Bold reform of Indonesia`s petroleum sector is being aggressively pursued by the Indonesian government of President B.J. Habibie. The main goal of this reform is to revoke the monopoly of Indonesian state oil firm Pertamina and introduce competition into the country`s oil industry.
But observers wonder whether the government has enough time to implement the planned measures, given the unknown character of a newly elected administration and the potential instability surrounding the country`s new political system.
Indonesia`s excruciatingly complex electoral system is not due to produce a new president until November. Although the watchword of the election has been "reform," none of the leading contenders for the presidency is a reformer at heart. It is possible, many observers suggest, that, once a new government is in place, the momentum for political and economic change-particularly in the oil sector-may dissipate.
Nevertheless, the legislation drafted and currently before parliament is sweeping in scope and calls for nothing less than the dismemberment of Pertamina. This is anticipated to be one of the great battles of Indonesia`s brave new reform era, given the close connections between vested interests in the petroleum industry and senior politicians.
The new reform legislation is the brainchild of Kuntoro Mangkusubroto, Indonesia`s Minister of Mines and Energy. The ministry would end up taking over many of Pertamina`s responsibilities.
Kuntoro is considered one of Indonesia`s most competent ministers and the only one with a proven record of reform. Educated in engineering at the Bandung Institute of Technology of Indonesia and at Stanford University in California, in the early 1990s he reformed the state-owned tin conglomerate PT Timah, which, while still majority state-owned, has been successfully launched on the London and Jakarta stock exchanges.
If the legislation is approved, his ministry would have 6 months to take over the supervision of contracts involving foreign and local companies that hold oil and gas concessions through Pertamina. And within a year, all of Pertamina`s drilling and oil production activities would be subject to the sort of cooperation agreements the government would make with any other company.
The call for reform
Pertamina was created in 1969 as a state-owned monopoly charged with managing Indonesia`s oil and gas development. Over the years, it has operated almost as a sovereignty unto itself, ignoring transparent business practices, often acting independently of any ministry, and increasingly taking on the role of a cash cow for then-President Suharto and his cronies.
But even as it came increasingly to symbolize Indonesia`s pervasive cronyism, there was the realization that something had to be done about Pertamina`s inefficiency. In 1993, the company began a restructuring program that reduced production costs to $5.10/bbl from $11.70/bbl and reduced the company`s work force to 30,000 from 45,540.
But legislators are now calling for further change. And the proposed new petroleum law is creating unprecedented tension between Pertamina and the state government.
Pertamina`s pressure to reform itself was increased when Pertamina Pres. Soegianto, at his post for less than a year, was fired by President Habibie in December 1998. The new president of Pertamina is Martiano Hadianto, the post-Suharto director-general for customs.
Under legislation currently before parliament, Indonesia`s inefficient oil and gas industry would be brought up to international standards. Doing so would encourage sorely needed foreign investment by deregulating areas where Pertamina holds a monopoly-the downstream sectors of refining, distribution, and marketing.
The reformers believe that competition would gradually lower prices for refined products, helping to offset the effects of government moves to slowly peel away subsidies that provide Indonesians with some of the world`s cheapest gasoline, diesel fuel, and kerosine.
As important, the legislation also would wrest from Pertamina the supervision of production-sharing contracts-a process long criticized by oil companies as being bureaucratic and corrupt-and give that task to the Ministry of Mines and Energy.
Deregulation would transform Pertamina itself into a commercially viable oil and gas company over a 2-year period, thus saving the cash-strapped government the millions of dollars now spent annually to prop up the inefficient giant.
Gas industry development
An improved investment climate in Indonesia would also encourage the development of natural gas for domestic use in the oil-dependent country.
A totally new gas supply industry is to be created if the new legislation is effectively implemented. The goal is to encourage more comprehensive use of the country`s enormous gas reserves, which are seriously underutilized.
