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Fueling Indonesians: Window of Opportunity or Regret? Kerosene is widely used as cooking fuel by Indonesian...

Fueling Indonesians:
Window of Opportunity or Regret?
Kerosene is widely used as cooking fuel by Indonesian households, with an annual usage of 10 million Kiloliters. It is a major subsidized fuel for household cooking, where its usage is over sixty percent of the 230 million population. The subsidy program costs the government heavily, where it amounts up to U.S.$4 billion a year. As the practice tends to bleed government expenditures quite heavily, the Indonesian government is embarking on a change in its current fuel subsidy involving kerosene. This is also due to the erratic price of crude oil, rampant smuggling of kerosene to unsubsidized markets, and rapidly increasing reported incidents of domestic fires triggered by kerosene. As a solution, the government decided that liquefied petroleum (LPG) would be used to replace kerosene. Though it is more expensive as compared to kerosene, LPG is efficient to use and manage. The Indonesian government is aware that many poor households would not be able to afford the required capital investment. The startup costs of buying a stove and paying a deposit for a fuel canister represents a serious barrier for many households.
Therefore, to encourage conversion, the Indonesian government will give each household a free stove, an LPG cylinder, and a first consignment of LPG, in addition to subsidizing the 3kg cylinders LPG. As the demand for LPG is expected to rise dramatically, Indonesian’s National Oil Company (PERRTAMINA) has declared that it is not capable of meeting the market demand, which is expected at two million tons annually. Hence, the government is inviting foreign oil companies to venture into Indonesia’s LPG market either as wholesalers or retailers – breaking PERTAMINA’s monopoly of the fuel market.
The government announcement, however, was received with absolute resentment from the public. Demonstrations were organized and people marched into the streets voicing their anger. Many were concerned about affordability and availability, as existing LPG supply is both expensive and limited, in addition to the potential loss of income of current sundry shops (sundry shops make up 90 percent of the kerosene distribution network). Others were worried about the potential change of lifestyle while a few claimed that food would never taste the same again.
The announcement, however, was anticipated by the foreign oil players considering the advancement of fuel consumption. Nevertheless, they were surprised with the government’s aim of converting the current usage of kerosene to LPG in less than a year. It simply seems an impossible task to convert a population of 230 million –70 percent of whom have below-average national income – to a new product. Following this announcement, Blue Oil immediately called for an urgent meeting at its Indonesian office in Jakarta to discuss the Blue Gas potential entry into Indonesia LPG market. Blue Gas is the leading global player for LPG, with market presence in 80 countries. The parent company of Blue Gas, Blue Oil, has already established a foothold in Indonesia in the Retail Service Station and Lubricants market. Vice President of Blue Gas, John Baily, Chairman of Blue Indonesia, Rodgier Van Cux, General Manager of Blue Gas – Southeast Asia, Johan Selleh, and Vice President of Corporate Communication-Blue Indonesia, Rudy Harianto, were huddled in an intense discussion.
“Surely you gentlemen agree that there is a strong business for Blue Gas to enter the Indonesian LPG market now,” said Rodgier Van Cux, who was eager to seize an opportunity of expanding Blue Group presence in Indonesia. “For years, Indonesia’s LPG market was monopolized by PERTAMINA. Foreign oil companies that attempted to enter the market faced government bureaucracy, hostile market conditions, and unprofitable return on investment. Now the window of opportunity opens by the invitation itself. Two million tons of annual market demand is too big of an opportunity to pass by. The demand is also the third largest after China and India,” he commented.
To further demonstrate his points, Rodgier read aloud the preliminary report on Indonesia’s LPG market. Indonesia houses a massive opportunity in an untapped LPG market. Armed with a population of 230 million and a steady growth of GDP, averaging 4.5 percent annually, it promises a huge market of LPG in Asia along with China and India. Under the leadership of the sixth president, Susilo Bambang Yudhoyona, Indonesia achieved credible economic growth over the backdrop of a stable political climate. Despite a market previously monopolized by PERTANIMA, LPG penetration in Indonesia is merely 15 percent, compared to neighboring countries that are 95 percent in Malaysia, 80 percent in Thailand, and 65 percent in the Philippines.
“There are a few fundamental factors at both the macro and micro level that need to be sorted out,” Johan pointed out. “Our experience of new entries in countries like China and India taught us to be extra vigilant in injecting capital investment without adequately anticipating what the end game would be,” he added.
