$4.44 million. The other majorcomplaint of these firms, mainly operating inchemical industries, precision parts and tyre

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manufacturing, was the lack of advance noticefrom PLN which would enable them to tailoroperations around the blackouts.[4] In order toincrease electricity generating capacity,Indonesia will divert gas that was previouslydestined for export, thus harming Japan’sdomestic energy security but benefittingJapanese firms in Indonesia.

Rapid population growth exacerbates suchshortages. The results of the latest nationwidecensus conducted in 2010 showed 237.6 millionpeople in the country, up from 205.1 in 2000.This increase of 32.5 million people equates toaverage net population growth of 1.49% perannum during the last ten years, meaning thatin the last 80 years Indonesia’s population hasmore than tripled.[5] Naturally, such growththreatens the government’s developmenttargets in education and healthcare, increasespressure on Indonesia’s creaking infrastructureand challenges the economy to provide evermore employment opportunities.[6]

Naturally, economic and population growthexert ever greater pressure on scarce energyresources. Yet the overall health of Indonesia’spetrochemical industries has been ininexorable decline. The country’s oil industry isone of the world’s oldest, but annual crude oilproduction peaked in 1994 at just over 1.6million barrels per day (bpd).[7] Since thenoutput has declined steadily so that crude oiloutput fell from 1.4 million bpd in 2000 to 0.9million bpd by 2009. Natural gas output alsodeclined in the same period, albeit lessdramatically from 2.9 to 2.5 trillion cubic feet(TCF).[8] While it remains a net exporter ofenergy, since 2004 Indonesia has been a netand steadily growing importer of oil. Imports ofcrude oil and associated petroleum productsincreased from 17% of Indonesia’s total importsin 2000 to around 33% by 2010. [9] Given thatthe Indonesian government has long providedfuel and electricity subsidies, such importsbecome increasingly unsustainable asIndonesia’s oil production falls at the same time

that domestic demand rises.

As a result, Jakarta feels compelled to reshapegas export policy in order to improve its ownenergy security and investment climate. At thesame time, oil and gas export revenues are notas vital to the Indonesian economy as they werein the 1970s and 1980s. Indeed, the share ofthe energy sector (oil, gas and miningcombined) in Indonesia’s GDP has been steadilydeclining as energy sector investments havelagged. Oil, gas and mining currentlycontributes about 10% of Indonesia’s GDP,down from around 15% in 2000. Looking atIndonesia’s total exports during the sameperiod, the share of oil and gas has fallen from2 3 % t o a r o u n d 1 9 % o f t o t a l v a l u e .Nevertheless, in the last 5 years the energysector still contributed approximately one thirdof all government revenue, bolstered by highglobal prices and increases in coal and miningrevenues.

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Source: Badan Pusat Statistik RepublikIndonesia (Statistics Indonesia)

The Bontang terminal is located relatively closeto Java and Bali, where much of the country’smanufacturing is also concentrated. Not only isit Indonesia’s biggest LNG plant, but it is alsomore centrally located within the sprawlingarchipelago than either the ailing Arun plant inAceh or the new Tangguh facility in Papua.Therefore, Bontang will be increasingly used tosupply the domestic market whilst more remoteplants such as Tangguh will still serve exportmarkets given the higher gas prices overseas.Whilst some of the Tangguh gas will be solddomestically, Indonesia does not have apipel ine network in place capable oftransporting large volumes from remotelocations. Jakarta considers establishing inter-island pipelines over the long distancesrequired to be prohibitively expensive. As Javais still dependent on expensive diesel oil tosatisfy much of its power requirements, thedevelopment of LNG receiving terminals isseen as a more cost effective solution to supplyits main population and industrial centres.

Whilst Indonesia’s population is the fourthhighest in the world after China, India and theUSA, population densities vary considerably.

Java, the economic and political powerhouse ofthe country, houses some 58% of Indonesia’spopulation within only 7% of its landmass, andits six provinces have the highest populationdensities in the country. Smaller neighbour Balihas the highest population density of anyprovince outside Java. These core islands alsocontain the lion share’s of Indonesia’s valueadded industries in manufacturing andservices. By contrast, the outer islands accountfor nearly 93% of the country’s landmass butcontain only around 40% of the population.However, much of Indonesia’s known resourcesare found in these outer islands, resulting incomplex logistical challenges in deliveringenergy throughout the sprawling archipelago.

As a result, Indonesian state gas distributorPGN announced in March 2008 that it wasplanning to build three LNG receivingterminals for the Bontang and Tangguh gas.The first will be the West Java FSRU in JakartaBay with a capacity of around 3 MT a year. Thiswill be followed by another terminal in EastJava to supply second city Surabaya, andthereafter in Belawan, North Sumatra toservice that island’s biggest city of Medan. TheWest Java terminal was originally expected tobegin operations in 2011 but has been delayedby financial problems and technical difficulties.Golar Energy recently won the US$500 millioncontract for its construction, which will be thefirst FSRU project in East Asia. In addition,three gas transmission networks will also beestablished linking East Kalimantan and Java,and several cities in Java, Sumatra, Kalimantanand Sulawesi will benefit from the developmentof urban gas networks. These developmentsunderline the fact that whilst Japan is still themain export market for Indonesian gas, it isincreasingly having to compete with domesticbuyers for supplies.

The effect of subsidies

One of the main reasons why Indonesia suffersfrom energy shortages is due to long-standing

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fuel and electricity subsidies, which raiseconsumpt ion l eve l s and encourageinefficiencies. Household consumers, especiallythose in the middle class, respond to artificiallylow prices by using more fuel and electricitythan if they paying market prices, whilstbusinesses also have less incentive to conserveand innovate. Energy intensity data revealsthat Indonesia uses more energy to produceelectricity than its neighbours Malaysia,Thailand and the Philippines, whilst someeconomists have even projected fossil fuelconsumption to fall by 20% if fuel subsidieswere eliminated.[10] Along with restricting gasexports, reducing subsidies is also integral tobolstering Indonesia’s energy security.

As a result of rising crude prices up tomid-2008, an increasingly large proportion ofgovernment spending has been required tosustain fuel subsidies, which are payments toPertamina by the central government tocompensate the firm for losses it experiencesdue to low domestic fuel prices. When oil pricesreach unexpectedly high levels, subsidiesconsume a higher proportion of the statedevelopment budgetn. Likewise, when oilprices are underestimated, the centralgovernment r i sks overspend ing ondevelopment. The dramatic price fluctuationsof recent years have thus made for achallenging policy environment for governmentplanners.

Nevertheless, reducing fuel and electricitysubsidies is still politically dangerous, withdemonstrations against their removal having ahistory which stretches back to the 1960s.Indeed, it was their slashing at the insistence ofthe International Monetary Fund (IMF), whichtriggered much of the unrest that culminated inending President Suharto’s 33 year reign inMay 1998. Subsequent attempts to phase outthe subsidies also caused riots and protests asconsumers feared rising l iving costs.Maintaining the subsidies has attractedcriticism, however. Whilst fuel and electricity

subsidies may be intended to help the poor, inreality the rich consume more of the subsidiessince it is they who drive motorcars rather thansmall motorbikes and have more electricalappliances. Research commissioned by theOECD suggests that the wealthiest 40% ofIndonesians benefit from 65% of fuel subsidyspending [11] whilst the Asia DevelopmentBank (ABD) notes that “the top 10% of incomeearners receive 45% of the fuel subsidies andthe poorest 10% less than 1%”.[12]

Furthermore, it can be argued that the currentsystem of subsidies actually hurts the poorsince less money is available for bothdevelopment and welfare projects.[13] A WorldBank report of 2008 put the cost of maintainingIndonesia’s total subsidies for both fuel andelectricity at over US$20 billion annually -greater than total government spending onhealth, education, housing and public security.Whilst crude prices have fallen from a high ofUS$147 a barrel on July 11, 2008, theopportunity cost to Indonesia’s overalldevelopment remains significant. Based on anoil price of US$77 a barrel, the government’s2010 budget projects that the combined cost ofelectricity and fuel subsidies will reachUS$15.73 billion in 2010, some 13% of totalgovernment spending.[14]

Nonetheless, Jakarta realises that reducing andeventually removing the subsidies isunavoidable. In 2008 it announced that, sincefuel subsidies are meant for those on low-incomes, it intends to gradually remove themfor private car owners. This policy shift is dueto commence in 2011 with a view to fullimplementation by 2014, when fuel subsidieswill be restricted to public transport andmotorcycles. The central government hasalready began reducing the electricity subsidy,which itself cost some US$6.2 billion in 2009.In June 2010, the House of Representatives(DPR) approved an Energy Ministry decreeallowing state electricity utility PLN to raiserates by 15% for industrial users. Beginning in

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July 2010, these rates are to be increasedannually as the subsidies are phased out. By2014 all businesses and the top 5% ofhousehold consumers must pay marketprices.[15] Current electricity prices inIndonesia of Rp600 (US7 cents) per kwh arearound half of the unsubsidised market price.

