Fueling Indonesians: Is this a

Fueling Indonesians:Is this a Window of Opportunity or Regret? Why? Please describe indetain to support your answer.Kerosene is widely used as cooking fuel by Indonesian households,with an annual usage of 10 million Kiloliters. It is a majorsubsidized fuel for household cooking, where its usage is oversixty percent of the 230 million population. The subsidy programcosts the government heavily, where it amounts up to U.S.$4 billiona year. As the practice tends to bleed government expendituresquite heavily, the Indonesian government is embarking on a changein its current fuel subsidy involving kerosene. This is also due tothe erratic price of crude oil, rampant smuggling of kerosene tounsubsidized markets, and rapidly increasing reported incidents ofdomestic fires triggered by kerosene. As a solution, the governmentdecided that liquefied petroleum (LPG) would be used to replacekerosene. Though it is more expensive as compared to kerosene, LPGis efficient to use and manage. The Indonesian government is awarethat many poor households would not be able to afford the requiredcapital investment. The startup costs of buying a stove and payinga deposit for a fuel canister represents a serious barrier for manyhouseholds.Therefore, to encourage conversion, the Indonesian government willgive each household a free stove, an LPG cylinder, and a firstconsignment of LPG, in addition to subsidizing the 3kg cylindersLPG. As the demand for LPG is expected to rise dramatically,Indonesian’s National Oil Company (PERRTAMINA) has declared that itis not capable of meeting the market demand, which is expected attwo million tons annually. Hence, the government is invitingforeign oil companies to venture into Indonesia’s LPG market eitheras wholesalers or retailers – breaking PERTAMINA’s monopoly of thefuel market.The government announcement, however, was received with absoluteresentment from the public. Demonstrations were organized andpeople marched into the streets voicing their anger. Many wereconcerned about affordability and availability, as existing LPGsupply is both expensive and limited, in addition to the potentialloss of income of current sundry shops (sundry shops make up 90percent of the kerosene distribution network). Others were worriedabout the potential change of lifestyle while a few claimed thatfood would never taste the same again.The announcement, however, was anticipated by the foreign oilplayers considering the advancement of fuel consumption.Nevertheless, they were surprised with the government’s aim ofconverting the current usage of kerosene to LPG in less than ayear. It simply seems an impossible task to convert a population of230 million –70 percent of whom have below-average national income– to a new product. Following this announcement, Blue Oilimmediately called for an urgent meeting at its Indonesian officein Jakarta to discuss the Blue Gas potential entry into IndonesiaLPG market. Blue Gas is the leading global player for LPG, withmarket presence in 80 countries. The parent company of Blue Gas,Blue Oil, has already established a foothold in Indonesia in theRetail Service Station and Lubricants market. Vice President ofBlue Gas, John Baily, Chairman of Blue Indonesia, Rodgier Van Cux,General Manager of Blue Gas – Southeast Asia, Johan Selleh, andVice President of Corporate Communication-Blue Indonesia, RudyHarianto, were huddled in an intense discussion.“Surely you gentlemen agree that there is a strong business forBlue Gas to enter the Indonesian LPG market now,” said Rodgier VanCux, who was eager to seize an opportunity of expanding Blue Grouppresence in Indonesia. “For years, Indonesia’s LPG market wasmonopolized by PERTAMINA. Foreign oil companies that attempted toenter the market faced government bureaucracy, hostile marketconditions, and unprofitable return on investment. Now the windowof opportunity opens by the invitation itself. Two million tons ofannual market demand is too big of an opportunity to pass by. Thedemand is also the third largest after China and India,” hecommented.To further demonstrate his points, Rodgier read aloud thepreliminary report on Indonesia’s LPG market. Indonesia houses amassive opportunity in an untapped LPG market. Armed with apopulation of 230 million and a steady growth of GDP, averaging 4.5percent annually, it promises a huge market of LPG in Asia alongwith China and India. Under the leadership of the sixth president,Susilo Bambang Yudhoyona, Indonesia achieved credible economicgrowth over the backdrop of a stable political climate. Despite amarket previously monopolized by PERTANIMA, LPG penetration inIndonesia is merely 15 percent, compared to neighboring countriesthat are 95 percent in Malaysia, 80 percent in Thailand, and 65percent in the Philippines.