Newsletter No. 778
News-Analysis
October 24, 2007

 

The following newsletter has been contributed by David Adam Stott (Shingetsu Member No. 17). Stott is based at The University of Kitakyushu and is a specialist on conflicts in Southeast Asia.

INDONESIA AND JAPAN: PARTNERS IN DISAGREEMENT

The Shingetsu Institute has repeatedly detailed the close historic ties between Japan and Indonesia, which have resulted in the larger archipelago relying quite heavily on its northern neighbour for ODA, foreign investment and as a buyer of its natural resource commodities. Therefore, ties between Japan and Indonesia will have been strained this week by another announcement on Monday 21 October that Jakarta wants to reduce its annual liquefied natural gas (LNG) exports to Japan from 12 to 3 million tons (MT) following the expiry of their current contracts in 2010 and 2011. These contracts cover six Japanese companies who combined import about 12 MT annually, with Japan accounting for about 50% of all Indonesian LNG exports. Such contracts typically run for 15- to 25-year periods given the huge investments necessary for LNG extraction.

Iin Arifin, vice president of Indonesian state oil and gas company Pertamina, was quoted as saying, “Japan wants us to keep volume at 12 MT per annum, but we disagree. We are still negotiating.” This reaffirms a similar statement made by energy minister Purnomo Yusgiantoro on the sidelines of the signing of the Japan-Indonesia Economic Partnership Agreement (JIEPA) in August regarding the 3 MT per annum figure. Moreover, Mr. Arifin could only commit to supply Japan for a further ten years after 2010-2011, with 3 MT annually in the first five years and 2 MT per annum in the second five-year period. Resource supplies form the bedrock of the bilateral relationship and such news will be received with trepidation in Tokyo.

Analysts will not be surprised by Monday’s statement but, nonetheless, it is embarrassing for Tokyo so soon after a high-profile visit by Japan’s then-Prime Minister Shinzo Abe in August that apparently saw the signing of approximately US$4 billion worth of energy projects as part of the bilateral JIEPA. Indonesia has long been Japan's biggest LNG supplier, and with intensifying competition with other countries, particularly China, to secure stable energy supplies, Tokyo has been making overtures to lock-up Indonesian gas for the foreseeable future. Therefore, it was reported that the JIEPA requires Indonesia to provide LNG to Japan even in the event of new regulations that force it to cut exports, but this appears somewhat wide of the mark. In return, the pact provides a framework to encourage Japanese investment in energy development projects in Indonesia -- the key word here being ‘encourage.’

Indonesian President Susilo Bambang Yudhoyono told a news conference after signing the agreement that, “As for LNG, while making efforts to meet domestic needs, we will strengthen our relations with Japan.” On Monday, Mr. Arifin was more explicit, “We will give priority to domestic demand. Exports can be done if there is a remainder.” It would thus seem that the references to energy supplies in the JIEPA are not worth the paper they are written on, a point picked up by the Yomiuri Shinbun and cited by Martin Thiry in Shingetsu Newsletter No. 738.

From Tokyo’s perspective, the very raison d’etre for the JIEPA, due to take effect early next year, is to guarantee a fixed and stable energy supply, especially as Japan faces growing competition for supplies of LNG from emerging markets such as China and India. In addition to LNG, Indonesia is Japan’s second-biggest provider of coal and sixth largest supplier of crude oil. Indonesia is the Asia Pacific's only OPEC member.

However, it is well known that soaring domestic demand in recent years has left the world’s largest LNG exporter struggling to meet its commitments to supply Japan, South Korea and Taiwan with agreed amounts of the gas. Such demands have been exacerbated by record oil prices of late, prompting Jakarta to shift its export focus and use more gas for domestic purposes to substitute for costly oil. In addition, there is a proposed scheme to build new large-scale coal-fired power plants to further move away from costly fossil fuels for power generation. No doubt Japanese investment in this massive project will be sought, as per the JIEPA, so Jakarta must tread carefully over the LNG issue.

In addition to increasing domestic demand, Indonesia has been suffering from a decline in its own LNG production capacity. For instance, output at the aging Arun field in Aceh is now around 12.8 MT per annum, down from a peak of 28.9 MT in 1999, and is continuing to freefall. Indeed, in May 2007 it was reported that Indonesia’s state gas distributor PT Perusahaan Gas Negara (PGN) was planning to transport gas from Papua to Aceh to overcome the gas shortage caused by Arun’s falling yield. In recent years, to meet this shortfall, Indonesia has been forced to buy spot LNG cargoes to meet export commitments to Japan, South Korea and Taiwan. Moreover, the most recent gas supply projections from the Energy and Mineral Resources Ministry state that the Aceh and North Sumatra region is expected to suffer a gas deficit of 446.5 in 2007, which could rise to 448.7 million cubic feet in 2008, and 499.2 million cubic feet in 2009. Hence, Monday’s announcement was the latest in a series of that can be traced back to at least January 2005 when declining production led Jakarta to defer and cancel 51 scheduled LNG shipments for that year.

