01 riscoinsights - Risco Energy - Riscoriscoenergy.com/assets/Uploads/insightsdownload/Risco... · 2016-11-02 · Both Kevin and Jayden see Indonesia’s overall economic performance

01

HIGHLIGHTS

Election Report

What to expect after Indonesia’s presidential elections

Insights

Unhealthy addiction: Fuel subsidies threaten ASEAN economies

Insights

US and Australia highlight Indonesia’s shale potential

riscoinsightsQUARTERLY

2014 – NO 01

RIsco InsIghts QuaRtERly: 01Risco Energy

01CONTENTS 01

act or react 04 Angus Graham

Risco Energy

and now the real work begins 08 Kevin Evans

www.pemilu.asia

oil and gas reform is essential for growth 14 Jayden Vantarakis

CLSA

untapped potential 17 Kim Morrison

Lion Energy

turning tides 23 Matthew Skinner and Zara Shafruddin

Jones Day

an unhealthy addiction 28 Angus Graham

Risco Energy

Mind the increasing gap 38 Chris Newton

Risco Energy

Market Performance 45

co

nt

En

ts

ElEctIon sPEcIal

ElEctIon sPEcIal

ElEctIon sPEcIal


02EDITORIAL

Welcome to the first edition of Risco Insights Quarterly

Investment in the Southeast Asian oil and gas industry is an inherently complex endeavour, requiring a careful alignment of economic, political, legal, resource and environmental factors, among many others. In each edition of Risco Insights we’ll be taking a deeper look at these complexities, leveraging our unrivalled experience in upstream oil and gas investing and the ASEAN region. We’ll also be drawing on our network of industry experts, bringing you perspectives on all facets of oil and gas in Southeast Asia including finance, law, politics, exploration, environment and operations.

In this inaugural issue, we’re exploring some of the industry’s most dominant themes – political change, regulatory uncertainty, energy deficits and the potential of unconventional resources.

Our feature explores the likely impact of Indonesia’s recent presidential election on the country’s energy sector. We share perspectives from Indonesian political expert Kevin Evans and CLSA analyst Jayden Vantarakis, with action – of varying impacts and urgency – predicted by both.

Continuing the theme of change, Jones Day’s Matt Skinner identifies the impact Indonesia’s reconsideration of bilateral investment treaties will have on protection for foreign investments in the country and possible safeguards. We also look at some of the most pressing threats to economies and oil and gas – ASEAN’s continued obsession with expensive and ultimately ineffective fuel subsidies and widening energy deficits that are most notable in Indonesia. Risco’s Chris Newton and Angus Graham take a detailed look at the causes and impacts of both in their respective contributions, offering options for improvement.

Looking to the future, Lion Energy’s Kim Morrison highlights the potential of unconventional oil and gas in the region, particularly Indonesia, and explores the lessons to be learned from the US and Australia in leveraging this emerging opportunity.

Enjoy the issue and visit our website for more commentary and analysis.

—

Tom SoulsbyCEO, Risco Energy Investments

E: [email protected]: www.riscoenergy.com

We’re thrilled to present the launch edition of Risco Insights Quarterly, our new publication that brings you diverse and practical perspectives on the state of ASEAN oil and gas from industry participants, not just observers. It’s a first for the industry in this region, a space we’re thrilled to occupy and one that reflects our drive for realising new possibilities in Southeast Asia.

Do you have an interesting perspective on ASEAN oil and gas that you would like to share? Contact Angus Graham [email protected]

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Game changer? What the Indonesian presidential election means for the country’s oil and gas future.

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Actor react

What can the oil and gas industry expect from Indonesia’s new president?

aRtIclE no.

Angus Graham, Risco Energy

01

No. 01: ELEcTION – act oR REact

On October 20th, Jakarta Governor Joko Widodo (“Jokowi”) will be inaugurated as Indonesia’s seventh president, having secured an absolute majority in the world’s biggest direct presidential election in July. To help inform debate about the election and its impact on the energy industry, we asked two independent experts, in Indonesian politics and investment respectively, for their views on the president-elect’s policies and ability to affect the country’s oil and gas future.

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RIsco InsIghts QuaRtERly: 01


A critical element to Jokowi’s campaign

is Indonesia’s ongoing economic

prosperity and increased growth rate

targets. Indonesia’s energy sector is

a significant economic constituent,

representing 15.6% of GDP in 2012

with oil and gas alone providing 16%

of state revenues. However, production

in ASEAN’s historically dominant oil

and gas producer is stagnating in the

face of soaring demand, prompting an

ever-expanding deficit gap currently

being filled by imports. Imports have

fuelled pressure on the country’s

current and trade accounts, which will

only increase without increased oil

and gas production. This pressure is

exacerbated by fuel subsidies dating

back to Indonesia’s OPEC membership

(it exited in 2009), which currently cost

the government more than oil and

gas revenues.

In his analysis for Risco, Indonesian

political expert and commentator Kevin

Evans highlights the unique nature of the

president-elect as Indonesia’s democratic

evolution continues. For the first time,

Indonesia will have a president who

doesn’t hail from a traditional elite – the

former furniture maker, and subsequently

mayor of both Solo and Jakarta, entered

local politics less than a decade ago.

Indonesia’s oil and gas revenue vs fuel subsidy cost

The cost of fuel subsidies wipes out revenue from oil and gas



Source: CLSA

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

350

300

250

200

150

100

50

0

Oil and gas revenue

Energy subsidy

Year

Rup

iah

(tn)

Structural change

is needed

05


Kevin observes key attributes

engendering a strong ability to deliver

results, absent of historical hang-ups

and constraints. The question is the

direction such execution will take.

Kevin expects early action in reducing

fuel subsidies and ultimately an

incremental improvement in the

investment attractiveness of upstream

oil and gas for both domestic and

foreign participants, recognising the

significant execution hurdles for the

latter. Where Kevin diverges from the

currently accepted outlook of “positive

expectation, questionable timing on

delivery” is in Jokowi’s ability to

overcome these hurdles within a few

years, aided by vice-presidential

facilitator Jusuf Kalla.

Jayden Vantarakis, Deputy Head of

Indonesian Research at CLSA, Asia’s

leading independent equity brokerage,

sees change occurring more quickly.

He views GDP growth of 7%+ pa as a

priority for Jokowi. The current structural

energy trade deficit and fuel subsidies

represent significant barriers to achieving

this and will have to be dealt with. Jayden

believes this will compel the new president

and his government to implement

positive structural reform to encourage

oil and gas investment to in turn stimulate

higher production.

Oil and gas revenue as a proportion of total Indonesian government revenue

1990

40% 42%

28%

21%

16%

2000 2005 2010 2014

10%

15%

20%

25%

30%

35%

40%

45%

5%

0%



Year

% o

f tot

al g

over

nmen

t re

venu

e

Oil and gas are material to Indonesia – albeit proportionately less than before

06

Source: CLSA

Risco Energy

Both Kevin and Jayden see Indonesia’s overall economic performance as a key motivator for action. History would support this view, expressed by the outgoing administration’s articulate Minister of Finance as “good times lead to bad policy and bad times lead to good policy”. Both expect a first step of subsidy reduction. The difference in their views lies in the implicit timing: Jayden is confident the next government’s primary desire to protect targeted growth will quickly catalyse the creation of a more attractive oil and gas investment environment, while Kevin is quietly optimistic for improvement over the next few years.

One area of oil and gas investment that clearly seems set to receive greater support is domestic participants. This is potentially a welcome source of investment, although it is not a singular solution and is unlikely to make material impact on such a significant (and expanding) energy shortfall. Domestic oil and gas participants naturally face balance sheet, funding and skill constraints in an

00

industry that is highly capital and skills intensive. For Indonesia, it is set to become even more so as the industry seeks resources in the more challenging eastern and deepwater areas of the country. The president-elect recognises the part global capital and skills have to play if Indonesia’s oil and gas production is to be increased to deliver corresponding support to the country’s economy. The issue is whether the hurdles can be overcome. The traditional comment on this would be “time will tell” but recent history of Indonesia’s president-elect suggests that directional clarity will come quickly.

—

Angus Graham Risco Energy Strategy & Research

E: [email protected]

W: www.riscoenergy.com


No. 01: ELEcTION – act oR REact 07


And now the real work begins

What to expect after Indonesia’s presidential elections

aRtIclE no.

Kevin Evans, www.pemilu.asia

02

While the final “mop-up” of Indonesia’s post-election contestation unfolds, the presidential election has been won by Joko Widodo (Jokowi) and his vice- presidential partner Jusuf Kalla (former VP in the first Yudhoyono presidency from 2004 to 2009). The scale of victory for Jokowi, 53% versus the 47% obtained by his competitors Prabowo Subianto and his vice-presidential running mate Hatta Rajasa, was by far the closest in Indonesia’s history. Now the country, and the oil and gas industry, await Jokowi’s early actions as president and their impacts on Indonesia’s economy and energy industry.

No. 02: ELEcTION – and now thE REal woRk bEgIns


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the new president What kind of president will Jokowi make? A unique one on many levels. Unlike all former presidents of Indonesia, Jokowi does not originate from any of the traditional elites, be that from an aristocratic, wealthy corporate or military background.