Unocal Corp., one of the largest operators in Indonesia, recently called on the government to implement a more-rational regulatory framework to encourage gas use. Unocal Vice-Chairman John Imle told a conference of the Indonesia Petroleum Association, "Now is the time to get it right, if I may be blunt.
"We often wonder about the import of subsidized diesel to Java for power generation almost within sight of gas flares in the Java Sea. And there is still gas being flared in East Kalimantan, despite the presence of power plants and a refinery that still consume liquid fuel."
The gas supply for power plants and industrial use has been severely constrained by an incomprehensible regulatory structure that has made it difficult for power station developers to use gas as feedstock, compared with the more straightforward process of securing domestic coal feedstock.
The new legislation would seek to overcome the bureaucratic constraints. It endeavors to liberalize the gas industry and remove the monopoly and regulatory role of Pertamina, which has been set up as a middleman between producers and consumers.
It would also remove the monopoly distribution role of state-owned Perusahaan Gas Negara (PGN). PGN has also sought to control the retail sector, a role that conflicts with Pertamina`s under current legislation.
Under the new laws, PGN would be broken into separate transmission and retail companies, and possibly an exploration and development concern. The following proposed market structure for gas supply would be implemented:
- Third-party access to pipelines. End users would be allowed to purchase gas from upstream producers and transport it via PGN trunk lines, paying only distribution charges, thus reducing PGN`s percentage of profit in each gas contract.
- Separation of transmission and trading activities. A full legal separation of the sectors would be effected by establishing new corporate entities. Most gas sales are to power stations under long-term contracts, and establishing a competitive market with flexible supply arrangements would further erode PGN`s dominance.
- Independent regulation. A new regulator would foster an environment of "competitive neutrality"; it would maintain the interests of the consumer, end user, and producer and would be accountable directly to the Ministry of Mines and Energy.
- Competition in trading. The market would be opened so that producers could sell directly to end users.
- Competitive trading for construction and ownership of new transmission and distribution pipelines. Developers of new pipelines would be able to negotiate the use of the pipeline directly, eliminating monopolistic pricing of transmission.
For gas exports, contracts would be directly between producers and buyers, with Pertamina maintaining its liquefaction operations at Bontang, East Kalimantan, and at Arun, North Sumatra, where it has majority stakes in LNG facilities.
Exploration, production
It is in the upstream sector-in production-sharing contracts, in particular-that the most sweeping changes would occur.
Long the bane of international oil operators, Indonesian petroleum law dictated that every aspect of operation in the country was subject to approval by Pertamina`s foreign contractor management body, Bppka. Dealing with the incomprehensible Bppka bureaucracy on simple matters, such as acquiring work permits for expatriate personnel, can take hours of filling in applications and months of waiting.
But this was not the only area in which bureaucracy bred waste.
During the 32-year tenure of President Suharto, Pertamina awarded 159 contracts to companies linked to his family and cronies. These contracts were awarded without formal bidding or negotiation processes.
By some accounts, Pertamina`s insistence that operators use approved subcontractors has added as much as 20-30% to the cost of oil and gas projects.
For instance, Pertamina`s long-standing policy that it approve all major purchases made by oil companies has taken on new proportions in the face of the rupiah`s severe depreciation. "Today," said one executive, "you need permission to buy toilet paper."
An Indonesian executive at a foreign oil company added: "What we want is Pertamina off our backs so we can regain control of our businesses."
Another issue for all production-sharing contractors is personnel. Not only does Pertamina prohibit them from firing, hiring, or promoting anyone without approval, but contractors also say the state firm often applies pressure on them to replace foreign workers with Pertamina-chosen Indonesians.
One oil operator had serious problems with Pertamina that took years to resolve, brought on by the operator replacing a retiring Indonesian president-director with an overseas executive.
The new petroleum law calls for nothing short of the removal of Pertamina from the upstream sector, at least administratively. It will take away the role of managing all foreign exploration and production contractors-which account for 95% of Indonesia`s oil and gas production-and transfer it to the Ministry of Mines and Energy.
