Power projects under way in the energy sector to meet Indonesia's rising demand

After years of treading water, Indonesia’s energy sector is finding new optimism in the fresh faces being appointed to key government positions by the new president, Joko Widodo, with the hope that they will be able to renew investor interest in the industry and spur a wave of development. The changes at the top come at a critical time, as myriad factors continue to buffet the sector in Indonesia, which ranked among the world’s top-five liquid natural gas (LNG) exporters in 2013 and remains Asia’s second-largest natural gas producer despite continuing production declines.

Falling Production

Gas output has been falling since reaching a high-water mark in 2010, when Indonesia produced over 8bn cu feet of natural gas per day along with 944,000 barrels of oil, according to an analysis by Risco Energy. Since that high point, a series of changes in the regulatory structure, starting in 2009, have hampered exploration of Indonesia’s substantial hydrocarbons resource potential, a problem that has been exacerbating the ongoing decline of domestic oil and gas production at a time of rising demand and a need for energy security, independence and sustainability.

As production has continued declining, the savings the government has reaped from cutting energy subsidies after the recent fall in oil prices have been counterbalanced by a drop in revenues from state petroleum projects. The World Bank is now forecasting a 57% decline in oil and gas revenues for 2015 compared to the previous year. State oil and gas revenues in 2013 were $31.36bn, or 98.89% of the government’s budgetary target of $31.71bn, according to SKK Migas, the sector regulator, while recovery of operating costs reached $15.93bn, or 28% of total gross revenues from oil and gas.

As oil prices have risen in 2015, the government is reconsidering its subsidy reductions, while state oil company Pertamina is incurring losses. Increasing consumption is also putting greater stress on the country’s electricity sector, as power generators work to keep up with demand from an increasingly energy-hungry population. To solve this, ambitious expansion plans to add thousands of gigawatts of new capacity to the grid over the next decade are already under way, although delays in some areas have extended target timelines, particularly for non-conventional power producers.

On the Downslope

The height of Indonesia’s oil boom took place in the late 1970s and early 1980s, when large, easily accessible “elephant” reservoirs were pumping upwards of 1.7m barrels per day (bpd), and the country was still producing around 1.6m bpd as late as 1995. Since then, these legacy fields have become less and less productive, while newer discoveries have been unable to replace the declining output of their predecessors. Output reached an all-time low in 2013 of 882,000 bpd, down from 918,000 bpd the previous year and well below the 1.18m bpd recorded in 2003, according to BP’s “Statistical Review of World Energy 2014”. Figures from SKK Migas, which measure only crude oil and condensate, paint a similar picture, with 825,000 bpd in 2013 compared to 1.09m bpd in 2004. In 2014 crude oil production totalled 794,000 bpd.

Older fields were supplemented by limited new development in 2013, when four new contract areas (CAs) entered the exploitation phase after a plan for their development was approved by the minister of energy and mineral resources. These new areas consisted of the Pandan, Belida and West Air Komering CAs in South Sumatra, along with the Bengara I CA in East Kalimantan. SKK Migas projects that they will add a combined total of 9.74m barrels of oil equivalent (boe) to national reserves. As of the end of 2013, total proved, probable and possible crude reserves were estimated at 7.39bn stock tank barrels by SKK Migas and 3.7bn proven barrels by BP, while the country’s natural gas reserves were estimated at 122.68trn standard cu feet (scf) and 103.3trn scf by those two sources, respectively.

Producers

There are currently five active producers that are responsible for the majority of petroleum output in Indonesia. The largest of these is Chevron and its subsidiaries Chevron Pacific Indonesia, Chevron Indonesia Company and Chevron Makassar, which together were responsible for 42% of crude output between 2002 and 2013. The number two operator by output is Pertamina, accounting for 15% of the total; followed by Total Exploration and Production Indonesia, responsible for 8%; ConocoPhillips (consisting of ConocoPhillips Indonesia and ConocoPhillips), with 5%; and China National Offshore Oil Corporation, accounting for 5%; with other companies making up the remaining 25%.

