NORTH SUMATRA: A TALE OF TWO ECONOMIES

Identifier: 
06JAKARTA13387

UNCLAS SECTION 01 OF 03 JAKARTA 013387

SIPDIS

SENSITIVE
SIPDIS

Embassy Jakarta Medan Affairs Office # 36, 2006

E.O. 12958: N/A
TAGS: ECON, EAGR, ENRG, ETRD, ID
SUBJECT: NORTH SUMATRA: A TALE OF TWO ECONOMIES

1. (U) SUMMARY: High prices for rubber and crude palm oil
keep North Sumatra's agricultural sector resilient.
Industry experts expect the trend to continue as demand for
oleochemicals and cooking oil increase, and biodiesel
production expands. On the other hand, North Sumatra's
manufacturing and construction sectors continue to suffer
from increased energy costs, poor infrastructure, and weak
government support. Rolling blackouts are frequent because
electricity generation cannot meet current needs, and future
construction will lag growing demand. Agriculture and
agribusiness cannot supply enough jobs for North Sumatran
youth, who might turn to criminality if no other
opportunities exist. END SUMMARY.

The Best of Times
-----------------

2. (U) Increasing global demand for rubber and crude palm
oil (CPO), leading to higher prices, is fueling expansion of
the agricultural sector in Sumatra, especially for the two
plantation-rich provinces of Riau and North Sumatra. Both
India's recent reduction in duties for cooking oil and
China's liberalization of its market as required under its
WTO commitments are expected to increase demand for
Indonesian-produced cooking oil. CPO producers also expect
production of biodiesel from CPO will lead to even higher
prices and steady demand for their product. Futures for CPO
show strong bullish sentiment, and international analysts
are quoted in press reports indicating international demand
should increase as a result of biodiesel production.
Medan's Belawan plans to expand its facilities to handle
additional CPO shipments.

Palm Oil for the World
----------------------

3. (U) Domba Mas is contracted to supply Proctor and Gamble
with 200,000 tons of fatty acids per year manufactured from
CPO and palm kernel oil (PKO). Domba is currently expanding
its refining capabilities and, with the expected completion
of a second factory in late 2007 or early 2008, North
Sumatra and Batam will produce the bulk of Indonesia's
oleochemicals. The volume of Indonesian oleochemical
exports have rebounded from a slump in 2002-2003.

4. (U) PT Data Consult, publisher of the monthly Indonesian
Commercial Newsletter, reported in May 2006 that CPO-based
cooking oil production increased from 4.3 million tons in
2001 to nearly 6.5 million tons in 2005. North Sumatra
leads Indonesia in the number of factories manufacturing
cooking oil from CPO. According to Industry Ministry
statistics, Sumatra produces over 60 percent of Indonesia's
CPO-based cooking oil.

And Biodiesel to Move It
------------------------

5. (U) Pertamina introduced biodiesel to the domestic market
in May at four filling stations near Jakarta, but the real
effort to promote biodiesel is GOI's plan to use biodiesel
for five percent of Indonesia's total energy needs. The
National Energy Management plan anticipates enough
production capacity by 2010 to manufacture 800,000 tons per
year of biodiesel. Indonesian companies are quickly
building plants to meet this demand, with two planned for
Riau province and an expansion of a pilot program in North
Sumatra slated to produce a total of 6,000 tons per year.

6. (U) The Indonesian Oil Palm Research Institute in Medan
uses biodiesel manufactured at the institute to power three
of their vehicles. Institute researchers told us that CPO-
based biodiesel is emissions neutral compared with
conventional diesel and creates little waste product. Some
of the residual materials, especially glycerin, can be used
in cosmetics and pharmaceuticals - though a Norwegian
engineer looking at this problem pointed out that the world
market for these products is virtually saturated, so
producers will be forced to compost or otherwise dispose of
this waste. Researchers told us the main focus of their
studies is reducing the temperature at which biodiesel can
effectively be used: biodiesel produced from palm oil using

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current technology is not usable below 10 degrees
centigrade, inhibiting export to markets in Europe and North
America.

