RESOURCE NATIONALISM IN INDONESIA

C O N F I D E N T I A L SECTION 01 OF 04 JAKARTA 003160

SIPDIS

SIPDIS

STATE FOR EAP/MTS AND EEB/ESC/IEC/EPC-GRIFFIN
DOE FOR TOM CUTLER/PI-32 AND C. GILLESPIE/PI-42
COMMERCE FOR 4430-BERLINGUETTE

E.O. 12958: DECL: 11/14/2017
TAGS: EPET EINV PREL PGOV ID
SUBJECT: RESOURCE NATIONALISM IN INDONESIA

REF: A. A) STATE 150999 (RESOURCE NATIONALISM)

B. B) 06 JAKARTA 05217 (SBY AND ECONOMIC NATIONALISM)

C. C) 06 JAKARTA 13253 (GOI SEEKS BETTER NATUNA
TERMS)

Classified By: Classified by Ambassador Cameron R. Hume. Reason: 1.4(b,
d)


1. (C) Summary. Indonesia has a long history of tension
between economic nationalists and those who welcome foreign
investment. However, our contacts report no upsurge in
resource nationalism-inspired actions. Indeed, the increase
in resource nationalism described in ref A has benefited
Indonesia,s petroleum sector as foreign investors have given
Indonesia a second look after receiving unreasonable
treatment elsewhere. In practice, foreign investors in the
extractive industries have long been able to participate only
as contractors for the Government of Indonesia (GOI). U.S.
firms complained to us regarding contract terms and bad faith
negotiations until late 2005. Since 2005 the GOI has
actually been more generous with contractor splits to entice
foreign upstream investors. The GOI has generally respected
deals once signed, despite vigorous protests by opposition
politicians and activists. State oil company Pertamina is
the primary beneficiary of resource nationalism in the
petroleum sector but lacks the technological skill to
capitalize on its privileged status. In the mining sector,
cabinet minister Aburizal Bakrie has been most successful in
using nationalism for his private personal gain. End summary.

OPEC,S Only Net Importer
--------------


2. (SBU) Indonesia is East Asia,s only OPEC member. But it
became a net oil importer in late 2004 due to years of lack
of investment in exploration and production. In 2006,
Indonesia ranked twenty-first among world oil producers and
eighth in natural gas. The turmoil of the 1997-1998 Asian
Financial Crisis took a heavy toll on the extractive
industries. Indonesia,s share of global petroleum
exploration and production spending plunged from eight
percent in 1998 to less than one percent in 2005. Crude
production continued its multi-year decline to an 11-year low
with 976,500 barrels of oil per day (bpd) in 2006. In April
2007 monthly output dropped below 850,000 bpd, a level not
seen since the early 1970s. President Susilo Bambang
Yudhoyono (SBY) came into office pledging to reverse the
trend to achieve a 1.3 million bpd production target.


3. (SBU) Many of the problems that U.S. extractive industry
companies face here reflect problems with the overall
investment climate. Working with the GOI, Parliament,
business, labor, and NGOs to promote reforms in this area is
among the USG,s top priorities here. U.S. firms continue to
express a high degree of frustration with the opaque and
lethargic decision making by GOI regulators, but they no
longer express dissatisfaction to us over the financial terms
of their deals. One American executive told us recently,
&It is not necessarily that Indonesia has gotten any better.
It is just that the rest of the world has gotten worse. It
is hard to get a deal done here but they generally stick to
it once it is done.8

Hardy Perennial: Indonesian Economic Nationalism
-------------- ---


4. (C) The legacy of harsh colonialism by the Dutch for over
three hundred years has left many Indonesians with a distrust
of foreign motives, especially in economics and business.
Under Soeharto, business was the business of Indonesia, but
free-market capitalism was not necessarily welcome. During
his long rule, Soeharto,s government created thousands of
state-owned enterprises (SOEs) in every sector of the
economy. Even today, the GOI has more than 150 SOEs, many of
which play large roles in key sectors. State oil Pertamina
is still the crown jewel for many economic nationalists here.
Foreign oil companies have been in Indonesia for more than
60 years, and the GOI had long required them to cut Pertamina
minority stakes. The company used to serve as little more
than the cash box for Soeharto and his cronies. It developed
little technical expertise, preferring to collect royalty
payments. The legacy of SOEs and mandatory local partners
for foreign companies has created throughout the entire

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society--and especially so in the resource sector--a
rent-seeking mentality. Elite Indonesian economic actors
have long focused on securing their 5 to 15% minority stakes
in foreign joint ventures, whether in mining or oil or travel
agencies or advertising firms. As a result, a Chavez-wannabe
in Indonesia would encounter fierce resistance from an army
of politically connected professional intermediaries, whose
parasitic existence depends on foreign energy and mining
firms.


