Newsletter No. 1339
News-Analysis
April 11, 2009

 

The following newsletter has been written by David Adam Stott (Shingetsu Member No. 17). Stott is based at The University of Kitakyushu.

JAKARTA PLAYS HARDBALL OVER SENORO LNG PROJECT

Indonesia spent much of 2008 demanding and getting record prices for new liquefied natural gas (LNG) contracts to supply Japan and South Korea, in what was an increasingly seller’s market. However, the deep recession in both of these Northeast Asian nations has changed this situation dramatically. Jakarta is now wondering if buyers in both countries will actually cancel their contracts to buy Indonesian LNG and is consequently scrambling around for alternative customers and uses for its most valuable commodity export. Nevertheless, at the same time, it is playing hardball with Japanese investors and customers over a new LNG scheme that promises to improve Indonesia’s standing in the global LNG scene.

Slumping Demand

The fact is that Japan’s economy is being hit simultaneously by shrinking exports and low spending at home as it gets exposed to the global downtown. With flaccid domestic consumption, exports were seen as key to Japanese economic growth and in recent years capital investment has poured into export industries. However, the country’s exports fell almost 50% in February, and this followed a contraction of 3.3% in real gross domestic product for October to December 2008 when compared with the third quarter of 2008. These results, an annualised rate of 12.7%, were Japan’s largest quarterly drop since its economy contracted at an annualised rate of 13.1% in the first quarter of 1974. Such distressing figures eclipse economic reversals in the United States and Europe.

As factories scale back production in the face of slumping worldwide demand, it was reported in March that Japan, South Korea, and Taiwan plan to divert twelve LNG cargoes from Indonesia to other markets this year. Hari Karulianto, the head of LNG business at Indonesian state oil and gas company PT Pertamina, said that these countries would not cancel their contracts with Indonesia but would probably re-sell the LNG to other buyers elsewhere. Pertamina expects Japan to account for six of these twelve diverted cargoes as the country uses most of its LNG imports to power businesses. One LNG cargo holds approximately 3 million British thermal units (MBTU) of gas. Given that Japan has long been the world’s biggest importer and consumer of LNG, such news underlines the grim economic data being reported from Northeast Asia. FACTS Global Energy calculated that Japan’s total LNG imports in 2008 amounted to 69.3 metric tonnes per annum (MTPA), an increase from 66.8 MTPA the previous year. That figure will likely be much smaller in 2009.

Subsequently, the number of LNG tankers sailing to Japan, the world’s biggest buyer, fell 47% in March and early April. According to Bloomberg ship-tracking data, in the first week of April eighteen LNG vessels were traveling to Japan, down from thirty-four two weeks previously. Japan’s biggest LNG supplier is Indonesia, followed by Malaysia, Qatar, and Australia, although the Persian Gulf exporter (i.e. Qatar) is expected to become Japan’s largest supplier by around 2010. Meanwhile, the same data showed that the number of tankers sailing to the United States doubled to four in the same period, vessels going to the United Kingdom increased from two to three, whilst those bound for Belgium jumped to six from two in a fortnight. This indicates that countries like Japan, which buy most of its LNG on long-term supply contracts, might be able to offload some of these contracted volumes elsewhere in the short term. Nevertheless, Bloomberg reported that signals were captured from 148 tankers on April 2, fifteen fewer than on March 20, accounting for around 50% of the global fleet of 297 LNG carriers. As a result, Indonesia is assessing the possibility of finding other LNG buyers, converting LNG into liquefied petroleum gas (LPG), and diverting more supply to domestic fertiliser producers.

Exporters, importers, and consumers of LNG are obviously hoping that recent trends are just a temporary blip, especially as LNG is a commodity that requires huge capital outlay to tap. Unlike crude oil, long-term supply contracts characterise a large part of the global LNG trade. Indeed, both of Indonesia’s currently operating processing facilities, Arun at Lhokseumawe in Aceh province, and Badak at Bontang in East Kalimantan province, were constructed in the mid-1970s under such supply contracts to Japan. Indonesia subsequently started exporting LNG to Japan in 1978 from Arun and in 1981 from Bontang. Excess production has been made available to other buyers, mostly in South Korea and Taiwan. As production at both plants has suffered setbacks in the last half decade, especially Arun which is almost exhausted, Japanese developers have been looking for new Indonesian gas to exploit. These efforts have been galvanised by the fact that their Bontang export contracts will expire in 2010 and 2011 and have been renewed at much smaller volumes and for shorter terms (see Newsletters 778, 1004, 1012, 1040, and 1077).

Jakarta Gets Tough on Senoro Project

The Senoro LNG refinery under construction in Banggai district, Central Sulawesi province, should be the first of these new projects to be realised. Mitsubishi Heavy Industries is a 51% shareholder in the US$1.4 billion development which had been scheduled to open in 2011. However, progress has been delayed repeatedly due to difficult pricing negotiations and is now slated to begin operations in 2013. In August 2008 it was finally agreed that Japan will buy 1.7 trillion cubic feet of gas (TCF) over fifteen years from the area. Survey results indicate an annual yield of 2 million tonnes (MT), all of which was seemingly destined for Japan. In February 2009 a provisional sales agreement was signed with Japanese utilities Chubu Electric Power and Kansai Electric Power to supply each with one MT per annum over next fifteen years, in deals worth an estimated total of US$7.7 billion.