Johan argued about the risk that the company would have to bear as he said, “The first factor is on subsidy; it appears that the government’s motive to retrieve subsidy from kerosene was primarily driven to curb high product cost and smuggling. What will happen when the reverse trend occurs? I mean when the LPG base price is higher than kerosene? Will the government then reverse its policy when we have already invested millions of dollars in capital?”
At present, the government-set LPG cylinder price in Indonesia is around U.S. 0.45 per kg (U.S.$450 per ton) against an indicated full-cost price in relation to market LPG prices of USD0.99 per keg (US$990 per ton). This is a huge differential to subsidize, particularly as much of the LPG demand growth in the future will be supported by LPG imports, where Indonesia—specifically PERTAMINA-has to pay the full international market price. For instance, their most recent LPG import tender into Tanjung Uban for redistribution elsewhere in Indonesia saw PERTAMINA paying December CP plus US$0.60 per ton for CFR delivery. The subsidy cost that PERTAMINA will bear is estimated at US$345 million in 2008 and could rise to US$1.8 million in 2012.
“I believe with the elections looming in 2009 and the Government awareness of the potential risk of social unrest in Jakarta and elsewhere, there would not be any major hike in LPG cylinder prices by the Government. However, what happens after that remains concern,” said Johan.
Johan continued, “The second factor is the uncertainty of a level playing field in Indonesia. Whether licenses issued will be fluid to foreign oil companies or whether there are restrictions of trade area and segments, etc. It is unlikely that PERTAMINA will allow its existing market share to erode with this invitation of entry to foreign oil companies. The government will likely devise some mechanism to protect the National Oil Company. Here the government’s transparency is imperative,” worried Johan.
“What would like be the protection mechanisms available to the government?” asked John.
“Well, quite a few actually,” replied Johan. “To start with, the government could restrict the area on trade on the foreign oil companies. It is generally known that the Island of Java houses 50 percent of population and that’s where the bulk of demand is. It is also by far the most developed area in terms of logistics. Government may opt to restrict foreign oil companies to trade into Java Island and only permit trade on the rest of the islands like Sumatra, Kalimantan, Sulawesi, etc. That will pave the way for PERTAMINA to maximize its profit on existing infrastructure, while the foreign companies struggle to build infrastructures that translate to lower and longer return on investment.”
“Can we seek confirmation on these potential implementations of restrictions before we decide to invest?” questioned John.
“We could, and even with the government assurance, there are risks that the policy changes when the new government is elected every four years. The sentiment of nationalism is high in Indonesia, thus issues like this will likely surface to win votes and support from the public,” replied Johan.
“On the micro perspective, we have to be careful which segment we choose to invest in,” Johan added. “There are two segments currently existing in Indonesia: 3kgh market, which is fully subsidized by the government and very popular, and the 12 kg market, which is not subsidized and is unregulated, where suppliers are free to position their price and is currently only targeted to the higher income group,” he claimed. “The factor to consider is that the 3kg cylinders are not a standard Blue Gas package anywhere in the global market. Thus we could not be able leverage on economies of scale if we need to adapt to this demand, if we ask for our cylinder manufacturers to change their design, the plant carousel will need to be fitted with non-standard injection capacity and the whole R&D cost will increase to analyze the safety issues and enhancement related to the 3kg cylinders,” he asserted.
“There is also the factor of imminent change of consumer preference in the future. The tendency is for the consumer to opt for a bigger package size once the domestic income improves. Our experience in China, India and even Malaysia proved the theory of evolving customer demand,” John added.
“In addition to that, there are no guarantees that government will continue to subsidize the 3kg market in the future. The motivation of subsidy is clear for now to promote the conversion of the public from kerosene to LPG. Without the subsidy, no conversion can take place without triggering public anger,” stated Rudy. “How the subsidy policy evolves beyond then is unknown. Should the government decide to discontinue the LPG subsidy, will consumer revert back to their old cooking fuel or look for new alternatives or substitutes?”
“So if we can put this into future perspective, should the subsidy no longer exist? There is little to differentiate on per kg basis between 3kg and 12 kg. Consumers will soon realize that 12kg cylinder, though they have to fork out more money for them, are more convenient as they eliminate the hassle of frequent replenishment (it is estimated that 3kg cylinder could last a work on normal cooking consumption),” stated Johan. “Are we then barking up the wrong tree, and should we focus our entry into the 3kg market now even though the demand is enormous?”
