In: Economics
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?
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