Securing the downstream petroleum industry

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.