Indonesia: Rich Potential For Downstream Entry

Like companies in many other industries, IOCs are clamoring to enter the markets of Asia's two emerging giants, China and India. However, staggering reforms mean India remains a largely closed market, while entry to China is highly restricted and closely guarded by state-owned companies with their own interests. In both these markets, international players looking to enter the downstream oil sector will face a potentially long and arduous journey to realize returns on their investments.

Lost in this rush are the opportunities offered by what is arguably Asia's third emerging giant, Indonesia. Already the fifth-largest economy in the region, Indonesia is a growing market, with a young and expanding population of over 230 million, a burgeoning middle class, and rapidly rising energy requirements which are forcing the country's once-monopolized oil sector to open up to international investment and competition.

2005 saw the beginning of deregulation, aimed at reducing the role of Pertamina, the NOC, to "just another competitor" and ending its monopoly in downstream oil processing, logistics, storage, and marketing. All branches of Indonesia's downstream sector have experienced years of underinvestment under Pertamina's monopoly, and are ripe for inputs of foreign capital and expertise. Although the political climate for foreign investment is increasingly promising, in practice corruption, bureaucratic inertia and local realities will make entry less straightforward. This means practical operational expertise and localized knowledge will be crucial to success in this market.

Underinvestment in refining capacity saw Indonesia fall into a net oil product deficit in 1999, and imports have risen to over 400 tb/d, or some 31% of total supply. Despite plans to expand refining capacity, Indonesia will remain an overall importer, justifying greater foreign participation and providing ample opportunities for integrated downstream positions by foreign players. Both the government and Pertamina have actively been seeking finance and technology for inefficient domestic refineries, and a strategic alliance with Pertamina would allow a foreign partner to gain strong leverage to establish an integrated presence in refining, distribution, and retail.

Currently, foreign participation in fuel retailing is limited to unsubsidized, high-octane premium fuels, which make up only about 5% of the total market. Despite this restriction, foreign players are able to target a niche segment with strong brand and quality values, though securing suitable retail sites will be tough in the face of Pertamina's dominant position and entrenched network of dealer and supply contacts.

Fuel subsidies remain a significant barrier to foreign retail entry, with currently only Pertamina holding rights to sell subsidized fuel. However, with oil revenues accounting for about a quarter of state revenue, steadily declining crude production and rising oil product consumption make fuel subsidies increasingly unsustainable, and repeal inevitable.

Despite the increasingly favorable climate for investment, pitfalls remain. Indonesia is a melting pot of cultural and linguistic groups, and a complex diversity of political and economic conditions. Post-Suharto, the country has made great strides towards becoming a functioning democracy, but effective governance remains hobbled by a balkanized party system, corruption, regional, and ethnic tensions, as well as the ongoing threat of religious extremism.

Therefore, foreign players must factor on-the-ground complexities and localized risks when formulating their strategic position in the downstream sector. Ongoing reform and the creation of a more level playing field between Pertamina and foreign competitors are a boon to foreign players, but the issues of subsidies, bureaucratic red tape, and securing viable retail sites will remain hurdles. However, the sheer size of its population, the growing economy and upward trajectory of demand factors make Indonesia a market surpassed only by China and India in Asia in terms of scale and establishing a strategic position in downstream. As Indonesia's energy needs will lead to greater deregulation, international players able to position themselves effectively in this market will stand to reap the rewards.

Key Conclusions:

Indonesia offers the scale and growth potential to international downstream players who seek new opportunities.

Deregulation of the refining and marketing sector paves the way for foreign players to either compete or partner with Pertamina.

Hurdles remain in the form of ongoing subsidies, bureaucratic red tape, and securing viable retail sites, although there are options to develop a targeted regional strategy.

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Bakhtiar Talhah is a Director and Head of the Asian Downstream Practice based in Kuala Lumpur, which houses PFC Energy's expertise in regional and competitive analysis for the downstream oil sector. For further information on this article contact Enews_btalhah@pfcenergy.com.