Securing the downstream petroleum industry

Totok Sugiharto, Strategic Planning, PT Elnusa, Jakarta

With growing competition and deregulation, the rules of the game in the downstream petroleum industry in Indonesia will undergo some major changes in the next few years. The revolution in the downstream petroleum sector (crude oil and petrochemical refineries, transportation, storage and bunkering, trading and distribution) has brought free-market dynamics to the structure of the industry and the strategies of various players.

Deregulation of the downstream petroleum industry will undoubtedly lead to battles for market share, with new players attempting to gain shares from current incumbents. To succeed in this battle, what will be the most effective strategies for Pertamina in the few next years?

Following the new oil and gas law (No. 22/2001) there is the potential for new players as well as for Pertamina to build a strong downstream petroleum business.

To develop a strong position in the Indonesian futures markets, a key imperative is to understand market psyche, behavior and need. Segmentation of demand is a powerful tool to help identify the most profitable areas, and to develop a supply line that meets consumer needs more efficiently and effectively than the existing competition.

In current market analyses, geographic and demographic segmentation is more often used, such as potential Indonesian consumer population data based on geographics, with Java making up 64 percent of the national demand for petroleum products that have been identified as the most profitable segments.

Petroleum consumers daily use about 920,000 barrels of refined fuel, whereas about 85 percent of demand is produced by seven refineries owned by Pertamina. This means the rest is imported by third parties, which indicates an economy of scale amounting to US$1.28 billion each year (one barrel of fuel is equivalent to $25). Whoever captures this market could become a major market player in the future.

Over the last three decades, Pertamina has played a central role in the national petroleum industry, since its authorization through a 1971 law, encompassing the entire spectrum of the business from exploration and production, the refining of crude oil and petrochemicals, fuel distribution and trading, transportation of crude oil and refinery products, pipelines and storage.

In November 2001, the government enacted a new regulation, namely UU No. 22/2001, and Pertamina was to be transformed from a government-run organization to a state-owned enterprise. However what will Pertamina's role be after the implementation of this regulation?

A new government regulation stipulated that Pertamina was no longer assigned to manage production-sharing contractors, who are now supervised by the Implementing Body, or BALAK.

Thus, Pertamina's role was reduced to only stocking and supplying fuel and refined products, as well as profit-oriented activities. As with other oil and gas companies, Pertamina now has two main activities in the upstream and downstream areas.

After the implementation of the new law, Pertamina's downstream business activities will not be engaged in the same activities, because these roles will be managed by a regulatory board (BATUR) that orchestrates and controls the stocking and supplying of refinery products.

Pertamina will only be one of the players under the supervision of this regulatory board. In the refining of crude oil, Pertamina now operates seven crude oil refinery plants, which does not include management arrangements for national refinery plants, and detailed regulations must still be prepared.

As an archipelago, fuel distribution to remote areas requires a tanker fleet and pipelines, which Pertamina owns. Further pipeline transportation will be an effective and efficient alternative medium of transportation. But investment costs for constructing pipeline networks are very large.

In terms of storage, Pertamina operates transit terminals, apart from, among others, inland depots and small depots on isolated islands in the eastern region. When considering the improved efficiency of these facilities, it would be impossible for Pertamina to maintain its role as a sole operator.

In trading, nowadays most petrol stations are privately owned, but all operations are still controlled by Pertamina because they sell Pertamina's products. With the existence of new players and better competition, these petrol stations no longer have to sell Pertamina's products. Considering that these retail functions represent "the money-making" part of the downstream industry, Pertamina has a strong interest in controlling its "retail" parts.

Based on market analysis and the perceived role of Pertamina after the oil and gas law, we can determine the following future business opportunities:

oAnyone will be able to trade and import petroleum products;

oThe Indonesian captive market will become more open, especially the areas left by Pertamina;

o After its restructuring, Pertamina will need "shadow companies", or players to secure the supply of petroleum products;

Pertamina will need to strengthen its market structure to ensure it does not lose its current captive market in the downstream industry. For this purpose, the following are suggested:

First, Pertamina should operate seven crude oil refineries, including petrochemical refineries, in line with operation controls to secure the supply of fuel and refined products throughout Indonesia. These assets could become a basic capital resource to support Pertamina's other downstream activities.

Second, operational and investment costs for tanker transportation are very large; after implementation of this act Pertamina should not manage transportation anymore, but should outsource this service to third parties. However, choices for outsourcing transportation equipment must be assessed carefully, because Pertamina should not carry large fixed costs, especially while preparing for real competition in the downstream sector.

Third, pipelines could be also outsourced and the operational control could be handled by other parties or subsidiaries, while Pertamina and other players could use these facilities together.

Fourth, storage facilities represent the most important link in the chain of the downstream petroleum industry, and could be outsourced as well. With the justification of operational control, these functions could be transferred to subsidiaries, and Pertamina and other players could also jointly use these facilities.

Finally, in trading, Pertamina should have direct control, especially in the management of petrol stations. These facilities represent the "money-making" aspect of the downstream petroleum industry. Meanwhile, commercial aspects in other refined products could use existing lines, through traders and distributors.

PT Elnusa is a subsidiary of Pertamina.