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Transition Management: Indonesia Kerosene to LPG Conversion Program

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Didin Kristinawati

1. Introduction

The Indonesian energy system has been dominated by the use of fuels with 36 percents energy consumption for domestic household. The price of fuel in Indonesia is currently one of the lowest in the Asian region as the government policy to subsidy the use of fuels. High oil prices lead to higher revenues and expenditures. However, expenditures have risen faster than revenues and for the central government, when the oil price passed $100 per barrel, the expenditures exceeded revenues. The deficit would have increased by 0.3% of GDP assuming no expenditure cuts in other government programs. One solution would be to remove subsidies. Therefore, the government implements policy to convert the use of kerosene to gas in the form of Liquefied Petroleum Gas (LPG). This conversion program can be regarded as one of the major breakthroughs in overcoming energy development while reducing pressure on the national budget.

The long resisting use of kerosene for household which moved to the use of LPG as an affordable and clean energy is a real innovation system and can be seen in transition management frameworks. The institutional framework of the LPG industry changed dramatically. The transition to a new system required a process of interrelated actors. We will address the different phases and actors involved in the transition of kerosene to LPG.

This paper aims to contribute in the understanding of system innovation in developing countries with special case of Indonesia, and more specifically to depict the role of the government agencies and other actors to success the conversion of kerosene to LPG as a transition process which involve structural changes of society. Section two will resume theoretical frameworks of transition management. The kerosene regime will be explored in section three. Then the predevelopment and take-off phases of transistion will present in section four. Section five depict the role of the government and other actors. Concluding remarks will be presented in the last section.

2. Theoretical Frameworks of Transition Management

Transition is transformation processes in which society or a complex sub system of society changes in a fundamental way over an extended period. The term refers to a change in dynamic equilibrium in which an existing equilibrium is suspended by a new one. Transition consists of combination of system improvement and system innovation, involving multiple changes. The process of change in transition is non-linear, slow change is followed by rapid change when concurrent developments reinforce each other, which again is followed by slow change in the stabilization stage (Rotmans et al., 2000).

The transition can be distinguished into four phases transition process; (i) The predevelopment phase where there is very little visible change but a great deal of experimentation; (ii) The take-off phase where the process of change gets under way and the state of the system begins to shift; (iii) The breakthrough phase in which structural changes occur in a visible way through an accumulation of socio-cultural, economic, ecological, and institutional changes that react to each other, during the acceleration phase, there are collective learning processes diffusion and embedding processes; (iv) The stabilization phase where the speed of societal decreases and a new dynamic equilibrium is reached (Rotmans & Kemp, 2004).

When analyzing transformation in socio-technical systems, it is useful to use the multi level scheme which makes distinction between niches, regimes, and he socio technical landscape. The term regime refers to dominant practices, rules, and ensuing logic of appropriateness that pertain in a domain either policy domain or technological domain, giving it stability and guiding decision making (Geels, 2003). Here we have kerosene regimes that will be explained in section three. The second level is niche that refers to places in which new things are done or domains for specialized applications. The niche can be a market niche or niche created by a company or government. The third level is the landscape, the overall setting in which processes of change occur. The landscape consist of the social values, policy beliefs, worldviews, political coalition, the built environment such as factories, price costs, trade patterns and incomes. The distinction between niches, regimes, and socio-technical landscape helps to understand processes of structural changes that can be seen as the outcomes of interaction between multi level processes (Rotmans & Kemp, 2004).

A common mechanism is landscape factors that put pressure on a regime of production, whose practices and technologies are challenged by new solutions pioneered in niches, with regime actors initially fighting and resisting alternative solutions focusing their attention and money on improving existing technologies, but over time changing course by investing in radical solutions. This is currently happening with conversion of kerosene to LPG (Liquefied Petroleum Gas) in Indonesia, long resisting use of kerosene for household which moved to the use of LPG as an affordable and clean energy, the belief system and management strategies of key actors’ change, new developments gain momentum, and regime shift may occur, this process will be presented in the next part of the paper.

