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Analysis: After investor departure, Balikpapan refinery suffers cost overrun, delays

Jakarta Post - September 27, 2023

Tenggara Strategics, Jakarta – The expansion of the Balikpapan oil refinery in East Kalimantan belonging to state-owned oil and gas holding company Pertamina has suffered a massive 30 percent cost overrun and a further delay to its completion. The Balikpapan refinery expansion is one of the few progressing refinery expansion and development projects mandated by President Joko "Jokowi" Widodo to reduce dependency on fuel imports, and yet it has suffered delays.

A consortium of Balikpapan Refinery Development Master Plan (RDMP) expansion contractors – SK Engineering & Construction Co, Hyundai Engineering Co Ltd, PT Rekayasa Industri, and PT Pembangunan Perumahan – proposed in October last year a contract amendment to adjust for the emerging supplementary costs, totalling US$1.2 billion, and thus making the total project cost soar from $3.8 billion to $5 billion. The contractors argued that the cost overrun could not be avoided, mostly as a result of the COVID pandemic.

In response, Pertamina hired consultant Foster Wheeler to scrutinize the consortium's proposal for supplementary funding. Foster Wheeler could only confirm an additional cost of $64 million. Before that, Pertamina had hired another consultant Worley Parsons Limited, but its recommendations were frequently unheeded as PT Pertamina Kilang Internasional and subsidiary PT Pertamina Kilang Balikpapan could not reach a consensus.

To this date, Pertamina has not decided on how to address the cost overrun proposal, leaving the Balikpapan refinery expansion project in limbo. As of now, construction progress on the first phase of the Balikpapan project has reached 76.7 percent. Any hold-up to resolve the cost overrun would further delay the project and inflate costs.

The Balikpapan expansion project is aimed at boosting its fuel-processing capacity from 260,000 barrels per day (bpd) to 360,000 bpd. The project is divided into two phases, with the first phase costing $3.8 billion initially to be completed in 2021. However, the COVID pandemic delayed the project to 2024 or even 2025, with cost overruns of $1.2 billion.

The cost overrun is not the only problem for Pertamina in the Balikpapan RDMP project. Pertamina has to shoulder all the cost of the project by itself after its partner Mubadala of the United Arab Emirates withdrew. To finance the Balikpapan RDMP, Pertamina recently raised a syndicated loan totalling $3.1 billion from four export credit agencies and 22 commercial banks, and now it has to face another cost overrun.

The massive cost overrun surprised not only Pertamina but also politicians at the House of Representatives. House energy commission deputy chairman Eddy Soeparno said he learned only recently about the cost overrun and the commission would investigate the real underlying causes. He noted that the Balikpapan refinery has an important role in reducing Indonesia's fuel import dependency. Currently, Indonesia imports around 35 percent of the country's fuel consumption of 1.3 million bpd.

According to Deputy State-Owned Enterprises Minister Pahala N. Mansury, when the Balikpapan refinery is completed – both first and second phases – it would save the country $2.5 billion per annum in foreign exchange from imports of fuels, liquefied petroleum gas and petrochemical products.

What's more

The Balikpapan RDMP project is one of a series of Pertamina refinery rejuvenation projects and new refinery constructions – called grass root refinery (GRR) – that were integrated into President Jokowi's Nawacita program in the energy-resilience sector, aimed at reducing fuel imports. The other RDMP projects include Balongan in West Java, Cilacap in Central Java, Dumai in Jambi, and Plaju in South Sumatra. Meanwhile, the GRR projects are two refinery projects in Tuban, East Java, and Bontang in East Kalimantan.

In 2015, Pertamina's management disclosed a total investment estimate ranging from $35 billion to $40 billion for the five RDMP and two new refinery projects. Should these projects reach completion in their entirety, Indonesia's oil-processing capacity is projected to double from 820,000 bpd to 1.68 million bpd. However, contrary to the initial claims, investor interest in these Pertamina refinery projects has proven increasingly limited.

To date, only the first phase of the Balongan RDMP project has been completed, increasing its oil-processing capacity from 125,000 bpd to 150,000 bpd. Dumai, Plaju, and Cilicap RDMP projects are still in the pre-feasibility study. It's still a long way to go, especially if Pertamina cannot find investors.

The two new GRR projects both face problems of financing due to problems with investing partners. The Bontang GRR project, for example, had to be aborted following the departure of investing partner Oman Overseas Oil and Gas (OOG), and the Tuban GRR project is still in limbo because Rosnef Singapore Pte. Ltd. of Russia could not execute the project due to Western sanctions over the Russia-Ukraine war.

What we've heard

Sources within Pertamina have mentioned that the ballooning cost of the RDMP Balikpapan project, which has amounted to $1.2 billion, has been a topic of discussion among a limited circle of companies for the past year. Specifically, since Hyundai Engineering proposed contract amendments around October 2022. However, Pertamina has not yet approved the additional costs proposed by the consortium of contractors led by Hyundai Engineering. Members of this consortium include SK Engineering & Construction, Rekayasa Industri, and PT Pembangunan Perumahan (PP).

The root issue here is that PT Pertamina Internasional is concerned that the cost overrun of the project will come to the attention of the Supreme Audit Agency (BPK). That's why Pertamina Kilang Internasional has hired two consultants, Pathfinder and Foster Wheeler, to review all components of the RDMP Balikpapan project's cost overrun.

Since early September, Pertamina Kilang Internasional, Pertamina Kilang Balikpapan and the consortium of contractors, have held multiple meetings to discuss these additional costs. However, Pertamina feels that the figures proposed by Hyundai are too high.

The same source states that the negotiation process between Pertamina Kilang Internasional and the consortium of contractors has been difficult and is ongoing to this day. The negotiations are especially heated concerning the rental costs of heavy equipment and the amount of equipment that deviated from the original design. In one of the meetings, the negotiation team was even reported to have walked out of the room.

Apart from being affected by the pandemic, which led to construction costs rising, deviations in some of the equipment purchased were also triggered by Pertamina's late decision-making.

Since the project began, Pertamina Kilang Internasional and Pertamina Kilang Balikpapan, as well as the division managing the existing refinery in Balikpapan, have often not been on the same page. The division managing the existing refineries in Balikpapan feels that the RDMP project ought to be Pertamina Kilang Internasional's responsibility, not theirs. In the past year, Pertamina Kilang Internasional, through Infrastructure Projects Director Kadek Ambara Jaya, has been trying to engage stakeholders to expedite the project.

Amidst the issue of cost overruns, rumors floated that PP and Rekayasa Industri wanted to withdraw from the consortium led by Hyundai. Local contractors were believed to be not entirely compatible with Hyundai's leadership style.

PP was even rumored to have only placed personnel on the project and did not contribute any capital. Pertamina did try to persuade Rekayasa Industri to stay within the consortium. Eventually Rekayasa Industri agreed, however they reduced share ownership within the consortium of contractors.

[This content is provided by Tenggara Strategics in collaboration with The Jakarta Post to serve the latest comprehensive and reliable analysis on Indonesia's political and business landscape.]

Source: https://www.thejakartapost.com/opinion/2023/09/27/analysis-after-investor-departure-balikpapan-refinery-suffers-cost-overrun-delays.htm