Subject: Business Week: Indonesia: Oil Smugglers Buy Low And Sell High

Business Week

SEPTEMBER 19, 2005


Indonesia: Oil Smugglers Buy Low And Sell High

On Aug 27, Indonesian Navy patrol boats cornered and detained a North Korean-flagged ship off the Riau Islands. The vessel, the Mount Tioman, with an Indonesian crew, was carrying more than 18,000 barrels of oil and sailing toward China when it was caught offloading some oil to several smaller vessels. Officials arrested the crews of the boats and confiscated the oil.

What was going on? Officials say the crew was breaking the law by exporting oil out of Indonesia -- one of the perverse consequences of Indonesia's heavy subsidies on petroleum products. Because of the subsidies, refined oil products are sold in Indonesia for about a quarter of international prices. Unleaded gasoline in Jakarta retails for just 25 U.S. cents a liter. "When you have such a huge price gap you leave the door open to arbitrage by oil smugglers," says Anton Gunawan, an economist at Citigroup (C ) in Jakarta. Smugglers can make huge profits by buying petroleum products locally and reselling them elsewhere in the region. In recent weeks nearly a dozen vessels carrying 80,000 barrels of gasoline and kerosene have been detained by Indonesian naval or police patrol boats, and nearly 100 crew members have been arrested. On Aug. 30 police also stopped several military trucks carrying gasoline to East Timor by land. Officials admit most of the smugglers get away scot-free. Indeed, there are charges that some of the profiteers are soldiers, police, and other government officials. In recent weeks seven employees of state oil company Pertamina have been detained for questioning in connection with smuggling. No charges have been filed.

Just how big is smuggling in Indonesia? Estimates vary, but industry insiders say more than 100,000 barrels a day escape the country. Asia's largest exporter of oil six years ago, Indonesia is now a net importer of oil. Production fell from 1.6 million barrels a day in 1998 to 970,000 last month even though the country has estimated reserves of 9 billion barrels.

Much of that imported oil leaves the country soon after it arrives. "The economy is growing at just over 5%, and yet oil consumption -- at a time when prices were rising -- rose 9% over the past year," says Michael Chambers, head of research at CLSA Emerging Markets in Jakarta. "My guess is that almost all the increase in consumption can be traced back to growth in smuggling."

Where is the oil going? Everywhere in Asia. At least half the boats detained in the past month were headed for China or North Korea. President Susilo Bambang Yudhoyono's government is cracking down on all forms of corruption. He has vowed to punish not just smugglers but military and other government personnel who collude with them.

Economists say there's a better solution. Given Indonesia's "17,000 islands, a huge coastline, and very little [police] resources, it is stop oil smugglers," says Fauzi Ichsan of Standard Chartered Bank in Jakarta. "The way to stop smuggling is to remove the root cause -- the huge subsidies." The government is moving in that direction, but slowly, to avoid social upheaval. That means smugglers are likely to keep smuggling.

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