“May I add that there is also the nagging issue of the timing of subsidy repayment from government,” added Johan. “It is easy to assume that the preference of timely payment will be at PERTAMINA advantage. We need to be prepared to have a huge cash flow locked in Indonesia should the subsidy repayment be perpetually delayed.”
“But it doesn’t make sense for us to limit ourselves only to the 12kg market” said Rodgier in response. “To start with, the demand of the 12kg market is very small as compared to 3kg, thus we will not achieve the volume to satisfy our appetite. Secondly, the government may find that Blue Gas’s proposal to limit to the 12kg market as unattractive, as they are focused on tackling the conversion mode which is targeted primarily on the lower income group. Thirdly, there is no guarantee that PERTANIMA will allow us to enter into the lucrative 12kg market without sharing the pain on the investment of 3kg market,” added Rodgier.
“There is also one final factor that needs to be sorted out,” said Johan. “We need to decide whether we should explore this entry independently or with other counterparts. In order to be a sustainable player in Indonesia, we must absolute control over supply and not depend on third-party supply.” (Depending on third-party sources would mean that product price would be dictated by the third party with absolutely no reliability of supply.) “An investment of an important terminal is huge, at USD250 million. To mitigate such exposure we should consider the opportunity of joint venture with a local payer, preferably a reputable one with strong financial standings and good government contacts that we can leverage,” suggested Johan.
“Well, gentleman, the issues are a lot more challenging than we expected. Anyway, let’s recap our action points and agree on the timeline,” said John. “We do not really have the luxury of time here, as the government of Indonesia is expecting a preliminary reply on our interest. Other players will have similar interests in this market, and a first-mover advantage will bring some credibility to our proposal,” he added.
The group agreed to meet in two weeks’ time to finalize the proposal to the Blue Gas Investment Board. Would this be a successful opportunity or a regretted entry in the making?

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Expert Solution

Fueling Indonesians:
Window of Opportunity or Regret?
Kerosene is widely used as cooking fuel by Indonesian households, with an annual usage of 10 million Kiloliters. It is a major subsidized fuel for household cooking, where its usage is over sixty percent of the 230 million population. The subsidy program costs the government heavily, where it amounts up to U.S.$4 billion a year. As the practice tends to bleed government expenditures quite heavily, the Indonesian government is embarking on a change in its current fuel subsidy involving kerosene. This is also due to the erratic price of crude oil, rampant smuggling of kerosene to unsubsidized markets, and rapidly increasing reported incidents of domestic fires triggered by kerosene. As a solution, the government decided that liquefied petroleum (LPG) would be used to replace kerosene. Though it is more expensive as compared to kerosene, LPG is efficient to use and manage. The Indonesian government is aware that many poor households would not be able to afford the required capital investment. The startup costs of buying a stove and paying a deposit for a fuel canister represents a serious barrier for many households.
Therefore, to encourage conversion, the Indonesian government will give each household a free stove, an LPG cylinder, and a first consignment of LPG, in addition to subsidizing the 3kg cylinders LPG. As the demand for LPG is expected to rise dramatically, Indonesian’s National Oil Company (PERRTAMINA) has declared that it is not capable of meeting the market demand, which is expected at two million tons annually. Hence, the government is inviting foreign oil companies to venture into Indonesia’s LPG market either as wholesalers or retailers – breaking PERTAMINA’s monopoly of the fuel market.
The government announcement, however, was received with absolute resentment from the public. Demonstrations were organized and people marched into the streets voicing their anger. Many were concerned about affordability and availability, as existing LPG supply is both expensive and limited, in addition to the potential loss of income of current sundry shops (sundry shops make up 90 percent of the kerosene distribution network). Others were worried about the potential change of lifestyle while a few claimed that food would never taste the same again.
The announcement, however, was anticipated by the foreign oil players considering the advancement of fuel consumption. Nevertheless, they were surprised with the government’s aim of converting the current usage of kerosene to LPG in less than a year. It simply seems an impossible task to convert a population of 230 million –70 percent of whom have below-average national income – to a new product. Following this announcement, Blue Oil immediately called for an urgent meeting at its Indonesian office in Jakarta to discuss the Blue Gas potential entry into Indonesia LPG market. Blue Gas is the leading global player for LPG, with market presence in 80 countries. The parent company of Blue Gas, Blue Oil, has already established a foothold in Indonesia in the Retail Service Station and Lubricants market. Vice President of Blue Gas, John Baily, Chairman of Blue Indonesia, Rodgier Van Cux, General Manager of Blue Gas – Southeast Asia, Johan Selleh, and Vice President of Corporate Communication-Blue Indonesia, Rudy Harianto, were huddled in an intense discussion.