Arguably more important is that he is the first national-level leader to emerge since Indonesia’s transition to presidential democracy at the turn of the century. His political experiences are therefore very different to those of his predecessors, all of whom believed they needed a “majority” on the floor of the Parliament to be effective. Given Indonesia’s natural political pluralism, this has translated into multi-party presidential cabinets that traditionally deliver little coherence and no guarantee of parliamentary support when needed. As governor, Jokowi led the Region of Jakarta with only 20% party support in the Provincial Council but managed to make

progress on critical issues in less than two years where even former strongman President Soeharto failed to effect change. While Jokowi’s Jakarta-insider detractors may denigrate his lack of familiarity with national politics, I believe they are severely underestimating him. He has shown himself to be an effective mobiliser of political capital, adept at making an often lethargic and risk-adverse bureaucracy move forward.

Jokowi will be supported by his vice-presidential partner, a man already seen as a successful and can-do former vice president and the relationship between them will be an important dynamic during the next five years. Jokowi’s leadership model as mayor and governor has been to enjoy close, effective and mutually supportive relationships with his deputies, engendering loyalty and support for him and his programs.

Presidential election results declaration by KPU

Jokowi scored 53.1%

71.0mof the popular votes

Source: General Election Commission (KPU) Risco Energy

Jokowi scored 53.15% (71m) of the popular votes, against his opponent Prabowo Subianto’s 46.85% (62.6m).Source: General Election Commission (KPU)

Presidential election results declaration by KPU

46.9%62.6 million votes 53.1%

71 million votes

v

Prabowo Subianto’s 46.9%

62.6mof the popular votes

Risco Energy

09


“Many members of both parties appear happy to align with the new president, but replacing their party leaders looks set to be a messy affair.”

the next stepsThe new president will be inaugurated around 20th October with a new Cabinet announced within the following week. As the inauguration approaches, Jokowi will focus on putting together a parliamentary support coalition, developing a “kitchen cabinet” to prepare for the transition, and identifying possible Cabinet ministers. Among the usually annoying distractions at the time of the inauguration of a new president is the clamour for instant results. No president since President Soeharto has managed to disregard this pressure so we should expect the incoming government to submit to demands for a 100 day program of initiatives.

At this stage critical components of the incoming coalition include Jokowi’s party PDIP, still led by former President Megawati, the National Democratic Party (a new party led by former Golkar heavyweight Surya Paloh) and the National Awakening Party founded by former President Wahid and now led by the current Minister of Manpower, Muhaimin Iskandar. Developments in parties that did not support Jokowi’s campaign will also be important.

Particular attention should be focused on the Golkar Party, currently led by big businessman, Aburizal Bakrie. His humiliating failure to launch his own presidential (or even vice-presidential)

candidacy, his party’s loss of 15 seats in the April legislative elections and his failure to align Golkar with the winning presidential candidate will not fall easy on this party that has enjoyed a place in every Cabinet since its foundation 50 years ago. The Islamist United Development Party, PPP, will also face great stress as its current leader has been named a suspect in a corruption case. Many members of both parties appear happy to align with the new president, but replacing their party leaders looks set to be a messy affair.

“we should expect the incoming government to submit to demands for a 100 day program of initiatives...”

No. 02: ELEcTION – and now thE REal woRk bEgIns 10



Early impacts for oil and gasBased on positive experiences as Jakarta’s governor, Jokowi may look to place his stamp on the national bureaucracy early to make clear that a number of comfortable old practices are to be left behind. His firmly declared vision that Indonesia recall its maritime identity indicates an early and sustained focus on improvements in port and sea transport and related infrastructure.

One potential development that has particular relevance to Indonesia’s oil and gas industry, and significant impact on the country’s economy, is early action to slash fuel subsidies. Incoming Vice President Jusuf Kalla spearheaded the most daring program to redress the fiscal hole created by the fuel subsidies in 2005 when the government literally doubled the price of fuel. To head off the destabilising demonstrations that normally accompany fuel price rises, the government implemented an historic new move with direct cash payments to poor citizens.

The result was, in many respects, a revolution nobody noticed. It was an historic breakthrough in a country where poverty had always been defined collectively. For the first time in history

poor citizens were provided with cash payments for an adjustment period with the country’s extensive and trusted post office network providing the backbone for delivery. The roll out of price increases late in the Fasting Month certainly dented public enthusiasm for wild demonstrations while the payments to poor citizens cushioned the impact of fuel cost rises.

A major increase in fuel prices, even with targeted support for poor citizens, would certainly create space in the tight budget for the new government to look at other medium-term initiatives. Indirect impacts would also see the exchange rate improve (which in itself would be a net positive for the budget) although 1% to 2% would likely be added to inflation during the next year.

“It was an historic breakthrough in a country where poverty had always been defined collectively.”


11


wider oil and gas prospectsPresident-elect Jokowi recognises Indonesia’s need to prioritise energy self-sufficiency. In addition to addressing fuel pricing, his platform proposes to redress the long-term decline in national oil and gas production. Recognising that national oil production has halved over the past 20 years, Jokowi proposes a number of measures including accelerating the switch from oil to gas in the transport sector, promoting enhanced oil recovery in existing sites and implementing a major overhaul of the existing Oil and Gas Law. To kick-start the process he proposes an emergency government regulation in lieu of a law to redress some of the weaknesses in the existing legal regime that have created legal uncertainty.

While these moves look promising, a number of issues could unhinge efforts. Even an emergency government regulation requires initial in-principle acceptance from the Speakership of the Parliament and must then be endorsed by the Parliament as normal legislation by the end of the existing session. Failure to do so means the emergency regulation is deemed rejected and is abandoned in favour of the previous legislation. While this is rare, it is not impossible, and

may be used by a parliament seeking to impose its authority on a new president. Questions over the security of the passage of legislative changes will add to the legal uncertainty in the sector, certainly in the short term.

The role of foreign capital in the oil and gas sector is another issue. The recent rise of natural resource nationalism, while most aggressively felt in the mining sector, has also impacted the oil and gas sector. The president-elect has issued statements reflecting a view that foreign capital and expertise will help Indonesia boost its production. The countervailing view from those more closely aligned with his political opponents, suggests that Jokowi may need to expend some political capital to push back against these nationalist sentiments.

where policy making discretion is criminalisedOne further dynamic for the president-elect to face is his call for more “calibration” of the risks between reward and investment by private and state investments. This includes a call to update the fiscal payments and royalties system to take into account issues such as the realities of each oil field, net present value, internal rates of return, payback period, profitability ratio as well as geological factors.

Complicating the effective implementation of these very progressive breakthroughs relates, ironically, to another key and positive development in Indonesia over the past few years – the fight against corruption. In practical terms, the proposal to provide flexibility in determining conditions for revenue extraction from different production sites would fill almost all rational Indonesian policy makers these days with dread.

Any decision made using discretion in determining rates of royalties or production cuts, could be argued as a “corrupt” deal even where there was no evidence that either party misappropriated funds or resources for personal benefit. The simple assertion that the “state lost revenue”, arguing the state could have secured more money from the deal, could warrant the launch of a legitimate anti-corruption investigation.

The very broad interpretation of what amounts to corruption in Indonesia, while clearly designed to reduce the “wiggle room” for the corrupt, has also made it difficult for honest public servants and political leaders to make use of the policy-making discretion necessary to make good, fast and secure decisions.

“Even an emergency government regulation requires initial in-principle acceptance from the speakership of the Parliament.”



12


capital “frenemies”Given the capital and technology intensity of operations in the oil and gas sector, it is almost impossible to imagine how expansion or transformation of the oil and gas sector can take place in Indonesia without foreign capital. While economic nationalists may dream

of using state funds to support the sector’s growth, the reality of tight fiscal conditions and the battle for these funds from other sectors limit this. Embracing reality means recognition that boosting national levels of production requires investments of capital and technology that the domestic market simply lacks. This is often easier said than done. Even so, as noted above, the president-elect does enjoy some autonomy from the national commercial vested interests associated with

the oil and gas sector and other nationalist groups that argue the country can have its cake (expand domestic production) and eat it too (do so without external capital and technology).

In many respects, the heaviest cloud over the Indonesian sky for investors is not new laws, adjustments in revenue sharing or the size of the fuel subsidy. Given experiences over the past few years, certainly in the mining sector, the key question facing foreign investors is whether the new president will be setting a welcome mat or a “keep out” sign in front of all these potentially positive Indonesian developments. While recent history might suggest the latter, the president-elect’s reputation as a problem solver may well come to the fore in dealing with a problem like long-term declines in production. I believe there is finally reason for quiet optimism that a welcome mat may unfold within a couple of years.

“the key question facing foreign investors is whether the new president will be setting a welcome mat or a ‘keep out’ sign.”

—

kevin Evans Founder, Pemilu

E: [email protected]: www.pemilu.asia


Risco Energy

13


Oil and gas reform is essential for growth

How the sector will help the new government lift Indonesia’s economy

aRtIclE no.

Jayden Vantarakis, CLSA

03

No. 03: ELEcTION – oIl and gas REFoRM

It is difficult to assess the likely impact of the recent presidential election on Indonesia’s oil and gas industry without first considering the country’s broader economy and its recent performance. We consider broader economic factors to be key in determining the potential for structural reform in Indonesia’s oil and gas sector following the election of the nation’s new president.

