Indonesia's Petrochemical Industry (I)

This two-part research piece covers Indonesia's petrochemical industry, heralded as one of the rising golden boys of the economy. The first section covers the industry outlook.

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Indonesia -- a former member of World Bank’s Asian Miracle community -- remains one of the most lucrative economies in the Asia Pacific. With average annual GDP growth of over 5% since the 1998 crisis, Indonesia is poised to become an economic powerhouse; in 2030, its GDP is projected to rank 4th globally. Owing to its peaking demographic dividend, continuous human capital improvement, and wide-ranging natural resources, Indonesia could even transition to a developed nation status as early as 2045 -- a major feat for a hugely diverse country with an immense population.

The positive macroeconomic outlook generates a favorable trickle-down effect on all sectors. Nonetheless, manufacturing, especially petrochemical, is reaping bigger benefits due to vast opportunities in both domestic and international trade.

Petrochemical facility owned by Chandra Asri in Banten, Indonesia. Source: the Jakarta Post

Net export

In the past two decades, GDP growth has been mainly fueled by growing consumption; from 2000 to 2016, 55% of the GDP growth originates from expenditures. This sizable percentage is attributed to the ever-increasing middle-income class, now accounting for one-fifth of the population and more than 40% of total consumption. Investments are the second most significant component, representing 35% of the GDP growth, while the government constitutes around 10%.

Net exports, however, have been abject. With almost zero contribution to the GDP growth, its performance has been the aching point of Indonesian authorities. It also implies that the Indonesian economy has much room to expand when its export potential is fully optimized. Upon realizing this issue, the Indonesian government under Joko Widodo’s presidency -- keen to leave a strong-economy legacy -- then set export growth as the national priority.

This strategic shift brings favorable tailwinds to the manufacturing sector. Indonesia is long recognized as a commodity exporter due to its simple processing requirement. This, nevertheless, restricts Indonesia’s trade development as it could not compete in higher-value segments. Hence, the government launches explicitly a blueprint to boost Indonesian manufacturers’ competitiveness. Dubbed as Making Indonesia 4.0, the government outlines ten focus areas to aid Indonesian businesses.

The government’s pledge is especially beneficial for the petrochemical industry for two main reasons. First, the focus areas will be prioritized in several sectors, such as foods and beverages, electronics, as well as automotive. These three sectors have been significant users of petrochemical products; if their productivity is enhanced, the demand for petrochemical items will only increase. The increment itself will not be minimum: the three sectors above made up more than 30% of Indonesia’s export value in 2016 alone, implying their vast market base.

Indonesia’s export product in 2018 categorized according to two-digit Harmonized Trade System; processed

Second, the petrochemical industry itself is included in the government’s prioritized list. Some of the policies outlined in the blueprint will give a massive boost to the industry’s development. For example, the government aims to simplify the convoluted regulations and provide tax exemptions for promoting innovations through its omnibus law, meaning that business expansions will be more accessible. In the meantime, massive infrastructure spendings -- physically and digitally -- will aid the industry’s mobility and reach. Furthermore, an emphasis on human capital improvement through better education and vocational training will aid workers’ productivity -- a critical factor considering the abundance of young workers in Indonesia’s current demography.

Soaring local demand

While the push for export is expected to be the dominant demand contributor, the local demand is also likely to surge. The first factor that will fuel this increment is the growing calls for further “downstreaming” of commodities to improve the country’s ballooning current account deficit. This widening is primarily attributed to an enormous import of oil and gas products, eventually exposing the Indonesian economy to global volatility. The government then took the initiative to slash this import by encouraging local businesses -- especially energy companies -- to divert their products to local processing instead of solely selling them overseas.

Indonesia has consistently experienced current account deficit under Joko Widodo’s tenure

The petrochemical industry is starting to get the windfall. For instance, Chandra Asri participated in a “downstreaming” project initiated by Bukit Asam Tbk, a state-owned enterprise mainly producing coal. In the Sumatra-based project, Chandra Asri is given the opportunity to convert coal into polypropylene. As a result, coal’s value is significantly boosted -- assuming that the project involves 9 million tons of coal, this conversion could add up to USD3.5 billion compared to raw coal. This certainly brings a good predicament for the trade balance, yet the biggest winner will still be the petrochemical industry. Besides getting a constant cheap supply of raw materials, its market is guaranteed and even has a chance to further develop as the downstreaming intensifies.

The second factor that signals a hike in domestic demand for petrochemical products is the growing middle-income class. BCG estimated that the population of middle-income and affluent class would balloon from 88 million in 2014 to 141 million in 2020. Similar to the net export scenario, as domestic purchasing power rises, the demand for most consumer-oriented industries will also increase as household expenditure increases. For instance, Indonesia has already recorded the steepest rise in FMCG consumption in 2017 compared to its Asian peers, with the trend projected to carry on. With petrochemical products being one of the primary raw materials for the items, the demand towards them will increase. As per Orbis Research, Indonesia’s packaging market - one of the biggest consumers of plastic resins - is poised to grow by more than 5% annually from 2016 to 2021. This trajectory means the petrochemical industry is inevitably heading for a fertile spell.

Left: Indonesia’s household expenditure per capita. Right: Indonesia’s middle-class population

Growth in FMCG consumption in selected Asian countries, Q42017 vs Q42016

Demand supply gap

The rapidly increasing demand, however, is not matched by the supply addition. Consultancy firm Nexant forecasted that from 2017 to 2023, the CAGR of Indonesia’s polypropylene consumption would reach 4.7%, outpacing global’s CAGR and South East Asia’s CAGR by 1.1pp and 0.5pp respectively. The same case applies to polyethylene: Indonesia’s CAGR consumption (4.4%) is poised to beat global’s CAGR and South East Asia’s CAGR by 1pp and 0.5pp respectively. Polypropylene and polyethylene themselves are by far the dominant processed petrochemical products used in Indonesia’s manufacturing industries: polypropylene is the raw material for virgin plastic packaging and various automotive parts, while polyethylene is the main material for bottles, plastic films, and plastic bags.

Indonesia’s polyethylene and polypropylene consumption growths vs global and SEA

Assuming the existing capabilities and investment amount, the supply shortage is expected to widen further. Nexant predicted that by 2023, the polyethylene deficit would reach 593 kiloton/annum (KTA), up from the 2016 level of 484 KTA. The deficit would be even more substantial for polypropylene: 1,282 KTA in 2023 compared to 748 KTA in 2016.

Demand-supply gap of various petrochemical products in Indonesia

This gap does not only exist among the downstream products. Some upstream products such as ethylene - the precursor of polyethylene - also face swelling shortages. Nexant estimated that ethylene’s consumption deficit in Indonesia would increase from 524 KTA in 2016 to 758 KTA in 2023, barring any significant improvements in capabilities and investments.

These deficit threats, particularly in critical materials such as polyethylene and polypropylene, would further embolden the importance of the petrochemical industry in the Indonesian government’s industrialization agenda. From an economic point of view, boosting domestic capabilities in producing petrochemical items would lessen the current account deficit burden. As an illustration, if the projected polypropylene deficit of 1,282 KTA is prevented, more than USD1.5 billion of imports could be saved (based on ICIS PP resin price of USD1,300/MT in Q32018). More importantly, from the supply chain perspective, domestic fulfillment of demand would bolster efficiency: it would reduce logistics cost and protect dependent industries from global trade uncertainties. The sanctioning of tax holiday by the Indonesian government in 2019 towards Chandra Asri’s new polyethylene plant, which recently started production, highlights this notion.

Continue reading to part II