Bppka will be stripped out of Pertamina, restructured, and streamlined, and then placed within the ministry. By detaching Bppka from Pertamina and making it more transparent, the new legislation aims to vastly reduce the bureaucracy and eliminate corruption.
As stated previously, the awarding of PSCs would be the purview of the ministry, and other contract systems, such as terms of work, would be considered by it.
Outstanding issues
Not surprisingly, the goals of the new legislation give rise to a host of issues that must be resolved. For starters, in the gas industry, the manner in which the present system of subsidies is transformed into a more market-oriented, cost-price arrangement is anything but clear.
The issue has enormous political ramifications. The gas price to fertilizer producers is heavily subsidized in order to provide Indonesia`s farmers with cheap fertilizer.
In the refined products sector, subsidized diesel prices are having an adverse effect on the industry, not only in the area of domestic demand but also in natural gas use. This is because the subsidies make it far more attractive to use imported diesel, rather than natural gas, for power generation and industry use.
Removing fuel subsidies abruptly is virtually impossible, however, given Indonesia`s political and economic situation. The country has suffered greatly under the Asian economic crisis, seeing its per capita income fall to $200/year from $1,000. And the World Bank estimates that, by the end of last year, 40% of the country`s 200 million people were living below the poverty line.
Clearly, government subsidies in these situations need to be delivered. One of the major alternatives being discussed is some sort of a voucher system that could be financed through external sources and would permit market-driven pricing.
Another serious impediment to proposed reforms is how to respond to the loud and occasionally violent calls from Indonesia`s provinces for greater autonomy and a more equitable share of the benefits of oil development. Since Indonesia gained independence from the Netherlands, people in the provinces feel the central government in Jakarta has controlled the exploitation of local resources and has failed to reinvest enough of the proceeds.
The policy of managing and distributing the income derived from production-sharing contracts is an extremely sensitive issue. In the present PSC system, all production revenues go directly to Pertamina and the central government treasury. As part of the reform package, Minister Kuntoro is reportedly examining how the PSCs between the ministry and oil operators can be altered to allow for a percentage of the revenue to flow to provincial governments.
Regulating the fundamentally new industry structure is another unresolved issue. This would be done either by the Ministry of Mines and Energy or by a separate government entity.
Whichever it is, observers question whether the government has the expertise needed for sophisticated regulation and whether the salaries of the bureaucrats in charge will be high enough to prevent corruption. One of the problems with Pertamina is that the regulatory officials of the company have been hopelessly underpaid and, critic allege, have had to resort to payoffs to survive.
Prospects for reform
Intense debate surrounds the reform effort, and many long-time Indonesia-based oil executives fret that, in the new structure, one corrupt bureaucracy will merely be replaced with another. They make the point that the new law fails to address the major issues of collusion, corruption, and nepotism in any meaningful way.
Others say that getting all phases of the legislation passed and implemented will be challenging, to say the least.
For instance, with 70% of its workers in the downstream sector, Pertamina is particularly resistant to plans to deregulate refining and distribution.
The state company`s supporters are taking shelter behind a web of laws, rooted in the 1945 constitution, stipulating that Indonesia`s natural resources belong to the state and that economic areas affecting the people`s livelihood shouldn`t be in private hands. They point out that, despite Pertamina`s continued state-owned status, opening downstream industries to private-and particularly foreign-companies would violate that principle.
While the battle for oil sector reform will be grave and grand, a blow against the status quo has been struck. An independent report issued by PricewaterhouseCoopers on July 9 revealed that graft and inefficiency cost Pertamina about $6.1 billion in lost revenue during 1997 and 1998 (see Watching Government, p. 30). The funds were lost due to embezzlement, illegal commissions, mark-ups on procurement contracts, and sheer inefficiency.
Minister Kuntoro was quick to respond to the report: "I was painfully surprised to learn of the auditor`s findings. This should be taken into serious account in reforming Pertamina."