3. Former Kerosene Regime in Indonesia


The Indonesian kerosene regime was formed in the 19th century, as the first company Royal Dutch was formed in 1885, based on production from Pangkalan Brandan, island of Sumatra. The company grew rapidly as Sumatran output rose throughout the 1890s. British Shell Transport and Trading initiated its own oil production in Borneo shortly thereafter. By 1907, the two companies had joined to form Royal Dutch Shell. Since then, the exploitation of oil in the archipelago began. During Japanese occupation, efforts were limited to rehabilitation of damaged fields and wells as the impact of war. Oil production was discontinued during the war for independence. When it was over and the nation started to run more organized governance, control over oil business became less clear.

Numerous small companies spurted to take advantage of oil fortune thus causing disputes. To subdue the disputes, control over oil was given to the Army. To anticipate it, the government established a state owned oil company on 10 December 1957 namely Pertamina. The 1945 Indonesian Constitution had stated that “Land and water and the natural riches therein shall be controlled by the State and shall be exploited for the greatest welfare of the people.” Under the new mining law, oil and natural gas mining is only conducted by the State, and the State’s company is authorized to engage in oil mining on behalf of the State. This resulted in Pertamina to act as a regulator -as representation of state- for partners who were under Cooperation Contract mechanism in Pertamina mining areas.

During the oil price shock of 1973-1974, Indonesia gained boom in cash flow. Indonesia’s oil production peaked in 1977 at over 1.64 million barrels per day. By 1982, production had made a pronounced decline, reaching 1.26 million barrels per day. Strong economic growth, combined with under priced domestic fuels by subsidy caused Indonesian demand for refined oil products to rise rapidly throughout the 1980s and 1990s, and Pertamina was charged with the task of organizing new refinery capacity.

Figure 1 Production, Consumption, Export, Import of Oil. Source: Data Ware House ESDM (September 2009)

As early 1989, when domestic demand was still less than exports, the clashing trend lines of falling production and rising consumption generated an expectation that the country would cease to be a net oil exporter sometime in the late 1990s. The country became a net oil importer during 2005, and total consumption of refined products is now greater than domestic crude production. The country already relied heavily on imported crude for its domestic consumption. Declining oil production has led to stagnation in oil and gas revenues, oil and gas now play a smaller role in Indonesia’s public finances than they did in 2000, prior to the increase in global oil prices. Since the East Asian crisis, there has been very little investment in new fields in Indonesia, and the existing fields are aging.

Suharto’s New Order regime (1968 – 1998) inherited and continued fuel subsidies from former President Soekarno (1945 – 1967). These subsidy increased markedly in the period of the Asian financial crisis from 1998 to 2000 elected government of President Susilo Bambang Yudhoyono responded by increasing subsidy. The reasons are to keep stabilization and get votes for the next election. Kerosene subsidy becomes a political commodity. The candidates attract voters by promising of cheap fuel which means more subsidies, they neglect the current availability of oil production, and long term development prospects of energy. However, the government kept the subsidized prices of gasoline, diesel and household kerosene fixed rather than linked to global prices, even though gasoline prices approached international prices toward the end of 2005. Since 2005, the international oil price has once again doubled, while domestic fuel prices have been kept constant. Kerosene is the most heavily subsidized fuel product, with a subsidy of $0.40 per liter (at 2007 average prices), more than twice its administered price of $0.20 per liter. Even after the May 2008 fuel-price adjustment, subsidies remain the largest spending item in Indonesia’s budget (Hertzmark, 2007).

In 2008, government subsidies of energy products will almost certainly reach over 4% of GDP or almost 20% of central government spending. One factor influencing the volume of subsidized product consumed is the gap between the subsidized price and the cost of the unsubsidized product. As the gap widens, consumers have more reason to switch to the subsidized product, and smuggling becomes more profitable. As a result, consumption increases. Short of a significant drop in international crude oil prices, Indonesia’s policy makers have two options for limiting subsidy spending: raising retail prices of fuel products, or reducing the quantity of subsidized products consumed. Increasing the price of any fuel product will lead consumers to reduce their use of that product, and to switch to other products.

Figure 2 Energy Subsidies dominate 2008 government expenditure in billions of dollar.
Note: Assumes oil at $95 per barrel. Source: Ministry of Finance, APBN-P for social expenditure 2008.

Subsidies have direct and indirect effects on household real income. Households benefit directly from lower energy prices and indirectly through lower prices for other goods and services, as the fuel subsidy makes them cheaper to produce or distribute.