As a result of selling electricity at far belowcost, PLN posted losses of US$1.2 billion in2008, the biggest loss of any state-ownedenterprise in that year.[16] The rate hike isthus intended to stabilise the firm and to fundmuch-needed electricity infrastructureupgrades. The government has set itself adeadline of 2012 to add 10,000 megawatts tothe power grid, a capacity increase ofapproximately 40%. Since a further 10,000megawatt increase would still be needed toeliminate electricity rationing entirely, PLN isimplementing a thorough overhaul of itsgenerating capacity which requires an averageinvestment of US$7.6 billion a year until 2018.Under the present system of subsidies, suchambitious expansion plans would be far toocostly since greater output leads to ever moresubsidies. [17]

New LNG projects

This section will deal with the five LNG projectsbeing affected by Jakarta’s energy policyreforms. Japanese investors and energy buyersare closely involved in all five schemes, despitepolicy upheavals in Jakarta which threaten theviability of new LNG projects in Indonesia.Indeed, Japanese firms are behind moves toestablish three new LNG processing plantswithin the next half decade. The longexperience of Japanese firms operating in thearchipelago, along with Indonesia’s geographicproximity and remaining untapped potentialensures that the country is still a viableinvestment destination. The Japan-IndonesiaEconomic Partnership Agreement (JIEPA)reinforces this perception given that one ofJapan’s main objectives in signing was to

strengthen the hand of its resource interests inIndonesia.

LNG production and exports [18]

LNG exports by volume

LNG exports by destination

Senoro Donggi

In resource terms, the first fruit of the JIEPAwas supposed to be the Senoro Donggi LNGprocessing facility near the town of Luwuk inCentral Sulawesi province. However, itsdevelopment has been repeatedly delayed bypricing negotiations, threatened by governmentinterference and subjected to legal challenge.Senoro Donggi, which was originally slated tobecome Indonesia’s fourth LNG processingplant, is now expected to come on linesometime in 2012 or 2013.

Mitsubishi Heavy Industries holds a controlling

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51% stake in the project, and reportedly forgedahead after receiving export guarantees beforethe signing of the JIEPA in August 2007. TheJapan Bank for International Cooperation(JBIC) agreed to partially finance the US$3.7billion project, on condition that Japaneseutilities Kansai Electric and Chubu Electricwould each receive half of the plant’s 2 milliontonne (MT) annual output for 12-15 years. InFebruary 2009 provisional sales agreements,otherwise known as Heads of Agreement(HOA), were signed with both the Japaneseutilities to supply each with 1 MT per annumover 15 years. By June 2009 the plant’s frontend engineering and design (FEED) had beencompleted and the consortium had chosen themain contractor for the Engineer, Procure andConstruct (EPC) stage of the project. Theexports to Kansai and Chubu were set tocommence in 2012 but the project stalled inJune 2009 when Indonesia’s then Vice-President Jusuf Kalla, himself a Sulawesinative, insisted the gas be sold domesticallyinstead, since Indonesia faced energy shortagesat home. Moreover, Kalla claimed that theagreement to export all output to Chubu andKansai contradicted legislation to prioritisedomestic demand over exports. Indonesia’sEnergy and Mineral Resources Ministry alsorejected the contracts on the basis that theagreed sales price was too low. The contractedgas price had been set at US$3.85 per millionBritish thermal units (MBTU), similar to pricessecured by Chinese and South Korean firms forTangguh LNG although for somewhat longerterms and bigger volumes. Despite the fact thatthis price would rise under the Japan CrudeCocktail index if oil prices also increased, inMarch 2009 Indonesian state petroleum firmPertamina also argued that the agreed pricewas too far below prevailing global prices ofbetween US$8 and US$9 per MBTU.

Throughout 2009 it appeared that theIndonesian side was trying to secure betterterms from Mitsubishi and its Japanesecustomers, mindful of the furore surrounding

its underselling of the Tangguh LNG to Chinaand South Korea. Jakarta delayed the projectagain by setting six preconditions for finalapproval of the plant’s construction, chiefamong them a price increase. With theTangguh issue having become politicised incampaigning for the July 2009 presidentialelections, the administration wanted to be seenby voters to play tough with Japanese interests.As a result, it seized on a February 2009 floor-price proposal made by the Indonesian Houseof Representatives’ Commission VII on energy.

The Commission’s main precondition wasJapanese acceptance of an absolute minimumprice, determined by the Indonesiangovernment, which would apply if crude pricesfell to US$40 a barrel or under. The February2009 provisional sale agreements did notspecify any minimum price for the gas from theproposed LNG plant. As a result, it wasrumoured that Chubu and Kansai might seekinternational arbitration to settle the case,potentially threatening the feasibility of theSenoro scheme. However, in July 2009 EvitaLegowo, the Energy Ministry’s director generalof oil and gas, dismissed this possibility bystating that the initial supply agreements wereonly provisional and that all prices have to beapproved by the Ministry before they arefinalised. She added that, “The government hasnot signed anything related to the project. Theinitial agreement was between the companiesconcerned”.[19]

Nevertheless, the possibility of Indonesiareneging on the Senoro agreement caused adiplomatic rift between the two governmentsthat reached all the way up to the top. At first,the Japanese Ambassador Kojiro Shiojiri wroteto Indonesian President Susilo BambangYudhoyono warning of potential damage tobilateral ties if Jakarta restricted exports fromSenoro. Soon after, Japanese Prime MinisterAso Taro also spoke about the issue withPresident Yudhoyono at the G-20 meeting inLondon on April 1, 2009. He reiterated Tokyo’s

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stance that the stability of Indonesia’s LNGsupply is crucial to Japan. Despite such intensediplomatic pressure, in March 2010 IndonesianEnergy and Mineral Resources Minister DarwinZahedy Saleh backed Kalla’s stance overkeeping the Senoro gas for domestic usedespite Kalla no longer being Vice-President.

The Indonesian government was also insistingthat the Mitsubishi-led consortium meet fiveother requirements to gain approval for theSenoro plant. These included selling at least25% of the gas on the domestic market, arevision to the project’s development plan andresolution of an outstanding legal disputebetween Mitsubishi and PT LNG Energi Utama.This dispute dates back to August 2008, whenJakarta-based Energi Utama sued Mitsubishifor more than US$709 million in damages. Inaddition to claiming it had exclusive rights tothe Senoro scheme, Energi Utama also accusedthe Japanese firm of purloining confidentialinformation regarding production costs, thusunfairly enabling it to win the LNG plantconstruction contract.

In March 2009 Energi Utama formally lodged aclaim against Mitsubishi with Indonesia’sBusiness Competition Supervisory Commission(KPPU), which subsequently launched aninvestigation. Three months later, the KPPUcleared Mitsubishi of the alleged unfairbusiness practice charges, citing a lack ofevidence. Nonetheless, the body criticised stateoil firm PT Pertamina and PT Medco EnergiInternasional for not exercising appropriatecorporate governance when choosing itspartners in the scheme. It also pointed toinsufficient oversight from the government andBPMigas, Indonesia’s upstream oil and gasregulator, which contributed to the dispute andthe ensuing delays.

The case had appeared closed but in June 2010the KPPU announced further investigations intoEnergi Utama’s allegations of collusion in thetendering process. The KPPU has again been

looking into apparent violations of theAntimonopoly Act (Act No. 5/1999), specificallyArticle 22 concerning collusion and Article 23regarding the use of confidential biddinginformation by competitors. The KPPU isadditionally investigating a new allegation thatMitsubishi consortium also violated Article 19d,regarding discrimination in the businesscommunity. Mitsubishi and its local partnerswere summoned to hearings between July 19,2010 and September 19, 2010, and the KPPU’sinvestigation was set to run until October 12,2010. Reports in the Indonesian press suggestthat irregularities in the tendering process didindeed occur. For instance, Mitsubishi wondespite submitting a more costly bid thanEnergi Utama. Upon securing the tender, theMitsubishi consortium subsequently doubledthe cost of the required investment to completethe project.