7. (U) Derom Bangun, Chairman of the Indonesian Palm Oil
Producers Association, is optimistic biodiesel production
will generate sustained growth for his industry. Although
crude oil prices needed to be at least 65 - 70 USD per
barrel for CPO-based biodiesel to be competitive, Bangun
thought government subsidies could help in the short term.
(Note: Pertamina currently pays 4,600 Indonesian Rupiah
(approximately .50 USD) per liter of biodiesel, which it
sells at a loss for 4,300 Rupiah. End Note.) For the
longer term, he believed biodiesel could become an important
component of world-wide energy needs, though he noted
agricultural products -- such as rapeseed, corn, and castor
-- were competitive with CPO as the base from which to make
biodiesel. However, because oil palm plantations and
processing facilities are already well established, little
additional employment opportunities will arise. On many
plantations, families live in plantation supplied housing
and jobs are passed from parents to children.

It Was the Worst of Times
-------------------------

8. (SBU) Following last year's reduction in fuel subsidies,
North Sumatra's manufacturing sector slumped. In addition
to higher costs for energy and transportation, interest
rates also remain high. Factory owners report reductions in
employee numbers and outright factory closings because of
increased energy costs. PT Kedaung Medan Industrial, a mid-
size manufacturer of glass and tableware products with a
sizable export market (including to WalMart), closed one of
its four factories in Medan because of increased energy
costs, laying off 1,000 people. PT Effem Indonesia, a
subsidiary of Mars Incorporated, recently closed its cocoa
processing plant in Medan, laying off over 200 people.
According to Effem's Commercial Manager, Suharji Gasali,
processing that was formerly done in Indonesia will now be
done in China.

9. (SBU) One local businessman described the North Sumatran
economy as the worst since the 1998 financial crisis. He
claimed 90 of 110 wood working plants had closed and the
remaining 20 were struggling. Advisor to North Sumatra's
Governor Polin Pos Pos claimed decentralization impeded
action at the provincial level, pushing control to the
Regency level. Regents, he noted, did not have the skills
to improve local economic conditions, leaving Jakarta in
control. Jakarta, Pos Pos lamented, gave no direction,
leaving provinces powerless to act.

10. (U) Prominent Medan businessman Jonner Napitupulu said
high interest rates have not directly hurt construction, but
banks are reluctant to make loans because bank officials
fear criminal prosecution if loans later become non-
performing. Construction sites in Medan experience a brief
spurt of activity once funding is obtained, but projects
drag on without completion. Pos Pos noted that lower
interest rates would be a necessary but not sufficient
condition to spur economic growth.

Basic Infrastructure Problems
-----------------------------

11. (SBU) In addition to increased energy costs, other
factors -- lack of steady electricity supply, poor
infrastructure, arbitrary taxation, stifling brreaucracy,
and the prevalence of protection rackt s -- conspire against
economic investment in North Sumatra. Napitupulu reported
local businessmen were looking overseas to invest rather
than investing locally. He did not think Indonesia should
try to grow by attracting foreign investment, but should
develop internally first.

12. (U) Electricity production shortfalls particularly hurt
manufacturers. Even though most factories have generators
for back-up power supply, the brief interruption in
electricity can damage sensitive equipment and damage
production runs. At a recent meeting hosted by a visiting

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team from the Indonesian Parliament, manufacturers took aim
at PLN for failing to provide stable electrical power. PLN
plans to bring three additional power plants on-line in the
coming years, but the increased capacity is unlikely to even
meet expected growth in demand.

Comment
-------

13. (U) Inflation and a weak employment picture have hurt
the poor people in North Sumatra. Inflation has reduced the
purchasing power of people on fixed salaries, especially
those earning minimum wage or just above minimum.
Agriculture, the dominant industry in North Sumatra, props
up the provincial economy, though it cannot provide the jobs
needed to employ the growing labor force. Without jobs for
the young people of North Sumatra, many of them might turn
to the so-called youth groups, prevalent in North Sumatra,
that are responsible for protection rackets and other
criminal activity, adding further to the woes of the
manufacturers.
Pascoe