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.