Chubu Electric has remained committed to itsHOA preliminary agreement. Japan’s third-biggest utility has had to pay a premium on theLNG short-term market in the last 12 monthsafter an earthquake in August 2009 forced it tosuspend operations at its Hamaoka nuclearpower plant. However, the uncertaintysurrounding the project prompted Kansai topull out in August 2009. Conscious thatJapanese customers will likely pay more for thegas than if it was sold locally, the consortiumhas maintained that export is the best optionfor both the plant’s financial viability andIndonesia’s reputation as an investmentdestination. In 2008, the OECD estimated thatIndonesia’s domestic gas prices are at least athird less than international prices.[20]Nonetheless, Kansai’s decision prompted thetwo local partners Pertamina and Medco, whichhold 31% and 18% respectively, to open talkswith several potential domestic buyers whosubsequently baulked at the asking price. SinceIndonesia lacks the expertise to exploit anddevelop its own gas resources, and needsforeign investment to fuel its own economicgrowth, Mitsubishi’s role in the Senoro project

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is considered critical to its feasibility.Pertamina has also noted that both Mitsubishi’sparticipation in the scheme and the plant’soverall financial viability are predicated on itsoutput reaching the Japanese market.

Jakarta eased the pressure somewhat when adecree was issued in September 2009 to allowfirms to export gas if no domestic buyers wereforthcoming. Subsequently, Japan’s KyushuElectric and South Korea’s state-run Korea Gas(KOGAS) both signalled their interest in lifting0.3 MT and 0.7 MT per annum respectivelyover a 15 year period, following Kansai’sdecision not to renew its HOA for 1 MT perannum in 2009. This prompted Mitsubishi topropose US$2.5 billion of funding if they couldexport most of the LNG, and a compromise wasannounced on June 17, 2010 that the plantwould have to sell only 25% of its production onthe domestic market. At the same time,BPMigas chairman Raden Priyono confirmedthat the project had satisfied all the regulator’sdemands, and was only waiting for finalapproval from Vice-President Boediono, whoreplaced Kalla in October 2009.

Nevertheless, as of October 2010 the SenoroDonggi project was still in need of finance, withthe developers canvassing both foreign andIndonesian financial institutions for investmentcapital. The figure of US$3.7 billion accountsfor both upstream and downstream, with someUS$2 billion still required to fulfill upstreamcommitments, namely the exploration andproduction of gas from the Senoro-Toili andMatindok gas blocks. The remaining US$1.7billion is needed for downstream costs - thebiggest being the actual plant construction. InSeptember 2010, it was revealed that KOGAS,the world’s single largest corporate buyer ofLNG and South Korea’s sole wholesaler, was innegotiations with Mitsubishi to acquire a 9.8%equity stake in the Senoro LNG project. [21]Mitsubishi is also hoping that the JBIC willmake good on its original commitment topartially finance the project, especially now

that the export issues seem resolved.

By October 2010, the project seemed to befinally falling into place. Chubu Electric hasconfirmed it aims to buy 1 MT per annum ofLNG for about 13 years, commencing in thesecond half of 2014. The firm expects to sign afirm contract for the purchase in October 2010,and also intends to offload some of the SenoroLNG to third parties. Kyushu Electric, however,instead signed a HOA with the Gorgon LNG gasproject in Western Australia for 0.3 MT perannum over 15 years, the same volume it wasreportedly interested in acquiring from Senoro.The firm has also signed up to buy 0.7 MT perannum over 20-years from Wheatstone, anotherChevron LNG project in Western Australia.Kansai Electric has recently performed a u-turnand reopened talks with Pertamina to purchasesome of Senoro’s output. Nevertheless, doubtsremain over the plant’s financial viability, giventhat the Senoro and Matindok fields’ reservesare not huge and 25% of their output must besold domestically. Mitsubishi has yet to committo a timeframe for its development but is underpressure from Jakarta to make a f inalinvestment decision (FID) as soon as possible.Furthermore, all export sales agreementsremain preliminary and may be annulled in theevent of further difficulties with the scheme.Indeed, with new LNG developments underwayin Australia, Papua New Guinea and Qatar,Indonesia can ill afford to place furtherobstacles in the path of the Senoro project.

Sengkang

Despite such difficulties, Tokyo Gas has been intalks to join another LNG project in Sulawesi -the Sengkang scheme led by Australia’s EnergyWorld Corp (EWC). The Japanese utility firmhas been trying to acquire a 25% equity stakein each o f EWC’s four whol ly ownedsubsidiaries involved in the scheme, and hassigned a HOA to buy 0.5 MT of LNG annuallyfrom Sengkang. Initial output is projected at 2MT annually from 2012 before potentially

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rising to 5 MT per annum. However, in March2010 BPMigas subsequently slammed rejected?the preliminary sales agreement with TokyoGas as it claims EWC has yet to apply forapproval for the project from the regulator. Ithas even threatened to impose sanctions onEWC executives but the firm counters thatcopies of the project approval have beendistributed to numerous government agenciesand even the President himself. Despiteimprovements in recent years, this caseillustrates that doing business in Indonesia canstill be an opaque and murky process.

Indeed, this is not the first time that EWC andBPMigas have clashed over the Sengkang LNGplant. In January 2010, the regulator rejectedplans for the plant as being incomplete.Specifically, BPMigas Chairman Raden Priyonocharged that, “The plan of development is notbacked up with valid data. How can we approvethe plan of development if we don’t even knowthe reserve data? It’s strange they want to drillwithout an initial seismic survey.” EWC arguedthat a full 3D seismic survey would be overlyexpensive for such a marginal field as theSengkang Block, and proposed a mini-seismicsurvey instead.[22]

The Sengkang project is scheduled to take lesstime to complete than other LNG processingplants as it will be tapping gas from an alreadyactive field, whose output is presently used tofuel the gas-fired Sengkang Power Plantoperated by EWC subsidiary PT EnergiSengkang. The Sengkang Block is estimated tocontain some 2-4 trillion cubic feet (TCF) ofrecoverable gas, whilst a further 300-500billion cubic feet (BCF) of gas is apparentlyavailable for the US$500 million LNG plant.

In keeping with Indonesian government policy,it is also thought that much of the productionwill serve the domestic market. This could bethe reason for the regulator’s criticism of anythe preliminary sales agreement with TokyoGas. EWC does intend to export an unspecified

‘small percentage’ of the LNG in order toincrease the facility’s financial viabilityalthough it remains to be seen if Tokyo Gas willindeed secure 0.5 MT of LNG annually.However, any delays in the plant’s developmentwill likewise delay LNG supplies to state-ownedgas distributor PT Perusahaan Gas Negara(PGN). EWC reportedly signed a preliminaryagreement in September 2009 to sell between1.5 and 5 MT of LNG annually over five yearsto PGN’s proposed regasification terminals inJava and North Sumatra. EWC has also secureda take-or-pay supply contract with stateelectricity firm PT Perusahaan Listrik Negara(PLN) until 2022. Since the Sengkang plant islocated closer to Indonesia’s major populationcentres than any other LNG facility, it isunlikely that much more than 0.5 MT of LNGper annum would be available for export toJapan.

Abadi

Whilst other Japanese firms have been facingdifficulties in Indonesia, Inpex has beenconsolidating its position as one of the majorforeign resource firms operating in thearchipelago. In September 2009, the companyreceived formal approval from BPMigas toconstruct an offshore LNG plant to process gasfrom the Abadi gas field in the Timor Sea’sMasela b lock. Inpex puts est imatedconstruction cost at around US$10 billion,significantly higher than Indonesia’s other newfacilities in Papua and Sulawesi. Indeed, adegree of controversy has followed this plant,too. News reports surfaced in August 2009, justprior to the final approval announcement, thatPT Tiara Energy, along with partners Flex LNGand Samsung, were offering to build the Abadifloating LNG plant for a cost of around US$4.5billion.

