Indonesia Oil Policy

As one of the oldest in the world, Indonesian oil in commercial quantities was discovered in northern Sumatra in 1883, leading to the establishment of the Koninklijke Nederlandsche Maatschappij tot Exploitatie van Petroleum-bronnen in NederlandschIndië (Royal Dutch Company for Exploration of Petroleum sources in the Netherlands Indies) in 1890. It was merged in 1907 with the Shell Transport and Trading Company, a British concern that had been drilling in Kalimantan since 1891, to form Royal Dutch Shell. Royal Dutch Shell dominated colonial oil exploration for more than thirty years. By 1911 Royal Dutch Shell operated concessions in Sumatra, Java, and Borneo (then called Kalimantan), and Indonesian oil which almost reached into 4 percent of total world production.

In 1950s, the post-independence government increased its control over the oil sector through increasing operations of several government-owned oil companies and stiffening the terms of contracts with foreign oil firms. As the most important oil fields in Indonesia, the Duri and Minas fields in the central Sumatran Basin, were discovered just prior to World War II by Caltex, a joint venture between the American companies Chevron and Texaco, although production did not begin until the 1950s. By 1963 the Duri and Minas oil fields, located in Riau Province near the town of Dumai, accounted for 50 percent of oil production.

In 1968 the government companies--Indonesian Oil Mining company (Pertamin), National Oil Mining Company (Permina), and the National Oil and Gas Company (Permigan)--were consolidated into a single operation, the National Oil and Natural Gas Mining Company (Pertamina). It was the time that a new form of contract--the production-sharing contract--was introduced. A production-sharing contract split total oil production between the contractor and the government, represented by Pertamina, and allowed the government to assume ownership of structures and equipment used for exploration and production within Indonesia. Indonesia's contract terms were considered among the toughest in the world in which the government in most cases receiving 85 percent of oil produced once the foreign company recovered costs.

In 1977, annual oil production in Indonesia peaked at over 600 million barrels. The official price of Minas crude was then about US$14 per barrel, a substantial rise from the 1973 price of about US$4 per barrel as a result of OPEC's successful market manipulations. Prices continued to soar in 1981, reaching US$35 per barrel, and oil exports peaked at US$15 billion, or about 70 percent of total export earnings. In 1982, however, production declined, reaching a low of 460 million barrels and the oil market began to weaken that same year, when Indonesia's Minas crude was priced at US$29. The market collapsed in 1986, bringing the Minas price to below US$10 per barrel. Recovery of oil prices began slowly and by 1989 Minas was priced at about US$18 per barrel. Total production in 1989 was almost 500 million barrels, and oil exports were valued at US$6 billion.

Indonesia's oil production was formally governed by a quota allocation from OPEC. For instance, at the March 1991 OPEC ministerial meeting, Indonesia's quota was set at 1.445 million barrels per day, below the estimation of country’s production capacity of 1.7 million barrels per day. Indonesia's quota represented about 6 percent of total OPEC production. About 70 percent of Indonesia's annual oil production was exported on average during the late 1980s, but domestic consumption was increasing steadily and reached half of annual oil production by 1990.

In 1989 and 1990, the government loosened some provisions for new contracts to stimulate exploration, particularly in frontier areas. Improved oil market conditions in the late 1980s also contributed to a surge in production-sharing contracts. Fifty-seven of the 100 contracts active in 1992 were signed from 1987 to 1991. The newer contracts committed US$2.8 billion in exploration during the 1990s. Production from existing oil fields was still dominated by Caltex's operations in Sumatra, which accounted for 47 percent of Indonesian oil production in 1990. Twenty foreign oil companies, primarily United States-based, were active producers in 1990.

In 1990, Indonesia had proven oil reserves equal to 5.14 billion barrels, with probable reserves of an additional 5.79 billion barrels. Throughout the archipelago there were sixty known basins with oil potential; only thirty-six basins had been explored and only fourteen were producing. The majority of unexplored areas were more than 200 meters beneath the surface of the sea. Indonesia's oil reserves were usually found in medium- and small-sized fields, so that continued exploration was vital to maintain production and known reserves.

