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Lower oil prices create challenges, opportunities for government
When President Joko âJokowiâ Widodo was sworn in as Indonesiaâs seventh president on Oct
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hen President Joko 'Jokowi' Widodo was sworn in as Indonesia's seventh president on Oct. 20, 2014, Brent crude oil traded at US$85 per barrel and experts worldwide asked 'how low can it go?' Five months later, prices stand around $55, with analysts divided over recovery prospects.
What does this mean for Indonesia's efforts at petroleum sector reform? Looking at Indonesia in the light of broader trends worldwide generates answers variously troubling and encouraging.
The price drop poses steep challenges for Indonesia's 'upstream' ' the identification and extraction of hydrocarbon deposits ' and may have harsh effects on government budgets in petroleum-rich localities.
At the same time, the drop strengthens incentives for reform that can confer longer-term economic benefits.
On balance, the fiscal pain caused by the decline will not be as severe for Indonesia as for the likes of Venezuela or Russia, where government budgets are extremely dependent upon petroleum revenues. (Indonesia derived a reasonable 20 percent of public revenues from oil in 2014.) And much of the reduction in these revenues may be offset by savings to be gained from reducing outlays on fuel subsidies.
But the pain of revenue reductions will not be equally borne by all Indonesians. Indonesia's decentralized distribution of oil revenues means that some subnational governments, many of them excessively dependent on petroleum revenues, face a rude awakening. The provincial government of East Kalimantan derives more than 50 percent of its revenues from oil and gas.
The district government of Bojonegoro in East Java expects revenue transfers from the central government to be 63 percent lower this year than originally projected.
Jokowi came to office seeking to revitalize investment in exploration, with the aim of staving off large declines in reserves and production. Even during the 2004-2013 boom, with countries worldwide ramping up exploration and production to take advantage of high prices, Indonesia's efforts to replace aging fields stalled, with production falling by 22 percent and reserves by 13 percent.
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State companies like Pertamina find themselves with reduced access to credit, and on less attractive terms.
The government's multifaceted strategy for increasing investment ' attracting greater interest from international companies by streamlining procedures while simultaneously increasing state operator Pertamina's share of the domestic market ' would have been a tightrope walk under any circumstances. With the drop in prices, a successful reinvigoration in the near term is virtually impossible.
A recent Wall Street Journal survey of economic forecasters indicated that the downturn has already substantially impacted petroleum sector capital expenditure worldwide, with a further 'sharp pullback' expected throughout 2015. Such cuts have a particular impact on exploration and development of new projects.
Within this global context, the projection by the Indonesian Petroleum Association that capital expenditure by contractors will decline by 20 percent in 2015 should come as no surprise. Nor should Pertamina's plan to cut capital expenditure by almost 50 percent, pulling back dramatically on earlier plans for expansion.
Access to financing has tightened across the world, and as the perception of risk in the industry grows, state companies like Pertamina find themselves with reduced access to credit, and on less attractive terms.
The impact of this delay in investment will not be felt by most Indonesians today, since new investments in exploration were unlikely to produce immediate fiscal gains. Rather, they will have an impact over time, making it that much harder for the country to develop anytime soon the new fields that would reverse the production decline.
Despite the negative impact on investment in Indonesia's upstream oil sector, many analysts, including those at the Wall Street Journal and Moody's, suggest that on balance the near-term impact of the price drop on the country's economy will be marginally positive.
The biggest reason for this is that Indonesia uses more oil and gas than it produces, so lower prices confer a net benefit. It will benefit Indonesian firms that rely heavily on fuel imports, at least partially offsetting the impacts of the depreciating rupiah on the cost of other imported inputs.
More significantly, the drop provides Jokowi's government with the opportunity to remove costly subsidies from the fiscal ledger while minimizing short-term harm to consumers.
The long-term potential benefits of subsidy reform are well documented. Subsidies have devoured as much as 21 percent of the national budget in recent years. Dramatically reducing them will free up substantial funds to invest in priority sectors that can promote long-term growth instead of consumption.
The government has already begun to pursue such a shift, as seen in the proposal to double capital expenditure in the 2015 budget. By improving perceptions of the country's fiscal sustainability, the reforms can contribute to improved investor perceptions, as evidenced by the speculation that Standard & Poor's may give Indonesia an investment-grade credit rating.
Even within the oil and gas sector, the downturn creates incentives for reform that can benefit Indonesia in the long term. New constraints on access to capital increase the pressure on Pertamina and other state companies to improve corporate governance and clear balance sheets of costly non-core assets if they want to convince markets of their credit-worthiness.
Today's market forces also intensify the need for Indonesia to clarify procedures and implement real institutional reform with respect to international companies. Confusion around the fate of SKK Migas and the future of Indonesia's upstream contract regime have clouded the industry for years.
The price drop brings the urgency for reform into sharper relief. And steps by the government to remove redundancies, increase accountability and consistently enforce conflict-of-interest protections would have effects that last beyond the downturn. Progress on the long-delayed changes to the Oil and Gas Law would provide a platform for these critical institutional reforms.
Finally, the new landscape requires better communication from the government to the Indonesian people. Indonesia was suspended last month by the Extractive Industries Transparency Initiative (EITI) for persistent delays and inconsistencies in publishing reports.
Resolving those problems and vigorously implementing EITI is a important step. Generally, developing better platforms for consistent, two-way communication around the sector is more critical now than ever.
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Emanuel Bria is the Asia Pacific senior officer at the Natural Resource Governance Institute (NRGI) and Patrick Heller is NRGI's director of legal and economic programs.
