FIFTH ANNUAL CONFERENCE ON COMPETITION AND REGULATION IN NETWORK INDUSTRIES 30 NOVEMBER 2012 RESIDENCE PALACE, BRUSSELS, BELGIUM

The Economic-Wide Impact of Natural Gas Allocation in Indonesia: An Analysis Using Recursive Dynamic Computable General Equilibrium Model
Aldi Hutagalunga and Djoni Hartonob, Centre for Studies in Technology and Sustainable Development (CSTM) University Of Twente, Drienerlolaan 5, 7522 NB Enschede, The Netherlands Phone: +31 53 489 5772 Fax: +31 53 489 4850 a.m.hutagalung@Utwente.nl b Department of Economics,University of Indonesia djoni.hartono@gmail.com
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Abstract Since the beginning of the 1980s Indonesia exported the natural gas to other countries, in particular countries in the region. However, the prospects for Indonesian gas are changing due to a refocus in natural gas policy of the country in 2001. The implications of this policy change have become more visible and show the difficulties Indonesia is facing with respect to the national management of natural resources. Theres strong emphasizes to change the direction of natural gas management from export oriented to the domestic market. Such a drastic change is not backed by the current Indonesian gas production. About half of the volume needed for the domestic market is not available in the short run since the gas is contracted in long term export contracts. The remaining production not yet covered by contracts is by far not enough to cover the growing need of the domestic market. But then the question is what is the proper hierarchical order between the economic sectors with respect to the economic effects of natural gas consumption. According to the official reasoning, natural gas should support economic development and prosperity in Indonesia and that is why the government applies the instrument of gas allocation. But unfortunately this instrument is applied without adequate scientific grounding in the economic effects of the gas allocation. This paper wants to contribute to a better scientific grounding of the Indonesian gas allocation policy for the domestic market, by
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analyzing the economic effects of current gas allocation with the help of Computable General Equilibrium (CGE) model.

Keywords: Natural Gas, Computable General Equilibrium, Gas Allocation, Resource allocation

1. Introduction Since the beginning of the 1980s Indonesia exported the natural gas to other countries, in particular countries in the region. However, the prospects for Indonesian gas are changing due to a refocus in natural gas policy of the country in 2001. The implications of this policy change have become more visible and show the difficulties Indonesia is facing with respect to its management of natural resources. Theres strong emphasizes to change the direction of natural gas management from export oriented to the domestic market. Such a drastic change is not backed by the current Indonesian gas production. About half of the volume needed for the domestic market is not available in the short run since the gas is contracted in long term export contracts. The remaining production not yet covered by contracts is by far not enough to cover the growing need of the domestic market

Facing this problem, in 2010, the Ministry of Energy and Mineral Resources established Ministerial Regulation No 3 concerning natural gas allocation for the domestic market. This regulation set the rules for the prioritization of natural gas allocation among the four biggest domestic gas consumers in Indonesia: the Petroleum Operation sector, the Fertilizer production sector, Power Generation sector, and other industry. According to the Ministerial Regulation the available natural gas for the domestic market had to be allocated in this hierarchical order giving priority to the Petroleum Operation sector, next to the fertilizer sector and so on. In this way the regulation was expected to guide the allocation of the scarce natural gas.

However, the rationality of the hierarchical order of sectors never has been explained. Therefore it is unclear what the ideas behind the order in gas allocation actually is. According to the official reasoning, natural gas should support economic development and prosperity in
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Indonesia and this argument also has been used to legitimate the instrument of gas allocation. But this instrument does not explain why one sector is prioritized over the other. So the allocation instrument is applied without adequate scientific grounding of the economic effects of the gas allocation order for the national economy.

This paper wants to contribute to a better scientific grounding of the Indonesian gas allocation policy for the domestic market, by analyzing the economic effects of current gas allocation with the help of Computable General Equilibrium (CGE) model. With the help of this methodology it is possible to analyze the economic effects of Indonesian domestic gas allocation systematically and in more detail. In this way the analysis in this paper provides for a scientific grounding of gas allocation which is currently missing in Indonesia. The following question has guided our analysis: How should Indonesia prioritize natural gas allocation for the domestic market to achive the optimum benefit for the national economy? The paper is structured as follows. The next section briefly introduces Indonesias natural gas market and current gas allocation. Then section 3 discusses the methodology of CGE model. In section 4 we discuss different scenario we developed for CGE Model. Section 5, provide impact analysis of every scenario, and section 6 discussion and section 7 summarizes the major findings.