Inpex holds a 100% stake in the Abadi field,and had been assessing what kind ofprocessing plant to build after deciding not toprocess the gas in nearby Australia. BPMigas

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has pushed strongly for Inpex to build afloating LNG facility in Indonesia, arguing it isboth more efficient and economical, and thuscould be completed sooner. This is probablydue to the field’s remote location, around 200kilometers south of Saumlaki island in easternMaluku province. The faci l i ty wil l beIndonesia’s first such offshore plant and isexpected to come on stream in 2016. Suchfloating LNG facilities are seen as increasinglyattractive by energy firms looking to exploitremote gas fields, since processing the gas intoLNG is conducted offshore on large ships,instead of being piped to an onshore processingplant.

As with the exploitation of unconventional gas,Indonesia sees itself in a race with Australia todevelop floating LNG plants. Royal DutchShell’s Prelude gas field, some 475km north-northeast of Broome in Western Australia,could become the world’s first floating LNGfacility if it begins production on schedule in2016. If Inpex can start production from theAbadi field before Prelude comes online, itcould be a huge boost both for the firm and forthe Indonesian oil and gas industry as a whole.However, the Abadi project cannot afford manycontroversial delays since as many as sevenfloating LNG projects could be underdevelopment or in production in northernAustralia within the next decade. If the Abadidevelopment goes awry, as with the Senoroplant in Sulawesi, then Australian LNG willbecome increasingly attractive to Asian firms.Likewise, foreign firms looking to tap otherIndonesian gas deposits near the border withAustralia might view processing the gas at anAustralian floating LNG plant as a moreattractive option than doing so in Indonesia.This risk is potentially significant given theprofusion of smaller, so called ‘stranded’natural gas deposits which are thought to existin the Timor Sea between Indonesia, EastTimor and northern Australia.

The proposed Abadi floating LNG plant.

Inpex estimates the Abadi field contains morethan 10 TCF of gas reserves, which would makeit Indonesia’s second-biggest new gas fieldafter Tangguh in Papua province, which hascombined reserves of 14.4 TCF. The firmexpects annual production to reach around 4.5MT per annum under its approved plan ofdevelopment but Indonesia’s former Energyand Mineral Resources Minister PurnomoYusgiantoro has stated that the estimated fieldreserves may actually yield up to 9 MT of LNGper year. Inpex intends to export the bulk ofthe LNG to Japan, although it will have to sellat least 25% of it on the domestic market. Onthis key issue BPMigas remains coy, and inAugust 2010 agency spokesman Elan Biantorowould only say, “Some of the LNG will beexported and some for the domestic market”.[23] Given the struggles which Japanese firmsare experiencing over the Senoro andSengkang LNG exports, it is seems likely thatthe Abadi field also faces an uncertain future.The plant’s huge construction costs mean thatfinancial viability will only be guaranteed if thebulk of its LNG can be exported. However,unlike the centrally located Sulawesi LNGplants, Abadi’s remote location means itsoutput is more attractive for export.

Whilst Inpex remains the sole operator of theAbadi field at present, Indonesian state oil andgas concern Pertamina has been eyeing a 30%participating stake in the project. As Indonesialacks the expertise to tap its own natural gasreserves, it has become standard practice forPertamina to piggyback on foreign-developed

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projects in the archipelago as it seeks toincrease its gas reserves and production.Although Inpex is 30% owned by the Japanesegovernment, in February 2009 it emerged thatthe firm was facing a liquidity shortage due tothe global financial crisis, with Royal DutchShell also looking to buy into the Abadi project.It now appears that Inpex is instead raisingadditional investment capital by issuing newshares, although it might sell part of its 76%stake in the Ichthys LNG project near Darwinin Australia. Nonetheless, it is thought thatInpex’s lack of experience in developingfloating LNG technology will force it to partnerwith another foreign firm such as Shell with arecent track record of innovative LNGdevelopment. However, the Anglo Dutch firm isheavily committed to developing its ownfloating LNG technology in Australia, where noconcerns over export allocations exist.[24]

Inpex originally signed a 30-year agreement todevelop the Abadi field back in 1998 but madelittle progress on the scheme until Jakartaissued an ultimatum in January 2008, orderingthe firm to submit a firm development plan orlose its contract. It duly submitted one in June2008. Now that formal approval has beensecured, the Indonesian government is pushingfor plant construction to begin in 2011 as itcompetes with Australia to open the world’sfirst floating LNG processing facility.

The Masela block is around 350km northof Darwin, Australia in water depths of

400m to 700m.

Tangguh

Meanwhile, a long delayed project that hasfinally come to fruition is the Tangguh LNGplant in West Papua province, operated bymultinational BP. Soon after it startedproduction in May 2009 both of its processingunits, or trains, were shut down as then BPchief executive Tony Hayward revealed that thefirm had intentionally delayed operations dueto low global LNG prices. Aware that Jakartawould be unhappy about such delays, localmanagement distanced themselves fromHaywood’s remarks and blamed the shutdownson technical issues instead. The result is thatTangguh shipped only 16 LNG cargoes in 2009,well under its original target of 56, althoughthe plant is presently on target to deliver 116cargoes in 2010. Of these, 28 are set forChina’s Fujian province, 24 for South Korea, 55for Sempra Energy’s new receiving terminal inMexico and nine to Chubu Electric Power inJapan. BP Indonesia owns 37% of the projectwith its major partners being Japan’sMitsubishi, Nippon Oil and Sumitomo alongwith the China National Offshore OilCorporation (CNOOC), and the plant has aprocessing capacity of 7.6 MT per annum.

The Tangguh pro jec t has a l so beencontroversial as critics have attacked the lowprices secured by Chinese and Korean buyersas a case of gross underselling. Customerswere initially hard to find for the Tangguh LNGbut BP eventually signed a 25-year contract tosell 2.6 MT per year to fellow shareholderCNOOC in 2002, in addition to 20-yearpurchase agreements with Korean firmsPOSCO and K-Power to supply 1.15 MT perannum signed in 2004. Rising world commodityprices thereafter prompted some Indonesianlawmakers to argue that these contracts evenundercut domestic gas prices. Whilst theoriginal contracts with CNOOC, POSCO and K-Power were subsequently revised upwards,

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with a closer tie to world crude prices, volatileglobal energy prices and a glut of LNG on themarket in the Asia-Pacific made these pricingnegotiations drawn out and complicated. Whenoil prices were inching towards US$140 abarrel, Jakarta even threatened to renege onthese sales agreements unless the buyersagreed to pay more, although this could beviewed as verbal sparring prior to the 2009legislative and presidential elections.Nevertheless, the spike in oil prices before theglobal financial crisis prompted someIndonesian politicians to suggest the countryshould receive greater economic benefits fromits oil and gas exports.

In November 2009 it emerged that ChubuElectric was in advanced negotiations to secure18 cargoes of the Tangguh LNG, equal to 0.5MT a year for three years. Whilst no pricingspecifics were revealed, BPMigas chairmanPriyono claimed the buyer proposed quite ahigh price. Given the controversy over theoriginal supply contracts, these commentssuggest that Chubu will be paying substantiallymore per cargo than CNOOC, POSCO and K-Power, who finally agreed to pay aroundUS$3.8 per MBTU. The Chubu gas will bediverted from a flexible contract to supply 3.7MT of LNG annually to American firm SempraEnergy, who have the right to divert half of thisvolume elsewhere. BPMigas also announced inJune 2010 that Tangguh will supply 0.5 to 0.7MT of LNG per annum to the new receivingterminal near Jakarta, due for completion in2012. The regulator was quick to stress that, aswith the Chubu contract, this LNG will be partof Sempra’s diversion volume and will notaffect exports.[25]

Despite the plant’s remote location, the centralgovernment has earmarked some of Tangguh’sfuture production for the domestic market. Thefacility presently has two LNG processingtrains in operation, with a third train underconsideration. Jakarta is adamant that outputfrom this proposed third train will serve the

domestic market. KOGAS has been interestedin developing this third train, but has beendeterred by Jakarta’s reluctance to provideexport guarantees. As with Senoro Donggi,such a stance affects the viability of new LNGdevelopments in Indonesia.

