Developing RI gas market

Developing RI gas market

James Castle and Todd Callahan, CastleGroup, Jakarta

Aggressive new players from Asia, Australia and the Middle
East are successfully challenging Indonesia's decades-long
domination of Asia's LNG market. In a sign of the times, a
Japanese power utility recently announced that it would curtail
purchases from Indonesia by 2.3 million tons per year, another
utility from Taiwan recently chose Qatar over Indonesia for a
US$8.6 billion LNG contract and the country has lost important
bids in China.

Although such setbacks are extremely disappointing, they may
be a blessing in disguise. Waning LNG exports may finally
encourage Indonesia to rethink its domestic energy strategy. The
wave of observers now calling on the government to pay greater
attention to developing the country's domestic gas market and
reduce its dependence on regional LNG buyers are right.

Indeed, energy analysts have been saying this for years. In a
nation with burgeoning energy needs, more of the nearly 3
trillion cubic feet of gas produced each day in Indonesia should
be utilized at home. It is cheaper and cleaner than alternative
sources. More LNG and piped gas ought to be sold in Java and
other areas of the country that face mounting energy shortages.

Still, despite extensive reserves, Indonesia's domestic gas
sector remains remarkably underdeveloped compared to its
neighbors. This is due to the fact that gas has traditionally
been developed for the lucrative export trade while the domestic
market, where investment in pipelines and other enabling
infrastructure is minimal, has been largely ignored.

And, although subsidies are coming down, Indonesia's energy
economy continues to be over-reliant on expensive fuel oil
products. A switch to gas would produce enormous savings for the
country. In some cases, diesel is actually cheaper for PLN than
gas because the Ministry of Finance pays the difference and it
does not affect PLN's cash flow. This is a real blow both to
energy efficiency and the countrys finances. It is a pernicious
distortion that must be eliminated.

In a concrete example of how much can be saved, consider power
generation. The country is hemorrhaging money by burning diesel
and mfo at its plants across Java. At current prices, diesel
costs approximately US$4.50 per unit while gas costs $2.50 to
$3.00 per unit. Switching to gas would save the country up to
$300 million annually.

Given the growing appetite for electricity, the shift would
yield even higher savings in subsequent years. For this reason,
PLN needs more public support to sign gas supply agreements from
Ujung Pangkah, Oyong, ONWJ, Kepodang and Corridor (see box).
Beyond PLN, demand for gas from other customers like Perusahaan
Gas Negara (PGN), the state fertilizer producers and other large
users is also expanding. Hence it is imperative to bring more gas
fields on line to keep pace with demand.

Despite the clear economic case for gas, several financial
obstacles are preventing policy changes that will drive greater
gas consumption. One perceived impediment is price. Although
Indonesia's most expensive gas is still much cheaper than diesel,
buyers tend to view gas as a commodity in which the price should
be the same in all cases.

In the Indonesian context, where the sector is still
undeveloped, this view is incorrect because gas is not a freely
traded commodity. Both buyer and seller need to make long term
commitments to justify the investment needed to realize the
benefits of gas utilization. Prices differ because every gas
field is unique and has different development costs.

In negotiations, the buyer's reference point should not be the
cheapest gas in Indonesia. It should be the cost of alternative
fuels and what constitutes an acceptable price for both buyer and
seller for the specific development in question.

A second obstacle to completing more gas agreements is the
various guarantees that producers require. Production sharing
contract operators need Standby Letters of Credit (SBLCs), take-
or-pay clauses and other contractual assurances before investing
in projects that typically deliver returns over 20 year periods.

In the case of PLN, SBLCs are a particularly serious stumbling
block because of bank lending limits. With PLN's demand for SBLCs
in the range of $800 million per year and credit availability to
PLN under current lending limits only $550 million, PLN cannot
sign appropriate guarantees.

To overcome this problem, PLN has asked Bank Indonesia not to
include its SBLCs in the legal lending limit with government
linked banks like BNI and Bank Mandiri. High-level consideration
should be devoted to removing this obstacle so that PLN can
rationalize its energy needs.

There is compelling logic for this request because even though
SBLCs do represent exposure, they are not identical to direct
loans. The SBLCs do not represent actual drawdowns. They are only
potential drawdowns that are unlikely to be used in full.

The lack of a more robust domestic gas sector has handicapped
the economy and cost the government hundreds of millions of
dollars per year.

After more than five years of economic crisis, Indonesia can
no longer afford an energy mix that depends on expensive fuel oil
products, especially imported ones when there is an alternative
local fuel available in abundance. PLN and other large industrial
users must gradually break this dependence with the help of Bank
Indonesia and the Ministry of Finance. If this can be
accomplished, significant government progress will have been made
in restoring the economy and placing the country on a sounder
footing.

James Castle is the founder of CastleAsia, a leading research
and business information company based in Jakarta. Todd Callahan
is a technical advisor at the same firm.