Trends and Opportunities in the I ndonesian Oil and Gas sector 1 To - PDF document

Good morning ladies and gentlemen and thank your for the introduction… The title of my presentation today is: “Trends and Opportunities in the I ndonesian Oil and Gas sector” 1

To convey my message and provide a reference source for you, I have the following presentation structure:  A brief overview on Indonesian Energy Supply and Demand and the role of gas  Some Specific Gas market insights  The emergence of Coal Bed Methane as a a potentially material and disruptive supply source  A quick look at the implications of commercial success in the emerging Indonesian CBM Industry  An overview of the key investment implications of this rapidly changing gas business 2

More information on Risco Energy can be found at www.riscoenergy.com 3

Like many developing countries, the primary driver of energy consumption is economic growth and this chart clearly shows the impact on energy consumption of Indonesia’s dramatic economic growth since emerging from the 1998 Asian financial crisis. The economy shows an energy intensity of around 1.0 meaning it take one unit of energy (a TOE in this case) to deliver one unit of GDP growth. Energy subsidies are however still pervasive in the Indonesian economy and changes in subsidy levels also periodically impact annual energy consumption growth. Indonesia's 10 year CAGR in energy consumption is 3.6%. At a forecast 6.0% economic growth rate, Indonesia’s energy consumption will double in the next 12 years and gas should play a key role in meeting this demand increase. 4

Indonesia’s economic development of the 1970’s and 1980’s was partly oil export driven. However declining production and rising consumption saw Indonesia transition to become an oil importer in 2003 and loose its OPEC membership shortly thereafter. Indonesia remains a substantial gas exporter however. Indonesia’s status as the worlds largest LNG exporter, was lost to Qatar a few years ago, however Indonesia continues today as a net oil and gas exporter on a boe basis. However, on a value basis, with Indonesia importing some half of its petroleum product needs and exporting LNG and piped gas, the hydrocarbon trade account is in balance. Indonesia’s coal production and exports have skyrocketed in the last five years as it feeds energy hungry India and China in particular with thermal coal. Production of renewables, largely geothermal and increasing palm oil is growing steadily from a small base however the full potential of geothermal is a long way from being realized. 5

The bottom line is that Indonesia’s net energy exports remain strongly positive with the industry’s historic export status being driven successively by oil, then gas and now coal. Will CBM or Shale follow? 6

Now lets derive some insights from trends in the natural gas market 7

Indonesia's gas production is still rising although the rate of increase has moderated substantially since the growth of LNG export expansion came to an end in the early 1990’s. Pipeline exports boosted export growth in the 1990’s and more recently the Tangguh LNG plant in Papua came on stream as Indonesia’ third LNG export facility. The most striking long term trend is now the rise of domestic gas consumption. This is driven by the pricing benefits of natural gas and government policy to replace expensive petroleum product imports (which are subsidized) with domestically produced gas. 8

So how is the gas production utilized? In 2010 some 83% of Indonesian gas production was sold, with the rest being either consumed in production operation or lost through flaring and shrinkage. Of the gas that was sold some 38% was consumed in the domestic market and the remainder was either exported as LNG, largely to Japan, Korea or Taiwan or through pipelines to Singapore and Malaysia. PLN (State Electricity Company) and PGN (State Gas Company) and Fertilizer Producers (State owned) were the largest domestic consumers responsible for over 70% of consumption between them. All were supply constrained in 2010. 9

Unlike oil reserves, proven gas reserves have continued to grow in Indonesia as exploration has more than replaced production. A leveling off in proven reserves is however evident in recent years and a decline in potential reserves is also evident, driven by declining exploration investment and smaller exploration find sizes. 10

While Indonesia is gas resource and reserve rich most fields are undeveloped and distant from the major markets in Java with supply constrained by a lack of transportation infrastructure. 11