2. Indonesias Natural Gas Market Indonesia is a country gifted with many different types of natural resources, among others oil and natural gas. Despite the huge gas reserves, Indonesia is facing many problems in exploiting the natural resources (see Hutagalung et al 2011). The domestic market is rather underdeveloped and concentrates on the Island of Java. The restricted domestic consumption of natural gas basically concentrates in the industrial segment, the household segment of the market is still neglectable, despite a refocus of natural gas policy from export to the domestic market. In 2006 oil, natural gas and coal were dominating the primary energy mix of the country, with oil
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accounting for about half and natural gas for about 25%. The share of natural gas in the countrys primary energy mix is expected to grow to 30% in 2025. This seems to be a manageable increase, but in reality it is a huge challenge given the overall growth of primary energy demand.

2.1 Natural Gas Demand and Consumer Figure 2 shows a projection of supply and demand of natural gas in Indonesia until 2025. The production forecast is based on information of gas producers on their reservoir simulation with expected volumes. Data on gas demand are based on already contracted gas sale agreements and projections of gas demand. The figure clearly shows a significant gab between supply and demand of natural gas on the domestic market, which is a serious problem; because for several reasons, the gab cannot be narrowed by additional natural gas production see Hutagalung et all 2011).

Figure 2 Forecast of Natural Gas Supply and Demand Source : Ditjen Migas, Natural Gas Roadmap 2011 Natural gas demand started to increase in 2005 when the government removed the subsidy on diesel fuel (HSD) for the industrial sectors. This encouraged a significant shift from diesel to natural gas in all industrial sectors causing a significant shortage of natural gas on the domestic market. The sudden rise in demand could not be met by the contracted natural gas for the domestic market and production could not be increased for several reasons (Hutagalung et al
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2011). Consequently, the domestic shortage of natural gas became very serious since 2011, endangering crucial economic sectors which are heavily depending on a secure and reliable supply of natural gas. The major economic sectors for which natural gas is crucial are the following sectors: Oil Production/Enhance Oil Recovery. Enhanced Oil Recovery (EOR) is a method used to increase the oil production by injecting heat (by burning the natural gas) to the oil reservoir in order to reduce the viscosity of the oil. The resulting additional crude oil production is significant (more than 50 thousand barrels oil per day), which requires 250 MMSCFD1 of natural gas as heat source and this additional production brings in additional state revenues. Due to the specific characteristics of the Indonesian oil fields and Indonesian oil, there is no alternative for natural gas in EOR. . Fertilizer/Petrochemical Industry The Indonesian fertilizer industry consumed about 11% of the total domestic gas supply in 2011. Currently the revitalization of old fertilizer plants by new ones is prepared which is expected to require 300 MMSCFD of natural gas in the period 2013-2030. If the plans are effectuated this would increase the current fertilizer volume with more than 4 million tons a year. Fertilizers are very significant for Indonesian agriculture and for the production of fertilizers natural gas is a crucial resource. There is no alternative feedstock available. The demand for fertilizers is growing and facing the increasing demand needs new production facilities which will increase the demand for natural gas. Electricity Previously, diesel fuel dominated the energy mix share for power plant, however as electricity subsidy increased steadily every year the subsidy became a burden for the state budget and it is expected that coal will become the dominant fuel again in Indonesian electricity production for the coming decade (RUKN, 2010). In 2008 the energy mix for electricity production is oil 36%, coal 35%, 17% of natural gas, follow by geothermal and hydropower 3% and 9% respectively (RUPTL, 2012). According to the last projection by
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MMSCFD = Million Standar Cubic Feed per Day 5

PLN2, the share of natural gas in 2020 will be approximately at the same level as 2008, without additional gas supplies it will be very difficult to effectuate this scenario. Industry/manufacture industry Industry category refers to all industry other than Fertilizer and Petrochemical Industry and used natural gas as fuel. Include in this sector are food and beverages, textiles, paper, ceramics, glass, cement, metal industry. Total Gas Demand of Industry in 2011 (Yusgiantoro, 2012) is 1522 MMSCFD, where metal industry and paper have the largest share with 60% and 16% respectively. Other industries are ceramics and glass with 9% and 4% while the rest of the industry uses neglectable volumes of natural gas.