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Indonesia was given a shock in the second half of 2013 that rekindled memories of the painful Asian financial crisis of the late 90s. The Indonesian Rupiah – seen rightly as a barometer of confidence in the country – swiftly declined 24% to levels above Rp12,000 against the US dollar. The currency has since hovered between Rp11,000 and Rp12,000 during 2014. The key reason for the decline is Indonesia’s growing current account deficit and international investors’ aversion to funding deficit countries – and particularly emerging markets – as the global economic situation shows signs of recovering. Indonesia’s current account deficit widened during 2013 to 4.5% of GDP. The Central Bank has now set about keeping it in check at a maximum 2.5% of GDP, a level it argues is supported by a baseline portfolio and foreign direct investment flows.

The inevitable consequence of narrowing the current account deficit is slower imports and consumption and therefore slower economic growth. Higher interest rates have dampened imports (the Central Bank has lifted the policy rate by 1.75% to 7.5% and there is talk of more tightening) and a failure by Indonesia to address infrastructure bottlenecks and labour laws during the past four years of cheap global money means exports are not taking up the slack. After enjoying

years of above 6% real GDP growth, Indonesia has become complacent. In the first quarter of 2014 real GDP growth slowed to 5.2% and looks set to remain subdued.

Turning our attention to the performance of the country’s energy market within this broader economic context, we estimate that Indonesia will become a net importer of energy, in monetary terms,

sometime between 2014 and 2017. This is driven by continued subdued thermal coal prices, rising unchecked oil consumption fuelled by wasteful subsidies, and stagnating oil and gas output. If Indonesia pursues a path of industrial development to drive further growth, we estimate that its energy needs will continue to rise, increasing from an estimated US$100bn in 2012 to US$190bn in five years’ time. On the production

side, oil output continues to slide, now 20% short of Indonesia’s elusive one million barrels per day target with less than 10 years’ reserves and flat gas production.

Without addressing the structural energy trade deficit Indonesia is now saddled with thanks to years of regressive policy in the oil and gas sector, the country is facing the prospect of even slower economic growth in the years to come. It also restricts state finance and the ability of the new president to carry out other economic programs.

The Indonesian rupiah

swiftly declined

24% to levels above 12,000against the US dollar late 2013

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No. 03: ELEcTION – oIl and gas REFoRM 15


Indonesia now receives 16%

of total government revenue

from oil and gas royalties and

taxation, down from 42% in

2000, and the state spends more

on subsidies than it receives

from the sector. Slow growth

due to fiscal and monetary

constraint is exactly what the

new president does not want

to see – with Jokowi outlining

goals for 7–9% GDP growth

during this campaign. For

these reasons, we expect that

the new government will bite

the bullet and set a program

of encouraging investment in

oil and gas through positive

structural reform.

6,000 3

2

1

0

-1

-2

-3

-4

-5

4,000

2,000

0

-2,000

-4,000

-6,000

-8,000

-10,000

-12,000

Current account

Proportion GDP (%) (RHS)

Sep

200

8

Mar

200

9

Jun

2009

Sep

200

9

Dec

200

9

Mar

201

0

Jun

2010

Sep

201

0

Dec

201

0

Mar

201

1

Jun

2011

Sep

201

1

Dec

201

1

Mar

201

2

Jun

2012

Dec

201

2

Mar

201

3

Jun

2013

Sep

201

3

Dec

201

3

-50

-40

-30

-20

-10

0

10

20

30

40

50

03 04 05 06 07 08 09 10 11 12 13 14CL 15CL 16CL 17CL 18CL

Oil Gas Coal Energy trade balance

Indonesia’s net energy deficit by fuel type

Source: Government of Indonesia, CLSA

Source: CLSA estimates

Indonesia’s current account: absolute and relative to GDP

Indonesia’scurrent accounthas moved into

deficit

Indonesia’sexisting oil & gas

net deficitis set to become a

totalenergynet deficit

—

Jayden VantarakisCLSA, Deputy Head of Research

E: [email protected]: www.clsa.com

No. 03: ELEcTION – oIl and gas REFoRM


US$

bn

US$

m

16


Demonstrable US success in unconventional shale oil and gas

has driven recognition of other geographies that may follow in

its path. Australia’s unconventional potential is well recognised,

with significant local and foreign investment in recent years.

However, in focusing on emerging unconventional basins

in Australia, many are overlooking the significant potential

of near-neighbour Indonesia. Lion Energy’s Kim Morrison

shares his insights into Australia’s emerging industry and

opportunities to be embraced in Indonesia.

Untapped potential

Australia’s potential in unconventional shale oil and gas is frequently cited but Indonesia’s emerging potential is often overlooked

aRtIclE no.

Kim Morrison, Lion Energy

04

No. 04: untaPPEd PotEntIal


17


East Java Shales

Southern Sumatra Basin

Central Sumatra Basin

North Sumatra Basin

Barito Basin

Kutai Basin

Papua Shales

The unconventional oil and gas

potential of Australian basins is an

increasing focus of both domestic

and overseas companies seeking

to emulate the stunning success

of unconventional plays in the US.

Early mover companies have been

leveraging existing holdings or

building large acreage positions in

Australia’s emerging focus basins for

unconventional hydrocarbons since

2008. The emphasis has specifically

been on shale oil and gas, and

tight oil and gas opportunities

(see Table 1). These companies

have to date secured more

than US$1.5bn in funding

from major international

investors to realise these

opportunities.

Australia: set to follow in the steps of the US?

Officer

Cooper

Galilee

Arckaringa

Georgina

Canning

Amadeus


Emerging focus basins for unconventional hydrocarbons in Australia and Indonesia

Source: Risco Energy


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Risco insights QuaRteRly: 01Risco Energy

While successful unconventional projects in the us are quite diverse,

common technical characteristics exhibited include:

access to mature, good quality source rock

a proven active petroleum system

the presence of brittle rocks with reasonable porosity which are susceptible to fracture stimulation, either as part of the source rock or in close proximity. This allows access to hydrocarbons migrating from nearby source rocks, giving rise to “halo” or hybrid plays.

some level of overpressure – i.e. pressures that are higher than normal to provide additional reservoir energy and enable hydrocarbons to flow from a shale or tight reservoir

isolation from conventional reservoirs to enable fracture stimulation to be concentrated within a specific layer.

No. 04: untaPPeD Potential

Risco insights QuaRteRly: 01

19

One of the key reasons for interest

in Australia is the broad geological similarities of

the basins to successful US projects, with similar

age and source rocks. Based on these features,

the Energy Information Agency (EIA, 2013) views

key Australian basins as having healthy potential

(437tcf unproved technically recoverable wet

shale gas). But in contrast to the US, Australia’s

onshore conventional oil

and gas exploration has had

modest success at best.

Onshore discovered reserves

are only around 4,200mmboe

(comprising approximately 77%

gas) with very modest discovery

sizes averaging 5mmboe (IHSE).

This is very low when compared

to world-class offshore provinces

of the Greater North West

Shelf (approximately 35,000

mmboe) and the Gippsland

Basin (approximately 7,500mmboe). While the

correlation of discovered conventional reserves

with unconventional potential is imperfect, it is a

factor investors should consider.

It is still early days in Australia to determine where

these key characteristics will come together to

enable successful plays. There are probably less

than 100 wells targeting shale gas and oil and very

limited horizontal wells with multi-stage fracture

stimulations (Ord-Minnet review 2014). Activity

has been greatest in the Cooper Basin, Australia’s

most prolific onshore basin (with around 5tcf

discovered conventional gas), where pure shale

and hybrid opportunities have been pursued.

Beach Energy has been particularly active in the

basin and, together with co-venturers Santos

and Origin Energy, recently announced the

completion of the Roswell-2 horizontal well in the

Permian-age Roseneath Shale. A

large fracture stimulation program

was undertaken on the well which

was subsequently flow tested for

28 days, achieving a stable rate

of approximately 0.75mmscfd

through a 48/64” choke. While

achieving this gas flow is positive,

given the costs involved higher

rates than this will be required

for commercial development.

It is expected ongoing work

of Beach and other operators

such as Santos, Strike Energy, Drillsearch and

Senex will combine and provide critical mass

in helping to refine key techniques to unlock

Cooper’s unconventional opportunities.

In addition to the effort required in proving the

technical feasibility of Australian unconventional

plays, the remoteness of many of the target basins,

exemplified by a lack of infrastructure, distance

from markets, water and land access constraints,

all present significant commercial challenges.

Australianonshore discovered reserves

are only around

4,200(comprising approx. 77% gas)


“Early mover companies have been leveraging existing holdings or building large acreage positions in Australia’s emerging focus basins for unconventional hydrocarbons since 2008.”