5. (C) Now that Indonesia is a genuine democracy, a nascent
populism mingles with the old vestiges of economic
nationalism. Former People's Consultative Assembly
Chairman Amien Rais is the most prominent politician waving
the flag of economic nationalism in hopes of strengthening
his likely presidential bids in 2009 and stirring up trouble
for SBY in the meantime. In 2006 Rais and several other
prominent political figures issued a broadside in the form of
a public letter attacking SBY for the GOI deal with
ExxonMobil (EM) to develop the Cepu oil and gas field. The
group also criticized Freeport,s continued mining operations
in Papua. The open letter offered a mixture of incorrect
facts, misrepresentations of the truth, muddled thinking,
irrational economics, and tried and true economic nationalist
grievances. Rais frequently makes public statements that
Freeport pays no taxes or royalty payments in Indonesia from
the Grasberg copper and gold mine in Papua. Freeport
executives tell us they have met repeatedly with Rais to show
him their tax and royalty receipts, which equaled 1.5% of GDP
in 2006. We expect to see a continued upsurge in this
populist form of economic nationalism as we get closer to the
2009 election.

Foreign Oil Companies Bear All Risk
--------------


6. (SBU) Under Indonesia,s 1945 Constitution all natural
resources belong to the people. In practice this means that
foreign investors in the extractive industries may
participate only as contractors for the Government of
Indonesia (GOI) in return for a percentage of the profit.
Production Sharing Contracts (PSCs) are the principal way
through which the GOI regulates oil and gas exploration in
Indonesia. With the passage of the Oil and Gas Law in 2001
the GOI moved away from other models of cooperation
(Technical Assistance Contracts, Enhanced Oil Recovery
Contracts, and Technical Evaluation Agreements) to put all
new developments into the PSC model. PSCs generally have a
30-year term for new investment and may be extended for
another 20. Contractors bear all the risks and costs for
exploration and may recover their expenses only from
commercial production. PSC contractors obtain an after-tax
equity share of 15% (more in higher risk frontier areas and
as high as 35% for natural gas) after recovering their
exploration costs and investment credits. In practice,
however, a foreign company with several PSC areas earns a
return of less than 15% on the recovered oil since they earn
no cost recovery or tax deductions for unsuccessful wells.


7. (SBU) PSCs also have long featured a Domestic Market
Obligation (DMO) under which contractors were required for a
time period defined in their contract to sell 25% of their
production to the Indonesian market at reduced prices. In
January 2006, Energy Minister Purnomo announced a new natural
gas policy reorienting the then-world,s largest LNG exporter
to serve primarily domestic needs. Purnomo also announced
that PSC contractors would be required to sell &up to 25%8
of the production domestically at prices far below market
bench marks. The GOI has been unwilling since that time to
clarify whether this represents a ceiling or floor. The lack
of clarity has caused much angst among IOCs. To be sure, the
GOI continues to honor its current LNG export contracts. As
they have diverted natural gas to local use, the GOI has been
forced to go on the spot market to purchase LNG for delivery
to its South Korean and Japanese buyers at a cost of almost
$2 billion during the last two years, according to our
industry contacts. The GOI has told their foreign buyers
that they cannot expect to have their LNG contracts renewed
as they expire over the next six years.


8. (C) The protracted negotiations between ExxonMobil and the
GOI over the development of the Cepu oil field typify the
tension in Indonesian economic policy making between the

JAKARTA 00003160 003 OF 004


necessity to attract foreign capital and a deep ambivalence
and suspicion toward international investors, according to
many of our energy contacts. On March 15, 2006, EM and state
oil company Pertamina concluded more than four years of
negotiations on the joint operating agreement for the Cepu
block in East Java. EM will invest more than $2 billion in
the project, which will hit peak production of 171,000 bpd in
2010, representing an increase in national output of 15
percent. EM executives told us that they found the
negotiations to be painful and frustrating. They say they
concluded the deal only after they made high-level
representations personally to President Yudhoyono, who had to
replace the board and CEO of Pertamina to get the deal done.
EM executives also told us that the GOI showed much greater
flexibility in negotiations in advance of important high
level USG-GOI meetings, perhaps suggesting an important means
of combating the tendency toward economic nationalism here in
Indonesia.