Bontang

Whilst several new LNG projects are in variousphases of development, Bontang remains thejewel in the crown of Indonesia’s oil and gasindustry. The facility currently has eight trainswith a total processing capacity of around 22.5MT per annum. Bontang, 15% owned by theJapan Indonesia LNG Co (JILCO), has been oneof the world’s most prolific LNG facilities sinceit opened in 1977 under supply contracts withJapanese utilities.[26] Indeed, Bontang LNGhas enabled East Kalimantan to post thehighest Gross Regional Domestic Product(GRDP) figures of any Indonesian province.[27]Even as gas reserves around Indonesia’s otherLNG plant in Aceh province dwindled,upgrades to Bontang allowed the country toconsolidate its position as the world’s largestLNG exporter until Qatar displaced it in 2006.The plant’s output did subsequently increase to24.59 MT per annum in 2004, but fell off soonafter when its gas fields suffered productionproblems. As a result, Jakarta requested thatJapanese buyers cancel 41 LNG cargoes set fordelivery in 2005 and clearly signalled thatIndonesia’s world leading LNG industry was in

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trouble. This was repeated in 2007 when thegovernment failed to deliver some 72 cargoesto foreign buyers, mainly those in Japan. [28]Such difficulties fulfilling contracted exportrequirements presented Jakarta with furthermotivation to reduce Bontang’s LNG exports toJapan.

Bontang is presently the source of around 90%of Japan’s LNG imports from Indonesia Underlong-term contracts with Japan’s KansaiElectric Power, Chubu Electric, KyushuElectric, Osaka Gas, Toho Gas and NipponSteel, the plant has been exporting around 12MT annually to the island nation. Up to early2010, approximately 230 MT of LNG has beenexported from Bontang to Japan, South Koreaand Taiwan, most of it to Japan. However, LNGexports to Japan from this plant in EastKalimantan province will end in 2020.Whilst itstill has the ability to supply Japan with around10-12 MT a year, export volumes to Japan arebeing dramatically reduced in order to serviceIndonesia’s domestic market. Contracts tosupply Japan with 8.4 MT per annum expire atthe end of 2010 and similar deals to sell afurther 3.6 MT conclude in 2011. Even thoughsuch contracts typically run for 15 to 25 yearperiods, they will be renewed for only 10 years,with 3 MT annually until 2015 and thereafter 2MT per annum until 2020. Highlighting thepoor management of the industry, however, inMay 2010 Indonesian Energy and MineralResources Minister Darwin Zahedy Salehsuggested that these smaller export contractscould be further revised downwards in order tosupply the domestic market. Ironically, it hassince emerged that Indonesia will have aconsiderable oversupply of LNG in 2011 as aresult of restricting exports from Bontang,largely due to delays in establishing the WestJava FSRU. For investors and customersseeking continuity and stability in Indonesia’soil and gas industry such uncertainty is a majorconcern, especially since developing LNGprocessing facilities is a very lengthy and costlyprocess.

Whilst the LNG market is generally more stablethan crude, since around 85% of global supplyis sold under multiyear contracts, and it wasreported in March 2009 that buyers in Japan,South Korea and Taiwan might divert up to 12cargoes of contracted Indonesian LNG to othermarkets in Asia or Europe. However, by August2010 the effects of the global downtown haddissipated to the extent that both South Koreaand China almost doubled their LNG importscompared to the previous August, whilst Japantoo reported increased import volumes. In theshort-term, this rebound in the regional LNGtrade will benefit Indonesia. The floatingreceiving terminal to be constructed nearJakarta will receive 1.5 MT a year fromBontang once it becomes operational in 2012but BPMigas estimates that Indonesia will have68 excess cargoes of LNG in 2011, mostly fromBontang. The terminal had been due tocommence operations in 2011 but has beendelayed to at least December 2011, hence theglut of 68 cargoes. The regulator has statedthat approximately 20 of them will be sold onthe spot market, depending on domesticdemand. At prevailing prices, each cargo isworth around US$30-65 million on this short-term market. BPMigas has also been marketingthis excess in Japan, China, Taiwan, SouthKorea and Thailand. Osaka Gas, Kansai Electricand South Korea’s KOGAS are apparentlyamong the interested parties as their long-termcontracted supplies from Bontang are reduced.This extra gas has also been offered toSingapore’s new US$1 billion LNG receivingterminal, due to open in early 2013 with aninitial capacity of 3.5 MT per annum. Any suchdeal would augment Indonesia’s existing long-term supply deal with the city state. Furtherhighlighting the lack of clarity and coordinationthat characterises Indonesian gas export policyhowever, this decision followed statements theprevious month that Indonesia was looking toreduce gas export volumes to Singapore inorder to better supply its domestic market. [29]

As a result of Indonesia’s plans to reduce

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exports, Japan is anxious to diversify its LNGsupply base. In September 2010 NakanishiKohei, managing director of state-backed JBIC,said that from 2011 the country is consideringincreasing its LNG imports from Russia’sSakhalin-2 project, which began exporting in2009. Russia presently supplies 4.3% of Japan’soverall LNG imports, compared to Indonesia’s20% share. Over half of LNG output fromSakhalin-2 will be sold to Japanese buyersunder long-term contracts. Nakanishielaborated that Sakhalin is the most naturaland convenient oil and gas source for Japangiven that, “The distance between Sakhalin andJapan is one-sixth of the distance betweenJapan and the Middle East and nearly half thedistance to Indonesia. This means we can offerour clients a better price due to lowertransportation costs.” [30]

Since Japan is the world’s biggest buyer,accounting for around 30% of global LNGdemand, such moves indicate that a majorrealignment is underway in the sector.Indonesia’s decision to restrict exports comesat a time when more LNG projects are set tocome online worldwide, especially in itssouthern neighbour Australia. Indonesia hasbeen the biggest supplier of LNG to Japan sincethe late 1970s, but has recently been overtakenby both Malaysia and Australia, who exported6.88 MT and 6.33 MT of LNG respectively toJapan in the first six months of 2010, comparedto Indonesia’s 6.30 MT. [31] Australia has a raftof LNG projects under development, fromwhich Japan, South Korea, China and Indiahave all made commitments to buy uponcompletion. Given that Indonesia, Malaysia andBrunei have less scope to boost export output,these new projects in Australia will likely meanthat the southern giant will increasinglydominate the Asian LNG trade. In 2011,Woodside Petroleum’s new Pluto processingplant in Western Australia is scheduled tocommence exports of 2 MT per annum toKansai Electric Power and 1.75 MT annually toTokyo Electric Power. The Gorgon and

Wheatstone projects, both led by Chevron, willfollow thereafter, with deliveries to Japanpossibly starting in 2014. Australia’s LNGexports to Japan are projected to reach 29 MTper annum by 2017, more than double presentvolumes.

Indonesia presently has three LNG plantsin operation.[32]

Unconventional gas

The issue of natural gas is central togovernment development planning. During theSuharto era (1966-1998) oil and gas exportrevenues were used to finance agricultural andindustrial development, particularly greaterrice production. With little surplus from oilnowadays, LNG export earnings assumegreater importance for government budgets.Whilst Indonesia has a dilemma over how tobalance its domestic energy requirements withearning export revenues, a quiet revolution inenergy development could assist governmentplanners. In recent years American energyfirms have been pioneering the exploitation of

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coalbed methane (CBM) and shale gas, andunconventional gas techniques and technologyare now appearing outside of North America. Itis thought that unconventional gas depositsmight exist throughout the Asia-Pacific, andseveral schemes have already been proposed inAustralia and Indonesia.[33] Indeed, Indonesiahas been aggress ive ly scour ing forunconventional gas reserves like CBM andshale gas in order to boost its fragile energysecurity.

The archipelago is thought to possesssignificant CBM reserves of approximately453.3 TCF across some 11 different locations.It is estimated that up to 112.47 TCF might beclassified as proven reserves with some 57.60TCF viewed as potential reserves. For CBMexploration and production, the potentially highyield basins are in South Sumatra (183 TCF);Barito in southeastern Kalimantan (101.6 TCF);Kutai in East Kalimantan near the BontangLNG plant (89.4 TCF); and central Sumatra(52.5 TCF). Others are located in NorthTarakan in northeast Kalimantan near adisputed boundary with Malaysia (17.5 TCF);Berau also in East Kalimantan (8.4 TCF);Bengkulu in Sumatra (3.6 TCF); Pasir Asam-Asam also in southeastern Kalimantan (3.0TCF); southwestern Sulawesi (2 TCF);Jatibarang in northwestern Java (0.8 TCF); andOmbilin in West Sumatra (0.5 TCF). However,extracting gas from unconventional sourcesnecessitates taking environmental risks sincethe rocks containing the gas must be mademore permeable. Whilst most of Indonesia’sknown deposits are not located in heavilypopulated areas, unconventional gas has thepotential to wreak tragic environmentalconsequences nearby. As the Lapindo mudflowdisaster in Java has demonstrated, Indonesiahas a poor recent record in this area, especiallywhen well-connected domestic capital isinvolved, and environmentalists will beconcerned by plans to tap unconventional gasin the archipelago.