The above overview shows the huge dependence of crucial economic activities in Indonesia on natural gas. It also shows the significance of several of these sectors for Indonesias GDP, such as the manufacturing industry with contribute for 24% of Indonesian GDP (BPS, 2012). For the continuation of the Indonesian economy a constant supply of natural gas is crucial. We already indicated that the increasing domestic gas demand cannot be met by supply in the coming years. So the expected gas shortage on the Indonesian domestic market requires an adequate policy response in order to minimize the negative economic impact. Indonesias policy response is national gas allocation and the question is how economic effective this allocation policy is. This question will be investigated in the rest of this paper. We first explain gas allocation as policy instrument in the next section. 2.2 Natural Gas Allocation National gas allocation was implemented for the first time in 2010. It was the contingency plan for natural gas supply shortage aiming at the efficient and effective allocation of natural gas for the benefit of the country (KESDM, 2010). The allocation order is based on the importance of the gas for an economic sector, where a sector in the higher rank will get the first opportunity to get the gas followed by the sector in the lower rank. The priority order of the sectors has been set as follows: 1. Enhanced oil recoveries/Petroleum Operation;

State Own Company who monopoly electricity market 6

2. Fertilizer feedstock; 3. Power plant, 4. Fuel or Feedstock for Industry The rationality behind this priority ranking is unclear. For instance, the decision to set Petroleum Operation as the first rank of priority has been criticized by energy expert3 because the natural gas is used only to boost Oil Production to maximize state revenue whereas it could give more benefit for the economy if the gas would be available for industrial production. The proclaimed prosperity for the national economy next to state revenues is not reflected by the national gas allocation policy and this inconsistency has been debated ever since the beginning of gas allocation in 2010.

To analyze the problem of natural gas allocation through a proper lens, it is necessary to look back at the basic concept of resource management. It is common for a developing country with a planned economy4 like Indonesia, to apply planning for the benefit of economic development (Munasinghe and Meier, 1993). Morever, Munasinghe (1980, 1988) introduced the hierarchical framework, so called Integrated National Energy Planning linking energy inputs with economic effects in the national economy. See figure 1.

To achieve development goals, a set of policy instruments is available, e.g physical controls, technical methods, investment influencing policy, pricing, tax, subsidy and other incentives (Munasinghe and Meier, 1993). According to Munasinghe and Meier physical control is most effective under circumstances of energy shortage, both in the short and the long run: The most fundamental task of energy analysis is to define alternative option and quantify their impacts on objectives established for national energy planning. (Munasinghe and Meier, 1993)

Pri Agung Rachmanto and Kurtubi in Media Indonesia criticized priority of Petroleum Production in Media Indonesia (Indonesia Newspaper) 4 ^ Alec Nove (1987), "planned economy," The New Palgrave: A Dictionary of Economics, v. 3, pp. 87980. 7

Figure 1 Hierarchical conceptual framework for integrated national energy planning (INEP) Source :Munasinghe and Meier (1993) Gas allocation can be considered as an instrument of national energy planning, which is common practice in countries like India (see Jain and Sain, 2011), Pakistan, and even in United States (US), (see Koplin, 1955). We found a similar sector ranking in Pakistan and India with the fertilizer industry and power sector heading the ranking in natural gas allocation. India considers the fertilizer sector crucial for food production and the agricultural sector as well as for power production (Jain and Sain, 2011). Pakistan has a slightly different ranking where priority is given to the commercial sector followed by the fertilizer sector and electricity generation. The USA has no specific rank of priority. Unfortunately none of these countries argues the rationality of the priority setting in gas allocation in a scientifically benign way. So we need to provide for the argumentation by an own analysis of the economic effects of the chosen priority setting of gas allocation in Indonesia.

Thus far we came only across one attempt of scientifically grounding the priority setting in Indonesian gas allocation. It is an unpublished master thesis applying Input-Output analysis (IO) Wibowo (2008). In his thesis Wibowo evaluates the output multiplier of each gas consumer
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as a basis for priority ranking. The major limitation of I-O analysis in this context is that it assumes linearity correlation and that it cannot analize short or long run effects. The I-O analysis is not able to deal with the dynamics in the economic system. We fill the gap in this paper by providing a dynamic analysis with Computable General Equilibrium (CGE) model. CGE is able to analyze links between all economic sectors in a dynamic way. Application of CGE in energy planning can be found on Seddighi (1985) for optimal planning in oil producing country, and Nagvi (1998) for energy suppy and demand modelling, although no specific case study on natural gas can be found in the literature. Nevertheless, an analog study for water allocation can be found in Qin (2011) and Hatano (2006) who investigate the impact of water allocation on the national economy. A similar study has been conducted by Juana (2006) for intersectoral water reallocation. All the above mentioned applications of CGE share the idea of estimating The economy wide impact of reallocation of a natural resource among the production sectors for the benefit efficiency improvement(Juana,2006). This is how we used CGE in our own analysis of natural gas allocation in Indonesia. The next section introduces the methodology.