Indonesia began LNG production in 1977 after the Arun field in Aceh came on-stream and since then has been the world’s foremost LNG producer. However, in recent years LNG industry insiders have been concerned that poor policy and government mismanagement are threatening Indonesia’s competitiveness, and they have been pressing Jakarta to strengthen LNG governance and revise or clarify key regulations. Many of those who rely on Indonesian LNG supplies, in Japan and elsewhere, look wistfully back to the stability of the Suharto Era (1966-1998) when Indonesia was rarely accused of weak governance, and LNG supplies from Arun in Aceh and Badak in Bontang, East Kalimantan dominated the world’s supply.

Tokyo probably suspects that Monday’s announcement is also part of a ploy by Jakarta to drive the price up, conscious of the competition in securing LNG supplies that Japan finds itself in and with its contracts in Indonesia due to end soon. Tokyo’s fears are fanned further by the pricing controversy surrounding Indonesia’s latest gas field in Tangguh, Papua, scheduled to start shipping LNG in 2008. It has emerged that much of the Tangguh LNG has already been sold below the established market price to the China National Offshore Oil Corporation (CNOOC), a 16.96% shareholder in the Tangguh scheme. At the same time, buyers in Japan, who have already been paying higher prices for the past thirty years for LNG from Aceh and Bontang are trying to secure more gas from Indonesia and are thought to be prepared to pay handsomely for it.

Thus, the Energy and Mineral Resources Ministry and the Upstream Oil/Gas Management Board (BP Migas) have reportedly been offering half of Tangguh’s LNG to Japan and South Korea at far higher prices than China will be paying, with the LNG being redirected from the share due to be sold to Sempra Energy of San Diego. It has been speculated that the Tangguh contract with Sempra might be cancelled in order to supply Japan and South Korea at these higher prices. As Sempra is due to receive 3.7 MT of LNG annually for twenty years at US$5.94 per Million British Thermal Units (MBTU), to cancel this contract it must be assumed that Japan and South Korea will be paying much more, especially as the Americans will undoubtedly demand compensation. Meanwhile, China is due to receive 2.6 MT a year for twenty-five years at US$3.35 MBTU, and SK Power and Posco from South Korea have agreed an annual supply of 1.2 MT for twenty years at US$3.5 MBTU.

Such low prices are even below those for LNG currently supplied from the Badak field in Bontang, currently Indonesia’s biggest gas field, but which itself has been facing difficulties since it was reported in January 2006 that four of its LNG trains face closure. A Badak official was quoted in November 2006 as saying that Bontang LNG will produce 316 cargoes of LNG in 2006 and 310 cargoes in 2007, even though Indonesia has a contractual obligation to sell 365 cargoes of LNG from Bontang each year. With declining productivity at both its major gas fields, in Aceh and East Kalimantan, Indonesia needs to get a good price from the LNG in Papua, and the Jakarta Post believes that even domestic petrochemical, fertilizer, power, ceramic and other industries are thought to be prepared to buy gas at a price higher than that agreed with China.

Therefore, it is something of a mystery why Japan is expected to pay market price or above whilst the Chinese are not, especially considering that Nippon Oil Exploration (Berau) is a 12.23% shareholder in the project and LNG Japan Corporation (a joint venture between the Sumitomo Corporation and Sojitz Holdings Corporation) is a 7.35% stakeholder. One possible reason is that the August 2006 signing of a US$2.6 billion loan agreement with the Japan Bank for International Cooperation, the Asian Development Bank and several international commercial banks to finance the Tangguh LNG project does not cover the full cost of the scheme. Hence, Tangguh’s operators, headed by multinational Beyond Petroleum, had been in negotiations with Chinese banks to secure a necessary further US$900 million by the end of 2006. In addition, there is also the possibility that the Tangguh development has been linked to CNOOC’s July 2007 announcement that it had taken a controlling 51% stake in the development of biodiesel from crude palm oil and bioethanol from sugar cane or cassava in Papua and Kalimantan.

Also on Monday this week, Fujio Mitarai, Chairman of Nippon Keidanren (Japan Business Federation), expressed his concerns about future LNG supplies to the visiting Ginandjar Kartasasmita, head of Indonesia’s Regional Representatives Council (DPD-RI) for 2004 to 2009, when the two met at the Keidanren head office in Tokyo’s Otemachi district. Ginandjar, also Chairman of the PPIJ (Indonesia-Japan Friendship Association), is in Tokyo to hand a personal letter from Indonesian President Susilo Bambang Yudhoyono to Japanese Prime Minister Yasuo Fukuda, an old friend during Suharto’s New Order regime and chairman of the Indonesia-Japan Association (Japinda).

There is a suspicion in the Indonesian press, as detailed by Martin Thiry in Shingetsu Newsletter No. 716, that Japan got the better of the JIEPA, and therefore Indonesia, often characterized as a proud nation, could be reminding Japan of a certain reality in the bilateral relationship -- namely Japan’s resource dependence. As it seems likely that many areas of the JIEPA have yet to be fully ironed out, the negotiating game continues to be played out. These negotiations will be a true measure of Fukuda’s premiership and may test his connections and friendships in Indonesia to the full. It remains to be seen if Qatar’s promise of help with LNG supplies (see Shingetsu Newsletter Nos. 440, 444, 456, and 516) will tip the negotiations Japan’s way. Facing fierce competition for scarce resources from China, among others, in emerging LNG-producing areas such as Siberia, it will be interesting to see the Japanese reaction to this latest volte-face from Indonesia, one of Japan’s closest partners in Asia.