Source: Hari Karyuliarto, Head of LNGBusiness of Pertamina, December 8, 2009,

presentation at International PetroleumTechnology Conference, Doha, Qatar

In its bid to pioneer the Asian CBM sector, as itdid the LNG industry, the Indonesian centralgovernment has so far awarded some 20 CBMcontracts, and Jakarta hopes some of theseblocks will begin production as early as 2011. Ithas also set a target of producing LNG fromCBM before 2014 which, if successful, wouldmake it the first country to produce LNG frommethane. The Energy and Mineral ResourcesMinistry is confident that the requiredinfrastructure will be in place by then since itmaintains that CBM can be processed into LNGat the existing Bontang LNG plant. EvitaLegowo, the Ministry’s director general for oiland gas, has been quoted on the Ministry’sofficial website as saying, “Australia is aimingto produce LNG from CBM by 2014. If we wantto be the pioneer, we must beat them to thepunch.” [34] The Ministry states that CBM LNGwill be used to supply the Indonesian domesticmarket but that electricity production fromCBM will take priority over LNG processing.Any excess CBM production will thereafter beconverted into LNG although it is unclearwhether any of this excess will be exported.

CBM production is still a cutting edge field ofexploration and development. As withconventional gas, foreign oil and gas firms willhave to spearhead any innovative gas projects

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within the archipelago. It remains unclear as towhether the requirement to prioritise thedomestic market will also be enforced inunconventional gas, however. Compromises onexport allocations will have to be made ifforeign developers are to help Indonesia boostits gas output. Among the other potentialplayers, China is also aggressively searchingfor homegrown unconventional gas sources asits LNG imports rise sharply. Faced withsoaring demand and pressure for a cleanerenergy makeup, the Chinese government isaiming to increase the share of natural gas inthe country’s primary energy supply from 4% atpresent to 10% by 2020. Indeed, Beijingofficials recently estimated that China mightquadruple its imports of LNG by the end of2015. As a result, Beijing has been signingdeals with Western petroleum majors to tapunconventional gas resources and industryanalysts Wood Mackenzie predict that this newavenue could supply over 25% of China’soverall gas demand by 2030. [35]

Analysts are still unsure as to what effectunconventional gas will have on the global LNGmarket. However, it seems likely that countrieswith large domestic sources of unconventionalgas, such as the United States, will acquire lessLNG from abroad, thus influencing global LNGprices. It is also thought that Chinese domesticcoal-seam and shale-gas production, in tandemwith a proposed pipeline from Russia, couldreduce Chinese LNG demand and threaten thefeasibility of new LNG developments in theAsia-Pacific. Some industry analysts, such asFranks Harris of Wood Mackenzie, seeunconventional LNG reaching only 5% of totalglobal LNG supply by 2020. More generally,Harris also sees unconventional gas accountingfor some 15% of total global gas supply by2020. [36]

Investment climate

To fully realise Indonesia’s ambitious LNGdevelopment plans requires large-scale foreign

investment since domestic energy firms do nothave the capacity to lead such technicallydemanding projects. This section will considersome of the issues which concern foreignenergy investors, many of which also affectboth foreign and domestic investment generallyand the wider economy as a whole.

In the decade before the Asian Financial Crisisof 1997-98, Indonesia benefitted from largeforeign investment inflows which fuelled GDPgrowth approaching 10% per annum. Much ofthis came from Japanese firms fleeing the riseof the yen by moving lower tier manufacturingoperations to Indonesia, with its lower labourand other production costs. The archipelagohas struggled to attract similar levels of foreigninvestment since 1997, however. Politicalinstability was an issue in the early post-Suharto years but the archipelago hasremained largely stable since 2001. Eventhough Yudhoyono has twice won thepresidency on promises of clean governmentand policy reform, little progress has beenmade on issues that affect foreign investmentand debate still rages in Indonesia over theefficacy of neo-liberal economic orthodoxy.[37]

The difficulties frequently cited by foreigninvestors in Indonesia include: opaque

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bureaucracy, vague legislation, a weak legalsystem and widespread corruption; all of whichfeed high levels of policy uncertainty.Indonesia’s creaking industrial infrastructure isa further deterrent for manufacturinginvestment. However, all of these factors alsoexisted to a greater or lesser degree during theSuharto era but did not seemingly deter foreigninvestment. In particular, Indonesia suffersfrom insufficient investment in its energysector to satisfy burgeoning domestic demandand attract investors into value addedindustries. To some extent, Indonesia is caughtin a vicious circle whereby it requiressubstantial foreign investment to upgrade itsindustrial infrastructure but foreign investmentdemands better industrial infrastructure beforecommitting to Indonesia.

Whilst Jakarta has made some moves since1998 towards reforming its energy sector,recent research suggests that some of thesereforms have actually heightened the sense ofrisk for foreign investors in this sector. Forinstance, upstream oil and gas regulatorBPMigas is seen by foreign oil and gasinvestors as woefully understaffed with only367 staff overseeing an industry whichattracted US$10.9 billion of investment in2009.[38] As a result, “the way BPMigaschooses to discharge its duty to supervise andcontrol the operation of production-sharingcontractors has the effect of severely delayingand impairing the development of Indonesia’shydrocarbon resources”.[39] Thus, whilst thecountry’s resources remain attractive to foreignextraction firms, as demonstrated by thenumber of new production-sharing contracts(PSCs) sealed each year, the amount of actualrealised development is seriously hampered byinsufficient inducements. This is exacerbatedby the dramatic price volatility of petroleum inrecent years, which makes future returns moredifficult to gauge and decisions where to placelimited investment capital more challenging.

Compounding these failures is a perceived lack

of understanding of the industry among policymakers, members of parliament and theirsupport staff. The same research indicates thatamong this cohort the prevailing attitude isthat i t i s bet ter to wai t and conductnegotiations with extraction firms from aposition of strength rather than ‘undersell’Indonesian resources. Given the marketvolatility of the past decade, judging the besttime for such negotiations is more of an artthan a science, however. Moreover, the longgestation periods for LNG schemes also workagainst such thinking, as demonstrated by thefurore surrounding the Tangguh LNG salescontracts with China and South Korea. Relatedto this view is the feeling that Indonesia todayis in much better shape than in 1967 whenSuharto first opened up the country to foreignresource investment in a desperate bid toimprove the country’s parlous fiscal position.Consequently, policy makers are not as anxiousto attract foreign oil and gas majors as inprevious decades.[40]

A glimpse behind the curtain of such thinkingwas seen in April 2010 when legislators wereconsidering amending the Oil and Gas Law togive Pertamina first option to take over any oilor gas fields whose PSCs were coming to anend.[41] Some Indonesian policy makers wantto redress foreign dominance of the country’soil and gas sector, and such a move wouldundoubtedly strengthen Pertamina’s positionrelative to foreign firms. However, the reality isthat Indonesia has a surfeit of capital,technology and expertise when compared tothese foreign operators and risks damaging thisvital sector by alienating foreign investors.From the perspective of foreign oil and gasfirms, Indonesia’s management of this industryis wracked by complacency, inconsistency andeven incompetence, fuelled by the long yearswhen Indonesia dominated Asia’s oil and gassector.

Another common criticism from foreigninvestors in the sector is the lack of clarity in

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Indonesian oil and gas legislation. Thisambiguity is seen to be deliberately fostered toallow officials scope to take advantage ofloopholes for personal gain.[42] Furthermore,those in the industry charge that even well-drafted laws can be bypassed by presidentialand ministerial decrees, in essence changingthe terms and conditions of contracts aftertheir signing. More seriously, foreigndevelopers complain that there is inadequaterecognition in Indonesia that the process offinding and extracting fossil fuels is becomingprogressively more difficult and costly due tothe fact that the most easily accessible reserveshave already been depleted. At the same time,these firms also perceive a deterioratingoperating environment, in terms of regulationsand the profitability of PSCs.[43] With theIndonesian crude oil industry in seeminglyirreversible decline and a stream of new LNGprojects under development among itsneighbours, foreign oil and gas firms arehoping that Indonesian policy makers will takethese factors into greater account when tryingto boost domestic energy security.