Although the long, slow decline of oil production has inevitably led to an increase in imports to fuel power plants as well as the cars and scooters plying the country’s ever-more-crowded roadways, a surge in natural gas output in the 1990s and 2000s kept Indonesia on the positive side of the energy balance for a time. The discovery and development of substantial gas fields by the 1990s helped fuel natural gas production for decades, providing new energy sources for the domestic market as well as an attractive export commodity. Mirroring the production cycle of crude output, natural gas production peaked in 2010 at 8bn cu feet per day and continues to decline on an annual basis, dipping just under 7bn cu feet per day in 2013. “Oil exploration and production will continue moving to deep waters as current reserves are running out,” Bambang Ediyanto, president-director of Indonesian offshore marine service company Baruna Raya Logistics, told OBG. “This will bring a great window of opportunity to marine services companies, although the industry will have to adapt its technology, fleet and technical know-how to maximise growth.”

New Prospects

A number of large new projects currently under way are expected to slow the decline in output, although many of the most promising ones have been delayed due to technical or regulatory issues. Chevron revealed in October 2014 that its $12bn Indonesian Deepwater Development (IDD) gas project is facing nearly a two-year delay as the company waits for a revised budget to receive government approval. Peak daily production from the IDD is forecast to reach as high as 1.1bn scfd of gas and 47,000 barrels of condensate, and the project is scheduled to come on-line by 2018. Although Chevron has received government approval to move forward with operations on the initial Bangka field off the coast of Borneo, development of the second phase, which was expected to start up in 2019, is being delayed while the company makes final investment decisions and applies for contract extensions for the Gendalo-Gehem play.

The two other major deepwater projects on the horizon – Inpex’s Abadi field in the Masela block and Eni’s Jangkrik field in Muara Bakau – are also facing delays. Inpex signed a production-sharing contract (PSC) for the Masela project in 1998, yet first production from Abadi is expected 20 years later, in 2018, while the Eni PSC was inked in 2002, with production expected to start in 2015.

In all, Indonesia has not seen a new project come to fruition since 2008, when ExxonMobil brought the Cepu field on-stream, and that too was at rates far below the original target. The Cepu field is expected to reach full production in 2015. In addition to these projects, BP has committed to invest $10bn over a decade to add a third train and two new offshore platforms to its Tangguh LNG project. As of December 2013, there were a total of 317 CAs active across Indonesia. Of these, 79 were in the exploitation phase (57 in production and another 22 in development) and another 238 in the exploration stages (including 23 in the termination process).

Trade

Indonesia’s declining production has taken a toll on the country’s finances over the past four years, a situation that has been exacerbated by the recent fall in global energy prices. Oil and gas exports declined to $28.75bn in 2014, the lowest level since 2010 levels of $28.66bn, according to data from the Bank of Indonesia (BI). As production has fallen, government revenues have followed suit, with the state collecting $38.07bn in 2011, $35.57bn in 2012 and $33.59bn in 2013. At the same time, rising domestic consumption of petroleum products caused imports to spike, from $25.43bn in 2010 (the last year with a positive energy trade balance) to $43.3bn by 2013. As a result, Indonesia’s oil and gas trade balance went into the red in 2011, with a $650m deficit, compared to a $3.23bn surplus the previous year, and it has since expanded to $9.71bn in 2013 and $11.84bn in 2014. Due to low crude oil prices, however, this balance has improved significantly.

Indeed, the fall in oil prices that began in late 2014 has been a double-edged sword for Indonesia. On the one hand, it provides relief in the form of lower import bills and mitigates the effects of energy subsidy reductions on the public, but on the other, it has resulted in a fall in export revenues. The value of oil and gas imports declined in each of the last three quarters of 2014 to $10.69bn, $10.40bn and $9.16bn, respectively, while export receipts dropped to $7.51bn, $7.26bn and $6.38bn in the same span.