There are other reasons why fuel subsidies are an ineffective social safety net. First, subsidies reduce spending for public services and poverty reduction. Indonesia’s public services and infrastructure are in great need of upgrading, but subsidies crowd out these crucial investments. Second, subsidies undermine good macroeconomic policy. Spending on subsidies tends to rise when the global economy booms and fall during downturns. Third, subsidies hinder competitiveness. In Indonesia, Pertamina is the only company licensed to sell fuel at subsidized prices. Although new companies have entered the market recently, they are restricted to market- priced fuels which are almost double the main subsidized fuels. Firms and households make inefficient and uncompetitive choices, resources are used in ways that do not maximize their returns, and production processes are less efficient than they would be if producers faced the true cost of their activities. For example, consumers choose fewer fuel- efficient cars, or live further from their workplaces than they would if they faced the true costs of using fuel. This also increases carbon emissions that are damaging to the environment and harmful to the health of the population. Lastly, subsidies generate opportunities for corruption and smuggling of products. Fuel products can be bought domestically at below-market prices and smuggled to neighboring countries, or used for purposes not intended to benefit from the subsidy (Bulman et al., 2008).

High oil prices lead to higher revenues and expenditures. However, expenditures have risen faster than revenues and, for the central government, when the oil price passed $100 per barrel, so expenditures exceeded revenues. According to Ministry of Finance, assuming the price of crude oil is at USD 120/barrel for 2008, the fuel subsidy will exceed 200 billion rupiahs, while national budget which have been approved by the house of representatives, the maximum budget allocated for fuel subsidy is only 135,1 billion rupiahs. The deficit would have increased by 0.3% of GDP assuming no expenditure cuts in other government programs. However, the recent policy move will not be enough if oil prices remain at, or above, $100 a barrel, and if Indonesia continues to fix fuel prices. One solution would be to remove subsidies from the political process altogether by linking regulated fuel prices to the market price in such a way that Indonesians gradually accept the true opportunity cost of the fuel they use.

4. Shifting Kerosene Regime to LPG: Predevelopment and Take-off Phases

Kerosene is widely used as a major subsidized fuel for household cooking as market niches, its consumptions approximately 9.9 Million Kilo Liter per year. It is used by 60 percent of 230 million populations which means that subsidy expenditure equal to 4 billion USD per year (Bulman et al., 2007). Government subsidies are used to reduce the cost of a fuel to encourage its use. These subsidies policy becomes counterproductive as they are expensive for the government and eating up significant portions of the national budget because the kerosene demand is getting increase. In 2008, the kerosene subsidies estimated reach up to 7 Billion USD and tend to increase in the upcoming years.

Figure 3 Energy for Households Consumption. Source: World Bank Calculations From SUSENAS 2007

The rich are the main beneficiaries of the fuel subsidy. It is often argued that fuel subsidies protect the poor. As the chart shows, the top 10% of Indonesia’s income distribution consumes 45% of the subsidy, in sharp contrast to the poorest 10%, which receives less than 1%.

On the other hand, the domestic consumption of LPG is expected to continue increasing with the growing popularity of this type of gas among Indonesians. Liquid Petroleum Gas (LPG) or bottled gas comprises butane or propane which is hydrocarbon gases produced during the petroleum refining process mentioned above. They are gaseous at normal temperatures but when compressed become liquid. It is typically purchased in cylinders of various sizes: 3 kg, 5 kg, 12 kg, and 50 kg. LPG is used predominantly for cooking and is very easy to use, is efficient and burns cleanly. It is not commonly found in rural areas but is used amongst middle or high income groups in urban areas. The high initial cost of purchasing appliances and cylinders, relatively sophisticated technology, irregularity of supply and risk of explosion mean that it is not widely used in the majority of poorer areas. Cylinders are usually exchanged at filling stations and since there are few of these in rural areas and transport is poor, access to this fuel source is also difficult.

In Indonesia, LPG is consumed almost exclusively by households, including restaurants and hotels, and the annual rate of LPG consumption has continued to increase from year to year. As a matter of fact, popularizing the use of LPG is not a priority in Indonesia’s energy policy. According to this policy, for many years LPG is not intended to be a replacement for oil fuel but it is intended to be part of energy diversification. In practice, however, the use of LPG has continued to grow, especially among households. The predevelopment phase of transition already began where there are very little visible changes.

