The Fuse

How Will Indonesia’s Oil Industry Fare After OPEC Suspension?

by Andrea Alie | December 07, 2016

As OPEC members decided in Vienna to cut bloc-wide production by 1.2 mbd, Indonesia, which already struggles to meet increasing domestic demand, was unable to exact even a temporary production cut, forcing it to leave the organization.

In 2015, Indonesia puzzled analysts with a return to OPEC following a six-year suspension. Now, less than a year after it rejoined, the country has again halted its membership so that it can continue to pursue increasing production targets. Amid struggles to attract investment in offshore reserves, Indonesia returned to OPEC in 2015—even as a net oil importer and the cartel’s fourth smallest producer—to access investment opportunities, and it successfully signed a number contracts in the past year. However, as delegates OPEC members convened in Vienna to cut bloc-wide production by 1.2 million barrels per day (mbd), Indonesia, which already struggles to meet increasing domestic demand, was unable to exact even a temporary production cut, forcing it to leave the organization. Even though the country returned to the cartel for just one year, Indonesia was able to strategically make its membership work to its advantage by securing large investments in its upstream resources after struggling to do so for some time.

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Gains from recent membership

Despite relatively low costs of production—approximately $15.60 per barrel—its oil industry has been in steady decline.

Indonesia’s investment climate is known to be particularly burdensome. Despite relatively low costs of production—approximately $15.60 per barrel—its oil industry has been in steady decline and its contributions to OPEC’s total output were fairly minimal at less than 2 percent. Many international oil companies (IOCs) are slimming down or eliminating operations within the country, putting more than 30 percent of Indonesian oil production at risk over the next decade. Besides trying to maintain existing facilities, investment partners will be needed to access offshore fields where 60 percent of the nation’s 3.7 billion barrels of proved reserves are located. Contracts signed with Saudi Aramco and the National Iranian Oil Company have provided a needed lifeline to the industry in the wake of IOC departures. Much more investment will be needed, but where those funds may come from currently remains unknown.

Cutting production would have been at odds with domestic plans to boost crude oil supply to 2.6 mbd by 2030, up from the current level of 720,000 b/d.

Upon arriving in Vienna, Indonesia’s Energy and Mineral Resource Minister Ignasius Jonan said that the 2017 government budget allowed a 5,000 barrel per day (b/d) cut, which at less than 1 percent of production was far below the roughly 4.5 percent reduction approved by the cartel. Cutting production would have been at odds with domestic plans to boost crude oil supply to 2.6 mbd by 2030, up from the current level of 720,000 b/d. That increase will be achieved through a combination of increasing refining capacity and additional investment in, and development of, overseas oil blocks, targeting Russia, Iran, and Iraq.

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But these investments may now be in jeopardy. The purchase of OPEC members’ oil and gas blocks went on a notable hiatus after Jakarta’s 2009 suspension from the group. Pertamina, the state-owned oil company, owns blocks outside of Indonesia, in Iraq (acquired in 2002), Libya (2 acquired in 2006), Qatar (acquired in 2009), and Algeria (acquired in 2014). While the Algerian block negotiations began after Indonesia suspended its membership, it was not until October 2015 that Pertamina began to drill wells.

In 2014, Jakarta rejected proposals from both Saudi Aramco and Kuwait Petroleum to build refineries in Indonesia due to contract disagreements centered on taxes and other regulatory issues. After the country’s reinstatement in OPEC in late 2015, a deal was struck between Pertamina and Saudi Aramco to upgrade Indonesia’s Cilacap refinery from 348,000 b/d to 370,000 b/d by 2022. Additional lifelines offered by Saudi Aramco were at least two bids to upgrade facilities in Riau and West Java. Moreover, in November 2015, Pertamina reached an agreement with Iran to import 928,000 barrels of liquefied petroleum gas (LPG) in 2016 and up to 5.8 million barrels in 2017 that Indonesia could refine and export.

The reasons behind Indonesia’s return to OPEC at the time—the need for fresh investments and deals with other member states—were clear and supported by Indonesian Minister Sudirman Said statements that the country intended to “join hands with Saudi Arabia” and “purchase LPG from Iran at low prices and on a long-term basis.” Indonesia is still waiting to confirm if Iran, which won the bid in August, commits to building an $8 billion oil refinery. The country is also currently in an exploration agreement for the purchase of two onshore oil fields that have a combined estimated production level of 60,000 b/d, projects that Indonesia needs to meet its ambitious 2030 targets. President Widodo confirmed that the suspension of membership would allow the government to focus on increasing production and generating oil revenues.

Investment options now that Indonesia’s left OPEC

If the pending deals do not progress, then Indonesia will need to do more to strengthen the investment climate for IOCs in order to increase production in the coming years.

The deals with OPEC countries are significant because they come in the wake of announcements from Chevron, ExxonMobil, BP, and Inpex to let current contracts expire. Japan’s Inpex, in addition to two such non-renewals, also placed plans to build a refinery with Shell on hold due to disagreements with the government. While the Indonesian oversight body SKK Migas approved the $15 billion offshore plan, Indonesian President Joko Widodo rejected it in favor of an onshore version, estimated to add $7 billion in costs and complicate pipeline logistics. Such interference and a host of agencies playing a role in permitting of oil projects has rendered Indonesia somewhat unattractive to IOC investment.

Government plans of a doubling oil production will not be achieved without external financing and additional industry partners with technical know-how. At such a critical juncture in its industry, Indonesia cannot afford to isolate the main pool of investors, mostly OPEC members who will benefit from the collective 1.2 mbd production cut agreed to in Vienna. The decisions regarding outstanding bids for refineries and the purchase of blocks between Indonesia and the oil cartel will provide some indication as to whether Indonesia has left the group on good terms or if a rift has opened in the wake of Indonesia’s refusal to adhere to group policy. If the pending deals do not progress, then Indonesia will need to do more to strengthen the investment climate for IOCs in order to increase production in the coming years.

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