The sharp increase in crude oil and fuel prices between 2004 and 2008 ended abruptly when crude prices dropped from around US$140 per barrel to $40 as the global financial crisis took hold. The recent increase in prices back to around $70 per barrel shows the reduced pressure on Indonesia's fiscal burden and trade balance was temporary.
The hard lesson is that the volatility of global oil prices will inevitably pose risks to oil and fuel importing countries, particularly to those maintaining domestic fuel price subsidies. It can be calculated that at crude and fuel price levels of $40-50 per barrel Indonesia must spend more than Rp 100 trillion ($10 billion) on imports annually; almost twice the Ministry of Finance's Rp 50-60 trillion 2009 budget for fuel subsidies.
While this is less than 2008's peak of Rp 120 trillion, these estimates may have to be revised upwards if crude prices stay at current levels.
The growth in demand for fuel domestically, insufficient domestic refining capacity and the decrease in local crude production increased the country's dependence on imported fuel products and reduced its net crude exports.
While export revenues of liquefied natural gas (LNG) have, in general, grown in recent years, the overall trade balance in oil and gas continues to deteriorate.
Therefore an expansion of the country's crude production, starting with a rapid increase in investment for exploration and the speedier development of new discoveries, is critical. More investment is also required to explore and develop the country's gas potential, given the importance of continued growth in LNG exports and the domestic demand for cleaner fuel.
State oil company Pertamina's plan to build two new refineries in Bojonegoro and Tuban, East Java, as well as to expand the existing refinery in Balongan in West Java, need to be accelerated. An expansion of domestic refinery capacity, particularly if integrated with petrochemical facilities and combined with growth in indigenous crude production, will improve fuel economics and supply security, and improve the country's trade balance.
Notwithstanding the country's resource potential, companies operating or planning to invest in Indonesia face multiple challenges. The low oil price environment makes it less attractive for companies to expand production capacity and to risk their cash in exploring for new oil and gas prospects.
The industry's fiscal regime, i.e. the profit sharing that private operators receive, is less competitive than in many other emerging countries. It could take 3-5 years for complex upstream and downstream construction projects to complete commercial arrangements, construct the facilities and start production.
Financing large-scale refineries and LNG projects in Indonesia is challenging even under favourable economic, price and margin conditions.
Moreover, many levies, duties and local government policies and practices, which arose partly as a consequence of the country's administrative and fiscal decentralization, have adversely affected the country's investment climate.
Thus it is recommended that the government offer incentives for foreign and domestic oil companies to help them increase and accelerate their investment in the sector. This could be introduced for example in the form of temporary fiscal incentives for competitively-selected, capable domestic and foreign oil and gas operators who credibly commit to feasible investment projects in the next 1-3 years.
On the upstream side this could include adjusting rules and procedures pertaining to exploration taxes, import duties, cost recovery, royalty and government take and domestic gas pricing. For the refinery and gas processing/transport projects, the equity portion could come from Pertamina, state owned gas company PT PGN, state electricity firm PLN and other suitable strategic partners.
The latter could include Southeast Asian, Asian and international state or private oil and gas companies. The participation of creditworthy international partners to help secure feedstock and as partial product off-takers enhances the projects' financing feasibility and improves economic feasibility.
State-owned banks can be encouraged to look into debt financing alternatives for these projects. Equally importantly, potential collaboration with multi-lateral and export credit agencies should be actively explored.
Ongoing efficiency and institutional improvement efforts across all sector participants must continue. On the construction side, the projects should be openly tendered to credible international contracting companies.
The ideal tender package should include engineering, procurement and construction (EPC), as well as viable financing proposals. One positive aspect of the current economic crisis, somewhat lower oil prices and reduced sector-wide capital expenditures, is the anticipated fall in EPC, steel and other material costs.
The current low crude oil and fuel product price environment should be used by the Indonesian government to improve the industry's international competitiveness and to incentivize investments in the country's oil and gas sector. Oil and gas prices will increase as world demand recovers.
Notwithstanding constraints in the national budget and the extremely difficult funding environment, it is of critical importance that the government work closely with national and international energy companies, key state-owned enterprises and banks as well as multi-lateral and export credit agencies to invest in the country's oil and gas sector.
The writer is a research fellow at the Asia Competitiveness Institute, Lee Kuan Yew School of Public Policy, National University of Singapore. These are his personal views.
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