Pragmatism is winning out over ambition, at least as far as energy reform in Indonesia is concerned. When he assumed office in 2014, Indonesian President Joko "Jokowi" Widodo promised big changes for both the upstream and downstream energy sectors in an effort to attain greater local control of hydrocarbon production and stanch the flow of state funds into expensive consumer fuel subsidies. With this, Jokowi hoped to foster long-term self-reliance in extraction and production while channeling subsidy savings into much-needed infrastructure improvements, right-sizing fuel demand and lowering the country's reliance on imported fuel. All of the changes were part of Jokowi's overall bid to foster an economy based on manufacturing and industry, rather than raw commodity exports.

The Big Picture

Long a major hydrocarbon producer, Indonesia has struggled to lessen reliance on imported fuels since losing its net exporter status in 2004. But Indonesian President Joko Widodo's ambitious energy reforms have hit numerous snags over the past five years. While his objectives to shore up local control of production and curb reliance on foreign imports remain, his second term will feature a continued slow, pragmatic approach to reform.

Five years on, the results have been mixed. On the downstream side, Jokowi did move quickly to scrap key gasoline subsidies and cap diesel subsidies right after taking office in 2014, making painful cuts to a decades-old system that had long sapped government budgets. But even as Indonesia proved willing to cut prices and give market forces a greater role after oil prices began to fall in 2014, the government was not willing to continue them after oil prices began to recover. Instead, Jokowi's government has taken a more cautious approach out of fears of a public backlash and economic repercussions, compelling gasoline prices to remain flat for long stretches and dramatically raising diesel subsidies in 2018 (albeit with a resolution to drop them in 2020). On the upstream side, Jokowi's efforts to recentralize a large share of oil and natural gas production in state-owned Pertamina has also stumbled. The Indonesian behemoth has managed to secure operatorship of key blocks, but the government has put the brakes on giving Pertamina further responsibilities due to its lack of expertise, financing constraints and resulting production declines — to say nothing of Jakarta's fears of alienating vital foreign oil majors in the process. Through it all, oil price volatility has not helped either.

Together, it means that caution will be the watchword for Jokowi going forward. The president will continue to pursue his goals of rationalizing the downstream fuel market and indigenizing hydrocarbon extraction in the long term — but not at the cost of jeopardizing economic growth or setting a pace that unduly disrupts production.

A Cautious Approach to Upstream Reforms

Indonesia's hydrocarbon sector has deep roots and a long history of foreign partnerships, yet it has suffered in recent years from declining production and skyrocketing domestic demand. With this in mind, Jokowi is aiming to expand exploration and production to fill the gaps left by declining blocks. On the production side, his government wants to empower Pertamina to play a stronger role in the domestic industry and move into overseas markets. This effort to expand Pertamina's production role at the expense of international companies is part of Jokowi's overall strategy of resource nationalism to localize control of these resources and move up the value chain.

Indonesia was a net oil exporter until 2004 when it became a net importer. Indeed, OPEC suspended the country in 2009 because of the earlier loss of its net exporter status. Jakarta briefly rejoined in 2015, only to refreeze its membership a year later in resistance to OPEC-mandated production cuts. By 2018, consumption was more than twice as high as production — a state of affairs that is unlikely to change with hydrocarbon blocks declining and Indonesia's growing economy ever-hungrier for energy.

Natural gas, by contrast, has assumed an increasingly larger share of Indonesia's hydrocarbon production, rising to 60 percent of oil and gas production in 2018. By 2020, it is set to rise to 70 percent and then to 86 percent by 2050. Still, major oil and natural gas fields face longer-term decline, requiring more robust exploration (and therefore investment), particularly in more challenging deep-water blocks in the east. While Pertamina is capable of tackling aging fields, the deep-water blocks will require greater international involvement and larger spending commitments.