Responding to the increased price of oil, the government developed policies to reduce dependency on oil. To this end, the government reassessed the benefits of oil subsidies and showed its willingness to eliminate the oil subsidy. However, because this policy redirection may lead to changes in the structure and system of the Indonesian economy, it is being implemented gradually. Moreover, the focus of the subsidy, which had been on commodities, has been shifted from the benefits of the rich to the welfare of the poor. A National Development Program called Propenas started in 2000 stated that eliminating the oil subsidy was to be achieved by 2004. Unfortunately, external factors (the global economy and fluctuation in the oil price) and internal changes (rising poverty rates and unemployment) have constrained the government from implementing the policy completely until recently (Adam et al,. 2008).

In line with the elimination in the oil subsidy, the government has another scheme to compensate for the effect of rising oil prices. The policy was known as the ‘compensating program for oil subsidy elimination’ and was first implemented in 2000. Through this program, the government reallocates the oil subsidy to other programs, which are aimed at helping poor people and supporting other development programs. It is expected that the compensation program will also help the government to minimize its budget deficit. Like the oil subsidy, compensating programs are principally to maintain the purchasing power of the poor because rising oil prices decrease their domestic welfare. In 2000, there were eleven programs, including health, education, small business and other socially beneficial programs. In 2008, the programs were reduced to one only, that is, cash transfer or more popular with BLT (Bantuan Langsung Tunai).

However, there are difficulties to control the effect of rising global oil prices, and the government is forced to implement the option of fuel price increase and totally remove energy subsidies. This opens opportunity window for the government to implement policy to convert the use of kerosene to gas fuel in the form of Liquefied Petroleum Gas (LPG). The fact that national budget cannot afford kerosene subsidies became an advantage for the take off of LPG. This conversion program can be regarded as one of the major breakthroughs for reducing pressure on the national budget.

The reason to convert to LPG and not other form of energy is that Indonesian owns natural gas reserves of about 92.5 trillion cubic feet, in 2003 ranks the 10th of the world largest gas reserves. The reserves are scattered around the archipelago, with considerable of them can be found in East Kalimantan, North Sumatra, West Papua, and China Sea areas. The amount Indonesian natural gas reserves are quite larger than those of oil. Besides using flare resulting from oil-refining processes, LPG can also be produced using the hydrocarbon compounds of natural gases. However, only 0.53% of Indonesia’s natural gas output is processed into LPG while 54.41% is processed into LNG and 10.8% into energy for large-scale industries such as petrochemical, fertilizer, cement, and steel. In 2000, Indonesia produced 2.09 million metric tons of LPG, of which some 1.32 million metric tons (63.3%) came from gas plants and the other 766.6 thousand metric tons (36.7%) from oil refineries (Nugroho, 2004).

5. The Role of the Government and Other Actors

The government aims of conversion program are to reduce subsidy by 33 percents or 2.2 billion USD annually after program completion (as mentioned above, the kerosene subsidy is 4 billion USD annually), to reallocate kerosene for more profitable use such as jet fuel, and to promote cleaner energy. The master plan is 42 million LPG packages will be distributed to eligible households starting from May 2008 to end of 2009 while 4 million kilo liters of kerosene will be withdrawn. By conversion program, budget for subsidized fuel is expected to reduce considering that subsidy for 1 kg LPG (of 1.7 liter kerosene energy equivalent) is lower than subsidy for kerosene. In 2010 onward, the government plans LPG will be the main cooking fuel with estimated total volume 3.5 ton per year. 6 million kilo liters of kerosene will be withdrawn (Akbar, 2008).

Figure 4. Targeted Area for Kerosene to LPG Conversion Program.
Source: Pre-Conference Workshop Clean Cooking Fuel, 2008

Another important actor currently involved is state owned company PGN Ltd. who handled production of LPG. PGN sells LPG to Pertamina who pointed to distribute LPG in cylinder cube with capacity 3, 12, 50 kilograms. The price of LPG in the market is 10 percent higher than previous subsidized kerosene. However, kerosene is no longer subsidized so that people tend to buy LPG as it currently becomes cheaper. PGN who actually exist many years ago, now play important role with Pertamina to guarantee the availability of LPG.