Many of these concerns are replicated acrossthe economy and are reflected in the WorldBank’s Doing Business 2010 report, whichplaced Indonesia 122nd out of 183 economiessurveyed for overa l l ‘ ease o f do ingbusiness’.[44] Whilst Indonesia ranked areasonable 41st at ‘protecting investors’, itmanaged only 146th at ‘enforcing contracts’.Oil and gas developments are invariably large-scale and long-term investments whose viabilityis under the greatest threat from an inadequatelegal system which does not provide a reliableand impartial system of dispute resolution.Indeed, several oil and gas majors directlyattribute the decline in Indonesia’s oilproduction to insufficient legal protection oftheir investments. More generally, suchuncertainty makes large-scale and long-terminvestments less attractive relative to short-term investments designed for quick returns.Such large-scale and long-term investments are

essential for Indonesia’s energy security; thuslegal uncertainty deters new development andnegatively impacts the economy as a whole.Another familiar complaint among foreigncompanies in Indonesia is the difficultyinvolved in establishing new ventures,especially when compared to neighbours suchas Singapore, Malaysia and Thailand. TheWorld Bank ranked Indonesia only 161st in thiscategory in its Doing Business 2010 report.[45]Many foreign startups in Indonesia seethemselves as instant targets for officialharassment from immigration, police andlabour officials. Indeed, foreign firms operatingin the archipelago have long voiced concernsthat whilst their compliance with every singlerule is regularly tested, local companies are notsubject to the same strictures.

Counter-intuitively, even anti-corruption drivesare perceived to have damaged the investmentclimate in Indonesia with the bureaucracybecoming much more circumspect insupporting new initiatives. In reformasi-eraIndonesia, civil servants risk being accused ofcorruption if their decisions eventually becomemore expensive than projected, even if theywere made with the best of intentions. Alongwith many other laws in Indonesia, thedefinition of corruption remains vague andopen to a wide variety of interpretations. As aresult, decision making takes place much moreslowly than in the Suharto period, and thislethargy affects many sectors of the economy,not just the oil and gas industry.[46]

Another cornerstone of political reform inIndonesia has been devolution. During the lastdecade, Jakarta has reversed Suharto’s policyof concentrating political power in the capitalby pursuing a radical decentralisation policywhich has granted much greater powers toover 400 local district governments. Under Law25 of 1999, 15.5% of oil and 30.5% of gasrevenues are now meant to remain within theirprovince of origin. This legislation was enactedduring a period of violent conflict in various

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provinces which prompted many to fear thebreakup of Indonesia itself. In particular,separatist demands were heard in the resourcerich provinces of Aceh, Papua and Riau,although in Riau these demands were notparticularly vociferous and were not considereda genuine threat to the central government.Giving local governments a better deal wasseen as a way to keep them within the Republicand not join East Timor in seceding. However,whilst it may have served to forestall thedisintegration of Indonesia, these changes haveresulted in a more complex environment forforeign operations within the archipelago.Unlike in the Suharto years, when all majordecisions were made in Jakarta, foreign firmsnow also have to deal with local governments,which often have different priorities to thecentre. Moreover, additional layers ofgovernment o f t en mean i nc reasedopportunities for rent seeking by a largercohort of stakeholders, and each new piece ofnew legislation provides further avenues forsuch behaviour.[47] Compounding matters,these newly empowered local officials usuallyhave less experience in dealing with naturalresource issues than their colleagues in thecentra l government . The resu l t i s aproliferation of government decision makers,further policy uncertainty and, in some cases,additional taxes and fees not specified in theoriginal PSCs.[48]

It seems that a battle is now playing outbetween those in government who are trying toimprove Indonesia’s investment climate andothers who seek to profit from their position asgatekeepers. For instance, Evita Legowo, theEnergy Ministry’s director general of oil andgas, has publicly expressed her concern overlocal government corruption in approvingenergy and mining projects. Meanwhile, GitaWirjawan, Chairman of Indonesia’s InvestmentCoordinating Board, has detailed his agency’sincreasingly interventionist attempts topromote investment by pressuring theIndonesian bureaucracy to speed up the

approvals process.[49] Throughout much ofIndonesia, the civil service offers unrivalledemployment opportunities so that potentialinvestors increasingly have to run the gauntletof stakeholders eager to ride the bureaucraticgravy train.[50] Indeed, the United NationsDevelopment Programme (UNDP) estimatesthat 48 new local government units inIndonesia are using some 70% of their budgetjust to pay civil servants’ salaries.[51]

Conclusion

The issue of natural gas is central togovernment development planning. Restrictinggas exports is part of a comprehensiverefashioning of energy policy, triggered by anexus of declining oil production, increasingdomestic energy demand and unsustainablereliance on costly oil imports. The expiry oflong-term sales contracts with Japaneseutilities will enable Indonesia to beginreplacing costly oil with gas-fired powergeneration. However, Indonesia faces adilemma. Longer-term domestic energysecurity dictates that the country reversedeclining gas production from its ageing fieldsby promoting the exploration and developmentof new gas finds. Since this task will fall toforeign extraction firms, compromises onexport allocations will have to be made asserving the Indonesian domestic market is notsufficiently lucrative. This logic dictates thatJakarta should allow gas in more remotelocations such as Papua and Maluku to bemostly exported to Northeast Asia, whilstretaining output more centrally produced inKalimantan and Sulawesi for the domesticmarket.

In order to attract foreign investment,Indonesia also has to improve its investmentclimate. Equitable cost-recovery rules and theregulatory environment are a source of concernfor many foreign oil and gas firms, whilstIndonesia’s creaking industrial infrastructurehampers its manufacturing sector. As

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investment in infrastructure has lagged, so hasinvestment throughout the economy. Thus,Indonesia is caught in a vicious circle wherebyit requires substantial foreign investment toupgrade its industrial infrastructure but foreigninvestment demands better industrialinfrastructure before committing to Indonesia.The answer is to deal with bureaucracy,corruption, legal issues and policy uncertaintyfirst. Thus, President Yudhoyono needs to showgreater commitment to tackle these issues, forthe good of the Indonesian economy as a whole.

The country’s gas exports act as a shop windowto attract investment across all industries. Inparticular, the country sees i tself incompetition with neighbour Australia toinnovate both floating LNG plants andunconventional gas. If successful, this couldgive the whole oil and gas industry in Indonesiaa significant boost. However, high levels ofpolicy and legal uncertainty continue tofrustrate investors and hampers consolidationof this sector. Much improved energy sectorgovernance is needed to encourage large newinves tments , espec ia l l y s ince LNGdevelopments in Indonesia could be competingwith more than 12 proposed LNG projects inAustralia and Papua New Guinea. In Australiaalone some 140 MT per annum of new LNGcapacity could become available in the comingdecade. Qatar, now the world’s biggestexporter, is also looking to increase its LNGexports. Therefore, a greater awareness of theexternal environment might be needed ifIndonesia is to improve its domestic energysecurity and boost export revenue from its gasfields. For Japan, Indonesian LNG remainsattractive because of its geographic proximitybut new developments in Australia and PapuaNew Guinea also threaten this perception.

One of the key motivations for Tokyo signingthe JIEPA was to secure access to Indonesianmineral resources, particularly gas. Whilstsignificant Japanese investment in new LNGprojects has since followed, their viability has

been threatened by political interference whichillustrates the difficulties of doing business inIndonesia. Given the controversy surroundingboth the Senoro and Sengkang LNG schemes, itseems likely that the Abadi development alsofaces an uncertain future. The plant’s hugeconstruction costs mean that its financialviability will only be guaranteed if the bulk ofits LNG can be exported. Unlike the centrallylocated Senoro and Sengkang LNG projectsthough, Abadi’s remote location means itsoutput should be more attractive for export.However, if the Abadi scheme goes awry, thenAustralian LNG will become increasinglyattractive to Asian investors. Likewise, foreignfirms looking to tap other Indonesian gasdeposits in the Timor Sea might viewprocessing the gas at an Australian floatingLNG plant as a more attractive option thandoing so in Indonesia. In order to be preventthis scenario, Jakarta has to clean up theapprovals process, improve the generalinvestment climate and show greater flexibilityregarding its gas export policy. Complicatingmatters, Japan is Indonesia’s biggest bilaterallender and Jakarta is aware that any suchexport deals transcend mere businessconsiderations.