3 Methodologies 3.1 Computable General Equilibrium (CGE) Model The CGE model is built upon microeconomic theory (Hosoe, Gasawa, Hashimto, 2010) From microeconomic analysis, it is assumed that households select a different combination of consumer goods to maximize their utility under budget constraints, while on the other side, firms choose the appropriate combination of intermediate inputs and factor inputs to maximize their profits, which are subject to certain technological constraints (He, Y.X., et al., 2010). Both producers and consumers determine the supply and demand function of the economic system, and the price and quantity will be formed were the equilibrium would meet (He, Y.X., et al., 2010). In this paper we used the DEN model5 which is the development of DEN- ORANI GRD models (Horridge, 2002). The production structure of the model can be seen in figure 3.

The model was developed in cooperation of DEN-UI-UNPAD in the Study Kajian Dampak Pengurangan Subsidi Energi Terhadap Perekonomian Nasional, Investasi Infrastruktur Ebt Dan Kehidupan Sosial Masyarakat (DEN, 2011) 9

Figure 3 Structure of CGE Model Source: DEN CGE Model, 2011 3.1 Structure of CGE Model This structure of CGE model consists of several blocks of equations, however due to space limitation, only some of the equation is described:

1. Production block: The equations in this block reflect the structure of production and producer behavior.

1.1 Demand for primary factor

Vi1 prim . pi1 prim = Vi1lab _ o pi1lab _ o + Vi1cap pi1cap + Vi1ind pi1ind the value of land cost, and V 1prim is the sum of all primary factor costs (Yusuf, 2008).

(1)

where V 1lab_o is the (initial) value of labour cost, V 1cap , i is the value of capital cost, V 1 ln is

1.2 Sourcing of intermediate input

1_ s 1 1_ s x1 csi = xci c pcsi pci

(2)

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where x1csi is the demand for commodity c from source s (either domestic or imported) by industry i, x1_sci is the domestic-import composite of commodity c, p1csi is the price of commodity c from source s faced by industry i, p1_sci is the eective price of domesticimported composite, and commodity (Yusuf, 2008). is the Armington elasticity between domestic and imported

1.3 Substitution among energy commodity

1ener ener s 1ener x1fi s = xci 1 p1_ fi pi i

(3)

where x1_sfi is the demand for energy or fuel type f by industry i, x1ener i is the energy composite, p1_sfi is the price of energy f faced by industry i, p1eneri is the efective or average price of energy, and is the elasticity of substitution among energy commodities.

1.4 Substitution between energy and primary factors

eprim eprim 1 x1fiener = x1 p1fiener pi1eprim ci i

(4)

where x1eneri is the demand for energy composite, x1eprimi is the primary factor and energy bundle (composite), p1eprimi is the efective price of primary factor and energy composite, and is the elasticity of substitution between energy composite and primary factor composite. The demand for primary factor composite (x1primi ) is given as:
1eprim eprim x1fiprim = xci p1fiprim pi1eprim 1 i

(5)

where p1primi is the efective price of primary factor composite (Yusuf, 2008) 2. Household: This block consists of equations that reflect the behavior of households and other institutions :

2.1 Household demand

The total real consumption of household h (x3toth) can be defined as:

3tot Vh3tot .xh =

V
cCOM sSRC

3 pur 3 csh csh

(6)

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where x3csh are the demand for commodity c from source s imported or domestic) by household h (Yusuf, 2008).

2.2 Household Income

Household income can be defined as :

Yh y h = +

Y
o C C cap hi

la b ho

la b _ i 1 la b h ( p1 + xo )+ ho h

i IN D

b 1ln d ln d h Y hla + x ih ) o ( pi

i IN D

(p

1cap i

+ x

1caph ih

)+Y

tr g h

trg h

tr h y trw y + Y htr h y w h + Y htr w y w h

(7)

tr h e tr h x tr w x ta x + Y htr h e w g Y ht r h x w h Y htr w x w h Y ht a x w h

where yh is the percentage change of household nominal income, Yh is the (initial) value of total household nominal income, Y labho is the value of labour income for skill po1lab_i o is the price of labour of skill x1labhoh is the quantity of labour of skill o supplied by household h; Y
lnd hi

is the value of income from land of industry i, p1lndi is the returns to land, x1lndhih is the

household supply of land; Ycaphi is the value of income from capital, p1capi is the returns to capital, x1caphih is the quantity of capital supplied by household h, Ytrgh and wtrgh are the value and percentage change, respectively, of transfers from government, Ytrhyh and wtrhyh are the value and percentage change, respectively, of transfers from other households, Ytrheh and wtrhe h are the value and percentage change, respectively, of transfers from the enterprise or corporate sectors, Ytrwyh and wtrwyh are the value and percentage change, respectively, of transfers from abroad (rest of the world), Ytrhxh and wtrhxh are the value and percentage change, respectively, of transfers to other households, Ytrwxh and wtrwxh are the value and percentage change, respectively, of transfers to the rest of the world; and Ytaxh and wtaxh are the value and percentage change, respectively of household income tax (Yusuf, 2008). 3. Block of Market Clearing and other equations: The equations in this block determine the market clearing conditions for labor, goods and services in the economy. National balance of payments is also included in this block, and in addition there are other equation that determine macro variables as well as some definition or identities (Yusuf, 2008).