Jokowi's reform objectives still stand, but the past five years have brought headwinds and adjustments for Indonesia. Overall, the 2013-2018 period resulted in greater volatility both for Indonesia and the global oil sector, particularly in the wake of the 2015 oil price drop and subsequent fluctuations. Factors such as continued oil price volatility and uncertainty about Indonesia's energy reforms dragged total oil and natural gas investment down by nearly half from 2014 to 2017. Exploration and development constituted much of the drop — raising particular worries for Jokowi's energy hopes. In 2017, Indonesia drew just $10.3 billion in investment; it attracted more last year ($11.9 billion), but that was still far less than the $17.4 billion targeted. 2019 is not shaping up to be much better either, as investments totaled a mere $5.2 billion. Indonesia's resource nationalism has also decreased investor returns, reducing international interest. This is worrisome for Indonesia given that many international companies that have left — or been pushed out of — the Indonesian market are unlikely to come back readily even if Jakarta offers incentives.

Between 2014 and 2025, 27 hydrocarbon block contracts are set to expire — providing an opportunity for the government to hand over operations to Pertamina. But given the company's inefficiency and lack of expertise, as well as fears about the potential disruption to production, Jakarta has hesitated to allocate more blocks to the company.

Three big blocks, in particular, illustrate Jakarta's wariness: the Rokan oil block on Sumatra, the Mahakam oil and gas block offshore in the Makassar Strait and the Corridor oil and natural gas block on South Sumatra. Taken together, these comprise a substantial proportion of the country's output. In Mahakam and Rokan — the country's largest natural gas-producing block and second-largest oil-producing block, respectively — Pertamina beat out foreign majors to grab the blocks.

As Jokowi embarked upon his second term, however, he changed his approach on the Corridor block — likely because of Pertamina's poor performance, declining investment figures and his new political strength following the elections. Noting that Pertamina's takeover of Mahakam had precipitated a production decline of over 25 percent, Jakarta took a much more pragmatic and measured approach to balance resource nationalism and foreign investment.

Corridor's production-sharing contract among U.S.-based ConocoPhillips, Spain's Repsol and Pertamina was set to expire in 2023, but last month, Jakarta refused to hand over operations to its state-owned company as part of a 20-year contract extension. Instead, the government only raised Pertamina's share from 10 percent to 30 percent, while dropping ConocoPhillips' stake from 54 percent to 46 percent. And though the contract includes a technical transition period beginning in 2026 in which Pertamina will gradually take over operations, the deal will not culminate in the state-owned company assuming a controlling share of the block. With this, Indonesia is trying to balance foreign company interest with its resource nationalist goals.

The Indonesian government has made other efforts to sweeten the pot for continued foreign participation. In 2017, it introduced new contract terms, known as the gross-split scheme, which have brought greater predictability to the process and added tax breaks and incentives for extraction in difficult environments. And, in March 2018, the government eliminated 22 of 51 restrictions on energy sector business licenses and eased the corporate tax burden on select projects. There are some signs that this has already borne fruit amid improvements in the country's "reserve replacement ratio," an index measuring new, proven hydrocarbon reserves compared to current production. The ratio hit as low as 55 percent in 2017, but greater certainty about regulations and incentives raised the figure to 106 percent in 2018 — which outstripped even government targets in hitting a seven-year high.

Jokowi's reform objectives still stand, but the past five years have brought headwinds and adjustments for Indonesia.

But much will depend on how Jokowi proceeds with the long-delayed replacement of the country's 2001 oil and gas law, which the government implemented after Indonesia's transition to democracy in 1998 to regulate hydrocarbon extraction. The new law would both enhance stability in the sector and potentially dissuade foreign participation by formalizing some of the government's push to regain greater control over the sector. Drafts of the bill indicate that it would increase Pertamina's role and limit that of private companies by giving energy business licenses to a new state-run operator. Additionally, it would cement Pertamina's right of first refusal on new blocks and, after 50 years, another chance to assume control over them. Downstream, meanwhile, the law would allow the government to increase the amount of oil and natural gas it can compel operators to sell on the domestic market.

