MM 5010 Strategic Decision Making and Negotiation

Final Exam Paper The Negotiation of LNG Tangguh Price to Fujian, China

By: Rizka Anindya Suprapto 29111034 R-45 A

MASTER OF BUSINESS ADMINISTRATION SCHOOL OF BUSINESS AND MANAGEMENT INSTITUT TEKNOLOGI BANDUNG 2012

1. Introduction Liquid Natural Gas or LNG or commonly known as blue gas, is one of alternative source of energy to replace the fossil source of energy. The high availability compared to fossil source, and the combustion of LNG is more efficient also causing this source of energy are more preferably than the crude oil as source of energy. The demand of natural gas is quite high, as for the household use, industry use, and also automotive as human started to develop new source of energy like Fuel Gas (Bahan Bakar Gas).But, not like Crude Oil that can be contained for long time, LNG do not have a long time after extracted from the drilling field. In the drilling field they set some cube to keep the fresh natural gas after extracted to keep them save from the air pressure that may cause explosion. Indonesia is one of the major Natural Gas Producer in the world. in 1997. United States of AmericasSatellite called LANSAT found the overflow Natural Gas reservation in Teluk Bintuni, West Papua. According to British Petroleum analysis Teluk Bintuni Gas Reservation could achieved approximate 14.4 trillion cubic feet. Later on this Liquid Natural Gas that come from Teluk Bintuni Reservation called LNG Tangguh. Until, 2012 there are four LNG Tangguh Project based on Government to Government Contract. Those are, Fujian (China), K-Power and Posco (South Korea), and Sempra Energy (Mexico). But, unfortunately one of this contract have become controversy as it considered by the public as unfair contract for Indonesia, it is the contract with Fujian, China. In 6 September 2002, the Indonesia Government signed the LNG Tangguh contract with Fujian China, and appoint BP as the main contractor in this contract. The initialprice agreed is US$ 2,4/mmbtu (Million Metrics British Thermal Units), this price come from the ceiling price price formula , where the price LNG per mmbtu is made not more than the upper limit of crude oil price at the time US$ 25/barrel, but unfortunately this formula doesnt make as if the crude oil price is raised the LNG price also could be raised and this contract is last for 25 years. The volume that Indonesia exported to China, is 2,6 million tons/year with the revenue US$931 million/year. This contract considered as one of the unfair contract for Indonesia, as when the contract signed the world crude oil price is still under US$ 40/ barrel, but since then the crude oil pass through

over US$ 100/barrel, as quoted in 2008, Vice President Jusuf Kalla stated that if this contract keep going for until 25 years, it could bring about 700 trillion loss to Indonesia. The controversy also come, as the domestic LNG price is occur between US$5-6 per mmbtu, and with the high demand, some potential buyer from the domestic market, also attracted to LNG Tangguh Gas. In the other side, if the Indonesia Government wants to unilaterally terminate the contract then they should pay US$300 million. This controversy makes the public pressure for the Indonesia Government to re-negotiate this LNG Tangguh price contract to Fujian, China. 2. The Current Situation To keep the public pressure low, the Indonesia Government had the re-negotiation for the LNG Tangguh Fujian Contract in 2006, the result of the re-negotiation is the LNG Tangguh price raised become US$ 3,35/mmbtu with reference to the 2006 crude oil price US$ 38/barrel. Unfortunately, this price still considered way too cheap, where the domestic price for LNG in Indonesia is between US$ 6-10/mmbtu and the international LNG export price is between US$16-20 /mmbtu. In late 2010 until 2012, the controversy of this case becomes tense again where the domestic need of LNG in Indonesia raised. State-owned Enterprise like PLN, have high demand on LNG to support their business, and willing to pay US$ 9 /mmbtu for LNG Tangguh, in the other hand PERTAMINA also put bid LNG Tangguh for US$ 10/mmbtu with the 1.5 million metric ton. In fact, the re-negotiation of this LNG Tangguh Contract only can be held only one time for 4 years, when the first negotiation in 2006 is not giving the satisfaction result, and the government couldnt achieve any agreement in 2010, then for the 2014 re-negotiation period, the Indonesia Government should prepare their aspiration for the LNG Tangguh price and save Indonesia for having a big loss because of this bad negotiation in the first place. As in the several media, mentioned that based on Indonesia Crude Price/ICP) is US$ 100/barrel, the ideal price of LNG Tangguh is US $ 7 /mmbtu, but Indonesia some parties having opinion that Indonesia should also considered about the international LNG price by US$ 16-20/mmbtu as the based for the negotiation. Some said, that maybe Indonesia should terminate this contract unilaterally, and paying US$ 300 million penalty rather than having the loss that couldnt be compared to the revenue. Until this late of 2012, Indonesia still preparing their stand point in renegotiate the LNG Tangguh Price to Fujian, China.