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4. Inter Temporal Block: In order to have dynamic CGE model which can be used for a few years, capital function and labor supply function must be dynamic functions. These functions illustrate the changing from year to year, which is defined as equation [8] and [9]:
K = Y0 - DK0, K0 = Y00 - DK00 Y is investment; D is depreciation rate, n price of new capital price

(8) (9)

Subscript "0" indicates the initial value (start-of-period). Thus, changes in the investment period does not affect the growth rate of capital in this period, but in the next period both sides of equation (8) in equation (9) has been multiplied by 0 to relate Y0 and K0 with the values that appear in the initial database : Y00 K00 (DEN-UI-UNPAD, 2011)
3.2 Database of CGE-Social Accounting Matrix

Social Accounting Matrix (SAM) is a comprehensive, economy-wide data framework, typically representing the economy of a nation; a SAM is a square matrix in each account represented by rows and columns. Each cell shows the payment from the account of its column to the account of its row. In this paper we used Indonesias SAM of 2008 as the database for CGE model, since it is the last SAM published by Bureau of Statistics, available at the Indonesian Central Agencies of Statistic (Badan Pusat Statistik or BPS). SAM is published by BPS every 5 years since 1975. The validity and reliability of SAM can be found in several studies using earlier version of Indonesian SAM, for example Hartono and Resosudarmo (2008), Lewis (1991), Thorbeck (1992), Azis (2000) and Clement et al. (2003). Table 1 shows the classification of Indonesias economic sectors which have been used as database of the Indonesian SAM in our model. We modified the original SAM slightly to make it more adjustable for the purpose of our analysis. Our modification is the disaggregation of the energy resource sector - coal, natural gas, crude oil and geothermal- and mining, the separation of the petrochemical sector from refinery in general and the distinction between electricity and urban water and gas. We considered this disaggregation necessary since we are focusing on energy intensive sectors of the economy. After disaggregation, our analysis covered
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43 economic sectors, which we considered sufficient for reliable and valid statistical results. Another modification is household type which is aggregated in one type of household. Table 1 Production Sector Classification
Sector Classification Food crops Estate crops Livestock Forestry and hunting Fishery Metal (ore) Coal Mining Crude Oil Natural Gas Geothermal Other Mining Food Processing Textile and Leather Wood Processing Papmachi (paper & metal) Petrochemical Sector Classification Refinery (inc all refinery product and LNG) Electricity (subsidy and non subsidy) Urban Gas Clean Water Construction Trade and Storage Restaurant & Hotel Train Land Transportation Air-Water transportation and Communication Supporting Services Bank and Insurance Real estate Public service Personal Service

Source: BPS, 2008

3.3 Parameters of the Model

Elasticity parameters used in this model is the Armington number, which expresses the elasticity of substitution between products of different countries. The elasticity of export demand values demand responses of export commodities to changes in the international market price. And finally the elasticity of value added values the response of the change in labor force in various types of jobs due to wage changes. Normally, these parameters are empirically assessed by time series and econometric analysis. However, because of data limitations in the field, parameter values in this paper have been taken from previous studies, both studies conducted in Indonesia (Yusuf, 2008). We specifies value of the parameters in table 2 Table 2 Elasticity parameters of the model, Sector Armington 17.2 Natural Gas 5.2 Crude Oil 3.3 Petrochemical 4.4 Electricity 2.95 Paper 2.95 Metal

Export -34.4 -10.4 -6.6 -8.8 -5.9 -5.9

Value Added 0.2 0.2 1.26 1.26 1.26 1.26

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3.25 Rubber 3.25 Food 3.75 Textile Source : GTAP database for Indonesia

-6.5 -6.5 -7.5

0.23 0.23 1.26

4. Scenario

Using the CGE model for empirical analysis, we can change the properties of endogenous and exogenous variables to simulate certain policies under certain conditions. First we set economic growth within the time frame 2008-2025 without any policy change as baseline scenario. We used this base line scenario as comparison with the other scenarios with the allocation priority rankings. GDP growth for baseline scenario is taken from actual data for period 2008-2011 and government planning for 2012-2025 as in table 3 then we develop several scenarios of curtailment of gas supply in different sector, Oil Production, Petrochemical, Electricity and Industry which consist of three industrial cluster, Textiles, Food Industry and Papmachi (Metal Industry and Paper). Table 3 GDP Growth 2008-2025
Years
2008 2009 2010 2011 2012-2014 2015-2025 Source : BPS and MP3EI, 2011

