Redefining Indonesia’s fossil future and energy industry

by: Edward Cunningham, Boston, Massachusetts

This week Jakarta hosts the ASEAN Summit two years ahead of schedule. Later next month it will organize the East Asian World Economic Forum (WEF) for the first time.

As ASEAN’s largest economy and the world’s fourth most populous nation, Indonesia plays a pivotal role in shaping change in Asia. Increasingly, Indonesian decisions are shaping global change as well, particularly in energy trade and the environment.

However, it is precisely in these strategic areas that Indonesia’s vision falls short. A transformative national energy vision must begin with a fundamental redefinition of the way Indonesians view themselves and their economy.

Most importantly, Indonesia can no longer afford to think of itself as a “resource rich” nation. A government that spends 20 percent of its national budget on energy subsidies, has withdrawn from OPEC, refines below 70 percent of its crude oil, and continues to rely on imported diesel to power many of its generation plants clearly must change its approach to energy use if economic growth is to become sustainable.

Over the past decade alone, Indonesia has transformed from a major energy exporter to an energy importer, characterized by rising production costs, growing energy subsidies, a manufacturing sector declining as a percentage of GDP, and over one-third of its people still lacking access to electricity.

Sustaining healthy economic growth will require a thorough overhaul of the political economy of Indonesia’s energy sector.

A combination of misaligned energy pricing signals and a largely unreformed energy industry structure ironically renders economic growth a source of spiraling cost to the nation.

As the IEA observed in its 2010 World Energy Outlook report, “Indonesia’s fuel subsidies have the negative consequence of making growth itself an unaffordable expense to the government of Indonesia, which must pay more money for every new unit of electricity sold — money that is not spent on economic growth needs or social programs.”

The IEA predicts that, even under the more progressive “New Policies Scenario” — a model that incorporates currently planned reductions in subsidies and aggressive climate targets — Indonesia will be the world’s fourth largest consumer of coal in two decades, just behind the US. China and India will rank first and second respectively.

Sustaining energy security will require a diversification of energy supply and the reduction of peak energy demand.

Important advances in renewable energy investment support have been made, such as Indonesia’s feed-in tariff for electricity produced from geothermal energy, and the creation of a laudable US$400 million co-financing fund from the World Bank to aid the building of such plants.

A transition to larger domestic consumption of natural gas will alleviate some transportation fuel needs. Yet while Indonesian political leaders recognize the need for energy market reform and diversification, many industrial leaders continue to invest in a fossil future.

Such underlying tension results in President Susilo Bambang Yudho-yono announcing dramatic goals to reduce greenhouse gas emissions by a minimum of 26 percent by 2020, while over two-thirds of Indonesia’s primary energy demand continues to be met by fossil fuels, led by national coal demand averaging 14 percent annual growth between 1990 and 2008.

As many have written, sustaining the environment will in large part also depend on gains in efficiency — or the ways in which energy is used.

However, as in China, it must be recognized that the long life cycle of such coal-fired power investments and the pace of current investment in coal mean that much of Indonesia’s needed national efficiency gains will need to made on the supply side of the ledger, probably through ultra supercritical power conversion technology and electricity prices that reflect time of use costs.

Coal investment policy will need to focus on the creation of higher value-added activities along the coal supply chain such as logistics, processing, and, potentially, higher investments in coal bed methane production sites, that in turn will enable Indonesian firms to capture more value than in the past and consolidate the footprint of coal exploitation.

Indonesian leaders from the energy industry, government and academics will convene at Bimasena, Indonesia’s Mines and Energy Society, May 10 and 11 to discuss the public policy challenges with counterparts from the Asian region and the US.

This international seminar, entitled “Energy, Innovation, and Sustainable Development”, is being organized by the University of Indonesia’s Faculty of Economics along with the Harvard Kennedy School, and sponsored by Bimasena and the Rajawali Foundation.

It is the hope of these partners to identify a path forward that will enable Indonesia to strengthen intensification of energy investment, diversification of energy supply, and conservation of energy demand.

It is only through coordinated advances on these three fronts that Indonesia will be able to ensure
wrobust real economic growth, energy security, and environmental sustainability.

The writer is a joint post-doctoral fellow at Harvard University’s Ash Center for Democratic Governance and Innovation and the Belfer Center for Science and International Affairs. In the fall of 2011 he will join Boston University’s Department of Geography and Environment as an assistant professor focusing on energy markets, energy policy, and the political economy of development.

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