Falling Back on Subsidies Downstream 

But upstream reforms are only part of the picture. Jokowi's promises on energy reform also encompass the consumer end of the energy sector, as he has pledged to impose tough cuts on fuel subsidies to reduce runaway consumption and a growing reliance on foreign imports so as to free up government revenue for health care, infrastructure and education. At the start of his first term, Jokowi made headway in eliminating key gasoline subsidies and limiting those for diesel, reducing such expenditures by 2.3 percent of gross domestic product in 2014 to between 0.3 and 0.7 percent from 2015 to 2019. Thanks to the savings, Jokowi's government raised infrastructure spending from 1.7 percent of GDP in 2014 to 2.2 percent in 2015 and toward 3 percent since 2017. But since his initial success, Jokowi has failed to maintain the pace amid concerns that rising fuel prices could dampen economic growth, raise the cost of living and hurt his political fortunes. In short, it was much easier for Jakarta to cut subsidies when global oil prices were low than when those prices recovered.

In the end, the government has retained a major hand in setting fuel prices, retaining veto power over quarterly price changes and compelling Pertamina (which controls the lion's share of fuel retailing) to provide implicit subsidies on gasoline by selling it below actual world market prices. This sapped the massive company's funds because it had to shoulder the costs of the difference — particularly when oil prices rose. Because this has burdened Pertamina, the government announced in November 2018 that it would compensate the firm $1.3 billion for fuel sale costs in 2017. Elsewhere, however, the government has struggled to stop illegal deviation from fuel prices at the government-mandated price in far-flung regions.

Pertamina has also found it difficult to fulfill promises to refine more fuel domestically to feed markets in Indonesia. One of the company's divisions, PT Pertamina (Persero), is still the major player in retail fuel because of its distribution network and because it owns seven of Indonesia's nine oil refineries. The government, however, launched the Refinery Development Master Plan in an effort to raise this refining capacity, which currently sits at 1.1 million barrels per day, to 2 million barrels per day by 2024. Pertamina has pledged $7 billion per year from 2021 for this purpose, but it has so far failed to even reach its 2019 target of $5.5 billion.

And as 2019 presidential elections approached, Jokowi took an even more cautious approach to fuel prices. In March 2018, he publicly instructed ministers to keep fuel prices stable for two years. A month later, the government expanded its powers to control fuel prices. Then, in mid-2018, Jakarta announced plans to quadruple diesel subsidies to keep prices low. At the end of last year, the government announced plans that it would, in fact, raise premium gasoline prices, only to abandon the plan and drop prices across the board due to protests.

Indonesia's president faces a dilemma: Higher prices jeopardize economic growth, but sustaining lower prices is expensive, thereby requiring either higher taxes or government spending cuts.

Jokowi's Dilemma 

Although Jokowi's goal of higher and more liberalized fuel prices remains, he faces a dilemma: Higher prices jeopardize economic growth, but sustaining lower prices is expensive, thereby requiring either higher taxes or government spending cuts. Faced with such a difficult choice, Jokowi opted to prioritize lower prices in his 2019 budget, which included a 65.6 percent increase in energy-related subsidies over the 2019 figure. Accordingly, Jokowi only succeeded in raising the infrastructure budget by 2.4 percent from 2018, representing the slowest growth since 2014. With overall expenditures in the 2019 budget rising nearly 10 percent, Jokowi has promised to make up the difference with increased tax revenue, although that might prove a tall order given that Indonesia collected less than half of its targeted tax revenue in 2018. Still, now that Jokowi has secured a second term, the government has announced plans to cut the diesel fuel subsidy in 2020 to raise more funds to support liquefied petroleum gas development and also made easier by the fact that recently increased nationwide biodiesel requirements will result in a higher proportion of domestically produced palm oil in diesel blends.

Nevertheless, the trend is to maintain subsidies — something that does not bode well for Jokowi's erstwhile ambitions to enact downstream reforms. The global slowdown and the U.S.-China trade war have dampened Indonesia's non-oil and gas trade, widening the current account deficit to $31.1 billion in 2019 amid forecasts of further falls this year and next. This puts greater pressure on Indonesia to decrease its ballooning hydrocarbon imports. And while factors like the trade war, U.S. oil production growth and declines in global demand are all pulling down oil prices, supply-side disruptions and geopolitical tensions could raise it — raising the cost of Jokowi's price controls and the risks that hydrocarbon poses to Indonesia's bottom line on trade.