3. Analysis To analysis this LNG Tangguh Price case the writer is using the Distributive Approach, as we know the challenge of negotiation is to reach a set of settlement that is most favorable to oneself and does not give up too much of the bargaining zone. The bargaining zone itself means the range between negotiators reservation point. In this case the final settlement of the LNG Tangguh Price should fall somewhere between above Indonesia as Sellers reservation point and below the Fujian, China as buyers reservation point. We start the analysis on the 2006 renegotiation that resulting the LNG Price Tangguh raised from US$ 2,4/mmbtu to US$ 3,35/mmbtu. The writer assumed that the reason that Indonesia still have low price for LNG Tangguh because Indonesia getting the anchoring effect. The first open price of the 2006 negotiation is US$ 2,4/mmbtu, this make China likely wont pay higher for the LNG Tangguh, since the international price is US$ 3,8/mmbtu (as the crude oil price is US$ 38 /barrel). This anchoring effect makes Indonesia hard to negotiate and get the proper price for LNG Tangguh in the future. This graph below is showing us the Zone of Possible Agreement (ZOPA) Between Fujian, China and Indonesia in 2006 Renegotiation.

Picture.1 Indonesia-China ZOPA on LNG Tangguh Price Negotiation (2006) This graph show us Fujian Aspiration price, where they are happy to pay for the LNG Tangguh in US$ 2,4 /mmbtu also become their BATNA, and the reservation price is US$ 3,5/mmbtu

(because of the lack of Information in the Fujian, China side, the writer use own assumption in establish this reservation price for Fujian, the assumption is based on the highest price in the international market is US$ 3,8/mmbtu so assumed that Fujian are willing to buy under that price likely US$ 3,5/mmbtu). While in the other side, Indonesia aspiration price for LNG Tangguh is US$ 3,8/mmbtu (considering to have the same price with the international price), the aspiration price means that Indonesia would be happy to sell US$ 3,8/mmbtu to Fujian, and the reservation price for Indonesia is US$ 3/mmbtu (this is also the writer assumption, as the purpose of the negotiation is to raised the US$ 2,4/mmbtu, then we assumed the reservation should be above 2,4, and the assumption is US$ 3/mmbtu). This ZOPA analysis show that, the settlement of 2006 LNG Tangguh Price is because there are overlapping between Indonesia Reservation and Fujian Reservation between US$ 3 and US$ 3,5 , then the US$ 3,35 as the result is the possible settlement for this negotiation. Indonesia couldnt get the higher price because the anchoring effect that occur in the initial contract. Then we move on to the preparation of 2014 Re-Negotiation of LNG Tangguh Price. As we got the information before that the domestic price for LNG in Indonesia is between US$ 6-10/mmbtu and the international LNG export price is between US$16-20 /mmbtu. We assumed that Indonesia Government are happy to sell LNG Tangguh by the highest International price of LNG US$ 20/mmbtu, and might willing to reserve at US$ 10/mmbtu based on the highest LNG domestic price. While in the Fujian, China side, their aspiration price is same as the current price US$ 3,35/mmbtu, and may be willing to pay only as the lowest Indonesia LNG Price by US$ 6 /mmbtu, so based on this assumption the ZOPA would be in the negative position like this;