Early mover Basin Farminee company Deal date Amount of deal A$m

Buru Energy Canning Mitsubishi Jun-10 152

Falcon Beetaloo Amerada Hess Apr-11 80

Drillsearch Cooper QGC Jul-11 130

New Standard Canning ConocoPhillips Oct-11 111

PetroFrontier Southern Georgina Statoil Jun-12 210

Central Petroleum Amadeus/Perdika Santos Oct-12 150

Central Petroleum Georgina Total Nov-12 152

Beach Cooper Chevron Feb-13 350

Drillsearch Cooper Santos Jul-13

Buru Energy Canning Apache Nov-13 32

Senex Cooper Origin Feb-14 169

ToTAL 1,536

Australian early movers have secured more than US$1.5bn since 2010


Risco Energy

20

Source: Company websites, Lion Energy

Risco insights QuaRteRly: 01Risco Energy

Onshore Australia Onshore Indonesia

Land area (sq km) 7,692,024 1,919,440

Discovered hydrocarbons (mmboe) 4,200 37,800

Gas (tcf)* 19 (77%) 88 (40%)

Oil (mmbbl)* 800 (19%) 21,000 (56%)

NGL (mmbbl)* 180 (4%) 1,600 (4%)

No of exploration wells 3,500 3,200

Discoveries 760 889

Av. discovery size (mmboe) 6 43

*Note: (xx%) represents the percentage of gas/oil/NGL in each country’s total discovered hydrocarbon mix

In contrast to Australia, there are yet to be any dedicated unconventional shale gas or oil wells in Indonesia. However, the Indonesian Government is keen to promote the growth of the industry and has recently awarded the second shale gas Production Sharing Contract (PSC). The case for Indonesia’s potential is compelling. The country has some of the most prolific onshore basins in the

Indonesia: earlier stage, but arguably significantly greater potential than Australia

Table 2 – Australia and Indonesia: onshore conventional discovered hydrocarbons

No. 04: untaPPeD Potential

Risco Energy

Source: IHSE

Indonesian and Australian onshore production basins’ reserves

Asian region, featuring world-class source rocks. It is particularly interesting to compare the archipelago’s onshore conventional discovered hydrocarbons to Australia’s. Despite a land mass approximately one quarter the size of Australia, Indonesia has around nine times more discovered onshore conventional hydrocarbons at over 37bnboe (see Table 2 and graph).

Indonesia has 9 times more onshore discovered reserves compared to Australia, despite only 1/4 of the land mass.

Tota

l Rec

over

able

(mm

bo

e)

Averag

e Field size (m

mb

oe)

Indonesia Australia Indonesia Australia

21

CentralSumatra

Basin

SouthSumatra

Basin

NorthSumatra

Basin

KuteiBasin

CooperEromanga

Basin

Bowen-SuratBasins

EastJavaBasin

WestJavaBasin

BintuniBasin

OnshoreTarakanBasin

BanggaiBasin

SalawatiBasin

PerthBasin

14000

12000

10000

8000

6000

4000

2000

0

Gas Recoverable Oil Recoverable

18000

16000Condensate Rec.Average Field Size

280

240

200

160

120

80

40

0

360

320

RIsco InsIghts QuaRtERly: 01Risco Energy RIsco InsIghts QuaRtERly: 01

Sumatran basins contain excellent source rocks and a variety of unconventional opportunities, the characteristics of which we believe meet many of the key criteria for successful shale and tight oil and gas plays established in the US (Table 3).

Importantly, Sumatra has an oil industry dating back over 120 years with well -established infrastructure, as well as access to energy-hungry domestic markets and gas pipelines feeding Singapore and beyond. We are confident that as the early movers like Lion build the technical and commercial evidence, majors and large independents looking to emulate the success of the US will focus their attention on Indonesia’s unconventional potential in much the same way as they are currently doing in Australia.

Properties

North Sumatra Central Sumatra South Sumatra

Lower Baong Belumai Formation Bampo Shale Telisa

FormationBrown Shale/

KelesaTalang

Akar FmLehat/Lemat/ Benakat Shale

Rock description

Marine shale with carbonate lenses

Marine calcareous shale, carbonate and sandstone

Restricted marine black claystone, siltstone and thinly bedded sandstone

Marine shale with sandstone and siltstone

Lacustrine black organic-rich algal mudstone with carbonate-rich lense

Lacustrine to marine delta plain shale, quartzose sandstone and siltstone

Lacustrine shales, tuffaceous shale, siltstone, sandstone and coals

Age Middle Miocene

Early Miocene

Late Oligocene

Middle Miocene

Oligocene Late Oligocene to Middle Miocene

Mid-Late Eocene to Early Oligocene

Organiccontent/TOC

Recorded TOC

0.5-2.9% 0.5-3.4 0.5-1.0% (limited data)

0.5-3% 2-23% mean of 3.7%

1.5-8 % 1.7-8.5%

Maturity

Maturity window

Mid oil to gas window

Late oil to gas window

Gas window Early oil Peak oil to gas window

Peak oil to gas window

Peak oil to gas window

Mineralogy / brittleness

Pressure Generally moderately to occasional high overpressure

Normal to moderately overpressured




Normal to minor overpressure


Table 3 – Unconventional potential assessment for key shale gas/oil targets

Positive Reasonably positive Uncertain Negative factors Negative


—

Kim Morrison CEO, Lion Energy

E: [email protected]: www.lionenergy.com.au Source: Lion Energy

22


Foreign investors in Indonesia have long benefited from

international investment treaties but the recent announcement

to terminate the country’s bilateral investment treaty with the

Netherlands signals a change in approach from the Indonesian

Government. Jones Day Partner, Matthew Skinner, looks at the

changes ahead and how investors can ensure their Indonesian

investments remain protected.

Turning tides

What Indonesia’s reconsideration of bilateral investment treaties means for foreign investors

aRtIclE no.

Matthew Skinner and Zara Shafruddin, Jones Day

05

No. 05: tuRnIng tIdEs


23


Indonesia’s international investment

treaties have provided a great deal

of comfort for foreign investors in managing sovereign risks associated with their investment, such as unfair and inequitable conduct by the government or denials of justice by its judicial organs. Indonesia signed its first bilateral investment treaty with Denmark in 1968 and has since signed 69 others with other countries including the Netherlands, Australia, China, Singapore and the United Kingdom.

Despite Indonesia’s history of

embracing bilateral investment treaties,

the tides have turned. In March 2014,

the Indonesian Government announced

that it will not renew its treaty with the

Netherlands. Set to expire on July

1st 2015, the Indonesia–Netherlands

investment treaty is one of the most

commonly relied upon for foreign

investments in Indonesia, given

the breadth of its terms. Signalling

further things to come, the Indonesian

Government has also indicated its

intention to terminate all of its remaining

bilateral investment treaties.

The announcement is not all that

surprising given the changing landscape

for foreign investment in Indonesia.

It comes at a time when Indonesia is

making numerous regulatory changes in

its mining, natural resources and finance

sectors which may adversely affect

foreign investors, such as its recent ban

on raw ore exports. It also follows a

recent decision on jurisdiction in a US$1

billion investment treaty arbitration

claim, which went against Indonesia.

The Indonesian Government’s stance

is also consistent with moves by other

developing countries like Venezuela

and Ecuador to terminate or renegotiate

investment treaties.

This emerges amid growing global

backlash against these treaties on the

basis that they provide greater protection

to foreign investors than benefit to host

countries. While the announcement

is rightly cause for concern, foreign

investors can still take steps to ensure

that their investments in Indonesia

remain protected (see page 25).

In March 2014 the

Indonesian governmentannounced that it will not

renew its treaty with the Netherlands


Risco Energy

24


Assess treaty suitability:

When considering whether to make a new investment or restructure an existing one through a jurisdiction protected by an investment treaty, investors need to carefully consider which investment treaty provides the optimal range of protections for its specific circumstances. Investors will also need to watch out for so-called “denial of benefits” provisions that may, in certain circumstances, disqualify an investor from treaty protections.

3ASEAN a potential safe haven:

Investors may be protected under various multilateral investment treaties and free trade agreements to which Indonesia remains a party. For example, Indonesia is party to the ASEAN Comprehensive Investment Agreement which provides a robust regime for the protection of investments.

2Make or restructure investments before the treaty terminates:

Thanks to a “sunset clause” in the Indonesia–Netherlands bilateral investment treaty, investors will still be able to access the protections available under the treaty until 2030 if their investment is made or restructured through the Netherlands before July 1st 2015.

1

Steps to protecting foreign investment in Indonesia


Risco Energy

25


47

31

30

37

36

35

40

43

32

10

1723

22

34

3324

26

25

27

29

14

1

3

2

6

1312

7

39

42

41 44

45

46

19

18

21

28

38

416

20

9

15

8

11

51 Cuba2 Venezuela3 Argentina4 Luxembourg5 Switzerland6 Belgium7 United Kingdom8 Netherlands9 Germany10 Czech Republic11 Denmark12 Sweden13 Finland14 Morocco15 Spain16 France17 Poland18 Tunisia19 Italy20 Hungary21 Bulgaria22 Ukraine23 Slovakia24 Romania

25 Turkey26 Syria27 Egypt28 Jordan29 Saudi Arabia30 Mozambique31 Mauritius32 Iran33 Uzbekistan34 Russia35 Kyrgyzstan36 Pakistan37 India38 Sri Lanka39 Bangladesh40 Mongolia41 Thailand42 Laos43 PRK44 Vietnam45 Malaysia46 Singapore47 Australia

Indonesia’s current global bilateral agreements

“Indonesia signed its first bilateral investment treaty with Denmark in 1968 and has since signed 69 others.”