New Offerings

While the natural cycle of maturation is the most readily apparent cause for Indonesia’s declining hydrocarbons output, the sustained low levels of exploration activity are increasingly likely to have an equal or greater impact on production levels going forward. Exploration activities are among the lowest in decades, largely due to regulatory issues and new taxes, which have made oil majors more tepid in their responses to new tender issuances by Indonesia’s Directorate-General of Oil and Gas. Another cause is government delays on current contract extensions. Overall investment in exploration fell to $1.38bn in 2013, marking the third straight year of decline from $2.05bn in 2011 and $1.47bn in 2012, SKK Migas data show.

In terms of new offerings, in 2013 the government undertook two oil and gas bid rounds in March and May for a total of 13 conventional oil and gas CAs and one shale gas CA. These were, however, offset by the relinquishment of five CAs due to the inability of PSC contractors to fulfil their exploration and development commitments within the specified time period. At the end of 2013, another 23 CAs were likewise in the process of relinquishment. Two more bidding rounds were launched in mid-2014, consisting of 13 conventional oil and gas blocks and non-conventional shale oil blocks each.

Given the industry’s average lead time of six years to bring a hydrocarbons play from exploration to production (with recent experience in Indonesia pointing toward much longer development times), the effects of this lag are likely to linger into the future. Assuming the optimistic six-year developmental timeline, this low level of new production will continue through at least 2020 even if exploration were to increase significantly in 2015-16. “The Indonesian government wants the country to become an oil exporter again and to re-join OPEC by 2020, but to achieve these and other targets, large-scale investments and domestic market pricing reforms are needed,” Agus Salim, president-director of Pratiwi Putri Sulung, a supplier and servicer of a range of products for extraction, refinement, metering and delivery of natural gas, told OBG.

Shifting Sands

Much of the drop-off in new investment has been directly attributed to the implementation of new regulations beginning in 2009, including the passage of Government Regulation 79 (GR 79). This legislation exposed contractors to greater taxation, such as a transaction tax and land and building taxes. Another change applied in GR79 was the inclusion of cost recovery in the state budget. Administratively, this involved transferring cost-recovery outlays from the oil ministry to a federal budgetary line item, which constricted the flow of funds to new oil and gas projects.

The risks associated with outlays on large new projects were further increased by a separate government ordinance that made it harder for companies to extend their lease to continue producing through the life of a reservoir once it has been explored and developed. Confusion regarding the implementation regulations for such PSC extensions made the situation even more convoluted, particularly for large, multibillion-dollar deepwater investments that are developed in phases over a period of decades, which have experienced significant delays. Inpex, for example, is seeking a 20-year extension for its Masela block project, without which it would be unlikely to proceed.

Later on in 2010, the land building tax (LBT) resulted in hundreds of millions of dollars in new taxes levied on offshore oil and gas concessions that are in the exploration stage. The LBT required PSC operators to pay taxes on licensed acreage, regardless of whether their exploration efforts were successful. The net result for 2012 and 2013 was a combined $260m tax bill for 49 PSCs.

Trimming Sails

Although many of these regulatory items remain unresolved, the new Widodo administration has made a number of early moves that the industry has received with renewed optimism. A significant breakthrough regarding the LBT was made in January 2015, when the Ministry of Finance issued a new regulation exempting oil and gas exploration activities from the tax, although the fate of previously levied taxes from 2012 and 2013 remains unresolved. The tax move came on the heels of a number of other changes made in late 2014, including a reduction in petrol and diesel subsidies by Rp2000 ($0.17) per litre, and the creation of a new government task force dedicated to reviewing management of the oil and gas sector, with a specific focus on what President Widodo has referred to as “an oil and gas mafia”.

Other positive signs that have illustrated the government’s willingness to shake things up include replacing the heads of influential institutions. In October 2014, for example, the Widodo administration appointed Sudirman Said as minister of energy and natural resources, who himself promptly dismissed the director-general of upstream oil and gas in November. Oil and gas regulator SKK Migas and state energy champion Pertamina also both swapped out CEOs later that same month. Industry players are hopeful that a shake-up at SKK Migas could spur a decision on whether or not to extend expiring PSCs for some of the largest prospective gas plays currently being developed, including Chevron’s IDD project and Inpex’s Masela project.