9. (C) Currently, the two sides are again squared off over
the huge Natuna off-shore natural gas deposit (Ref C). The
contract could become a major source of contention. As of
now, however, the company has not sought our active support,
besides finding opportunities to raise it with GOI policy
makers when the opportunity arises. Our EM contacts say the
negotiating dynamic is similar to that of the Cepu
negotiations and no different now than when oil was trading
at $20 per barrel. The Natuna field was discovered more than
35 years ago but has lain dormant due to the high CO2 content
of the gas and the remote location of the field. The two
sides continue to haggle over the field operatorship and
financial percentages. In both the Cepu and Natuna
negotiations, the GOI has sought increased shares for
Pertamina financially but the main emphasis has been on
giving Pertamina personnel the skills and knowledge to
function as a real exploration and production company. Under
Soeharto, Pertamina was little more than a giant cash box for
the dictator and his cronies. The company had little
technical know-how and few personnel who could manage a
large-scale development. GOI contacts tell us they are
determined to replicate the success of next door neighbor
Petronas from Malaysia, which has the skills and balance
sheet to do complex, major oil field projects.


10. (C) Chevron and ConocoPhillips report no more than the
usual decade-old headaches associated in dealing with the GOI
energy bureaucracy. In fact, Marathon Oil and Anadarko
returned to Indonesia in the last three years in response to
the reformist signals sent by SBY,s administration. All our
companies continue to express frustration with the pace and
transparency of decision making by GOI regulatory officials,
but they find no connection between resource nationalism and
the lackluster tempo of bureaucratic decision making. Our
contacts say the biggest stumbling block to greater foreign
investment here is the GOI,s inability to coordinate tax
policy on the temporary import of drilling equipment, which
also far pre-dates the recent years of surging oil prices.
Our contacts believe that the intransigence may stem
partially from resource nationalism, but is more likely
rooted in the desire of bureaucrats to avoid causing losses
to the state treasury, which is equivalent to bribe-taking
under GOI law.

Mining More Susceptible to Populism
--------------


11. (C) Mining projects, which require less sophisticated
technology and less capital investment than petroleum
projects, seem to attract comparatively more attention from
economic nationalists. Despite a global commodities boom,
Indonesia has seen only $800 million per year in foreign and
domestic mining investment from 2000 to 2005, according to
GOI figures. Since the late 1990s, Indonesia has regularly
been singled out by an authoritative global survey for having
one of the worst investment climates for mining. This same
survey also regularly notes that Indonesia is one of the most
geologically prospective countries in the world. Fears of
poor treatment are holding up $11 billion of investment,
according to the Indonesian Mining Association. The most
prominent example of resource nationalism in Indonesia has
been Bumi Resources,s acquisition of Kaltim Prima Coal (KPC)
during 2001 through 2003 from a joint venture of BP and Rio
Tinto.

JAKARTA 00003160 004 OF 004




12. (C) Bumi Resources belongs to the parent company of
current Coordinating Minister for People,s Welfare Aburizal
Bakrie, one of the richest men in Indonesia. Under
Indonesia,s Contract of Work system, foreign companies must
over a specified number of years divest a majority of the
equity stake of each mine to the GOI or Indonesian partners.
Under foreign ownership KPC suffered from an abnormally and
suspiciously high amount of labor strife, according to
industry watchers. As a result, instead of divesting small
minority stakes over many years as required by GOI law, the
joint venture partners ultimately decided to sell 100% of the
company over only three years. Bumi paid $685 million for
KPC and another coal company in 2003. Our contacts at the
time told us these deals undervalued the companies at pennies
on the dollar. In 2007, Bumi spun off 30 percent of KPC to
India,s Tata Group in a deal which valued the firm,s coal
assets at $4.3 billion. Bumi executives have openly told us
and Wall Street investment road shows that they hope to
repeat such &value-oriented8 acquisitions in the future
with respect to Newmont Mining,s Indonesian assets.


13. (C) The Newmont divestiture process is ongoing and
currently poses no immediate risk to U.S. interests here.
Newmont is negotiating with several friendly Indonesian
parties about acquiring minority shares. However, again,
should Bakrie,s Bumi Resources seek to mount an unfriendly
takeover in the manner in which it acquired KPC, it could
become an investment dispute of importance to the USG. Our
message on this question is for an open and transparent
divestiture process, not a change in the current divestiture
requirement.
HUME