“Surely you gentlemen agree that there is a strong business for Blue Gas to enter the Indonesian LPG market now,” said Rodgier Van Cux, who was eager to seize an opportunity of expanding Blue Group presence in Indonesia. “For years, Indonesia’s LPG market was monopolized by PERTAMINA. Foreign oil companies that attempted to enter the market faced government bureaucracy, hostile market conditions, and unprofitable return on investment. Now the window of opportunity opens by the invitation itself. Two million tons of annual market demand is too big of an opportunity to pass by. The demand is also the third largest after China and India,” he commented.
To further demonstrate his points, Rodgier read aloud the preliminary report on Indonesia’s LPG market. Indonesia houses a massive opportunity in an untapped LPG market. Armed with a population of 230 million and a steady growth of GDP, averaging 4.5 percent annually, it promises a huge market of LPG in Asia along with China and India. Under the leadership of the sixth president, Susilo Bambang Yudhoyona, Indonesia achieved credible economic growth over the backdrop of a stable political climate. Despite a market previously monopolized by PERTANIMA, LPG penetration in Indonesia is merely 15 percent, compared to neighboring countries that are 95 percent in Malaysia, 80 percent in Thailand, and 65 percent in the Philippines.
“There are a few fundamental factors at both the macro and micro level that need to be sorted out,” Johan pointed out. “Our experience of new entries in countries like China and India taught us to be extra vigilant in injecting capital investment without adequately anticipating what the end game would be,” he added.
Johan argued about the risk that the company would have to bear as he said, “The first factor is on subsidy; it appears that the government’s motive to retrieve subsidy from kerosene was primarily driven to curb high product cost and smuggling. What will happen when the reverse trend occurs? I mean when the LPG base price is higher than kerosene? Will the government then reverse its policy when we have already invested millions of dollars in capital?”
At present, the government-set LPG cylinder price in Indonesia is around U.S. 0.45 per kg (U.S.$450 per ton) against an indicated full-cost price in relation to market LPG prices of USD0.99 per keg (US$990 per ton). This is a huge differential to subsidize, particularly as much of the LPG demand growth in the future will be supported by LPG imports, where Indonesia—specifically PERTAMINA-has to pay the full international market price. For instance, their most recent LPG import tender into Tanjung Uban for redistribution elsewhere in Indonesia saw PERTAMINA paying December CP plus US$0.60 per ton for CFR delivery. The subsidy cost that PERTAMINA will bear is estimated at US$345 million in 2008 and could rise to US$1.8 million in 2012.
“I believe with the elections looming in 2009 and the Government awareness of the potential risk of social unrest in Jakarta and elsewhere, there would not be any major hike in LPG cylinder prices by the Government. However, what happens after that remains concern,” said Johan.
Johan continued, “The second factor is the uncertainty of a level playing field in Indonesia. Whether licenses issued will be fluid to foreign oil companies or whether there are restrictions of trade area and segments, etc. It is unlikely that PERTAMINA will allow its existing market share to erode with this invitation of entry to foreign oil companies. The government will likely devise some mechanism to protect the National Oil Company. Here the government’s transparency is imperative,” worried Johan.
“What would like be the protection mechanisms available to the government?” asked John.
“Well, quite a few actually,” replied Johan. “To start with, the government could restrict the area on trade on the foreign oil companies. It is generally known that the Island of Java houses 50 percent of population and that’s where the bulk of demand is. It is also by far the most developed area in terms of logistics. Government may opt to restrict foreign oil companies to trade into Java Island and only permit trade on the rest of the islands like Sumatra, Kalimantan, Sulawesi, etc. That will pave the way for PERTAMINA to maximize its profit on existing infrastructure, while the foreign companies struggle to build infrastructures that translate to lower and longer return on investment.”
“Can we seek confirmation on these potential implementations of restrictions before we decide to invest?” questioned John.
