Question

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 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

Answer 1

The article presented in the question thoroughly points out the economic dilemma of comprehensively transforming the domestic fuel market in Indonesia from predominantly kerosene based on modern and ecologically efficient LPG driven, considering the varied economic impacts of both the products in the market from the consumer and producer/supplier perspectives. Primarily, emphasizing on the expected increase in the potential demand for LPG usage in Indonesian households, this would constitute an immense market opportunity for the gas or fuel suppliers or products to tap into the market and respectively enhance their profit and market share. However, a substantially high cost of initializing the transformation process by the households and the affordability of the LPG cylinders are major issues to be confronted by the domestic consumers or households in Indonesia which might impede or forestall higher sales of the LPG cylinders in the market leading to the lower revenue generation and profitability of the gas companies. This could lead to major market failure or inefficiency and jeopardize the entire transformation process intended or planned by the government to offset concerningly high government expenditure or spending on market subsidization of kerosene. As pointed out in the article presented in the question, it is also apprehended that the households belonging to the lower-income group would majorly or predominantly be affected by the higher market price of LPG cylinders. Even if the Indonesian government provides free LPG stove, cylinder, and first consignment initially along with subsidization of the 3kg cylinders, there has been widespread uncertainty about the sustainability of subsidized pricing policy, especially considering the significant demand-supply differential in the market and the relatively higher cost of production and manufacturing by the suppliers or producers. The general uncertainty over the sustainable affordability and availability of the LPG gas has generated widespread public resentment which might potentially affect the election outcomes in the country thereby preventing the government to undertake any drastic anti-consensual step or measure.

Now, as emphasized by Johan Selleh, the general manager of Blue Gas Company in Southeast Asia, the proposed or intended transformation in the domestic gas or file market in Indonesia can also pose some serious economic challenges and risks for the incoming new gas companies in the domestic gas or fuel market in Indonesia. First, given the price-fixing policies undertaken by the government in the domestic market especially for the 3kg cylinder, there would be a substantially huge differential between the market price of the cylinders set by the government and the actual cost-induced price of the cylinders offered by the gas companies which can lead to considerably high subsidization by the government and engender a major issue, considering the bulk of the supply coming from the gas importers in the domestic market. Furthermore, the 3kg cylinders are mostly popular in Indonesia and constitute the majority of the domestic market demand in the country, which is completely subsidized by the government. Hence, to ensure a sustainable commercial and economic success and growth in the domestic market, the gas companies would have to predominantly focus on the supply of 3kg cylinders. However, as apprehended by Mr. Johan, as Blue Gas Company does not provide 3kg cylinders in the international market, it would require massive investment for the company to sustainably produce and supply the 3 kg cylinders in the Indonesian market including manufacturing expenses, R & D costs, designing and configuration expenses, and so on. This could adversely impact the long-term and sustainable profitability of gas companies such as Blue Gas thereby, disincentivizing many such companies from investing in the domestic gas market in Indonesia. Secondly, the existing market structure can also become a potential issue for gas companies to successfully operate in the market. The consistent market dominance of PERTAMINA in the domestic fuel market in Indonesia and the overall monopolist structure of the market would pose a major challenge for the new entrants to successfully and sustainably operate or prevail in the market. As pointed out by Mr. Johan, the monopolistic tendencies and conducts by PERTAMINA and the various nationalist policy strategies or mechanisms implemented by the domestic government to safeguard the local company from the competitive forces in the market could concerningly lead to a declining market share of the gas importing companies in the market thereby leading to undesirable and socially inefficient or in-optimal market outcomes due to increasingly high market concentration. Thirdly, various administrative and other practical barriers to entry in the market by international gas importers such as government bureaucracy pertaining to business licensing and registration, unfavorable economic conditions in the country for foreign investment, various protectionist measures and policies of the domestic government also constitute some of the major concerns or issues that can potentially demotivate the gas or fuel companies from investing in the domestic market. Lastly, dynamic and ever-changing consumer and household demand in the domestic gas or fuel market in Indonesia is also a prominent concern for the gas companies as adjusting to or coping with the rapidly and unexpectedly changing consumer preferences and demands and any ensuing changes or modifications in the government policies could also affect the business or commercial operations of the gas or fuel companies. Hence, it can be practically considered as an economic deterrence for the gas or fuel companies willing to enter the domestic fuel market in Indonesia.

Therefore, from a business or commercial standpoint, the increasing household demand for LP gas or fuel in the domestic gas or fuel market in Indonesia could be potentially conceived as an immense market opportunity for the importing gas or fuel companies to invest in the domestic market in Indonesia. However, considering the various external and internal market limitations, the major challenge for both the gas companies and the Indonesian government is to ensure sustainable availability and affordability of LPG in the market which evidently rests on the future market efficiency/optimality and appropriate and reasonable government policies and measures. Hence, if these concerned issues and adversities as highlighted in the given article are not addressed or alleviated adequately, the intended market transformation could not be successfully sustained.