Beyond upstream gathering pipelines, the major gas transportation infrastructure centers around “South & Central Sumatra ‐ West Java” and “Natuna Sea – Singapore and Malaysia” Plans for pipelines from Kalimantan to Java have not been realized and are rapidly being overtaken by lower cost, quicker and more flexible LNG import terminals or Floating Storage and Re ‐ gassification units (FSRU’s) planned to address critical gas supply shortfalls in Java and North Sumatra. Pertamina and PGN are major players in this new infrastructure development with PLN being the major customer, especially where it has CCGT facilities burning expensive imported diesel fuel. 12

Indonesia remains undersupplied with gas as pipeline and LNG exports emanate mostly from fields distant to the Java gas demand centers This diagram shows that even with the development of LNG regasification terminals in Java and Sumatra, domestic market supply constraints are expected to remain. This demand forecast is also typical of many developed in Indonesia, where demand growth is fundamentally supply constrained and not reflective of the unconstrained gas demand potential. 13

A long history of low domestic gas prices, certainly lowered than export prices as this graphic shows, is one of the reasons behind the current domestic supply constraints. Lack of Infrastructure and customer credit quality were other significant factors impeding supply. Effectively, upstream suppliers were for many years being asked to subsidize largely state owned domestic consumers and support PGN’s fat profit margins. This was never sustainable in my view and led to the current shortfalls. This situation, driven by necessity, is now changing. 14

Upstream gas prices, as measured by new domestic gas contract signings have been trending strongly upward for a number of years, as oil prices have also trended upward and supply constraints increased. Years of low long flat nominal pricing has been replaced by higher starter prices with some form of indexation now the norm. Oil linked prices paid by some customers deliver prices in excess of US$10.0 / MMbtu at current oil prices. This is a good deal for both producers and customers. In 2011 the average headline price for new gas contracts was US$6.3 / MMbtu. This however compares with an average Minas Indonesian Crude Price (ICP) of US$ 113.63/ bbl. or US$18.90 / MMbtu. 15

The above is self evident. Indonesia’s policy of subsidizing petroleum product and electricity prices has proven increasingly costly and unsustainable with the 2012 subsidy bill expected to come in at >US$ 20 billion dollars, some 17% of total government expenditures. This alone is a large part of the gas policy push. 16

The chart clearly shows the compelling gas value proposition for energy customers whose alternative is market priced or for some, subsidized petroleum products. Also shown is the expected prices of re ‐ gassified LNG delivered from the Bontang LNG plant to customers in West Java from East Kalimantan. While this represents a 250% increase in gas prices, the result is still very cost effective gas and environmentally friendly energy. 17

Now lets explore the potential significance of the emerging CBM industry. 18

Three basins hold 80% of this potential. South Sumatra Kutai Basin Barito Basin However only South Sumatra and Kutai basins also have developed gas markets and infrastructure. 19

New CBM licensing regulations and fiscal incentives have resulted in the signing on 50 CBM PSC’s since 2008. The majority have been awarded through the joint study and direct offer mechanism that also proven to be a successful mechanism for conventional PSC’s. We can certainly expect more CBM PSC’s to be awarded in 2012 and perhaps by the end of the year, the first shale gas or oil PSC under Government Regulation 5 of 2012. 20

While local entrepreneurs such as Ephindo, and Medco pioneered CBM in Indonesia, the recent arrival of the super majors is testimony to CBM’s gas resource and economic potential. 21

Pertamina leveraged its large conventional PSC land holding to move into the CBM business largely financed by first mover local and foreign companies. Entrepreneurial local companies are the next most significant although their business models are different. Some such as Ephindo have focused on operating capability, technical skills and financial capacity while others have followed innovative access and broker models. A period of consolidation can now also be expected. 22

Through the 50 CBM PSC’s signed to date, Investors have committed to spend a minimum of US$317 million over the initial 3 years of each PSC and paid an additional US$61 m in Signature bonuses. The committed minimum work programs total 408 wells comprising 294 core holes and 114 pilot wells. This is a huge call on, and opportunity for, the CBM service sector that is only slowly rising to the challenge. 23

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