The Impact of Oil and Indonesia
In the world oil market, prices are determined by two phenomena.
The first of these phenomena is the law of supply and demand, commonly called "fundamental" factors. The second is the "psychological factor", which is the market anticipation of non-fundamental factors, such as geopolitics.
In "normal" conditions, the fundamental factors are dominant so that the prices reflect the supply/demand and inventory growth. If supply is bigger than demand, the inventory rises and prices will fall, and vice versa. The fundamental factors will determine the direction of prices – going down or up. Psychological factors will always affect the change in prices. The bigger the psychological factors, the greater the price changes.
Under "abnormal" conditions, for example, high uncertainty due to Covid-19, the psychological factors will dominate more. The uncertainty factor is exacerbated by the absence of an OPEC agreement with other large producers (commonly called OPEC +), especially Russia. This group did not agree to cut their production levels (collectively) by 1.5 million barrels per day (bpd) during the last meeting on March 6, 2020. Before this, OPEC + always managed to reach an agreement to cut production with good discipline. Saudi Arabia has always been the country with the highest production cuts. This OPEC + disagreement has triggered price drops.
The price has been very low, obviously because of the anticipation of excess supply, in addition to the Covid-19 outbreak which will cause the decline in the global economy. It will in turn reduce demand for oil. Previously, global demand growth reached 1-1.5 million barrels per day (bpd). In 2020, the International Energy Agency (IEA) projects negative growth of nearly 100,000 bpd. The fear over the weakening market grows, causing the pendulum to increase with high amplitude toward a super bearish situation. It has a domino effect on share prices on the world stock exchanges including Indonesia, which have dropped sharply.
A few years ago, before prices plummeted in 2014, prices in the normal condition were in the range of US$80-$100 per barrel. At present, with the large amount of “non-conventional production” from the US, normal prices fell to $55-$75 .
This high amplitude pendulum causes the price to be like a roller coaster -- very low in certain conditions, and when it recovers it will also be corrected with a high amplitude so that the price will increase sharply , then return to "normal". Then, when will fundamental factors be able to determine the price again? The "normal" condition changes dynamically according to supply and demand. A few years ago, before prices plummeted in 2014, prices in the normal condition were in the range of US$80-$100 per barrel. At present, with the large amount of “non-conventional production” from the US, normal prices fell to $55-$75 .
Saudi traders chat as they follow a screen displaying Saudi stock market values at the Arab National Bank in Riyadh, Saudi Arabia, Thursday, Dec. 12, 2019. Shares in Saudi Aramco gained on the second day of trading Thursday, propelling the oil and gas company to a more than $2 trillion valuation where it holds the title of the world\'s most valuable listed company.
Many (Western) media say this is a "price war", especially between Saudi Arabia and Russia. I\'m more of the opinion that this is a policy to maintain the market share because each of them is confident enough to survive because of their low production costs. The market share is important for the geopolitical role and thus (it hopes) it will force high-cost producers, especially unconventional oil in the US, to stop their production first.
The reality will not be that easy: "who will blink first?" The next question: will the current price return to normal conditions at $55-$75 or much lower, for example $30-$50 per barrel? Even if it rises again (rebound), how long will it take? Then, what are the consequences for Indonesia?
The anticipated market condition is that there will be prolonged oversupply. It will result in a price recovery in a short time, especially if there is no effective solution in handling Covid-19. The current price is very low, but it may still go down further with continued negative sentiment. Goldman Sachs estimates that prices could drop to $20 per barrel. No one can predict precisely, but low prices should trigger higher consumption growth. For example, after a sharp decline in 2020, the IEA predicts high demand growth to more than 2 million bpd in in 2021. This may reflect more of our desire and expectation, but it is quite possible if the Covid-19 outbreak can be successfully handled especially in all affected countries.
Consequently, consumption growth is expected to catch up with supply, where the surplus capacity is estimated at 4-5 million bpd. It takes at least 2-3 years for a healthy growth in oil consumption, around 1.5 million bpd each year. This means that it can take 2-3 years for demand to return to conditions that are in balance with supply. Along with that, prices can go up. With the perception that unconventional oil and gas reserves are still quite abundant and the costs can be quite competitive, say at the level of $30 per barrel, the possibility of a "new normal" level is at a relatively lower level, $45-65 per barrel.
Impact for Indonesia
As a net oil importer, falling oil prices bring good news for Indonesia. The cost of procuring fuel has gone down. Likewise, the burden of subsidies in the State Budget (APBN), for diesel, kerosene and LPG, will go down. The price assumption used by the APBN is far above the current price. The realization depends, of course, on what the average price is during 2019.
