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An All-Powerful Pertamina is Not the Key to Success in Indonesia

This op-ed originally appeared in The Jakarta Post.

As Indonesians debate the best means for reinvigorating the country’s oil and gas sector, recent policy announcements have amplified a long-standing question: What kind of state oil company does the country need?

Oil production has declined dramatically in Indonesia, falling by 25 percent in the past decade. Reserves have also declined, due to a combination of existing fields running out of petroleum and insufficient investment in new exploration.

All of this has resulted in significant declines in state revenues from the sector. Keen to reverse this trend, the ministries of finance and energy and mineral resources have announced plans to reduce some taxes and eliminate others in an effort to woo private companies and boost exploration investment.

At the same time, the government has decided to reorganize Pertamina as a holding company with control over all state assets in oil and gas. The exact contours that such a “super-holding” would take are not known, but the apparent goals include increased efficiency, increased state returns and reduced fuel prices.

This restructuring can significantly boost Pertamina’s commercial leverage. But as the plans of the new minister of energy and mineral resources and the rest of the government evolve, Indonesia shouldn’t go too far in granting unfettered power to Pertamina, which could have the unintended consequence of damaging the investment climate and diminishing national returns from the sector. Global experience points to several risks to consider.

First, when state-owned enterprises are granted expansive power to set or enforce government rules, the risk of conflict of interest rises dramatically.

Some Indonesians point to the example of Malaysia’s Petronas, an enterprise that has dominated policymaking and regulation and achieved success.

Indonesians understandably harbor aspirations that their state-owned enterprise might attain results like those of its Malaysian counterpart. But we do not believe that simply handing Pertamina the keys to the castle—enabling it to regulate the sector or guaranteeing it control over upstream projects regardless of performance—is the way to get there.

Rather, any reforms should increase incentives for Pertamina to perform, subject it to objective rules and benchmarks and require some competitive standards as criteria for securing exploration and production licenses.

And Indonesia is not Malaysia. With less effective administrative institutions and a more contested and fragmented political system, the kind of unified, closely-coordinated relationship between the prime minister and CEO that has enabled Petronas to advance in the absence of formal checks and balances is unlikely to work in Indonesia.

Second, positioning a “super-holding” Pertamina to play an overwhelmingly dominant role in new exploration and production would significantly increase the financial burden on both the state and Pertamina.

It would require Pertamina to finance a much greater share of exploration exercises—which fail far more often than they succeed—likely incurring substantial new debts.

In a context where state-owned oil enterprises from Brazil to Kazakhstan are trying to shrink their participation in projects in order to reduce costs, a measure that mandates Pertamina participation in every project would create significant liabilities without a guarantee of success.

Some increased exploration risk is tolerable—if the state has put in place mechanisms that make it likely that an increased commercial role for Pertamina will lead to more vigorous exploration and greater long-term returns.

Indonesia shouldn’t go too far in granting unfettered power to Pertamina.

But any assumpstion that a larger guaranteed role for the state leads inexorably to larger dividends and a more vibrant sector is not borne out by other countries’ experience.

Third, an outsized “automatic” role for Pertamina in upstream activities could lead to efficiency losses that would negatively impact economic returns to the state.

It could unintentionally crowd out exploration interest from the private sector, particularly if would-be investors are uncertain about what their contractual relationships with Pertamina would look like or how closely their rights would be protected.

Efficiency losses could also reduce Indonesia’s fiscal return on projects. The cost increases experienced when Pertamina’s upstream subsidiary took over operations on the West Madura Offshore project provides one snapshot of the company’s inefficiency relative to the private sector.

According to government data, during the first three years of Pertamina control over the project (2012-2014), average costs per barrel increased by 103 percent, to USD 21 per barrel from USD 11 per barrel during the final three years of control by Kodeco. Over the same period, average operating costs in the global oil industry rose by only 12 percent.

We believe that pursuing a nationalistic, Indonesia-first approach to resource governance is important, as it is in all countries. But we interpret the most important element of this approach to be an unyielding focus on generating long-term benefits for all citizens.

In Indonesia’s case, that means attracting a broad base of companies, taxing and overseeing their work rigorously, protecting the environment and ensuring transparency and accountability for all parties.

Pertamina should certainly play an important role in such an approach. The company must be empowered to seek out new reserves, improve domestic energy supply, generate revenues and dividends and drive a new generation of Indonesian innovation.

The state should grant Pertamina certain privileges to pursue these goals, and Indonesia should invest heavily in Pertamina’s staff and leadership as well as research and development.

But those privileges should extend only so far, and we believe that making Pertamina “all-powerful” is not the most promising path.

Most importantly, reformers should avoid making Pertamina the sector regulator. Instead, they should subject it to rigorous oversight by an objective body.

The government should also consider a system in which oil concession remains open for competition, but Pertamina is able to make a first application or is assigned some sort of bonus points in the bid assessment.

This can build in opportunities for the company to expand its portfolio while increasing incentives for Pertamina to become a dynamic commercial player capable of standing on its own.

Poppy Ismalina is associate director for Green Knowledge at MCA Indonesia. Patrick Heller is director of legal and economic programs at the Natural Resource Governance Institute.