Indonesian government challenge: Revive oil sector

Indonesia's leading presidential candidate Susilo Bambang Yudhoyono faces an urgent challenge: reversing a long-term decline in crude-oil production and investment that is creating huge economic problems for East Asia's only member of the Organization of Petroleum Exporting Countries (OPEC), the Asian Wall Street Journal newspaper reported in its Friday edition.

With the largest proven oil reserves in Asia and dozens of international companies operating in the country, Indonesia's energy sector should be helping to drive the economy. Instead, years of political confusion and regulatory chaos have led to a sharp drop in investment and production, even while domestic fuel demand continues to surge.

As a result, Indonesia became a net importer of crude oil for the first time earlier this year. And as global oil prices jump to all-time highs, Indonesia's practice of heavily subsidizing domestic fuel consumption is threatening to swamp the budget. Moreover, Jakarta has bungled efforts to reorganize the oil industry's regulatory environment, stripping state oil company PT Pertamina of much of its power, but failing to complete the job of setting up new laws and independent institutions.

Many industry executives now believe Indonesia is falling off the global map for new oil-exploration investment, even as it should be benefiting from record global prices.

"The image of the country [in] the global industry is that there are too many cooks in the kitchen, and nobody knows who's in charge," says Fereidun Fesharaki, a senior fellow at the East-West Center in Hawaii, who has worked as an adviser in Indonesia's energy business for 20 years. "These kinds of things don't give investors any confidence."

The first challenge for Yudhoyono, who will be sworn in as Indonesia's president on Oct. 20, is to avert a fiscal crunch by slashing ballooning fuel subsidies and raising state-controlled prices.

This year's budget was calculated using an estimated average price for crude oil of $22 a barrel. With world prices now more than twice that level, Indonesia's expected outlays on subsidies will triple to more than $6 billion -- far more than the country spends on education and health care combined.

But raising fuel prices is politically risky in Indonesia. Deadly riots triggered partly by a fuel-price increase in 1998 helped cause the collapse of former President Soeharto's authoritarian regime. Outgoing President Megawati Soekarnoputri was also forced to roll back an increase early in her administration after the move sparked a series of street protests.

Still, Yudhoyono -- who won more than 60% of the popular vote in Indonesia's Sept. 20 presidential election -- might have enough political capital to push a fuel-price increase through, provided he clearly explains that the cuts in subsidies will free up cash for programs that more directly help the poor.

"I don't think it will create public unrest," says Rizal Prasetijo, an analyst with J.P. Morgan Securities in Jakarta, who expects gasoline prices to be increased about 30% in the next few months. "He is a very good speaker; he will convince the people that this is the right thing to do."

But Indonesia's more fundamental problem is that its oil wells are drying up faster than new fields are being tapped. International companies, put off by Jakarta's confusing regulatory environment, have cut spending on exploration and development to a 30-year low. While Indonesia's OPEC quota is 1.3 million barrels a day, its crude-oil production slipped to just 1.02 million barrels a day last year, compared with a peak of 1.5 million barrels a day in 1998.

To be sure, geology plays a part in the production drop. Indonesia has one of the world's oldest oil industries -- dating back more than 100 years -- and the most obviously promising areas have already been extensively tapped.

Indonesia is now struggling to persuade oil companies to explore smaller, more remote sites. But interest has been low because of a range of issues, including heavy new taxes imposed on exploration efforts, as well as concerns about corruption and unrest in some regions.

Such issues have helped convince several global energy companies -- including Devon Energy Corp. and Kerr-McGee Corp. of the U.S., and Repsol YPF of Spain -- to leave the country over the past few years. In some cases, they sold out to Chinese or other Asian investors with a greater willingness on take on Indonesia's risks. Such sales have made China National Offshore Oil Corp. into Indonesia's largest offshore oil producer.

Still, many industry officials believe Yudhoyono has a great opportunity to get the production effort back on track by resolving a long-running deadlock between Pertamina and Exxon Mobil Corp. over how to develop Indonesia's biggest new oil discovery in decades.

Exxon Mobil bought rights to the Cepu field in East Java in 1999 from a company run by a son of Soeharto, the former president. After drilling more deeply than other companies had in the past, Exxon Mobil soon discovered that the onshore field contained an estimated 600 million barrels of oil.

But because Exxon Mobil's rights to the field expire in 2010, it has declined to make a substantial investment in deep-drilling equipment unless its contract can be extended, says company spokeswoman Deva Rachman. Pertamina, on the other hand, recently informed Exxon Mobil that it intends to allow the contract to expire so that it can tap the field itself after 2010.

"Cepu can almost be taken as a case study of some of the problems facing Indonesia," says Norman Valentine, Southeast Asian energy analyst with industry consultant Wood Mackenzie Ltd. in Edinburgh, Scotland.

"The general consensus is that things have been getting harder over the past few years, when they really should be getting easier if Indonesia is to remain competitive in a global sense for investment," he says. (*)