Indonesia Attempts to Improve Energy Security

14 March 2012 FDI Team

Background

Indonesia is an increasingly important member of the “Asian tiger economies”; with a six per cent growth rate in 2011, it has grown to be the largest economy in South-East Asia. In January 2012, that status was further bolstered as credit agencies raised Indonesia’s credit rating to investment grade for the first time since the 1998 Asian Financial Crisis. Significant obstacles remain, however, that may derail economic progress. Recognising this, in early March, Jakarta tasked the National Emergency Council with developing a long-term strategic energy plan. Primarily, the Council must address subsidy issues, dependence on carbon-based fuels and deteriorating downstream infrastructure. Failure to develop a more nuanced policy will have broad social, political and economic implications. 

Comment

The Indonesian economy is undergoing significant structural changes. Driven by President Susilo Bambang Yudhoyono (SBY), the government hopes to move away from being an exporter of primary goods to exporting processed products, simultaneously driving greater domestic consumption. Signalling this intent, addressing the plenary session of the National Emergency Council, SBY urged the Council to develop rigorous policies to foster energy security. Comprising government representatives and energy sector stakeholders, the body is to consider not simply short-term energy policies, but medium to long-term solutions to improve energy security.  

Indonesia is rich in hydrocarbon reserves, with an estimated 4.2 billion barrels of oil and 3.1 trillion cubic metres of natural gas. Despite this, however, the state faces significant challenges to its domestic, medium- and long-term energy security.

Historically a net exporter, Indonesia’s growing middle class is driving energy demand, with oil consumption rising four per cent annually. Since 2004, this has resulted in the state becoming a net energy importer, for both refined and crude oil products. In 2008, as further testament to the decline of the sector, citing its dependence on energy imports and disagreements on quota ratios, Indonesia resigned its OPEC membership.

Arguably, government-sanctioned fuel subsidies provide the catalyst for Indonesian energy insecurity. Adopted during the era of former President Suharto, the subsidies attempted to reduce consumer costs, and, ultimately, facilitate economic growth. Yet, as energy demand has increased the subsidies have become a growing budgetary burden, accounting for 38 per cent of the national budget; in 2011, they were the single-largest item of government expenditure. This has resulted in an ever-increasing budget deficit, diverting government resources from investment in energy infrastructure, particularly in the declining domestic refining capacity. STRATFOR notes, however, that cutting the subsidy may create social and political instability. During the 1998 Asian Financial Crisis, on advice from external creditors, President Suharto raised oil prices, ultimately a contributing factor to his demise. More recently, attempts by SBY to raise prices by 30 per cent met with mass riots and protests. The comparatively low cost of Indonesian fuel also generates security concerns, with low-level threats from organised smuggling groups operating in the Sulu and Celebes Seas, the porous tri-border sea area between Indonesia, Malaysia and the Philippines. 

The carbon intensity of Indonesia’s energy supply creates additional challenges for the nation’s energy security. In the near future, hydrocarbons are likely to continue to provide the bulk of Indonesia’s energy mix. Parallel to this, however, domestic oil production will continue to decline. To meet demand, therefore, Indonesia will need to increase oil imports from African and Middle Eastern markets. Accompanying this, however, is an increased vulnerability to geopolitical shocks, as demonstrated by the current uncertainty in Yemen, Iran, Nigeria and Syria. To decrease exposure to price fluctuations and the market volatility of foreign oil supplies, Indonesia may engage in an exploration policy. Surveys in the Sulu Archipelago and the Mindanao and Sulawesi Islands, may create tension due to ill-defined national jurisdictions in the tri-border area.

Reliance on hydrocarbons also brings concerns over pollution and greenhouse gases. Increasing emissions may see Indonesia targeted by international pressure to resolve excessive carbon levels, comparable to the current lobbying against China and India. Domestically, continued reliance on oil and gas will exacerbate already heavy pollution levels in major cities, such as Jakarta. 

Indonesia faces the additional challenge of insufficient and deteriorating energy infrastructure. Its domestic refining capacity is stifled by ageing facilities and unreliable distribution systems. Enhancing downstream energy infrastructure would reduce operating costs and simultaneously serve to improve environmental standards. Yet, as the Indonesian budget deficit grows, government resources will continue to focus on subsidies, fostering a vicious cycle of artificially large supply and demand. Jakarta should seek to create synergies with countries that receive Indonesian oil, such as China, Japan and South Korea. It is a win-win situation for these states to invest in augmenting Indonesia’s downstream capacity, particularly in production and processing. 

The National Emergency Council’s policy should consider a long-term, comprehensive, energy framework, with a particular focus on strengthening supply and co-ordination. To achieve this, Jakarta should consider investing in a renewable energy portfolio for a portion of its energy supply. This will lessen exposure to foreign oil markets and improve current environmental issues. Critical energy infrastructure requires significant investment as a matter of some urgency. Strategies to engage regional countries have the potential to reduce prohibitive capital costs. Additionally, energy diplomacy may provide opportunities for technology transfer, to improve the performance of current facilities. 

Given the central role of energy in Indonesia’s political and economic stability, the Council must implement a well-developed and action-based energy policy. Failure to do so could result in dire consequences for Indonesia, and for Jakarta’s economic aspirations to become a central figure in the Asian tiger economies.

Liam McHugh

Manager

Northern Australia & Energy Security Research Programmes

[email protected]

 

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