Power to the People

Although Indonesia is likely to fall short of achieving its goal of complete energy independence given the pace of rising consumption, the new government has sent some early signs that it is making a high priority of boosting electricity production using domestically sourced coal. Any effective short-term proposal to cut down on energy imports will have to involve increasing coal consumption. While this will not be popular with environmental advocates, it may be the only solution to the economic realities facing an electricity sector in need of a rapid and cheap power boost that does not reduce profitable LNG exports (see analysis).

The government’s announcement that it plans to add 35 GW of new power in just five years has been met with guarded optimism, given the dismal results of the country’s last strategic plan of this sort, which was meant to develop two successive capacity expansions of 10 GW each. Cost overruns, inadequate construction techniques, poor designs, grid connection challenges, land acquisition problems, funding difficulties and other problems caused significant delays for many of the projects in that plan. Many of the new power plants that were built still operate at below projected capacity. The so-called fast-track programme launched in 2006 to boost capacity by 20 GW also remains years behind schedule.

The addition of 35 GW of new electricity capacity between 2014 and 2019 is sorely needed to accommodate Indonesia’s continued economic growth and industrial aspirations. Energy sales have more than doubled since the beginning of the millennium, increasing from 79,165 GWh in 2000 to 187,541 GWh in 2013, according to data from Perusahaan Listrik Negara (PLN), the state-owned power producer and operator of the country’s transmission system. Total energy production achieved an all-time high of 216,189 GWh in 2013 after breaking the 200,000-GW record the previous year at 200,318 GWh. Striving to keep pace, Indonesia’s installed capacity has also expanded from 23.7 GW in 2001 to 50.9 GW in 2013, according to statistics from the Ministry of Energy and Mineral Resources.

With an electrification ratio of just over 80% at the end of 2013, a sizeable portion of the country’s rural population remains unconnected to the grid. As PLN works to extend coverage to even the most far-flung regions of the country, another pressing demand is to boost capacity in populated areas, including Jakarta and Tangerang, where skyrocketing demand has led to power interruptions into 2015. As consumption climbs, network losses also piled up to 9.91% of production in 2013, rising from 9.21% the previous year, according to PLN data. In the same period, the system’s average interruption frequency index also escalated, from 4.22 times per customer per year in 2012 to 7.26 in 2013.

Demand-Side Solutions

The challenge of rising electricity demand across the country’s vast geographic expanse is one that Indonesia’s policymakers have traditionally tackled by drawing up plans to build a steady stream of new power plants utilising a range of fuel types, from inexpensive coal-fired thermal power plants to less-traditional sources like solar and waste. Plans that entail the addition of tens of thousands of megawatts of new production capacity will alleviate the supply crunch if and when they are realised, yet at the same time, a much cheaper alternative is being explored.

Often considered as an afterthought in the energy mix equation, the concept of energy efficiency is now being looked at as a valuable component in the government’s long-term energy strategy. Since Indonesia is one of the region’s most voracious consumers of energy, to implement even basic energy conservation techniques could have a significant impact on domestic demand. The country’s appetite for primary energy has surged over the past decade on the back of strong economic growth, increasing from 995.74m boe in 2000 to 1.61bn boe in 2013.

Despite the rise in demand, Indonesia has managed to reduce its energy intensity, though there is still significant room for improvement. The country’s energy intensity has declined on average by 2.8% per year from 2000 to 2013, with a 3% decline from 2012 to 2013, according to data from energy intelligence service Enerdata. This greatly exceeded global efficiency gains made over the 13-year period, which averaged a 1% decrease in intensity. OECD nations saw a decline of 1.6%, while Asia was broadly in line with the worldwide average drop of 1%.