GDP Growth
6.01% 4.63% 6.2% 6.46% 6.4-7.5% 8-9%

In our simulation, we will compare the impact of reducing gas consumption proportionally to all consumers, with reducing the same amount of gas consumption to only particular consumers. Reducing gas consumption will decrease the output of sectors which is set as exogenous variable in the model. The elasticity6 of output with gas consumption is determined

The amount of output drop because of reduction in gas consumption 15

under different assumptions for each sector because of differences in sector characteristics in gas utilization. Those assumptions are: 1. Every 10 MMSCFD of gas consumption will help to increase oil production by 6500 Barrels/day (Ditjen Migas, 2011), and loss of this amount of oil is converted from a physical unit into a monetary unit for the purpose of simulation. 2. Elasticity for Petrochemical and Industry is estimated from the Output multiplier from Indonesian Input Output Table of 2008. The output multiplier for petrochemical is 1.0039 which means that for every 1 percent drop in gas consumption, Petrochemical output will contribute by 1.0039 percent and so on. 3. Elasticity of Petrochemical and Industry is estimated from Output multiplier from Input Output Table 2008. Output multiplier for textile, food industry and papmachi are 1.27; 1.06; and 1.37 respectively. 4. Elasticity for electricity sector is based on the equality of heat rate between High Speed Diesel (HSD) and natural gas. This means that a reduction in gas consumption will not decrease electricity output, but it would change the primary energy source from natural gas to (HSD) as the most likely energy substitute. Heat rate of 1 liter HSD is equivalent with 38887.7193 BTU7 of natural gas, and from this conversion rate we can calculate the increase in HSD consumption for every 1 MMSCF gas supplies that has been cut. We carried out two different simulation scenarios for each of the four prioritized sectors (table 4). The column gas level in the table shows the reduced amount of gas consumption which then converted into percentage of decline in output. Output decrease is the amount of drop in production of a sector because of restriction in gas consumption. The first column, gas level shows the absolute volume of gas consumption that will be reduced from a particular sector. However, since it is not possible to use absolute number in CGE model, this amount of gas has to be converted into percentage of relative share of overall gas consumption in the sector. For instance, if we run scenario of cutting 50 MMSCF from petrochemical industries, then we have to calculate the percentage of 50 MMSCF gas in its total gas consumption, this percentage will be used to calculate the amount of output drop of petrochemical base on assumption no 2 (see

1 MMSCF = 1000 MMBTU, BTU = British Thermal Unit, 16

above). Our calculation shows that it is equivalent to 4.76% drop in petrochemical output. This output decrease is used as exogenous variable in our CGE model which will be run continuously in every single year from 2012 to 2025. Table 4 Simulation Scenario (Output decrease)
Sim A1 A2 Gas Level 50 100 Proportional 2% 4% Crude 4% 8% Petrochemical 4.76% 9.51% Electricity 3% 6% Textile 12% 24% Industry Food 10% 20% Papmachi 12% 25%

Source : authors calculation

5 Results and Discussion

In this part, we elaborate and analyse the results of the simulation. We analyzed three different effects: 1. The macroeconomic effects for Indonesia in terms of GDP, employment, consumption and investment 2. The effects on the sectoral output 3. The effects on the national energy consumption

5.1 Macroeconomic effects for Indonesia 5.1.1 Gross Domestic Product (GDP)

The first analysis we did is assessing the impact of the two gas reduction scenarios on gross domestic product (GDP). The first scenario (A1) is a gas reduction of 50 MMSCF for each sector and scenario 2 is a gas reduction of 100 MMSCF (A2). Figure 4 displays the effects on GDP of the sectoral gas reductions of 50 and 100 MMSCF. The GDP effects of both scenarios are deviations from the base line scenario, the business as usual scenario when there is no policy intervention at all. Taking the food sector as an example, it shows that a gas reduction of 50 MMSCF leads to a decrease in GDP of 7,8% in 2012. Restriction of gas supply to the crude oil production and electricity production causes only less than 1% in GDP decrease. However the opposite impact occurred for the sectors
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petrochemical, food, textile, and papmachi (paper and metal). The national economy will suffer more than average if gas supply for Food is cut, followed by papmachi and textiles, with 3.6 and 1.8 % drop respectively. This is explained by fact that those industries have the most added values for the economy compared to crude oil production and electricity (Input-Output table, 2008) per volume of gas utilization, therefore a reduction of gas supply will reduce the sector output and GDP. Based on the effects on GDP Indonesian gas allocation should prioritize gas allocation as follows: 1. Industrial sector (Food, Textiles, paper and metal) 2. Petrochemical, 3. Crude oil production 4. Electricity.