Risco Energy Source: Jones Day, Risco Energy

No. 05: tuRnIng tIdEs 26


Myanmar

Thailand

Vietnam

Malaysia

Singapore

Indonesia

Brunei Darussalam

PhilippinesCambodia

Laos

“The Indonesian Government is clearly positioning itself to minimise its exposure...”

The Indonesian Government is clearly positioning itself to minimise its exposure under bilateral investment treaties and it will be interesting to see if the country’s new president and incoming government take a different stance. In any event, foreign investors in Indonesia should be diligent and take steps to secure or assess their protection under investment treaties before it is too late.

—

Matt SkinnerPartner, Jones Day

E: [email protected]: +65 6233 5502W: www.jonesday.com

—

Zara ShafruddinAssociate, Jones Day

E: [email protected]: +65 6233 5956W: www.jonesday.com

Indonesia and the ASEAN region*

* As a member of the ASEAN region, Indonesia has implicit bilateral agreements with other countries in the region.

Risco Energy Source: Risco Energy

No. 05: tuRnIng tIdEs 27


Subsidised retail fuel prices are a legacy of social benevolence

from when ASEAN was a net oil producer, rather than the net

consumer it is today. Risco’s Angus Graham explores how

subsidy costs have ballooned, now representing a material

threat to the economies and societies they were intended

to support.

An unhealthy addiction

How fuel subsidies are threatening ASEAN economies

aRtIclE no.

Angus Graham, Risco Energy

06

No. 06: an unhEalthy addIctIon


28


No. 06: an unhEalthy addIctIon

More than half of the countries

in ASEAN continue to subsidise retail fossil fuels

to provide some of the lowest prices in the world.

Dating back to the 1960s, in keeping with many net

oil producing countries globally, subsidies were

intended as a “social national resource dividend”

for the region’s neediest. Subsidies are essentially

the government buying energy at market prices and

reselling it to its residents at lower prices, primarily

seeking to benefit lower income citizens and support

economic development. For many of the poor, it is

the only tangible benefit they can obtain, especially in

developing resource-rich economies.

changing times

The last half century has seen considerable change in ASEAN,

not least its near wholesale shift from having surplus oil

production to now needing oil imports – essentially reversing

the original basis for subsidies in the first place. Strong and

sustained economic growth has driven massive demand

expansion and created a large and growing middle class who

now derive more benefit from subsidies than the originally

intended beneficiaries: the poor.

ASEAN’s move from a surplus of oil and gas to deficit alone

is placing considerable and increasing pressure on its

countries’ energy trade and current accounts. Oil and gas

deficits are only going to get bigger on the current trajectory,

with hydrocarbon demand growth far outstripping supply

increases. Global open market oil prices are an additional

exacerbating factor, quintupling in 2014 US dollar terms since

the early 1970s.

Such a transformation logically negates the original

foundation for the ability to provide fuel subsidies. Direct

costs to governments increase exponentially with ever more

subsidised oil imports, amplifying the negative economic

impact to countries. Yet in much of ASEAN, state-funded

fuel subsidies stubbornly remain, keeping consumer prices

artificially low.


Strong economic growth has seen Indonesia's growingmiddle class derive more benefits from subsidies than the region's intended beneficiaries:

the poor

29


an expensive habit

ASEAN’s subsidy addiction is costing

more each year – both in absolute US

dollar terms and relative to total global

subsidy spend. The International Energy

Agency (IEA) estimates ASEAN’s overall

fuel subsidy cost for 2012 at US$51bn,

nearly double that of five years earlier,

driven by higher international oil prices

and increasing demand. Oil subsidies

dominate at 68% of this cost, including

products such as gasoline and diesel, as

well as more socially sensitive products

such as liquefied petroleum gas (LPG)

and kerosene. Electricity (an indirect fuel

subsidy) accounts for over 20% with the

balance coming from coal and natural

gas price alleviation.


300

250

200

150

100

50

0

Price range of diesel pump prices globally (US cents/litre)

Subsidies lower sales price

Die

sel r

etai

l pri

ce (U

S ce

nts/

litre

)

Vene

zual

a

Saud

i Ara

bia

Iran

Kuw

ait

Bru

nei

Ind

one

sia

Mal

aysi

a

Thai

land

Ind

ia

Bra

zil

Phi

lipp

ines

USA

Vie

tnam

Nig

eria

Lao

s

Taiw

an

Pak

ista

n

Can

ada

New

Zea

land

Sing

apo

re

Cam

bo

dia

N K

ore

a

Aus

tral

ia

Ho

ng K

ong

Jap

an

S K

ore

a

Spai

n

Fran

ce

Ger

man

y

Swit

zerl

and

UK

Turk

ey

No

rway

Taxes increase sales price

non-ASEAN countries

ASEAN countries (excl. Myanmar)

asEan subsidies fuel some of the cheapest diesel prices in the world

Source: GIZ Transport & Mobility, Bloomberg, various, Risco Energy

30No. 06: an unhEalthy addIctIon

Note: Subsidised price used if available in country (non-subsidised fuel products also available at higher prices). USA viewed as broadly representing “neutral parity”. Prices as at 3Q 2014.


Fuel subsidies in asia

By country, Indonesia makes up half of the region’s total subsidy spend (perhaps unsurprising as ASEAN’s largest economy) with subsidies as a proportion of 2013 GDP also the highest at 3.4% This equates to the entire annual health budget and exceeds government revenues from oil and gas production. Malaysia represents 17% of total regional subsidy cost, accounting for 2.4% of its GDP. Thailand’s Oil Fund also has significant economic impact at 2.6% of GDP. All three of these countries have seen uplift

in absolute subsidy cost in 2013 to US$31.8bn (Indonesia), US$9.2bn (Malaysia) and US$5.2bn (Thailand). Both Indonesia and Thailand are clear oil importers, with Malaysia set to become one. Brunei is ASEAN’s sole remaining clear energy exporter (low volumes in both a regional and global context) and has the highest per capita subsidies. With little in the way of energy imports, this represents an opportunity cost rather than a direct

budgetary impact.

Fiscal impact Oil dependence Fuel subsidy Current account impact

Govt debt (% of GDP)

2013

Budget balance (% of GDP)

2013

oil consumption (% of GDP)

2013

Fuel subsidy (Yes/No)

Subsidy channel

Subsidy amount Current account % of GDP 2013

Net all imports % of GDP 2013(US$bn)

2013% of GDP

2013

ASEAN:

Indonesia 25.8 2.2 6.5 Yes Budget $31.8 3.4 -3.3 3.2

Malaysia 53.7 -4 7.8 Yes Budget $9.2 2.8 4.1 -0.2

Philippines 49.2 -1.4 4.1 No - - - 3.5 3.7

Singapore 104.7 1.3 6.0 No - - - 18.0 5.7

Thaliand 32.2 -2 11.4 Yes Oil fund $5.2 1.4 -0.7 7.6

Asia-ex-ASEAN

China 15.5 -2.1 4.7 Yes Oil fund $19.5 0.2 2 2.5

Hong Kong 0.5 0.5 5.7 No - - - 1.8 5

India 46.5 -4.5 7.9 Yes Budget $12.5 0.7 -1.7 4.9

South Korea 31.6 -1.3 7.1 No - - - 6.1 5.8

Taiwan 48.5 -1.6 7.1 Yes SOE n/a n/a 11.8 5.7

Note: ASEAN countries not including Brunei, Cambodia, Laos, Myanmar. China data 2012 and not including local government debt. Subsidies include those for oil, coal, gas and electricity.

Fuel subsidies in Asia

Indonesia makes up half of the region’s total subsidy spend

Source: UBS, BofA Merrill Lynch Global Research, CEIC, EIA, govt estimates, IEA, Risco Energy



Economic health warning

Many unhealthy addictions

continue because the worst

negative consequences

significantly lag the joys of

consumption. Harmful effects

manifest gradually, further

delaying ultimate recognition,

until they are so clear and

serious they can no longer be

ignored. Fuel subsidies are

little different – the negative

impact is initially economic,

with a knock-on effect into

other areas.

A system of fixed retail

subsidised fuel selling prices

is one of the most damaging

for an economy. The inability

to control unit costs and

volumes and thus, total

potential subsidy cost, creates

an uncontrollable negative

loop with an increasingly

visible economic impact.

Source: CLSA, Risco Energy

Local currency depreciates vs US dollar

Balance of trade and current account are negatively impacted

Pressures trade balance: Imports increase to satisfy demand, pressuring both the energy trade balance

and that of the country overall.

Fixed sales price vs floating cost: While a government’s local currency selling price is fixed, its floating US dollar purchase price is exposed to the uncontrollable variables of global oil prices and currency exchange rates.

Unintended demand stimulation: The arbitrage between fuels at open market prices and the much cheaper locally subsidised version stimulates

demand from unintended beneficiaries of subsidies, such as smugglers and the

more affluent.

Pressures currency: Negative impact on a country’s trade and

current accounts typically leads to local currency depreciation, which flows back to increasing the

cost to government of subsidising.