“We could, and even with the government assurance, there are risks that the policy changes when the new government is elected every four years. The sentiment of nationalism is high in Indonesia, thus issues like this will likely surface to win votes and support from the public,” replied Johan.
“On the micro perspective, we have to be careful which segment we choose to invest in,” Johan added. “There are two segments currently existing in Indonesia: 3kgh market, which is fully subsidized by the government and very popular, and the 12 kg market, which is not subsidized and is unregulated, where suppliers are free to position their price and is currently only targeted to the higher income group,” he claimed. “The factor to consider is that the 3kg cylinders are not a standard Blue Gas package anywhere in the global market. Thus we could not be able leverage on economies of scale if we need to adapt to this demand, if we ask for our cylinder manufacturers to change their design, the plant carousel will need to be fitted with non-standard injection capacity and the whole R&D cost will increase to analyze the safety issues and enhancement related to the 3kg cylinders,” he asserted.
“There is also the factor of imminent change of consumer preference in the future. The tendency is for the consumer to opt for a bigger package size once the domestic income improves. Our experience in China, India and even Malaysia proved the theory of evolving customer demand,” John added.
“In addition to that, there are no guarantees that government will continue to subsidize the 3kg market in the future. The motivation of subsidy is clear for now to promote the conversion of the public from kerosene to LPG. Without the subsidy, no conversion can take place without triggering public anger,” stated Rudy. “How the subsidy policy evolves beyond then is unknown. Should the government decide to discontinue the LPG subsidy, will consumer revert back to their old cooking fuel or look for new alternatives or substitutes?”
“So if we can put this into future perspective, should the subsidy no longer exist? There is little to differentiate on per kg basis between 3kg and 12 kg. Consumers will soon realize that 12kg cylinder, though they have to fork out more money for them, are more convenient as they eliminate the hassle of frequent replenishment (it is estimated that 3kg cylinder could last a work on normal cooking consumption),” stated Johan. “Are we then barking up the wrong tree, and should we focus our entry into the 3kg market now even though the demand is enormous?”
“May I add that there is also the nagging issue of the timing of subsidy repayment from government,” added Johan. “It is easy to assume that the preference of timely payment will be at PERTAMINA advantage. We need to be prepared to have a huge cash flow locked in Indonesia should the subsidy repayment be perpetually delayed.”
“But it doesn’t make sense for us to limit ourselves only to the 12kg market” said Rodgier in response. “To start with, the demand of the 12kg market is very small as compared to 3kg, thus we will not achieve the volume to satisfy our appetite. Secondly, the government may find that Blue Gas’s proposal to limit to the 12kg market as unattractive, as they are focused on tackling the conversion mode which is targeted primarily on the lower income group. Thirdly, there is no guarantee that PERTANIMA will allow us to enter into the lucrative 12kg market without sharing the pain on the investment of 3kg market,” added Rodgier.
“There is also one final factor that needs to be sorted out,” said Johan. “We need to decide whether we should explore this entry independently or with other counterparts. In order to be a sustainable player in Indonesia, we must absolute control over supply and not depend on third-party supply.” (Depending on third-party sources would mean that product price would be dictated by the third party with absolutely no reliability of supply.) “An investment of an important terminal is huge, at USD250 million. To mitigate such exposure we should consider the opportunity of joint venture with a local payer, preferably a reputable one with strong financial standings and good government contacts that we can leverage,” suggested Johan.
“Well, gentleman, the issues are a lot more challenging than we expected. Anyway, let’s recap our action points and agree on the timeline,” said John. “We do not really have the luxury of time here, as the government of Indonesia is expecting a preliminary reply on our interest. Other players will have similar interests in this market, and a first-mover advantage will bring some credibility to our proposal,” he added.
The group agreed to meet in two weeks’ time to finalize the proposal to the Blue Gas Investment Board. Would this be a successful opportunity or a regretted entry in the making?

ANSWER:this be a successful opportunity


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Fueling Indonesians: Is this a Window of Opportunity or Regret? Why? Please describe in detain to...
Fueling Indonesians: Is this a Window of Opportunity or Regret? Why? Please describe in detain to support your answer. Kerosene is widely used as cooking fuel by Indonesian households, with an annual usage of 10 million Kiloliters. It is a major subsidized fuel for household cooking, where its usage is over sixty percent of the 230 million population. The subsidy program costs the government heavily, where it amounts up to U.S.$4 billion a year. As the practice tends to bleed...
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