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Why Indonesia Should Abandon its Natural Gas Pricing Regulation

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Pacific Money | Economy | Southeast Asia

Why Indonesia Should Abandon its Natural Gas Pricing Regulation

The costs required to keep domestic natural gas prices low could outweigh the long-term benefits.

Why Indonesia Should Abandon its Natural Gas Pricing Regulation

The Jakarta headquarters of PT Pertamina, Indonesia’s state-owned oil and natural gas corporation.

Credit: Depositphotos

It has been a year since the Indonesian government decided to enforce a natural gas pricing policy for the country’s industrial and power generation sectors. The results remain far from what was expected at the time, and may end up worsening both the investment climate in the natural gas industry and the national economy as a whole.

The high domestic price of Indonesia’s natural gas has generally been cited as one of the main causes of the inadequate performance of the country’s industrial sector. The natural gas pricing regulation, which enforces a single standard price for the resource, was issued to keep prices low for the industrial sector and, thus, improve its performance. However, the implementation of the regulation has raised some concern that over the long term, it could potentially undermine the profitability and viability of the country’s natural gas industry.

Indonesia’s natural gas market is still heavily regulated and dominated by state-owned companies. Although this might guarantee a stable and low natural gas price for the domestic market, the benefit is limited and temporary. Low levels of investment coupled with high subsidies will create an accumulation of problems that could threaten the nation’s future energy security. In many other places, heavy government intervention to stabilize natural gas prices has proven to be ineffective to maintain market stability over the long run. Instead, Indonesia should learn from countries such as China and Malaysia that have recently deregulated their natural gas industries and moved toward a more competitive market.

As per the new pricing regulation, the government has a sole right to set natural gas prices for industry, power plants, households, and the transportation sector. Depending on the sector, Indonesia’s natural gas end user price hovers in the range of $3 to $6/MMBTU. The government also has full control over the upstream price, the transmission and distribution costs, and the profit margin received by each of the sector’s main players. This situation has already obstructed both upstream and downstream natural gas development in Indonesia. For instance, giant natural gas developments like IDD Gendalo & Gehem and Masela have been delayed due to lack of investment. Furthermore, there is a delay in the development of the Sakakemang onshore block development caused by fraught price negotiations between the Spanish firm Repsol and the Indonesian government. The proportion of the downstream natural gas infrastructure controlled by state-owned companies currently sits at 97 percent.

The huge gap between the current price of domestic and imported natural gas will create economic, social, and political complications when Indonesia can no longer satisfy national demand from its domestic production. Currently, the price reduction has been achieved by cutting the government profit’s share from natural gas upstream. In the event that the government needs to import additional gas from abroad, it might need to introduce heavy subsidies to keep prices stable and ensure social and political stability.

In the last decade, Indonesia’s natural gas market has experienced significant expansion, alongside the growth in the worldwide use of liquid natural gas (LNG). Previously, long-term contracts based on Oil Price Escalation, which sets prices according to the price of competing fuels, were a popular form of trading agreement, especially in Europe and Asia. This market mechanism trend, however, is predicted to decline as increasing numbers of natural gas buyers are adopting Gas On Gas (GoG) market mechanisms, which set prices based on the interplay of supply and demand.

The United States has spearheaded the marketization trend since 1992, when it began eliminating wellhead price regulation and allowed natural gas prices to be set by markets. In 2010, European stakeholders taking part in that year’s ONS Conference discussed the importance of hub prices and suggested the renegotiation of long-term European natural gas contracts. Since then, the use of the GoG market mechanism has risen significantly, reaching 98 percent and 78 percent of the total U.S. and European natural gas markets, respectively.

In 2011, Asian countries including China and Malaysia started to introduce natural gas pricing reform and move toward more competitive markets. These two nations used to keep low natural gas prices to domestic end users by subsidizing natural gas imports. Recently, they have decided to reform their domestic natural gas pricing by allowing market forces to play a larger role in creating a natural gas market balance in their countries. This will also untangle the government’s dilemma in providing affordable gas while also creating sufficient incentives for more domestic production and reduced imports.

China’s government performed city gate price adjustment across the country in 2013-2015, after successful trials in Guangdong and Guangxi provinces in 2011. In Malaysia, the government also introduced a natural gas subsidy rationalization program in 2011. The regulation, however, has mainly focused on Peninsular Malaysia as the center of natural gas demand in the country. Meanwhile, natural gas prices in Sabah and Sarawak continue to follow the old pricing regime due to the economic and social issues specific to these states.

According to a study of the impact of these reforms in China, the change in natural gas prices has not affected overall natural gas demand, but has instead made it demand more sensitive to the country’s GDP growth and long-term economic trends. As the world’s biggest manufacturing powerhouse, the decision of China’s government to reform natural gas prices in 2013 has already been carefully assessed to minimize its impact toward the country’s industrial sector. In fact, the natural gas pricing reform in China aims to rebalance economic growth.

Similarly, Malaysia’s natural gas monopoly and the associated subsidies have created a burden for the national budget for some time. Hence, the government’s introduction of a natural gas subsidy rationalization program in 2011 that significantly increased the growth of natural gas demand between 2012 and 2017, when it surpassed Indonesia’s consumption. The economic transformation and subsidy rationalization program also brought Malaysia’s economy to the highest rank among Asian developing countries in the World Economic Forum’s Global Competitiveness Report for 2014-2015.

In summary, the question of whether artificially reducing domestic natural gas prices can be used to boost economic growth and the productivity of a nation’s industrial sector remains inconclusive. In many cases, the cost required to provide low domestic natural gas prices tends to be higher than the benefit to be gained therefrom. Although natural gas imports might be inevitable for Indonesia, it is crucial to formulate a natural gas price that considers the costly import price without the need to introduce any form of subsidy in the future.

Based on the experience of China and Malaysia, price adjustments can be implemented gradually and separately within each of Indonesia’s 34 provinces based on their regional social and economic capabilities. Thus, the Indonesian government needs to evaluate the impact of its recent natural gas price regulation, particularly the one-price regulation for end users, which has already damaged the natural gas investment climate and will eventually affect both the nation’s energy security and its economic development write large.

Guest Author

Massita Ayu Cindy

Massita Ayu Cindy is an energy economics & financing researcher of Purnomo Yusgiantoro Center (PYC). Currently, she is also pursuing doctoral degree in School of Strategic and Global Studies, Universitas Indonesia.

Guest Author

Inka B. Yusgiantoro

Inka B. Yusgiantoro is the head of the research department of the Indonesia Financial Services Authority (OJK). Inka has been a part-time lecturer for macroeconomic, finance, and risk management courses in several public and private universities.