Hizbut Tahrir Indonesia Melanjutkan Kehidupan Islam
Written by: Idries de Vries
The turbulence of the crude oil price is causing headaches for both producer and consumer countries. When oil prices go up consumers suffer. When they go down producers suffer. But during volatility everyone suffers – producers don’t invest because they don’t know what the oil price will be, which can eventually cause shortages.
The following investigates what has been causing the current turbulence of the crude oil price, and how this has been affecting Muslim countries. And, using the guidance of Islam, it offers suggestions about what a country like Indonesia could do inoculate itself against it – such that the country will blossom no matter what the international crude oil price developments are.
Analyzing the current oil market
When analyzing the crude oil price, it is important to remember that it is influenced by not one but two forms of trade: paper trade and physical trade. Physical trade, in essence, is between the people who physically produced the crude oil and the people who actually want to use the crude oil. Paper trade, on the other hand, is between people who neither have crude oil nor ever want to have it. It is between speculators who place bets on the crude oil price going up or down, by offering to buy or sell it at specified prices sometime in the future. In the capitalist system, namely, these bets also influence the price.
The value of global physical trade (all goods and services, not just oil), the real economy, is estimated to be around $77 trillion. According the Bank of International Settlements the worldwide paper economy, officially referred to as the “global derivatives market”, is worth some $710 trillion. Because the paper economy is so large, and so much larger than the real economy, it has a substantial amount of influence on the price – not just that of crude oil, but essentially of all commodities.
The first question that needs to be answered regarding the recent swings in the crude oil price, therefore, is whether these were driven by speculation or by something in the real economy. This question can be answered by looking at the real economy to see if anything substantial changed there. If not, the conclusion is that paper trade drove the price changes. (Source: http://www.tradingeconomics.com/commodity/brent-crude-oil )
The First Drop: June 2014 – October 2014
In the real economy the following major events with relevance to the oil price have happened.
On the crude oil supply side the most important event took place in America, where oil companies developed new methods for producing crude oil from rock formations known as “shales”. Shale rock is extremely dense, so dense that liquids and gasses essentially get stuck inside. The traditional crude oil production methods do not work in case the crude oil (or natural gas) has amassed inside shale rock – one can drill a well into the shale rock, but only very little oil will come up to the surface through it. What the Americans did was optimize two existing technologies to get crude oil out of shale rock – horizontal drilling and hydraulic fracturing, i.e. “fracking”.
Horizontal drilling made it much cheaper for oil companies to reach the areas where shale rock contained crude. In the traditional method wells are drilled essentially straight down. So, if an oil company wants to get oil from another area, it has to move all its equipment to exactly above that area. With horizontal drilling the equipment no longer needs to be moved. The oil company just directs the drill-bit to wherever it wants it to go: straight down, or left, or right.
Fracking means injecting a liquid into the shale rock under high pressure. This causes the shale rock to crack open, enabling the crude oil to start flowing towards the well and up to the surface.
To produce crude oil from shale rock remained much more expensive than traditional oil production, but because the oil price was historically high for most of the period between 2007 and 2014, it was nevertheless profitable to do it.
As a result, crude oil production in America increased by some 3.5 million barrels per day, increasing the global daily supply of crude oil by approximately 4% to 92 million barrels per day.
On the energy demand side the most important event was disappointing global economic growth since the start of the Global Financial Crisis back in 2007. Most of the growth prediction of the International Monetary Fund have turned out to be too high, for example. Since energy demand is directly linked to economic activity (if there is more trade there is more need for transport, and when people buy more stuff they tend to end up using more electricity), and since crude oil is one of the most important sources of energy in today’s economy, lower than expected economic growth translates into lower than expected growth in crude oil demand.
In other words, during the period 2007 – 2014 global crude oil supply and demand did not move in tandem. Rather, they grew apart, which crude oil traders began to notice in the summer of 2014. In response they started to offer lower prices to the crude oil producers, who had to accept these terms if they wanted to sell their crude.
The original drop in the crude oil price was caused by events in the real economy, therefore.
The Second Drop: November 2014
In the past, the Organization of Oil Producing and Export Countries (OPEC) resolved supply and demand imbalances by increasing or decreasing production, in order to keep prices stable. This time round, however, OPEC decided not reduce its production. Instead, it decided to focus on maintaining its market share. Thus, it allowed prices to go down to rebalance supply and demand.
What OPEC hoped for was that the American shale producers would be the first ones to reduce production. As mentioned, shale production is much more expensive than traditional oil production, and most of the OPEC oil comes from traditional production. Logically, therefore, the shale producers would be the first producers for whom the crude oil selling price would go below the production price. So they would exit the market first, rebalancing crude oil supply and demand, stabilizing oil prices, while enabling OPEC to maintain its production.