Picture.2Negative Indonesia-China ZOPA on LNG Tangguh Price Negotiation

There are no overlapping zone, that the settlement price may occur, the negotiation may not succeed, and the price could be stay at USS$ 3, 35/mmbtu as the previous contract. Next is the writer recommendation on this negotiation, again we still use the fact that the domestic price for LNG in Indonesia is between US$ 6-10/mmbtu and the international LNG export price is between US$16-20 /mmbtu. We assumed that Fujian, China Reservation Price stay the same in US$ 10/mmbtu to make it appropriate with the Indonesia domestic Price while still below the international lowest price (US$ 16), while the aspriration price is remain the same as the previous contract price by US$ 3,35/mmbtu, and for Indonesia, the aspiration price is still to get as high as the highest export price of LNG US$ 20/mmbtu, then the changes is occur in reservation price, where Indonesia could use the US$ 7/mmbtu as their reservation, where its still proper because still on the range of domestic price (US$ 6-10/mmbtu), as in fact the US$ 7/mmbtu also the target of Indonesia to become the new price of LNG Tangguh (as quoted from several media interview). Then by using this new data, we can see the ZOPA is shifting to positive zone;

Picture.3Positive Indonesia-China ZOPA on LNG Tangguh Price Negotiation From the positive zone, we can see the settlement may occur between US$ 7 to US$ 10/mmbtu. Even though from the comparison Indonesia have to decrease its reservation price from US$ 10/mmbtu to US$ 7/mmbtu, this is needed to make the settlement achieving the best alternative,

because of Indonesia is not having the bargaining power in settling the price since the anchoring effect from the initial contract is occur. So, Indonesia should back off a little at least to have the right price between US$ 7-10/mmbtu, since we can not predict or change the Fujian, China to change their aspiration and reservation price. This is the best alternative, to raise LNG Tangguh price from the low price by US$ 3, 35/mmbtu. The fact that Indonesia is will become the lose side in this negotiation can be analyzed further. Indonesia in fact can not bid more price on the LNG Tangguh because the initial contract create the anchoring effect of the low price started by US$ 2,4 /mmbtu then the US$ 3,35/mmbtu and Indonesia stuck with this contract. The reason beyond this fact can be explained by analyzing Indonesia BATNA (Best Alternative to a Negotiated Agreement). Indonesias BATNA What happened in 2002 LNG Tangguh Contract may occur because Indonesia doesnt have their BATNA at that time, they doesnt have the other alternative when the negotiation with Fujian might not occur because they didnt get the proper price. In fact, why Indonesia doesnt have BATNA at that time, because as mentioned before, the LNG can not be stored for a long time like crude oil, where it have to immediately be used or it will be burned into the air. This means it will cause loss if it not streamed immediately. At that time, Indonesia domestic market did not show high demand on the LNG as its still prefer the oil fuel as the source of energy, and at that time, one of the potential buyer in Fujian, China, the problem is the contract that China side open is like tender contract, they will give it to the lowest price bidder, so Indonesia in term not want to get loss in losing the unused LNG they willing to sell with the lower price than the other provider to China. Indonesia has to compete with other countries that also sell LNG to China. The other fact is that China also have its own LNG and this lead to low Indonesias bargaining position, and this low bargaining position was also supported by the fact that price of natural gas at that time was at a low rate. At that time Indonesia did not have a good BATNA, because it came in between, occurring loss for the unused LNG or selling for the low price to other parties. Fortunately, nowadays, since the LNG demand also increasing, Indonesia now have its own BATNA, where mentioned that PLN and PERTAMINA as the State-Owned Enterprise, are having high needs on LNG, and willing to pay between US$ 9 to US$ 10/mmbtu for LNG Tangguh. This BATNA means that if Indonesia could not settle the negotiation with Fujian,

China in 2014, then may be the government should think about to terminate the contract by paying US$ 300 million dollar, and sell the LNG Tangguh to domestic market by the price US $ 6 to 10 /mmbtu, that is more profitable than the US 3, 35/mmbtu that projected will bring over Rp. 700 trillion loss.