INDONESIA - Competitive Pricing.

With local gas prices at a 30% discount to the subsidised price of heavy diesel, gas becomes very attractive once the infrastructure is in place. With the proposed gradual removal of the 25% subsidy on diesel and other fuels by 2008, a target put off for another year in 2006, it would continually improve the price competitiveness of gas relative to oil.

Prices of gas supplied to households and small businesses are capped by the state regulator BPH Migas. Gas supplies to industries are not subsidised as in the case of oil products sold to industries.

PGN will remain free to negotiate and set prices for natural gas sold to industrial customers, who account for 98% of its total revenues, with prices at around US$3.7-3.9/m BTU.

Gas producing companies can sell their gas directly to local customers; but at prices much lower than international gas prices. Gas producers with PSCs signed after 2001 must supply at least 25% of their output to the local market, which is a disincentive for gas E&P investors. In early 2007 there was talk about raising this obligation to 42% of the output under new PSCs (see gmt10IndnsGeoMar5-07).

PGN is rather secretive about its gas pricing formula. Large customers have approached oil and gas companies directly.

In recent years oil and gas companies have been selling their gas to PGN at US$1.50-2.50/m BTU at certain delivery points. But more recently oil and gas producing companies have said that, if PGN is able to guarantee the sale the gas at US$3.80/m BTU, they would be willing to build the required pipelines directly to customers with a supply contract of 10-12 years. With domestic demand for natural gas growing rapidly, at the expense of LNG exports, the need for many supply pipelines has risen in the past two years.

If this happens, the room for PGN to grow would be limited - PGN would provide the service for transmitting the gas, instead of getting the additional profit from gas trading.

Where pipelines are under-utilised, PGN used to have the monopoly rights as the distributor and transmitter of gas in the country. But with the introduction of the new oil and gas law in 2001, the monopoly no longer exists and domestic demand for natural gas has since grown rapidly.

The government now gives licences to distribute and transmit gas in certain areas. New licences may be granted for a certain area if there is a lack of pipeline capacity. As long as the existing pipeline capacity is under-utilised, which has been the case with PGN for years, new licence have been given.

There remains a potential for changes to be instituted in the regulatory regime and government policies, which in turn could harm the margins, and hence future operations and profitability of PGN.

Growth is constrained by the lack of infrastructure connecting gas reserves with customers. PGN has indicated that it has a long list of customers waiting to be served. Most of its customers are located in Java, while the major gas reserves are located in Sumatra and Kalimantan. The building of pipelines by the gas utility to connect these sources to the markets will help PGN expand its business, with gas to replace diesel. Many industries currently use diesel fuel for burning.

The diesel price for industry is not subsidised by the government, which makes natural gas far more attractive. PGN hopes to capture the demand growth in all transmission and distribution requirements associated. The glass and ceramics industry is the largest customer, followed by chemicals and paper industries. Gas is mostly used in fire furnaces (as in the glass and ceramics industry), for heating and cooking, and to a small extent for generating electricity.

PGN is finding it difficult to supply gas to all customers due to the lack of infrastructure connecting gas reserves to the customers and the fact that it has no direct control over the gas reserves. For existing gas supply contracts, no penalty can be levied on the supplier for not delivering the contracted amount of gas.

For example, the supply from Kangean gas (owned by the private local companies Energi Mega Persada; ENRG IJ, ENRG JK) has been below the contracted amount, due to declining pressure. There is no penalty for PGN not being able to supply the required amount to customers. But the company is charging higher prices to customers who use more than the contracted volume.

On Nov. 24, 2004, PGN signed MoUs with 98 new customers in West Java to distribute gas sourced from South Sumatra through pipelines. These customers are primarily industries in glass and ceramics, chemicals, textile, food, and fabricated metals, and two are independent power plants (IPPs). The total volume is 334 MCF/d, half of which was to go to the IPPs. PGN has indicated an average price of US$3.9/m BTU for these new customers, with the average length of contracts being between 2-3 years.

The liberalisation of Indonesia's downstream petroleum sector has been under discussion for several years. Pertamina maintained its retail and distribution monopoly for petroleum products until July 2004, when the first licences for retail sale of petroleum products were granted to BP and Petronas of Malaysia. However, Pertamina maintains a dominant position in Indonesia's downstream sector, operating all eight of the country's refineries, despite the coming to the local oil market of other foreign majors. The government is still promising to open the downstream sector to full competition, although progress has been slow to date.