NORTH SUMATRA: A TALE OF TWO ECONOMIES

UNCLAS SECTION 01 OF 03 JAKARTA 013387 SIPDIS SENSITIVE SIPDIS Embassy Jakarta Medan Affairs Office # 36, 2006 E.O. 12958: N/A TAGS: ECON EAGR ENRG ETRD ID SUBJECT: NORTH SUMATRA: A TALE OF TWO ECONOMIES ¶1. (U) SUMMARY: High prices for rubber and crude palm oil keep North Sumatra's agricultural sector resilient. Industry experts expect the trend to continue as demand for oleochemicals and cooking oil increase, and biodiesel production expands. On the other hand, North Sumatra's manufacturing and construction sectors continue to suffer from increased energy costs, poor infrastructure, and weak government support. Rolling blackouts are frequent because electricity generation cannot meet current needs, and future construction will lag growing demand. Agriculture and agribusiness cannot supply enough jobs for North Sumatran youth, who might turn to criminality if no other opportunities exist. END SUMMARY. The Best of Times -------------- ¶2. (U) Increasing global demand for rubber and crude palm oil (CPO),leading to higher prices, is fueling expansion of the agricultural sector in Sumatra, especially for the two plantation-rich provinces of Riau and North Sumatra. Both India's recent reduction in duties for cooking oil and China's liberalization of its market as required under its WTO commitments are expected to increase demand for Indonesian-produced cooking oil. CPO producers also expect production of biodiesel from CPO will lead to even higher prices and steady demand for their product. Futures for CPO show strong bullish sentiment, and international analysts are quoted in press reports indicating international demand should increase as a result of biodiesel production. Medan's Belawan plans to expand its facilities to handle additional CPO shipments. Palm Oil for the World -------------- ¶3. (U) Domba Mas is contracted to supply Proctor and Gamble with 200,000 tons of fatty acids per year manufactured from CPO and palm kernel oil (PKO). Domba is currently expanding its refining capabilities and, with the expected completion of a second factory in late 2007 or early 2008, North Sumatra and Batam will produce the bulk of Indonesia's oleochemicals. The volume of Indonesian oleochemical exports have rebounded from a slump in 2002-2003. ¶4. (U) PT Data Consult, publisher of the monthly Indonesian Commercial Newsletter, reported in May 2006 that CPO-based cooking oil production increased from 4.3 million tons in 2001 to nearly 6.5 million tons in 2005. North Sumatra leads Indonesia in the number of factories manufacturing cooking oil from CPO. According to Industry Ministry statistics, Sumatra produces over 60 percent of Indonesia's CPO-based cooking oil. And Biodiesel to Move It -------------- ¶5. (U) Pertamina introduced biodiesel to the domestic market in May at four filling stations near Jakarta, but the real effort to promote biodiesel is GOI's plan to use biodiesel for five percent of Indonesia's total energy needs. The National Energy Management plan anticipates enough production capacity by 2010 to manufacture 800,000 tons per year of biodiesel. Indonesian companies are quickly building plants to meet this demand, with two planned for Riau province and an expansion of a pilot program in North Sumatra slated to produce a total of 6,000 tons per year. ¶6. (U) The Indonesian Oil Palm Research Institute in Medan uses biodiesel manufactured at the institute to power three of their vehicles. Institute researchers told us that CPO- based biodiesel is emissions neutral compared with conventional diesel and creates little waste product. Some of the residual materials, especially glycerin, can be used in cosmetics and pharmaceuticals - though a Norwegian engineer looking at this problem pointed out that the world market for these products is virtually saturated, so producers will be forced to compost or otherwise dispose of this waste. Researchers told us the main focus of their studies is reducing the temperature at which biodiesel can effectively be used: biodiesel produced from palm oil using JAKARTA 00013387 002 OF 003 current technology is not usable below 10 degrees centigrade, inhibiting export to markets in Europe and North America. ¶7. (U) Derom Bangun, Chairman of the Indonesian Palm Oil Producers Association, is optimistic biodiesel production will generate sustained growth for his industry. Although crude oil prices needed to be at least 65 - 70 USD