Figure 5. LPG Conversion Package for free including LPG cylinder cube 3 kg, stove, connector pipe.
Source: Akbar Wahyudin, 2008

To replace the use of kerosene the government plan to give one package LPG for free including LPG cylinder cube and stove. This work began with survey to determine area and eligible household. The government will also address cases of defective gas stoves, which is considered as the only remaining problem hampering the program, after it resolved issued concerning the procurement of gas stoves and their LPG cylinders. The government also runs marketing and education program to educate end user, agents, and retailers. Most residents still keep the package until they are convinced that the use of LPG cylinders and stoves are safe. The government runs intensive campaign using public icon, celebrity, politician, and religion leader to educate people. At the same time, the government runs direct cash assistance program popular as BLT (Bantuan Langsung Tunai), compensate kerosene subsidy into cash money to afford basic living needs.

Pertamina said LPG consumption per January 2009 stands at 7,255 tons a day. This is a tremendous rise due to the conversion from kerosene to LPG. Increase is almost two fold and small families are using LPG in 3 kilogram tubes. In 2008, sales totaled 1.85 million tons. Increased LPG consumption will run parallel with increased infrastructure because distribution is done through a lot of stages involving production centers, imports, vessels, tankers, filling stations and trucks. Filling stations will likewise be run by private companies and licensing is very difficult to get. Pertamina hopes that regional governments simplify procedures for the obtainment of licenses.

Pertamina needs partners to distribute LPG cubes around the country and also company to produce new stoves. The government opens opportunity for tender, 11 firms had won the bidding for the procurement of the gas stoves for the program, with a total production capacity of 17 million stoves per year. Another 11 companies, meanwhile, will supply 13 million LPG cylinders (Pertamina, 2008). The government has divided the country into four distribution areas: area I covering Sumatra; area II covering Java and Bali; area III covering Kalimantan, Sulawesi, Papua and Maluku; and area IV covering West and East Nusa Tenggara. Distributors have to provide services in at least two different distribution areas. Thus, new institutional structures have emerged and at the same time their building capacity are challenged. In transition framework it is the breakthrough phase in which structural changes occur in a visible way through an accumulation of socio-cultural, economic, ecological, and institutional changes that react to each other.

6. Conclusion

The long resisting use of kerosene for households which converted to the use of LPG in Indonesia is a real innovation system and can be seen in transition management framework. It is radical innovation in terms of the effect that the institutional and the actors involved are influenced dramatically by the use of new LPG system for households.

Since 1967, the government has subsidized kerosene to keep stabilization and get votes for the next election. Kerosene subsidy becomes a political commodity for the candidates to attract voters by promising of cheap fuel, they neglect the current availability of oil production, and long term development prospects of energy. Unfortunately, the survey result showed that the rich are the main beneficiaries of the fuel subsidy. On the other hand, In Indonesia LPG is consumed almost exclusively by middle up households, including restaurants and hotels. In practice, the use of LPG has continued to grow, especially among households. The predevelopment phase of transition already began where there are very little visible changes.

However, the world trends indicate the continuous rising of oil price. High oil prices lead to higher revenues and expenditures. In fact, expenditures exceeded revenues. It became difficult to control the effect of rising global oil prices, this situation opens opportunity window for the government to implement policy to convert the use of kerosene to gas fuel in the form of Liquefied Petroleum Gas (LPG). The fact that national budget cannot afford kerosene subsidies became an advantage for the take off of LPG. The reason to convert to LPG and not other form of energy is that Indonesian owns gas reserves.

To replace the use of kerosene the government plan to give one package LPG for free including LPG cylinder cube and stove. Another actor currently involved is state owned company PGN Ltd. who handled production of LPG. PGN sells LPG to Pertamina who is pointed to distribute LPG in cylinder cube. Pertamina also needs partners to distribute LPG cubes around the country. The government also runs marketing and education program to educate the ciziten as user of the conversion program. We can see the breakthrough phases when new institutional structures have emerged and at the same time their building capacity and relationship between actors are challenged.

The conversion program itself still continues and the stabilization phase where a new dynamic equilibrium has not been achieved. However, this transition process has been considered a success as more than 5.3 million households across the country stopped using kerosene in 2008. Pertamina said, the program had saved the company 5.32 trillion rupiahs in fuel subsidies between 2007 and 2008. Pertamina has distributed more than 1.9 million units of gas stoves and LPG cylinders. Up to 2009, the program has covered 13 provinces where 6.3 million kiloliters of subsidized kerosene has been withdrawn, while 1.9 million tons of LPG have been distributed (Budiarto, 2009).

7. References

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