During the financial crisis in 1998, prices of many commodities spiraled upward, while the government hiked the price of fuel in May 1998, by between 25 and 70 percent, on the recommendation of the IMF. The measure led to massive riots that forced the government to scale back the increases. The damage, however, was done, and the unrest helped force then president Soeharto to resign on May 21.[1] Annual inflation was estimated by the Central Statistical Bureau to be about 80% for 1998. Subsidies were removed on several goods -- most notably rice, oil and fuel. Food prices, especially staples, rose by about 20% more than the general price index, notifying that (net) food consumers were likely to be severely impacted by the crisis whereas food producers had some protection.

For the IMF’s perspective, the biggest concern was the fiscal burden of the subsidy due to oil price fluctuation. In the year 2000 the fuel subsidy amounted to 40.9 trillion rupiah, or almost a third of total central government spending. Following reform package, the government also raised fuel retail prices 126% on 1 October 2005 to reduce subsidy costs, despite public protests. The state subsidized diesel, low-octane gasoline and kerosene for household use, accounting for 80% of total demand. Fuels for industrial use were pegged to international prices. The price rose cut demand in late 2004 and in 2005. But oil demand rose again to 1.2m b/d in 2007. The state had managed to keep oil demand limited to about 1.2m b/d.


While it produces significant amounts of oil, Indonesia became a net importer. State subsidies had kept the price of fuel low—currently petrol is 24 US cents a liter. Cutback in subsidies directly increased the price of transportation and kerosene, which was widely used by the poor for cooking. Over 40 million people in Indonesia lived on less than $US2 a day and over 17 percent of the workforce lack full-time jobs. The rapid increase in global oil prices worsened the government’s financial problems. The cost of state fuel subsidies was expected to rise from $US6.31 billion in 2004 to $US14 billion in 2005, or one third of all government expenditures. As a result, the budget deficit was rising to around $US4.3 billion, double the estimate in mid August. The added cost of buying imported oil had also contributed to the fall of the rupiah as state oil companies, including Pertamina, which had to purchase extra US dollars. Oil imports cost $US1.6 billion in July 2005, up from $US1.1 billion in January 2005.

In September 2008, Indonesia decided to resign from OPEC, because declining production had caused it to become a net importer. The decision was not unexpected, since Indonesia's production - largely concentrated in northern Sumatra - had stagnated and it has precious few sources of proven new reserves. In 2008, Indonesia was producing about 860,000 barrels of oil a day. For the coming years, the government aimed to reduce oil share in the national energy mix from 52% to about 20% in 2025. It needs to increase the percentage of gas, coal, and renewable energy for domestic consumption. The share for gas was projected to reach 30%, coal 33%, and renewable energy 17% by 2025. Bio-fuels will account for 5% of renewable energy share, while geo-thermals will share 5%, liquefied coal 2%, and other renewable energies up to 5%.

On October 5, 2005, widespread but relatively small demonstrations followed the announcement last Friday by the government of Indonesian President Susilo Bambang Yudhoyono of sharp rose in the price of petrol, diesel and kerosene. It was just a year after former general Susilo Bambang Yudhoyono won the Indonesian presidential election, skyrocketing global oil prices are compounding the country’s economic difficulties and placing his administration under serious political strain. The price of petrol rose 87.5 percent to 4,500 rupiah (44 US cents) a liter, diesel fuel 105 percent to 4,300 rupiah and kerosene, on which the poor depend for cooking, a huge 186 percent to 2,000 rupiah.

The price hike flows from the government’s recent decision to cap the country’s oil price subsidy at $US8.68 billion for 2005. A combination of high international oil prices, growing domestic demand, increasing oil imports and declining domestic oil production, due to low levels of investment, threatened to blow the subsidy out to $US14 billion. This would have more than doubled the 2004 figure and swallowed a third of government spending, creating a fiscal crisis.
In mid-2008 a surge in oil prices to records above $145/b forced the government to raise fuel costs to prevent ballooning subsidy bills from blowing up their budgets. That unleashed a wave of protests from Seoul to Jakarta and enflamed opposition parties throughout the region.[2] So when oil markets retreated to a four-year low of the $40s in early of 2009, governments seized the opportunity to pass on the cuts.

[1] Jakarta Post, 12/11/1999.
[2] Elections in Indonesia (as well as in India the year of 2009 and pending leadership change in Malaysia will make Asian leaders reluctant to risk fundamental moves to bring higher efficiency, but could be hard to reverse.