per barrel for CPO-based biodiesel to be competitive, Bangun thought government subsidies could help in the short term. (Note: Pertamina currently pays 4,600 Indonesian Rupiah (approximately .50 USD) per liter of biodiesel, which it sells at a loss for 4,300 Rupiah. End Note.) For the longer term, he believed biodiesel could become an important component of world-wide energy needs, though he noted agricultural products -- such as rapeseed, corn, and castor -- were competitive with CPO as the base from which to make biodiesel. However, because oil palm plantations and processing facilities are already well established, little additional employment opportunities will arise. On many plantations, families live in plantation supplied housing and jobs are passed from parents to children. It Was the Worst of Times -------------- ¶8. (SBU) Following last year's reduction in fuel subsidies, North Sumatra's manufacturing sector slumped. In addition to higher costs for energy and transportation, interest rates also remain high. Factory owners report reductions in employee numbers and outright factory closings because of increased energy costs. PT Kedaung Medan Industrial, a mid- size manufacturer of glass and tableware products with a sizable export market (including to WalMart),closed one of its four factories in Medan because of increased energy costs, laying off 1,000 people. PT Effem Indonesia, a subsidiary of Mars Incorporated, recently closed its cocoa processing plant in Medan, laying off over 200 people. According to Effem's Commercial Manager, Suharji Gasali, processing that was formerly done in Indonesia will now be done in China. ¶9. (SBU) One local businessman described the North Sumatran economy as the worst since the 1998 financial crisis. He claimed 90 of 110 wood working plants had closed and the remaining 20 were struggling. Advisor to North Sumatra's Governor Polin Pos Pos claimed decentralization impeded action at the provincial level, pushing control to the Regency level. Regents, he noted, did not have the skills to improve local economic conditions, leaving Jakarta in control. Jakarta, Pos Pos lamented, gave no direction, leaving provinces powerless to act. ¶10. (U) Prominent Medan businessman Jonner Napitupulu said high interest rates have not directly hurt construction, but banks are reluctant to make loans because bank officials fear criminal prosecution if loans later become non- performing. Construction sites in Medan experience a brief spurt of activity once funding is obtained, but projects drag on without completion. Pos Pos noted that lower interest rates would be a necessary but not sufficient condition to spur economic growth. Basic Infrastructure Problems -------------- ¶11. (SBU) In addition to increased energy costs, other factors -- lack of steady electricity supply, poor infrastructure, arbitrary taxation, stifling brreaucracy, and the prevalence of protection rackt s -- conspire against economic investment in North Sumatra. Napitupulu reported local businessmen were looking overseas to invest rather than investing locally. He did not think Indonesia should try to grow by attracting foreign investment, but should develop internally first. ¶12. (U) Electricity production shortfalls particularly hurt manufacturers. Even though most factories have generators for back-up power supply, the brief interruption in electricity can damage sensitive equipment and damage production runs. At a recent meeting hosted by a visiting JAKARTA 00013387 003 OF 003 team from the Indonesian Parliament, manufacturers took aim at PLN for failing to provide stable electrical power. PLN plans to bring three additional power plants on-line in the coming years, but the increased capacity is unlikely to even meet expected growth in demand. Comment -------------- ¶13. (U) Inflation and a weak employment picture have hurt the poor people in North Sumatra. Inflation has reduced the purchasing power of people on fixed salaries, especially those earning minimum wage or just above minimum. Agriculture, the dominant industry in North Sumatra, props up the provincial economy, though it cannot provide the jobs needed to employ the growing labor force. Without jobs for the young people of North Sumatra, many of them might turn to the so-called youth groups, prevalent in North Sumatra, that are responsible for protection rackets and other criminal activity, adding further to the woes of the manufacturers. Pascoe