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Figure 4 Impact on GDP (authors calculation) on Scenario A1 and A2

5.1.2 The effects on national employment

Employment shows a massive decrease in the short term (2012-2015) due to the decrease in GDP because of reduced sectoral output and corresponding employment levels. So the effect on national empolyment follows the pattern of GDP, analysed above. The biggest effect on employment occurres by reducing the availability of gas for food, textile, papmachi, with average 2.8, 0.9, and 0.3 % respectively followed by petrochemical. These sectors turn out to be labor intensive in Indonesia. Nevertheless, effect on employment only last in the short term, as in the long term there is possibility for labor movement across sectors which explain the lower level of unemployment from 2017 onwards.

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Figure 5 Impact on Employment (authors calculation) on Scenario A1 and A2

5.1.3 Household Consumption

A similar negative trend on employment is shown on household consumption, where a big consumption loss is occurring for food, textiles, papmachi and petrochemical scenario. Products of those industries satisfy primary consumption needs and a downturn in sectoral output decreases household consumption. Apart from the direct impact on consumption, there is also an

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indirect effect of decreasing employment on consumption. If employment goes down, consumers lose income and can spend less money.

Figure 6 Impact on Household Consumption (authors calculation) on Scenario A1 and A2

5.1.4 Investments

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As figure 7 below shows, the level of investment will also be affected by changes in gas allocation. The effect is indirect via a decline in GDP, which will decrease the level of investment. The strongest negative impact is when gas supplies in the petrochemical and papmachi are restricted. This does not come as a surprise because both sectors are capital intensive. A restriction of gas supply will decrease the industrial production and the level of investments of these sectors.

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Figure 7 Impact on Investment (authors calculation) on Scenario A1 and A2

5.2 Sectors Output

Next to the macro effects of gas allocation, this section explores the effects at the level of economic sectors. The results of the A1 and A2 scenarios are shown in more detail in the tables in the appendix. Here we only present the results of the scenarios A1 and A2 on several economic sectors in Indonesia. We choose to concentrate on sectors most significant for the national economy. According to our estimation, these sectors are: are foodcrops, food industry, textiles, papmachi, petrochemical, construction, trade, restaurant, bank, real estate, public sectors and services. In Appendix A1, we can see that food, and papmachi have the biggest impact on sectors output performance, where other sectors output decrease in range 4-15% that shows these sectors has strong linkages with others economic sectors (see discussion section for more details). Textiles and petrochemical shows more moderate impact, an average 1 and 0.5% respectively, however for crude and electricity, others sectors are almost unaffected. Crude is not consumed by industry or other sectors, in most cases it will be refined or exported. Electricity on the other hand is hardly affected due to the fuel flexibility in electricity production. However, the impact can become worse if prices of electricity rise due to higher fuel prices. In that case the higher price will affect almost all sectors of the economy since they all consume electricity. We also point out here that even a particular sector consumed natural gas in medium to low level of volume does not mean that curtailment will have low impact. Taking as example, food industry that used gas in small volume, but the economic impact on sector output is significant that can be seen from macro indicators and sectors output (within range 5-10% drop) In Scenario A2, we run higher restriction in gas consumptions which results in worst impact on output performance (see Appendix A2), almost doubles the impact of scenario A1 Sector output decrease in range 11-27% for food and papmachi scenario, where textiles and petrochemical shows and average 2.5 and 2% respectively. The impact on crude scenarios slightly increases from scenario A1 however still in moderate level within 0.2 - 0.4%, so does electricity scenario
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5.3 Substitution of energy resources

Table 5 shows the substitution effects of a restriction of natural gas. It shows that the change to other fuels is rather modest. Table five gives the average change in gas consumption for both scenarios during 2012-2025. It shows that the average effect is limited to 1-2%. In case of the Petrochemical sector, where natural gas is used as feedstock, the substitution to coal as energy carrier is minimal. For food, and textiles there is only small increase in HSD, because HSD has a higher price than natural gas and this will increase the costs of production. With higher product price, consumer will consume less and in the end will cut down sector outputs as discussed in section 5.2. Table 5 Average Change in Energy Consumption (2012-2025)
Scenario Gas Coal Geo HSD Gas -2 0.08 -0.02 -0.02 Crude -0.77 0.16 -0.46 -0.21 Petrochemical Electricity -0.09 0.01 0.34 -0.002 -1.14 -0.06 -1.63 0.00 Food -0.89 -1.51 -4.13 0.08 Papmachi -1.07 -0.68 -1.62 -1.88 Textile -0.17 -0.45 0.33 0.04