David Adam Stott is an associate professor atthe University of Kitakyushu, Japan and anAsia-Pacific Journal associate. His work centerson the political economy of conflict inSoutheast Asia, Japan’s relations with theregion, and natural resource issues in the Asia-Pacific. From April 2010 he is on research leaveat the University of Adelaide. He wrote thisarticle for The Asia-Pacific Journal.

Recommended citation: David Adam Stott,"Snakes and Ladders for Japan in Indonesia’sEnergy Puzzle," The Asia-Pacific Journal,47-1-10, November 22, 2010.

Notes

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[1] International Energy Agency (IEA) (2008),Energy Policy Review of Indonesia, OECDPublishing.

[2] Japanese loans to Indonesia have beenchannelled directly through Japanese donoragencies, and indirectly through the AsianDevelopment Bank and the InternationalMonetary Fund.

[3] John Riady, ‘Cutting Off Indonesia’s ComingEnergy Crisis’, Jakarta Globe, July 21, 2010.

[4] Novia D. Rulistia, ‘Japanese firms lodgeprotest over blackouts’, Jakarta Post, July 9,2008.

[5] Arghea Desafti Hapsari, ‘Census mayindicate population boom,’ Jakarta Post, August19, 2010.

[6] Such figures remind Indonesians that one ofSuharto’s major achievements was reducingpopulation growth from an annual average of2.31% to 1.49% during his 33 years in power.

[7] IEA (2008).

[8] Ministry of Energy and Mineral Resources,D a t a W a r e h o u s e(http://dtwh2.esdm.go.id/dw2007/ ).

[9] Hanan Nugroho, ‘Energy and economicgrowth’, Jakarta Post, July 15, 2010.

[10] Ibid.

[11] Luiz de Mello (2008), ‘Indonesia: GrowthPerformance and Policy Challenges’, OECDEconomics Department Working Papers No.637.

[12] Jorn Brommelhorster, ‘Asian DevelopmentOutlook 2008 Update’, Asia Development Bank,2008.

[13] Those living in more remote regions ofIndonesia do not enjoy the same benefits of thefuel subsidy as those living in the core islands

of Java and Bali. As the subsidy is dispensed atfuel depots to the distributors, who then addthe cost of transportation to the outer islands,residents of more remote areas inevitably paymuch higher prices than those living in thecentre. The reluctance of the centralgovernment to adjust the subsidies to reflectthis reality is due to the fact that export-oriented manufacturing and related higher-value services are largely concentrated on Javaand Bali, along with around 60% of thepopulation.

[14] Reva Sasistiya & Yessar Rossendar,‘Indonesia to End Energy Subsidies by 2014’,Jakarta Globe, March 22, 2010.

[15] Only business customers and residentialcustomers who had a power subscribingcapacity of more than 900 volt amperes wouldbe subject to the planned hikes between 2011and 2014. According to PLN data, only 5.1% ofits customers fit into this category. CameliaPasandaran, Faisal Maliki Baskoro, ArtiEkawat i & Dion Bisara , ‘ IndonesianGovernment Puts Cap On Electricity RateHike’, Jakarta Globe, July 20, 2010.

[16] Riady (2010).

[17] Indonesia placed 111th in the 2009 HumanDevelopment Index (HDI), compiled annuallyby the Uni ted Nat ions DevelopmentProgramme (UNDP) which combines health,income and education statistics to rank 182countries for whom sufficient data is available.Neighbours Malaysia, Thailand and thePhilippines were listed 66, 87 and 105respectively.

[18] Tables taken from US Embassy Jakarta(2008), Petroleum Report Indonesia 2008.

[19] UPI, ‘Setback for Japan in LNG project’,July 14, 2009.

[20] IEA (2008), p. 118–19.

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[21] KOGAS has also been negotiating to buy a15% stake in the Gladstone LNG project inQueensland, Australia being developed bySantos with estimated annual LNG output 7.2million MT. South Korean LNG consumption,used mainly for heating and power generation,is set to increase to 15.1% of all energyrequirements in 2012, up from 10.1% in 2000and 13% in 2009.

[22] Eric Watkins, ‘Indonesia rejectsdevelopment plan for LNG project’, OGJ,February 2, 2010.

[23] XE, ‘Indonesia: Inpex to Start Abadi FLNGConstruction in 2011’, August 19, 2010.

[24] Petroleum Economist, ‘Rising Indonesiangas demand threatens LNG export projects’,August 2009.

[25] Muklas Ali, ‘Tangguh LNG plant ready tosupply receiving terminal’, Reuters, June 11,2010.

[26] JILCO is a consortium consisting mainly ofJapanese utilities. Shareholders include KansaiElectric 19.3%, Chubu Electric 13.75%, KyushuElectric 12%, Osaka Gas 10.38%, Toho Gas 2%,TEPCO 2%; trading houses Nissho Iwai 10%, acoordinating committee of Mitsui, Mitsubishi,Itochu, Tomen and Marubeni a combined 9.6%;Nippon Steel holds 4.28% and Far East OilTrading, a Pertamina affiliate, 6.66%. Theremaining 7.49% is shared among a group ofJapanese banks.

[28] In addition to inconsistent gas output, alack of investment incentives has alsohampered Bontang in the last half decade. Forinstance, its LNG export contracts contain nopenalties if suppliers fail to meet contractedsales obligations. Moreover, ongoinginvestment in the aging facility has also beenslowed by questions regarding who isresponsible for plant maintenance, anduncertainty over Pertamina’s charging regime.[29] Reuters, ‘Indonesia to offer LNG to

Singapore’s terminal’, July 9, 2010.

[30] RIA Novosti, ‘Japan May Increase LNGPurchases from Russia in 2011’, September 30,2010.

[31] Nikkei, ‘Australia May Become Japan’sNo.1 LNG Supplier’, August 19, 2010.

[32] Table 1 and Figure 1 taken from PetroleumEconomist, ‘Rising Indonesian gas demandthreatens LNG export projects’, August 2009.

[33] Jakarta Post, ‘Indonesia set to be the firstCBM-LNG producer’, June 6, 2010.

[34] Ibid. Australia’s Curtis LNG project insouthern Queensland, expected to come onlinein 2014, is aiming to be the world’s first toproduce LNG feedstock from coal-seam gas.

[35] Wood Mackenzie, ‘Race for Supply - TheFuture of China’s Gas Market’, August 2010.

[36] Wood Mackenzie, ‘Wood Mackenzie saysUnconventional LNG will play a limited role inthe future of the LNG industry’, press release,April 20, 2010.

[37] Since Yudhoyono now has a much strongerhand in parliament than during his first term,in theory reform should be easier to pushthrough. Moreover, Jusuf Kalla, a staunchdefender of domestic big business, has beenreplaced as vice president by technocratBoediono, who largely subscribes to the IMF’sprescription of neo-liberal economic orthodoxy.

[38] Michael Boyd, Anne Devero, Jennifer Frias,Jeff Meyer and Greg Ross, ‘A Note on Policiesfor the Oil and Gas Sector’, Bulletin ofIndonesian Economic Studies, Vol. 46, No. 2,2010, p.246.

[39] Ibid.

[40] Ibid, p.241.

[41] Muklis Ali, ‘Indonesia’s Pertamina eyes

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expired oil blocks’, Reuters, April 1, 2010)

[42] Boyd et al (2010), p.242-243.

[43] Ibid, p.243-244.

[ 4 4 ] W o r l d B a n k 2 0 0 9(http://www.doingbusiness.org/rankings).

[45] Ibid.

[46] Boyd et al (2010), p.241.

[47] See Transparency International’s annualC o r r u p t i o n P e r c e p t i o n s I n d e x

(http://www.transparency.org).

[48] Boyd et al (2010), p.242.

[49] Terry Lacey, ‘The Threat to IndonesianEnergy Development’, Asia Sentinel, February27, 2010.

[50] Former Minister of Energy and MiningPurnomo Yusgiantoro has stated that nowadayssome 40% of economic decisions are taken byregional governments.

[51] Lacey (2010).