Regulatory Changes

In the case of Indonesia, some of the decline can be attributed to a growing effort by the government to improve energy efficiency. This move was originally made to address the alarming ballooning of Indonesia’s import bill and fuel subsidies, as well as the threat that rising domestic consumption would cut into LNG exports. In response, the government has rolled out more than a dozen efficiency measures over the past decade, starting with the 2006 Presidential Declaration No. 5 (the National Energy Policy) and including the issuance of GR 7 in 2007, regulations passed by the Ministry of Energy and Mineral Resources in 2012-13 regarding water and energy conservation, and the 2014 regulations by the National Energy Council (NEC).

To further reduce Indonesia’s energy intensity and reliance on imports in the face of sustained economic growth, the government has instituted a number of efficiency and conversation measures, which could account for the equivalent of more than a fifth of total energy demand by 2025. The targeted impact of energy efficiency measures has increased progressively within the government’s long-term strategic plans over the past decade, as electricity capacity programmes have consistently fallen short of expectations. Under the most recent study, which was released by the NEC in December 2014, energy efficiency could reduce total primary energy demand by 41m tonnes of oil equivalent (mtoe) in 2025 and by some 299 mtoe by 2050.

In addition to conservation measures, renewable energy is also set to take on an increased role in the primary energy mix, further reducing the need for oil and gas imports. Under the NEC’s proposal, renewables would account for 18% of the power supply by 2025, with this portion increasing to 30% by 2050, as compared to 11% and 10%, respectively, under a business-as-usual scenario. The proposal includes ramping up biofuel blending levels significantly from their current 10% contribution, increasing the use of mass transport, applying optimum energy-saving technology in all sectors, and having electric and hybrid vehicles achieve a 1% and 5% market share of vehicles, respectively, by 2050. Taken together, these moves are to cut usage by 1bn cu feet per day of natural gas and 700,000 bpd of oil by 2025, and by 6bn cu feet per day and 3.6m bpd by 2050.

New Law

The government is keen to finalise new oil and gas legislation before the end of 2015, with both Kardaya Warnika, head of parliament’s commission VII on energy, and his deputy Satya W Yudha, both recently expressing an intent to do so. Kardaya said the new law would provide a legal framework to enhance the investment climate, establish the sector as a driver for economic growth, clarify the status of regulatory and oversight agencies like SKK Migas, and stipulate the role of state energy companies while improving their competitiveness.

Outlook

Oil and gas output in Indonesia is likely to continue declining for the foreseeable future, as maturing fields and a lack of exploration and development will likely drag down production through to at least 2025. Longer-term prospects, however, remain substantially brighter given the country’s estimated exploration potential, which should continue to attract attention from both local and international oil outfits. Any move forward on the sort of large, long-term prospects that could curb the decline in overall production will largely depend on whether the new government implements more business-friendly policies and clarifies the rules. While the new Oil and Gas Law, if passed, will define the participation of the private sector and foreign investors, the legislation is expected to increase the role of state-owned companies in the sector.

Current market conditions have provided a window of opportunity for much-needed energy subsidy reform, freeing up hundreds of trillions of rupees to be spent elsewhere. While this new scheme has worked well so far, at a time of depressed oil prices, it is proving challenging for the government to maintain its stance in the face of price increases, particularly as the country’s citizenry are more accustomed to static pricing. When oil prices rise, the government will have to choose between unpopular domestic price increases and the budgetary risks of reintroducing higher energy subsidies.

After years of halting progress in the power sector, the new energy strategy has the potential to add much-needed capacity to the domestic market, provided that policymakers can avoid some of the pitfalls that have affected similar rapid development programmes in the past. A concentration on building coal-fired power plants, designed to run on inexpensive, domestically produced coal, should help to smooth out the process. In the meantime, the strategy’s emphasis on boosting efficiency and reducing Indonesia’s high energy intensity levels should also help to rein in the country’s domestic consumption.

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The Report: Indonesia 2015

Energy chapter from The Report: Indonesia 2015