Mindful of its increasing difficulties in securing a continued supply of Indonesian natural gas, Tokyo had demanded Senoro LNG supply guarantees as part of the Japan-Indonesia Economic Partnership Agreement (JIEPA) signed in August 2007. Jakarta, meanwhile, cited a lack of infrastructure to supply it to the domestic market as a reason why the LNG would be exported to Japan. However, within Indonesia there has been an increasingly loud chorus of disapproval over the deal, and legislators have criticised policy makers for selling natural gas to the Senoro LNG plant too cheaply. This gas will be sourced from the Senoro and Matindok fields owned by Indonesia’s PT Medco Energi International and PT Pertamina respectively.

Moreover, the agreement to export all output to Chubu and Kansai contradicts Indonesian government policy to take into account rising domestic demand when agreeing LNG export contracts. Sofyan Wanandi, a prominent Indonesian businessman and chairman of the Indonesian Employers Association (Apindo), has therefore argued that the Senoro project should not be exempt from the 25% domestic market obligation based on Law No. 22 / 2001 on oil and gas. This is despite the fact that the Senoro work contracts date back to 1997, thus predating the 2001 law. In fact, Wanandi claims that in the absence of the law, the government could force Pertamina and Medco to sell their gas domestically rather than export it.

Even though construction work was originally due to begin in 2007, Jakarta recently delayed the Senoro project again by setting six preconditions for final approval of the plant’s construction. It now seems the Indonesian side is trying to secure better terms from Mitsubishi and its Japanese customers, mindful of the furor surrounding its underselling of LNG to China and South Korea from the new Tangguh plant in Papua province. With the Tangguh issue having become politicised in campaigning for the 2009 presidential elections, the current administration wants to avoid any repeat which would provide ammunition to its opponents as it seeks re-election. As a result, it wants to be seen to play tough with Japanese investors and customers, and seized on a February 2009 floor-price proposal made by a special committee of the House of Representatives.

Consequently, the main precondition seems to be Japanese acceptance of an absolute minimum price, determined by the government, which would apply if crude prices fell to US$40 a barrel or under. The provisional sale agreements specify that the two Japanese utilities pay a price in accordance with the Japan Customs-Cleared Crude price, often referred to as the Japan Crude Cocktail, a formula which takes into account current crude prices and allows LNG prices to fluctuate along with them. The February 2009 provisional sale agreements did not specify any minimum price for the Senoro gas.

According to the government, the Mitsubishi-led consortium has also failed to meet the five other requirements for approval. These include the 25% domestic market obligation, a revision to the project’s development plan, and a resolution to an outstanding legal dispute between Mitsubishi and PT LNG Energi Utama. This dispute dates back to August 2008, when Jakarta-based Energi Utama sued Mitsubishi for more than US$709 million in damages. In addition to claiming it had exclusive rights to the Senoro scheme, Energi Utama accuses the Japanese firm of purloining confidential information regarding production costs, thus unfairly enabling it to win the LNG plant construction contract. Weighing into the controversy, Energy and Mineral Resources Minister Purnomo Yusgiantoro said on March 30 that some of the Senoro gas would be allocated to domestic fertiliser producers, and has also emphasised that a resolution to the legal dispute is necessary for final government approval. As a result, the Indonesian media has even speculated that the Senoro project could actually be cancelled.

Japan Reacts

With gas exports a crucial component of bilateral ties, and with Japan soon to face a slashing of contracted LNG volumes from Bontang, these pronouncements have unsurprisingly caused a diplomatic rift between the two governments. A letter from the Japanese Ambassador, Kojiro Shijiori, to Indonesian President Susilo Bambang Yudhoyono on March 19 reportedly said that Senoro’s failure would not only damage bilateral energy ties, but would also adversely affect overall investment cooperation between the two countries. His deputy, Takio Yamada, was also quoted as saying, “We hope that the project can run successfully because it is very important for Japan to secure its energy supplies and to maintain good relations between the two countries.” The Indonesian state media has adversely reacted to these implicit threats with Sofyano Zakaria, executive director of the Public Policy Studies Center (Puskepi) arguing that, “It is inappropriate for the Japanese ambassador to intervene in the Senoro project because the project is a matter of business relations between state-owned oil company Pertamina, Medco and Mitsubishi.” Such a response prompted Japanese Prime Minister Taro Aso to personally speak about the scheme with President Yudhoyono when they met for forty-five minutes at the G-20 meeting in London on April 1. Aso reiterated Tokyo’s stance that the stability of Indonesia’s LNG supply is crucial to Japan.

Given that Indonesia lacks the expertise to exploit and develop its own gas resources, and thus needs foreign investment to fuel its own economic growth, overseas investors from Japan and farther afield will be watching the Senoro project very closely. The JIEPA was meant to expand and deepen energy bilateral ties, but less than a year after its formal implementation relations in this area between Japan and Indonesia seem to be lurching from one crisis to the next. Whether personal conversations between the two heads of government yield any progress on the Senoro issue will be eagerly awaited.

Sources

Antara, ‘Govt Advised to Resist Japanese Pressure on Senoro Field,’ April 2, 2009.

Ben Farey, ‘Japan’s LNG Imports Slump; Cargoes Head to U.S., EU,’ Bloomberg, April 3, 2009.

Jakarta Post, ‘RI’s LNG Diverted to Other Markets,’ March 15, 2009.

Reva Sasistiya, ‘Donggi Senoro Asks Japanese Buyers to Extend Gas Sale Deadline,’ Jakarta Globe, April 2, 2009.

Tempo Interactive, ‘Japanese Prime Minister Asks for Certainty in Supply of Gas,’ April 6, 2009.