Liberalizing the oil industry

Liberalizing the oil industry

The state oil and gas company Pertamina will lose its monopoly
in the upstream oil and natural gas industry -- exploration,
mining and refining -- within two years, and in the distribution
of oil products within four years. That is the essence of the new
oil and gas industry law which was approved by the House of
Representatives on Tuesday.

The rationale for the liberalization move is that, like in
other industries, the greater the degree of competition and the
more flexibility enterprises and investors have in the way they
organize their operations, the greater will be the benefits for
consumers.

As investors will be permitted reasonable margins from both
crude oil extraction, and refining and end products, they will be
encouraged to increase investment in exploration. This contrasts
with the present situation whereby oil contractors are restricted
to crude oil production alone. The additional exploration will,
in turn, increase the volume of proven hydrocarbon reserves,
thereby prolonging the period of sustainable oil production in
the country. Most analysts predict that without steady,
significant discoveries of new reserves, Indonesia will become a
net oil importer by 2010.

Given the severely restricted capabilities of domestic
companies, especially since the 1997 economic crisis, foreign
investors will certainly continue to dominate the exploration and
extraction segment of the industry, which is highly risky as well
as being capital- and technology-intensive.

How can the government ensure that such branches of production
as oil and natural gas, which are vitally important for the
people, remain fully under state control, as required by the
Constitution?

The new law addresses this concern by requiring the setting up
of a steering body through which the government will administer
and award oil exploration blocs and oversee exploration and
extraction by foreign and domestic investors, and a regulatory
body through which the government will oversee wholesale and
retail oil and gas markets and maintain strategic oil reserves.
Both functions are now vested in Pertamina. To secure their
independence and integrity, the executives of both bodies will be
appointed by the President from candidates selected by the House
of Representatives.

The new law also contains clear-cut provisions requiring
consultations with local administrations regarding the oil blocks
in their areas that are to be tendered to investors, and clear
guidelines on land acquisition and compensation for local people.

Since Pertamina will be relieved of administrative and social
burdens, and of the responsibility for distributing fuel at
uniform prices throughout the country, it will then be able to
concentrate on exploration, production, refining and marketing on
a fully commercial basis so that profits may be maximized.

The two-year transition period to free competition in the
upstream industry and the four-year time lag before the whole
liberalization of the hydrocarbon fuel market are considered
adequate for Pertamina to gear itself up for free market
competition.

The concern that foreign companies will edge Pertamina
completely out of the oil market appears to be groundless. If
Pertamina is unable to restructure itself into a highly
competitive company with a completely new corporate culture as
well as managerial and financial autonomy during the transition
period, then there is no reason for the government and taxpayers
to continue supporting its existence.

After all, Pertamina already has a great advantage against new
players in that its refineries and marketing infrastructure (bulk
handling and storage facilities) are already in place, and its
marketing networks already well developed.

The biggest challenge now is preparing the steering and
regulatory bodies to become highly competent and efficient
watchdogs of the oil industry, ones which possess a high level of
credibility. This is essential as it is these bodies which will
determine whether the oil market will really become fully
competitive, especially after 2004 when domestic fuel prices will
be set on a par with international prices.

Whatever policies and guidelines are issued in implementation
of the law and however the two bodies are structured and managed,
one thing is clear: Indonesian consumers will be best served only
by opening the market to all types of companies -- producing or
marketing firms which buy products locally or import refined
petroleum products, and companies that produce oil elsewhere or
purchase oil from local reserves.