Increased consumption of

fuels by unintended beneficiaries of

subsidies

Gap increases between fixed local currency price and

floating international US dollar market

price

The negative feedback loop of fixed price fuel subsidies



An economy’s exposure to oil, and its

uncontrollable price, is significantly

increased if it features a potent combination

of fuel subsidies and deficits in both its net

oil trade and the country’s broader current

account and budget. Among ASEAN’s

more significant fuel-subsiding countries,

all three factors are present for Indonesia

and Thailand. Malaysia is not yet a net oil

importer and runs a current account surplus,

but has a significant

budget deficit.

Indonesia’s fixed price

fuel subsidies have

provided the clearest

symptoms of economic

harm. The government’s

spending on price

support has nearly

tripled in US dollar

terms in the last five

years and consistently

exceeded oil and gas production revenues

earned by the state. Despite the country’s

tangible economic progress in the last

decade, a combination of a net oil deficit

and the continued use of subsidies has

been a key driver for a growing current

account deficit over the last two years

(US$28.5bn in 2013, broadly similar to its

net oil deficit). It has been a key factor in

the Rupiah’s depreciation against the US

dollar, falling 45% from a peak of Rp8,400

in 4Q11 to over Rp12,000 in 4Q13 and 1Q14,

despite the Central Bank raising rates to

7.5%. The Rupiah cost to government of

the fuel subsidies rose with the currency

depreciation, reinforcing and widening the

negative effects of the practice. The Rupiah

is seen by Indonesians as a key barometer

of confidence (the memory of the Rupiah’s

collapse in the late 1990s remains fresh).

Today, Indonesians face higher prices

and debt costs than

they did two years

ago, impacting their

standard of living.

In Malaysia, subsidies

were a key factor in the

2013 currency weakness

that preceded Fitch’s

negative credit rating

downgrade. Subsidy

spending represented

5% of the country’s debt

and elevated its uncontrolled oil exposure.

Sharp rises in international oil prices and

increased risk aversion to emerging markets

heightened investor concern over Malaysia’s

large fiscal deficit. The result was a near

10% depreciation in the Ringgit from May

to June 2013 and a Fitch downgrade

in July, with the impact of subsidies on

public finances explicitly cited as a factor and

the Ringgit remaining a regional currency

under performer.


Indonesia's continued

use of subsidies has been the key driver of its

escalating debt

and the rupiah's depreciation



shooting upSubsidies artificially increase demand via unnaturally low prices.

Increased waste due to artificially low costs as excessive consumption

has little consequence.

Increased energy intensity, reducing energy efficiency. ASEAN has

the second highest energy intensity globally, requiring three times more

energy than Europe to produce the same economic output.

A market for crime. Arbitrage is big business, with subsidised

countries’ fuel up to 60% cheaper than more expensive neighbours,

aided by porous borders.

stunts growth The direct and indirect costs of subsidies retard growth and social

improvement, meaning:

Instantly consumable subsidies with no residual benefit take money

from sustainable long-term development in infrastructure,

health and education.

A massive opportunity. If Indonesia had not raised fuel prices in September

2013 (the first increase since 2008), subsidy spending would have

exceeded its entire health and education budgets combined.

A jam is created. Subsidies artificially increase use of vehicles (the single

largest use of oil) and increase traffic congestion, lost productivity and

higher fuel bills (US$181bn annually for the USA alone).

Unfulfilled potential. Companies supporting subsidies typically face

restricted cashflows, which could be used for new investment and

growth, and reduce their attractiveness to other companies as a reliable

counterparty. National oil companies and state-owned power

companies are typically the first in line to carry the burden of

subsidy programs.

• Thailand’ssolegassupplier,PTT,isobligedtoimportLPGatthefull

international price and resell at lower domestic prices. Thailand’s active

promotion of vehicles switching from oil to LPG, with cheap pricing a key

incentive, has been very successful but this has strained PTT’s gas business

which accounts for some 20% of its overall operating profit in 2013.

• Malaysia’sPetronasidentifiesregulatednaturalgaspricingasamajor

deterrent to investment in upstream gas production as well as complicating

attempts to increase LNG imports to overcome supply bottlenecks.

• Indonesia’sPertaminahasfacedseriouscashflowconstraintsfromUS

$2bn in receivables due from government to compensate its purchase of

internationally priced oil restricting its ability to increase investment in

both domestic and overseas production to aid energy security.

• PLN’s(Indonesia’sstatepowergenerator)abilitytoraisethe

electrification rate and avoid outages to existing users is seriously

hampered by price controls, as well as impacting its commerciality and

growth potential.

dirty Fuel subsidies increase negative environmental impacts and limit the

availability and adoption of cleaner alternatives, resulting in:

Environmental harm through higher consumption and increased

pollution and CO2 emissions.

A barrier to clean energy. Cheap fossil fuel reduces the attractiveness

of demand for more energy-efficient and renewable energy and retards

investment in the area. Fossil fuels surprisingly receive six times the

subsidy support globally of renewables.



off target Subsidies are remarkably ineffective at achieving their stated

objectives of helping the poor and supporting economic development,

resulting in:

A gift for the affluent. 61% of gasoline subsidy benefit goes to

the richest 20% of citizens, typically urban and car owning (IMF).

Disproportionate disadvantage. No more than 8% of global subsidy

benefits in 2010 reached the poorest 20% of the population (IEA).

a tough addiction to break As with many addictions, countries using subsidies find that while the originally

intended benefits are illusory and the unforeseen negatives are many, the habit

proves difficult to break. Like most addictions, weaning a nation off subsidies

requires a clear motivation and commitment to end the habit twinned with

setting, and sticking to, a defined and realistic plan minimising withdrawal

negatives and highlighting the positives.

The most immediate withdrawal pain comes from an initial price shock,

leading to inflation and cost impact. This indirectly stimulates food inflation

where demand is inelastic and lower income economies such as Indonesia

and the Philippines face the greatest exposure. Historically, this is where reform

efforts fall down. Political will is insufficient, support plans to ease the impact

are incomplete and there is sensitivity to perceived potential for social unrest

given this has been an historic catalyst for igniting a myriad of other issues,

ultimately leading to government change in Thailand and Indonesia.

Arguably the greatest practical hurdle in subsidy removal is overcoming

embedded vested interests that continue to abuse the system so lucratively.

Here again Kevin Evans cites Indonesia, albeit with hope for the future, given

president-elect Jokowi’s historic ability to circumvent traditional convention.

Ironically, Indonesia provided a micro-example of successfully removing fuel

subsidies in 2005, although it subsequently proved to be incomplete and

the support short term. As Kevin Evans highlights in his article, former Vice

President (set to become so again in October 2014) Jusuf Kalla, resolutely

drove through a sizable reduction in fuel subsidies accompanied by cash

handouts to the poor. He used the post office as the cash support distribution

channel, circumventing the traditional government bureaucracy plagued with

efficiency concerns. Despite World Bank scepticism, Kalla’s approach proved

remarkably successful. Unfortunately, the combination of remaining subsidies,

rising international oil prices and an upcoming presidential election led to an

erosion of political will and effective reversal.

Most of ASEAN’s fuel-subsidising countries have attempted reform, but none

has been able to completely give up the habit, the burden of which remains

significant, especially for Indonesia, Malaysia and Thailand. Indonesia and

Malaysia are actively discussing ways for further removal, but have yet to

implement them. Thailand is theoretically the best positioned for execution

with its military government absent of the consensual approvals that have

hindered democratic predecessors. To date, however, the Junta are the first

Thai military government not to have leveraged this advantage into reducing

subsidies.



Myanmar

Thailand

Vietnam

Malaysia

Indonesia

Brunei Darussalam

Diesel

Gasoline

LPG

Electricity

88 Octane

95 Octane

Natural gas

Kerosene

Source: IEA, Risco Energy

Key

Thailand

LPG, diesel and natural gas (vehicles) price controlled. Subsidised electricity for poor households

(for households and small businesses)

Brunei

Increased diesel and gasoline prices in 2008 for foreign-registered vehicles to limit “fuel tourism” from Malaysia, and applied a second increase for foreign vehicles in 2012.

Indonesia

Increased price for gasoline by 44% and diesel by 22% in June 2013. Promoting natural gas use in transport to reduce oil subsidies. Continuing successful kerosene to LPG conversion program, which started in 2007. Electricity tariffs are set to rise by 15% in 2013 (based on quarterly increases) for all but consumers with the lowest level of consumption.

Malaysia

In September 2013, subsidies to gasoline and diesel were reduced in a bid to cut budget deficit.

Plans to implement in 2014 a subsidy removal program set out in 2011 to gradually increase natural gas and electricity prices.

Myanmar

As part of power sector reforms, electricity prices were increased in January 2012. Diesel and gasoline prices were indexed to Singapore spot market prices in 2011.

Thailand

From September 2013, increasing LPG prices every month for all but street vendors and consumers with lowest level of electricity consumption. Increased electricity tariffs in September 2013, which will be revised every four months. Expected subsidy reduction by military junta has yet to occur.

Vietnam

Gradually moving towards market prices for oil and natural gas. Plans to introduce a roadmap for the phase-out of fossil-fuel subsidies.

Subsidised fuel products in ASEAN

88

95

88

95

36

asEan fuel subsidy reform efforts to date


cleaning up

Going cold turkey is unnecessarily brutal in replacing

this addiction with something healthier. Indonesia’s

2005 attempt at subsidy reduction illustrates effective

initial steps on the path to removal – phased subsidy

elimination accompanied by corresponding support to

the poor.

