Opportunities in a fossil-fuel based sector indispensable to the energy transition in Indonesia

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Indonesia state-owned Pertamina launched a refinery development master plan that seeks to revitalize five of its major refineries by increasing their capacities and product slate while improving product emissions standards and reducing the country's dependence on foreign imports.

In the lead upto COP26, Indonesia pledged its commitment to the energy transition by ensuring that 50 per cent of its electricity capacity will originate from renewable energy in the next decade, ceasing construction of any new coal power plants beyond those already scheduled, and reaching net zero by at least 2060.

Seemingly contradictory, petrochemicals are essential to the energy transition and indispensable in the manufacturing, construction and operation of key renewable energy infrastructure. Stronger demand for this infrastructure, driven by Indonesia's commitment to its energy transition journey, could boost demand further.

As the fourth largest population in the world with more than 270 million people, industrial demand for petrochemical products in the archipelago was projected to triple over the next 20 years prior to the pandemic, particularly fueled by Indonesia's flourishing agricultural, automotive and construction sectors. In the past few months, demand and production have regained momentum. Challenges remain, including in relation to the lack of cost competitive feedstock. However, there is potential for Indonesia's petrochemical sector to thrive with nurturing government actions.

Petrochemicals: key components of our day-to-day life and the energy transition journey

Petrochemicals are so ubiquitous in our life that they are essentially inconspicuous. Originally derived from petroleum or natural gas, petrochemical products can be found in soaps, shampoo, detergents, gasoline, plastic, polyester, paint and fertiliser. If you are reading this article on a computer or phone over a meal, the plastic of your device, the Styrofoam of your coffee cup and the fertiliser that cultivated the produce on your plate were likely derived from these chemical compounds.

Renewable energy infrastructure depends on petrochemical-based products. Petrochemicals such as ethylene and polyurethane are required for the solar panels used to convert sunlight to energy. Wind turbines, for example, require steel for their beams, which is produced using powdered coal and natural gas. Other parts of the turbines such as the engine houses, airfoils, and rotor blades are manufactured with resins derived from petrochemical-based products while oil-based lubricants are needed for its gearbox. Meanwhile, synthetic graphite, a key component for electronic vehicles and grid storage batteries, is made from petroleum coke, a compound derived from the petrochemical and oil refining process.

From farming to auto production - petrochemicals burn bright in Indonesia

According to GlobalData, there are dozens of petrochemical projects in the pipeline likely to start operations in the coming years, mainly spurred by the strong demand for fertilisers and plastics for construction as well as car manufacturing.

The archipelago currently consumes around 15.2 million metric tons of fertiliser annually, and domestic demand for fertiliser is increasing, with the current administration seeking to buttress the agricultural sector as one of the key pillars of the country's economy.

According to Fitch Solutions, Indonesia's construction sector is projected to grow on average 6.9 per cent annually through 2029. This is expected to drive demand for PVC, a versatile petrochemical product used for window frames, piping, flooring and insulation.

As an additional boost to domestic petrochemical consumption, the Indonesian auto-production industry is expected to be a major beneficiary of the Regional Comprehensive Economic Partnership, which is set to remove 90 per cent of the import tariffs between member countries over a 20-year period. Benefiting from reduced tariffs on exports and relatively low labor costs and land prices, Indonesian auto plants are projected to receive major investments from international automakers. This should fuel demand for petrochemical products, which are the building blocks for plastics and synthetic rubbers used in vehicle production.

Roadblocks remain

Despite these drivers, domestic petrochemical production has the capacity to supply only around 30% of demand. This has compelled the country to import the balance, including semi-finished and finished plastic products from China.

The Indonesian petrochemicals sector is constrained by the availability of commercially attractive feedstock. Hefty duties are imposed on the importation of petrochemical feedstock. And, despite being a major producer of natural gas - another petrochemical feedstock - Indonesia exports most of its production, rather than direct such production to service the domestic market. Local fertiliser plants are frequently undersupplied with gas and operate at below than installed capacities, resulting in country-wide fertiliser shortages.

Additional challenges include securing financing for petrochemical initiatives. International financial institutions increasingly invest only in projects that maintain emissions within internationally accepted standards minimise geological impacts to surrounding communities and alleviate other key Environmental, Social and Governance (ESG) concerns. This has encouraged developers to re-configure their projects in light of such concerns, typically resulting in additional development costs.

Opportunities for growth

The Indonesian government appears to have taken notice of these issues. State-owned Pertamina launched a refinery development master plan that seeks to revitalize five of its major refineries by increasing their capacities and product slate while improving product emissions standards and reducing the country's dependence on foreign imports.

To optimise the development of the petrochemicals sector, the government is also planning to establish economic zones with separate laws to minimise the involvement of central and regional governments, many of which may benefit from import duty exemptions for materials required for the petrochemical supply chain. This measure, coupled with any implementation of transparent policies and processes to curb corruption and governance issues, and heightened developer sensitivity to ESG concerns, may encourage foreign interest to invest in Indonesia's downstream petrochemical sector.

The government's will to minimise reliance on petrochemical imports may tailwind the Indonesian petrochemical sector to exponential growth and cement the development of fully integrated local petrochemical value chains. Until we are able to find viable alternatives, petrochemical-based products will continue to play an important, if understated, role in energy transition. The Indonesian renewable industry and value chain may reap the benefits of a robust and expanding domestic petrochemicals industry.

Winifred Lu (White & Case, Associate, Melbourne) and Samarth Sreenidhi (VP  - Legal, ChemOne) co-authored this publication.

This was initially published in The Business Times (12 September 2022).

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