Indonesia’s dubious downstream strategy

Keep trying for long enough and eventually you’ll get what you want. That seems to be Indonesia’s strategy to attract foreign investment in its ageing downstream sector — and recent developments indicate it might finally be bearing fruit. Whether that’s a good thing for Indonesia is another matter.

Russia’s state-controlled Rosneft last month signed a framework agreement for a new 300,000 b/d refinery at Tuban in east Java, in partnership with Indonesia’s state-owned Pertamina. That came just a week after state-owned Saudi Aramco and Pertamina awarded a basic engineering contract to upgrade the 348,000 b/d Cilacap refinery, adding to Aramco’s initial investment deal signed last November.

The progress is encouraging for Indonesia’s reform-minded president, Joko “Jokowi” Widodo. Shortly after coming to office in late 2014, Jokowi took a look at the country’s oil trade balance — with imports meeting half of the country’s 1.6mn b/d product demand — and pledged to invest $25bn to lift refining capacity by 60pc to 1.7mn b/d by 2025.

But the problem for Jokowi’s downstream ambitions is that Indonesia has been here before. In 2012, for example, Aramco reached an initial agreement for a 300,000 b/d refinery, also at Tuban. And in 2010, Kuwait’s KPC considered investing in a 200,000-300,000 b/d plant at Balongan in Java. And in 2004, 2005 and 2006, Iran’s state-owned NIOC, China’s state-controlled Sinopec and Aramco, respectively, agreed tentative deals for refineries of various sizes at — you guessed it — Tuban. But none of these deals ultimately materialised.

There are various factors that account for the lack of progress, not all of which are Indonesia’s fault. But more recent deals have also run into problems. Japan’s JX Nippon Oil and Energy this year pulled out of Jokowi’s 10-year investment plan after failing to reach terms on a refinery upgrade deal with Pertamina. The Indonesian company is a giant presence in the country’s oil sector, where it is also increasing its upstream operations at the expense of foreign investors. Pertamina was supposed to be stripped of its downstream monopoly more than a decade ago. But it still owns all seven of the country’s refineries and is expanding its share of the retail market.

So, given Indonesia’s abject history of attracting foreign downstream investors, do Rosneft’s and Aramco’s latest deals have any better chance of success? Developments in Indonesia and the global oil markets suggest they might. Indonesia’s expanding GDP, its relative success in riding out the global economic downturn and untapped energy demand are increasingly attractive prospects for investors in a low-growth world. Jokowi’s signature reform since coming to power — the lifting of most fuel subsidies early last year — has removed a major drag on the government’s budget. Attempts to fully liberalise gasoline and diesel prices have stalled, but the retail fuel market is still more responsive to fundamentals than in the past.

Foreign oil firms are also facing a changed world. The surge in US shale supplies has upended global market dynamics and pushed state-run companies in the Middle East and Russia to develop new customers in Asia-Pacific. The long-term crude supply deals that would likely accompany a final refinery investment would guarantee stable sales amid an uncertain demand outlook. Rosneft is already investing in India’s downstream through a stake purchase in Essar’s 400,000 b/d Vadinar refinery and has locked in crude and gas supply deals with China. For Aramco, which has had mixed success in its long courtship with Chinese refinery operators, Indonesia presents an attractive alternative.

But while these developments might as a whole boost the prospects of the latest deals, the benefits to Indonesia are arguable at best. Refineries are sizeable investments — up to $13bn for Tuban and $5bn just for the upgrade at Cilacap — with the Indonesian government likely having to meet a big chunk of the costs.

And why build at all when it’s cheaper to buy fuel from the market? Asia-Pacific is becoming increasingly glutted with oil products. The southeast Asian export hub of Singapore is an established supplier, while Indian refineries are increasingly looking east for new customers. And China’s slowdown is pushing more diesel, gasoline and jet fuel into the regional market. Refinery operators in Indonesia’s eastern neighbour, Australia, where investment decisions are less dictated by politics, have already seen the writing on the wall and are shutting down plants in favour of buying cheaper import supplies.

If Jokowi really wants the market to play a bigger role in Indonesia’s energy sector, he might consider taking a similar approach. The irony is that Jakarta’s long-stalled refining ambitions could finally be making progress just when they’re least needed.

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