The downstream oil and gas sector, especially processing, will be helped, at least in the short term. This is because the decline in the price of BBM products will not be as fast as the decline in crude oil prices. With the Covid-19 factor, especially in China, several downstream petrochemical plants in Indonesia receive extra demand because of limited supply from China.
Conversely, upstream oil and gas activities are more challenging . Oil and gas (upstream) production in Indonesia is stagnant. The production of oil even tends to decline. Production from the Banyu Urip field, which has risen to more than 200,000 bpd, has been able to help the pace of decline in the past few years, but the decline in other oil fields cannot be prevented because it has already passed its peak. Many geologists believe the prospect of oil and gas in Indonesia is still promising, even quite good. However, the findings are not as expected: relatively small and no large oil fields have yet been discovered.
Unfortunately, we are not aware of this problem. Instead of making the exploration activities more attractive, we make the upstream oil and gas investment condition more chaotic and there are no signs of improvement.
Unfortunately, we are not aware of this problem. Instead of making the exploration activities more attractive, we make the upstream oil and gas investment condition more chaotic and there are no signs of improvement. While out there, large reserves are discovered in countries previously unknown to have any, such as Guyana. The Energy and Mineral Resources Ministry ‘s plan to give upstream oil and gas players freedom to choose whether they will use the gross split formula or cost recovery scheme. This will help, but a broader breakthrough to reduce uncertainty is still needed.
Men work on an oil rig at Sinopec\'s Shengli oil field in Dongying, Shandong province, China September 2, 2011.
With the decline in oil and gas production, especially oil, the government revenues from oil and gas will decrease in line due to lower prices. Exploration will be increasingly unattractive because bona fide oil companies will prefer to go to more prospective locations and a better investment climate. The production will continue to fall because the development of fields will be no longer attractive due to low prices, including gas fields whose economic value is also declining as a result of the fall in fuel prices.
Discussing the gas sector is interesting, especially with the government\'s efforts to reduce prices to $6 per million British thermal units (MMBTU) at the "consumer gate" (plant gate). An over-supply condition is also occurring in the gas sector, including for the liquefied natural gas (LNG) market. The Henry Hub gas reference price in the US has been under pressure for some time, currently at $1.8 per MMBTU. Buying LNG from the US to Asia becomes quite competitive with prices of $6 per MMBTU at the destinations. In addition, the potential supply capacity of LNG producers is also increasing, far higher than demand, so the current spot price of LNG in the Asian market has fallen to around $4 per MMBTU. This means that the domestic gas pipeline price of $6 per MMBTU is not yet competitive enough, especially if the price reduction plan is limited.
The LNG price is also experiencing a roller coaster although the amplitude is not as great as in oil. Maybe you still remember, we once sold LNG to China and Korea at a very cheap price, around $4 per MMBTU, due to an oversupply condition in the market or being too late. On the other hand, we have also sold LNG at very high prices to Japan, Korea and Taiwan, at more than $15 per MMBTU, in addition to the high reference oil prices (ICP) of above $100 per barrel. The benchmark formula which is based on the oil price ratio (commonly called the slope) is also high because at that time demand was higher than the supply or sellers\' market.
If gas users in Indonesia are allowed to import, LNG prices are now very competitive even compared to piped gas.
In the present condition, gas buyers who have signed high-priced contracts are forced to bite their fingers because they cannot take advantage of the low spot LNG prices. If gas users in Indonesia are allowed to import, LNG prices are now very competitive even compared to piped gas. It should also be remembered that prices in long-term contracts are more competitive than the prices of piped gas.
Reducing domestic gas prices is absolutely a necessity, including for domestic LNG prices from Bontang and Tangguh. Low oil prices will also be a challenge for renewable energy. Biofuel prices will be relatively more expensive than fossil fuel prices. The situation is quite challenging and not easy to overcome.
However, like all trials, this condition also brings opportunity to improve many things. Some of the opportunities that can be taken from the decline in oil prices include, first, this is a good opportunity to shift the subsidy policy to a more targeted one. Second, the opportunity to improve governance in the oil and gas sector, especially in finding a breakthrough to improve the investment climate in the upstream or downstream oil and gas sector so that it can improve competitiveness and economic productivities in general.
Third, the opportunity to review all assumptions in planning and analyze the scenario that can occur. If Indonesia succeeds through this challenge, which is taking the maximum benefit from the decline in oil prices, while still providing an attractive investment climate in the upstream oil and gas sector, this price reduction will bring blessings to us.
Widhyawan Prawiraatmadja, the Governor of Indonesia for OPEC, 2015-2016
