Indonesia struggles to capitalize on its oil

With crude oil fetching over $140 a barrel, these should be the best of times for resource-rich Indonesia, the only Asian oil producer in the Organization of Petroleum Exporting Countries (OPEC).

Instead, Indonesia is quitting the cartel at the end of the year. Falling output from aging oil fields and a paucity of major new finds has left it unable to meet its OPEC production quota. Since 2004, it has been a net importer of oil.

The global thirst for oil – and predictions that high pump prices are here to stay – should be helping Indonesia's pitch to foreign oil companies who are constantly scouring the globe for new hydrocarbon deposits. Last week, Raden Priyono, head of BP Migas, the government regulatory agency for oil production, told reporters that 35.8 million barrels' worth of oil reserves had been discovered so far this year.

In 2007, Indonesia had 4.4 billion barrels in proven reserves, according to the CIA Factbook. That's more than either Malaysia and Vietnam, its nearest regional rivals, and just below Ecuador. Reserves in Saudi Arabia, the largest producer, are estimated at 264 billion barrels.

But Indonesia's pitch to oil companies has been soured by legnthy contract disputes, corruption scandals, fuzzy regulations, and friction with revenue-hungry local authorities. As oil exploration has faltered, output has suffered: Last year Indonesia only managed to pump an average 950,000 barrels a day, the 12th straight year of declines. OPEC's combined output in April was 29.7 million barrels a day.

Last week, Indonesia's anticorruption agency said it was investigating BP Migas for allegedly underreporting oil output between 2000 and 2007, with potential losses to the state of $21 billion. Smuggling of subsidized fuel to nearby countries has long plagued the industry, which was a source of corruption and patronage for decades under former President Suharto.

"There doesn't seem to be one big factor that says 'don't explore' and 'don't develop.' But there are many little factors that keep Indonesia from being the next big oil boom," says Arian Ardie, a senior partner of Navitas Strategic Consulting in Jakarta, which advises foreign clients in the energy sector.

Analysts say foreign oil companies are deterred by revenue-sharing contracts in Indonesia that typically allocate 85 percent of income to government coffers and 15 percent to private companies, with a 70/30 split for deepwater deposits. Other emerging oil-producing countries such as East Timor offer a far more equitable split to foreign producers.

Having already exhausted most of its richest oil fields, Indonesia is looking less attractive to oil majors that put a premium on size, says John Vautrain, a Singapore-based senior vice president for Pervin & Gertz, a US oil consultancy.

As long as foreign oil companies, big and small, see risk and uncertainty around every corner, analysts warn that Indonesia will struggle to pump more oil, even with the lure of sky-high crude prices. Indeed, these prices may persuade local authorities, whose land and cooperation is required for new oil facilities, to attempt to extract a greater share of revenues.

"In the oil and gas sector, there is risk for both Western and Asian and Chinese [investors]," says Kuturbi, director of the Center for Petroleum and Energy Economics Studies in Jakarta, who goes by one name. He predicts global crude prices will average $175 a barrel in 2008.

Indonesia does have some cards to play in the energy game. It has major natural-gas reserves that are processed into transportable liquids and exported. A new $5 billion BP-operated facility in West Papua Province is due to begin production this year, with buyers lined up in South Korea, China, and the US. Indonesia is also the world's biggest exporter of coal, which fuels power stations across Asia.

While that makes Indonesia a net energy exporter, its economy is feeling the pain from global crude prices. In May, President Susilo Bambang Yudhoyono cut fuel subsidies by 29 percent, a move that provoked scattered protests but left gas prices at about $2.50 a gallon, still cheaper than prevailing market rates. Most politicians are reluctant to raise prices further ahead of national elections next year.

Fuel hikes in 2005 led to a dip in domestic consumption, and analysts say there may be similar gains this time, though not enough to reverse Indonesia's position as a net oil importer. Without a significant upturn in exploration, this position may worsen, as over 70 percent of current crude production comes from aging fields that are in decline, according to the Indonesian Petroleum Association. Its data shows that oil exploration hit a 35-year low in 2004.

The only significant new oil field in development – Cepu, an onshore bloc in East Java – was held up for several years by contract disputes between US major ExxonMobil and Pertamina, the state oil company that is the joint operator. The project, which is due to start producing next year, became a symbol of the difficulty of doing business in Indonesia. Pertamina and ExxonMobil fought long and hard over revenue-sharing and control of the project, which was hailed in 2001 as a major find that would revive the country's flagging crude production. It also contains large natural-gas deposits.

A deal was finally reached in 2006 after Mr. Yudhoyono intervened, but analysts say friction between the two remains a concern and the dispute sent a negative signal to potential investors. ExxonMobil failed to respond to requests for an interview with its executives in Jakarta.