“There are a few fundamental factors at both the macro and microlevel that need to be sorted out,” Johan pointed out. “Ourexperience of new entries in countries like China and India taughtus to be extra vigilant in injecting capital investment withoutadequately anticipating what the end game would be,” headded.Johan argued about the risk that the company would have to bear ashe said, “The first factor is on subsidy; it appears that thegovernment’s motive to retrieve subsidy from kerosene was primarilydriven to curb high product cost and smuggling. What will happenwhen the reverse trend occurs? I mean when the LPG base price ishigher than kerosene? Will the government then reverse its policywhen we have already invested millions of dollars incapital?”At present, the government-set LPG cylinder price in Indonesia isaround U.S. 0.45 per kg (U.S.$450 per ton) against an indicatedfull-cost price in relation to market LPG prices of USD0.99 per keg(US$990 per ton). This is a huge differential to subsidize,particularly as much of the LPG demand growth in the future will besupported by LPG imports, where Indonesia—specificallyPERTAMINA-has to pay the full international market price. Forinstance, their most recent LPG import tender into Tanjung Uban forredistribution elsewhere in Indonesia saw PERTAMINA paying DecemberCP plus US$0.60 per ton for CFR delivery. The subsidy cost thatPERTAMINA will bear is estimated at US$345 million in 2008 andcould rise to US$1.8 million in 2012.“I believe with the elections looming in 2009 and the Governmentawareness of the potential risk of social unrest in Jakarta andelsewhere, there would not be any major hike in LPG cylinder pricesby the Government. However, what happens after that remainsconcern,” said Johan.Johan continued, “The second factor is the uncertainty of a levelplaying field in Indonesia. Whether licenses issued will be fluidto foreign oil companies or whether there are restrictions of tradearea and segments, etc. It is unlikely that PERTAMINA will allowits existing market share to erode with this invitation of entry toforeign oil companies. The government will likely devise somemechanism to protect the National Oil Company. Here thegovernment’s transparency is imperative,” worried Johan.“What would like be the protection mechanisms available to thegovernment?” asked John.“Well, quite a few actually,” replied Johan. “To start with, thegovernment could restrict the area on trade on the foreign oilcompanies. It is generally known that the Island of Java houses 50percent of population and that’s where the bulk of demand is. It isalso by far the most developed area in terms of logistics.Government may opt to restrict foreign oil companies to trade intoJava Island and only permit trade on the rest of the islands likeSumatra, Kalimantan, Sulawesi, etc. That will pave the way forPERTAMINA to maximize its profit on existing infrastructure, whilethe foreign companies struggle to build infrastructures thattranslate to lower and longer return on investment.”“Can we seek confirmation on these potential implementations ofrestrictions before we decide to invest?” questioned John.“We could, and even with the government assurance, there are risksthat the policy changes when the new government is elected everyfour years. The sentiment of nationalism is high in Indonesia, thusissues like this will likely surface to win votes and support fromthe public,” replied Johan.“On the micro perspective, we have to be careful which segment wechoose to invest in,” Johan added. “There are two segmentscurrently existing in Indonesia: 3kgh market, which is fullysubsidized by the government and very popular, and the 12 kgmarket, which is not subsidized and is unregulated, where suppliersare free to position their price and is currently only targeted tothe higher income group,” he claimed. “The factor to consider isthat the 3kg cylinders are not a standard Blue Gas package anywherein the global market. Thus we could not be able leverage oneconomies of scale if we need to adapt to this demand, if we askfor our cylinder manufacturers to change their design, the plantcarousel will need to be fitted with non-standard injectioncapacity and the whole R&D cost will increase to analyze thesafety issues and enhancement related to the 3kg cylinders,” heasserted.“There is also the factor of imminent change of consumer preferencein the future. The tendency is for the consumer to opt for a biggerpackage size once the domestic income improves. Our experience inChina, India and even Malaysia proved the theory of evolvingcustomer demand,” John added.“In addition to that, there are no guarantees that government willcontinue to subsidize the 3kg market in the future. The motivationof subsidy is clear for now to promote the conversion of the publicfrom kerosene to LPG. Without the subsidy, no conversion can takeplace without triggering public anger,” stated Rudy. “How thesubsidy policy evolves beyond then is unknown. Should thegovernment decide to discontinue the LPG