Source: Authors Calculation

6. Discussions

Our analysis shows an overall large impact on the economy if natural gas supply for the industry is restricted, whereas the restriction on gas supply for electricity production has hardly any negative effect on the economy. Our analysis furthermore shows that based on the economic effects a national gas allocation policy should take the following ranking into consideration from the Highest priority to the Lowest priority 1. Industry8 2. Petrochemical sector 3. Crude oil production

By government definition, industry category encompass food, textiles, papmachi although in this paper it is analyzed as separate sectors, as those three shows the most significant impact for economic their cluster in government policy which is industry is given the first priority 24

4. Electricity This ranking does not come as a surprise, since intuitively we can predict that the industrial sector with Food, Textile, metal industry and Petrochemical are the backbone of the Indonesian economy and have strong backward and forward linkages. Backward linkages are the implications of the development of an industrial sector on the development other industries that provide inputs (raw materials) for this sector. Forward linkages refer to the development of an industry toward other industries which use the products as inputs (raw materials) of that industry. Combined these linkages provide multiplier effects for the whole economy where gas supply restrictions in a particular sector will affect the whole economy by reduced output of that sector. The stronger the linkages of a sector, the stronger the negative impact on the economy. This is the case with the industrial sector in Indonesia. The oil production sector does not generate high linkages as the product (crude oil) is predominantly exported and therefore only contributes to the state revenues without any direct negative impact on the domestic economy. The electricity sector is another case. Here the linkages are strong, but the substitution potential to switch to other fuels is high. The substitution to other fuel carriers will only affect the level of energy subsidies in Indonesia. Since it is inevitable to cut gas supply because of shortage situation, then the proper choice has to be made, from our analysis we can safely conclude that the most optimum way to allocate natural gas according to the ranking Industry, Petrochemical, Crude oil and Electricity. The current ranking in Indonesias natural gas allocation is different from the one we suggested based on the macro economic effects. The production of crude oil is given priority in the current allocation policy. The argument for this priority ranking is money: crude oil production brings in state revenues and this money is highly needed. Part of the argument is also that only the production in one particular oil field, the Duri Oil Field, is given priority. All other production fields can produce oil without natural gas. According to the Indonesian government, the petrochemical sector, with the production of fertilizers, is actually heading the ranking in natural gas allocation. According to the Indonesian government, electricity and industrial production is flexible enough to switch to alternative fuels and therefore are not given priority over crude oil
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production and fertilizer production in the current national gas allocation policy. Our analysis shows, that from a macroeconomic perspective, this argument needs reconsideration, given the strong backward and forward linkages of the industrial sector. . With regards to our findings we conclude that the ranking by the Indonesian government in national gas allocation is inadequate and needs reconsideration and a proper scientific grounding.

7. Conclusion

This paper has reviewed problems and dilemmas Indonesia is facing in allocating natural gas and the remedies suggested to mitigate the problems. More specifically the paper raised and answered the following questions:

How should Indonesia prioritize natural gas allocation for the domestic market to achive the optimum benefit for the national economy?

Our analysis with CGE model analysed the economic impact of restrictions in of natural gas supply in various sectors. Based on the macro economic implications sectors affecting the economy the most should have priority in natural gas allocation. Based on our analysis in this paper we suggest the following ranking from high priority to low priority: Industry, Petrochemical, Crude oil production and Electricity. Our suggested ranking deviates from the current one applied in Indonesias gas allocation policy. Indonesia is giving priority to crude oil production and to the petrochemical industry for fertilizer production. We have shown that the industrial sector of Indonesia should have priority because the relatively large macro-economic effects in case of restrictions in gas supply in this sector. We are not able to assess the economic loss of the current ranking in Indonesias gas allocation. We only know from a case in 2011, a one month gas restriction in Indonesias industrial sector because of termination of gas supply from PGN (state own company) caused a total loss of US$ 500 million (IFT, 2011). At the same time it is not expected
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that the Indonesian government will change the priority ranking in gas allocation. It seems that the change from gas to coal in the fertilizer industry requires an investment of US$ 400 million (Media Industri, 2007) This money is simply not available and therefore it seems unlikely that the Indonesian government will change the current priority setting on the short term. The limitation of this study is that we used Indonesian SAM of 2008 which was made 4 years ago, further study in the future can use the most recent SAM which is not yet published by bureau of statistics, and develop different scenario that might be bring additional perspective in the topic.

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Apendix A1 Impact on Sectors Output for Scenario A1(authors calculatio)

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Apendix A2 Impact on Sectors Output for Scenario A2 (authors calculation)

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