Ideally, a well-functioning, targeted cash transfer system

would better satisfy the original objectives of subsidies

and more. Providing monthly payments to poor families

if they meet certain conditions, like keeping their children

in school and getting health check-ups, combats poverty

today as well as breaking the inter-generational cycle of

poverty for tomorrow. For many developing countries,

implementing any such system runs into administrative

and transparency limitations but that is not to say it

cannot be done.

Mexico and Brazil’s Conditional Cash Transfer (CCT)

programs are widely lauded for their effectiveness

at reducing income inequality. Both have existed for

decades and been subjected to some of the most

stringent evaluation and measurement of any social

programs globally. If imitation is the sincerest form

of flattery, their subsequent roll out in 38 additional

countries is praise indeed. Brazil’s CCT, “Bolsa Familia”,

saw poverty levels plummeting from 22% to 7% between

2003 and 2009. Mexico’s “Oportunidades” catalysed

incredible increases in children entering school with

middle school inscription rising 42% and high school

85%. Oportunidades creator, Treasury Undersecretary

Santiago Levy, noted that to ensure income actually

reached the poor, he had national (not local) government

administer electronic disbursements via banks, involving

very little infrastructure and physical interaction. The

result has been few opportunities for corruption,

and low overheads, with 95% of budget directly

received by beneficiaries. These South American CCTs

represent a proven investment in social and economic

development at a fraction of the price of subsidies. At

some 0.4% of GDP, this costs only one tenth of some

ASEAN countries’ subsidy burden and actually works

as originally advertised, unlike subsidies. There will be

momentary withdrawal pain as more affluent members

of subsidy society face the direct and indirect reality of

higher energy prices, although still dramatically cheaper

than most heavily taxed global fuel consumers. As the

addiction is cleansed, money saved will be available for

all those other things government wants – and needs – to

spend on: infrastructure, health and education.

—

Angus Graham Risco Energy Strategy & Research


To read further comments and publications by Angus Graham go to riscoenergy.com/insights


Brazil’s income inequality program saw poverty levels plummet

between 2003 and 2009

22%7%

from

to


Mind the increasing gap

Why Indonesia’s widening oil and gas deficit is pressuring the economy and how domestic production can narrow the gap.

aRtIclE no.

chris Newton, Risco Energy

07

Indonesia’s National Energy Policy seeks energy independence, yet the oil and gas deficit currently stands at US$1bn a month and is weighing on the nation’s economy. Continued domestic production decline and reliance on imports to fill the gap will expand the deficit to US$6bn a month or higher by 2025. Achieving energy independence means attracting investment to raise domestic production. Risco’s Chris Newton explores the upside potential of domestic production and its need for stimulation.

00No. 07: MInd thE IncREasIng gaP


38


oil and gas deficit gap ballooning Indonesia’s oil and gas trade deficit currently exceeds US$1bn per month in net imports driven by stagnating oil and gas production and skyrocketing domestic demand. The country’s fuel subsidies provide additional demand stimulus and direct cost to the government, as Angus Graham explores in his piece on ASEAN fuel subsidies in this edition.

Indonesia became a net oil importer (in volume terms) in 2004, a position that has continued to grow as oil production has steadily declined. Historic increases in gas production have partially stemmed oil’s decline in overall oil and gas volume terms. With nearly 50% of its gas production exported, Indonesia remains a net hydrocarbon exporter on a volume/barrel of oil equivalent (boe) basis – just. But as demand rises, oil production falls and gas production plateaus, the move to net importer is rapidly looming. In US dollar value terms, Indonesia has been a net importer – that is, in deficit – for several years as expensive imported petroleum products outweigh lower-value crude and gas or LNG exports. The path to an expanding deficit gap is clear.

Indonesia’s oil and gas trade deficit

exceeded US$1bn per month in 2013

Source: Statistics Indonesia

Indonesia’s oil and gas trade deficit

-5

Q1

0

2

4

6

8

10

12

14

2010 2011 2012 2013

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Bal

ance

, US$

bn

per

qua

rter

Exp

ort/

Imp

ort,

US$

bn

per

qua

rter

1

0

-1

-2

-3

-4

ExportImport

Balance

defic

itsu

rplu

s

Quarter / Year

Q1

2014



If Indonesia relies on imports to fill 2025 supply/demand gap thedeficit jumps to US$6bn per month

Economic burden buildsThe broader economic impact of the current

billion per month oil and gas trade deficit is

becoming increasingly clear, pressuring both

trade and current accounts and hindering

Indonesia’s currency and economic growth. This

is further amplified by the continued existence

of fuel subsidies, which averaged US$2.6bn per

month in 2013. Assuming imports continue to

fill the ever-widening supply/demand gap, we

forecast Indonesia’s oil and gas trade deficit will

balloon to US$6bn per month by 2025.

Even US$6bn may be too conservative when

understated assumptions in Indonesia’s National

Energy Policy (NEP) for oil and gas demand are

considered – see the following page.

5,000

4,500

4,000

3,500

1,000

500

2000 2005 2010 2015 2020 2025 2030

1,500

2,000

2,500

3,000

mb

oep

d

2025 EnergyPolicy Target

Demand

2.0 mmboe/d

Undeveloped

Natuna D-Aplha

Underdevelopment

Producing

Year

Indonesia’s forecast oil and gas demand

Note: Forecast oil and gas demand uses the 2025 and 2050 Natural Energy Policy targets. Supply uses the latest production, development planning reserves, and resource data. Assumes all known reserves and resources are developed. mboepd = thousands of barrels of oil equivalent per day


Source: Migas, Wood Mackenzie, Risco Energy


No. 07: MInd thE IncREasIng gaP

Primary energy demand totals 158mmtoe (million tons of oil equivalent) in 2010 rising to 400mmtoe in 2025 and 1,000mmtoe in 2050.

This means a doubling in energy demand per capita, from 0.7 to 1.4 by 2025.

There is an explicit and dramatic increase in the role of renewable energy in the energy mix, rising from 5% in 2010 to 23% in 2025 – largely at the assumed expense of oil.

Despite rising per capita consumption, energy intensity is targeted to decline by 1% pa to 2025 and energy elasticity to drop below 1.0 from its current level of circa 1.8.

Macro assumptions include GDP growth of more than an average 6.4% pa over the period, falling population growth, and a four-fold increase in GDP per capita.

“NEP assumes Indonesia’s per capita consumption rises while energy demand elasticity nearly halves.”

Our US$6 billion per month deficit forecast for 2025 faces potential uplift if a number of NEP assumptions prove to be understated:

While the role of oil and gas in the energy mix is targeted to decline between 2010 and 2025, total oil and gas demand will still increase by 3.6% pa (up from 3.2% pa between 2000 and 2010). For oil this means demand for 2.01mmstbopd (million standard barrels of oil per day) by 2025 and for gas 9.8bcfd (billion cubic feet per day).

Oil and gas demand appears understated given these targets rely on rising efficiency and a massive contribution from renewable energy, mainly geothermal and hydro. Interestingly, the latter are inconsistent with state power generator PLN’s own primary fuels planning.

This view of understated assumptions is shared by others. Wood Mackenzie sees Indonesia’s liquids demand in 2025 at 2.25mmbopd (million barrels of oil per day), some 250kbopd (thousand barrels of oil per day) greater than the policy target, which would materially increase our US billion per month oil and gas deficit gap forecast.

Risco Energy RIsco InsIghts QuaRtERly: 01



desperate need to stimulate domestic productionThe options to fill this gap are simple: carry on relying on imports and fuel further deficit increases, or increase domestic production, which is currently set for decline.

Increasing import reliance runs directly counter to the NEP’s clear objective of energy security and independence, the latter defined as “utilising the maximum potential from domestic sources”. But action is required to stimulate the activity and investment to drive meaningful and sustainable production increases.

Lower reserves and production

Higher imports

Reduced energy

independence and security

The NEP already recognises numerous current deficiencies that need to be addressed, including:

• inefficient energy use

• poorly targeted energy subsidies

• poor supply prioritisation

• energy prices lower than the economic price

• low investment interest

• reliance on fossil fuels while reserve replacement is low

• energy infrastructure limitations

• low domestic funding and participation

• limited research and development and technology application

• low community access to energy

• poor demand side management

• export driven with limited value add.

The NEP’s objectives clearly fit with stimulating investment in domestic production.

Energy Independence and National

Energy Security

Increased exploration and exploitation

investment

Increased domestic reserves and supply

Industry, technology and human capacity development

People benefit via economic multiplier and employment

Maximising gas supply and environmental

benefits

Indonesia’s National Energy Policy fit with stimulating domestic

production investment

Risco Energy

Uncompetitive

Investment

Environment



conventional oil and gas – set for continued declineIndonesian conventional oil and gas production faces continued decline with a broadly uncompelling investment climate from both a regional and global perspective. This was articulated in our “Bottom of the barrel” survey report and is demonstrated by the steady decline in new field wildcat exploration drilling – the key tracking metric. While exploration investment in US dollar terms has increased, this is mainly driven by cost inflation (particularly from rig rates) and by the recent move into expensive deep water exploration. The number of wells and what they successfully yield is most pertinent rather than their cost.

The long-term decline in wildcat exploration, the purest form of such drilling, has been halted over the last few years as the massive number of production sharing contracts (PSCs) signed in 2007–09 have drilled their exploration commitments. Unfortunately there has been little to show for this massive investment and this, combined with the deteriorating investment environment, means the necessary increase in exploration drilling activity is unlikely to eventuate. At the ESDM – IPA exploration forum in 2012, the IPA showed that at current rates of exploration efficiency, annual exploration drilling activity would need to triple if conventional oil and gas was to satisfy just 50% of Indonesia’s 2025 oil and gas supply/demand gap.

unconventional oil and gas – tremendous potential butremains nascentAccessing this potential could transform Indonesia’s production landscape, but it will require catalysing support.

Many of the issues faced by conventional oil and gas can cross over into unconventional, particularly ones of above ground operating and regulatory environment. Others are potentially amplified in an unconventional setting, such as land access (larger footprint) and services costs. Unconventional also has its own specific challenges such as high commercialisation uncertainty and a need for operator flexibility and speed, requiring lighter handed regulation than conventional oil and gas projects. Much of this can be addressed via clear, supportive and enabling regulation.

Within the unconventional space, shale has higher costs, lead times and risk when compared to coal bed methane (CBM), meaning more supportive fiscal terms are needed initially. Ideally, a flexible PSC regime would drive the economic viability of marginal shale projects while capturing a fair revenue share for the state from attractive ones – e.g. R/C (Revenue/Cost) terms. Shale is capital and technology intensive, suggesting PSC awards should be prioritised for companies with those assets.



two clear paths existIncreasing investment and hence production in conventional and unconventional oil and gas requires a competitive fit-for-purpose investment environment. A critical component is the right fiscal, regulatory and operating environment to compete for highly mobile capital, technology and skills. Indonesia has significant fiscal and strategic motivation for stimulating investment in new domestic hydrocarbon production. Increasing investment and hence production in conventional and unconventional oil and gas requires a competitive fit-for-purpose investment environment.

The government has two key near-term levers readily available to achieve increased investment in domestic production, in the form of adjustments to regulation and fiscal terms. Neither are “catch-all” solutions, but they are likely to materially impact the key measure of effectiveness: an increase in the number of pure exploration wells. The result will be corresponding progress towards increasing domestic production and creating greater energy independence and security. The alternative of an uncompetitive environment leads to falling reserves and production, higher imports, reduced energy independence and security and mounting economic pressures.

—

Chris Newton

Risco Energy Director of Business Development and Operations


Chris has written further on Indonesia’s national energy policy and how conventional and unconventional potential can be turned into increased domestic production. View these articles at riscoenergy.com/insights




MarketperformanceM

aR

kE

t P

ER

Fo

RM

an

cE

Oil and gas strategic themes and equity market performance Investors in oil and gas demand increasingly clear strategic focus from companies and the industry appears to be responding. This is evidenced by several corporations’ notable non-core asset realignments from ASEAN in the last year and equity markets rewarding this improved clarity with material share price (and value) increases.

Oil and gas is a cyclical industry and clarity of focus is insufficient for effective equity market value generation if inappropriate strategic themes are employed at the wrong time in the cycle.

At Risco, our primary motivation is value generation, which has driven us to track and analyse how industry strategies align with equity market performance. The following pages provide a simple illustration of how certain oil and gas strategic themes have performed in equity markets over the last one year.

Our proprietary equity indices group companies by strategic theme and their performance is compared to an overall E&P index and Brent crude oil.

The next Risco Insights Quarterly issue will share our view on how strategic themes’ historic operational and equity performance relates to future value generation.

45


MARKET PERFORMANCE


Strategic theme equity index(3) Population Theme description and focus area Example companies Index(2) 1 yr performance Category index

Acquisitions 41 Acquisitions for growth Bill Barrett 22.7% E&P strategy

CBM(1) 11 Coal bed methane WestSide 25.0% Unconventional

Deepwater 6 Deepwater exploration and development Anadarko 37.8% E&P strategy

Development 37 Development and production of oil & gas, taking little exploration risk Vaalco Energy 10.0% E&P strategy

Drilling services 11 Provision of drilling services Transocean 3.9% Services

E&P (Exploration & Production) 37 Conventional oil & gas exploration & production (E&P) Talisman 16.1% All

EOR 7 Enhanced oil recovery (EOR) operations and technology Arc Trust 11.9% Oil strategy

Exploration 47 Growth through exploration Tullow Oil 16.9% E&P strategy

Gas E&P 23 Conventional gas-focused exploration and production PTTEP 9.5% Gas strategy

Geographic focus 39 Focused tightly in a small number of geographies, plays or basins. E.g. onshore US players. Range Resources - -

Heavy Oil 2 Technical focus on heavy oil development and operations Trilogy Energy 21.2% Conventional

Integrated Gas 8 Integrated upstream and downstream gas, may include pipelines and power Cabot Oil & Gas -2.1% Gas strategy

Integrated Oil & Gas 19 Integrated upstream and downstream, including refining and marketing, petrochems etc. Most majors and NOC's 12.1% Downstream

Integrated Services 6 Integrated supplier of equipment and services Schlumberger 33.1% Services

LNG 4 Liquefied natural gas (LNG) represents a major component of growth strategy Woodside 8.4% Gas strategy

Oil E&P 8 Conventional oil-focused exploration and production Anadarko 8.0% Gas strategy(4)

Oil Sands 7 Oil sands development or operations represent a key strategic theme Husky Energy 20.9% Conventional

Pipelines & Midstream 5 Pipeline owner, transporting gas or oil Kinder Morgan Energy 6.2% Downstream

Production Optimisation 18 Optimisation or rehabilitation of existing production Most N American trusts 24.1% Oil strategy

R&M (Refining & Marketing) 8 Specialist refiners and marketers Valero 24.6% Downstream

Seismic 3 Provision of seismic services TGS-NOPEC -30.3% Services

Shale Oil & Gas 15 Shale oil & gas Apache 16.6% Unconventional

Technology 13 Key focus on the use of niche technologies to provide competitive advantage Transocean 20.2% Oil strategy

Notes: (1) CBM index: Green Dragon Gas (GDG LN) has been excluded from the CBM index for 1 year price performance due to potential for index distortion. GDG’s stock price nearly doubled over a week in 2014 driven by the stock-specific (rather than broader CBM sector-specific) issue of

licence status confirmation. The effect of GDG’s stock price rise is magnified on the overall index due to its significant index weight. (2) Index themes’ company constituents are market cap weighted. (3) Up to three strategic themes are identified for each company. If a company has been associated

with a specified theme, it is included in the corresponding index. A company may appear in several indices if it displays several themes. (4) Oil E&P included in the category as a benchmark comparable to gas strategies.

Strategic theme equity indices: What are they?

46

Source: Bloomberg, company websites, Risco Energy


MARKET PERFORMANCE

Strategic theme equity indices: 1 year stock price performance

Service sector strategies vs E&P and oilIntegrated outperforms, Seismic underperforms

70

80

90

100

110

120

130

140

Sep-13 Dec-13 Mar-14 Jun-14 Sep-14

1yr price performance (rebased at 100)

E&P

Oil focused E&P

Gas focused E&P

Integrated gas

LNG

Brent crude

70

80

90

100

110

120

130

140



E&P

Oil Sands

Heavy Oil

CBM

Shale

Brent crude

70

80

90

100

110

120

130

140



Acquisitions

E&P

Exploration

Development

Deepwater

Brent crude 70

80

90

100

110

120

130

140



Seismic services

Drilling services

Integrated services

E&P

Brent crude

70

80

90

100

110

120

130

140



E&P

Production optimisation

EOR

Technology

Heavy oil

Brent crude

70

80

90

100

110

120

130

140



E&P

Integrated Oil & Gas

Refining & Marketing

Pipelines/midstream

Brent crude

Conventional & unconventional vs E&P and oilConventional & unconventional similar outperformance, Brent underperforms

E&P strategies vs overall E&P and oilDeepwater outperforms, Brent underperforms

Gas & Oil strategies vs E&P and oilOverall E&P outperforms, Brent underperforms

Oil strategies vs E&P and oilSpecialist oil focus outperforms, Brent underperforms

Downstream strategies vs oilRefining & Marketing outperforms, Brent underperforms

Source: Bloomberg, companies, Risco Energy.

47


Read more insights and commentary from Risco at riscoenergy.com/insightsthis report is prepared for general information purposes only. any third party seeking to rely upon this report should seek separate professional advice in relation

to any of the facts or opinions set out herein. Risco Energy Investments Pte ltd, its affiliates, its and their directors, officers and employees, and the consultants

producing this report (“Risco”) do not assume and hereby expressly disclaim any liability to any third party in respect of the contents of this report or any opinions

or conclusions which might be drawn from it. any third party using or otherwise relying upon the contents of this report does so entirely at its own risk, and any such

reliance shall be construed as a waiver of any claim against any party comprising Risco in respect of the contents of this report.

Risco Energy is an investment company focused on upstream oil and gas in ASEAN

Documents

01 riscoinsights - Risco Energy - Riscoriscoenergy.com/assets/Uploads/insightsdownload/Risco... · 2016-11-02 · Both Kevin and Jayden see Indonesia’s overall economic performance