It was not an illogical decision by OPEC, in other words. Just one that underestimated the capabilities of the human mind…
As the crude oil prices went down the shale oil producers began to look for ways to reduce their operating cost. And they found ways. They reduced the amount of water they used for fracking. They began fracking a single oil well more than once. They began drilling wells closer together, such that the fracking of one well would increase the oil flow in the other wells. This, and other steps, enabled the shale oil producers to bring their operating cost down to a level where they still made money if they had to sell their oil for $50 or $60 dollar per barrel.
So the shale producers in America did not reduce their crude oil production, causing prices to continue to go down throughout the 1st half of 2015, stabilizing at around $60 per barrel.
The second drop in the crude oil price was therefore also caused by events in the real economy.
The Third Drop: July 2015 – August 2015
The new crude oil price balance was recently disturbed by information coming out of China. First the Chinese stock market crashed. Thereafter the Chinese government decided to lower the value of the Yuan. Both pieces of information, especially the latter, caused concern amongst speculators around the world that China’s economy would be growing less than they had expected earlier. Consequently, they began betting on the crude oil price going down further, which had the effect of actually pushing the price down to in the $40 per barrel range.
At the same time, nothing significant changed in the real economy – crude oil production stayed essentially the same and the refineries around the world continued to buy crude oil as before. The latest crude oil price is a paper trade effect, in other words.
Crude Oil Prices: Impact on the Muslim world
The impact of the crude oil price depends on whether a country is an exporter or importer of crude oil. If a country is an importer it tends to benefit from lower prices because it then has to pay less for its imports. If it is an exporter, on the other hand, it is hurt by lower prices since less money will flow into the country.
Many Muslim countries are major crude oil exporters. In Saudi-Arabia, Kuwait, the United Arab Emirates and Iraqin the Gulf. Algeria and Libia in North-Africa. Malaysia and Brunei in Asia. Nigeria in Africa. These countries have lost a large part of their national the income due to the crude oil price drop.
Most of them have been hit hard by this. This is because in the past they have not used their crude oil revenue to develop their economies. They just wasted it all.
Saudi-Arabia is one of the best example of this. It exports some 8 million barrels of oil per day but it has not invested the revenue it generated this way in anything productive. It did not build an education infrastructure that produces the brightest minds that drive technological innovation. Nor did it support development of companies that use innovation to produce the things the world needs and is willing to pay big money for. It really did used the crude oil revenue primarily for wasteful, extravagant consumption. For example, when the new king was inaugurated earlier this year he ordered gifts to the people around him worth $32 billion. Then in the summer he went on vacation to France, with 1000 friends and family members. Then in August Saudi-Arabia had to borrow $27 billion – at interest! – in order to be able to pay its bills…
Qatar is wasting its oil revenue in another way. It is not a major crude oil producer but a major LNG exporter, the price of which is linked to crude oil. Therefore is benefits from high crude oil prices and suffers from low crude oil prices, just like a crude oil exporter. Qatar is currently preparing to host the World Cup 2022. For this it is building football stadiums, hotels, railways, metro, roads, et cetera. In total it will be spending some $200 billion on all this. But Qatar is a country of just 250,000 people. There are currently some 2 million expat workers in the country primarily to help build the infrastructure for the World Cup. Who will be using this massive infrastructure afterwards? No one, and many of the new stadiums, roads and railroads will in the end become unused, collecting dust in the desert.
Muslim countries that import crude oil are benefitting of the lower prices. Indonesia, however, though a net importer of crude oil, is being hurt substantially.
Indonesia was one of the first crude oil producing countries in the world. It has a crude oil production history that goes back to the late 19th century. Yet, it never developed the capacity to find, extract and process crude oil itself. It has always been dependent on western companies to do this, until today. This absolute failure of government policy has wasted the Indonesian crude oil wealth in two ways.
First, western companies charge billions of dollars for their services. Because the profit in crude oil can be so great, successive Indonesian governments did not care much about this. Even after giving western companies billions of dollars the government still received billions of dollars – so who cares? But since the crude oil wealth is a property of the Ummah, this was in effect waste of the wealth of the Ummah. If Indonesia had developed its own capabilities in crude oil, it would have made billions of dollars more each year. People who argue that this it is very hard to develop these capabilities, and thuis that we should not criticize policy makers of the past too harshly, should look to China. In the last decade the Chinese have developed the ability to undertake some of the most complex crude oil operations – ultra deepwater development. In addition, China now produces the equipment used in crude oil operations – Indonesia still needs to import most of it.
Secondly, Indonesia still has a lot of crude oil potential. There are a number of areas inside Indonesia that have remained unexplored, but that most likely contain substantial amounts of crude oil. . Of Indonesia’s 60 crude oil and natural gas basins, less than 20 are today producing. Around 15 have seen preliminary exploration efforts but over 20 remain as of yet fully unexplored with only minimal seismic data being presently available (www.ccop.or.th/ppm/document/INWS4/INWS4DOC02a_Indonesia_Abdul_Muin.pdf).
Furthermore, developments in crude oil and natural gas technologies such as horizontal drilling and “fracking” have opened up the possibility of developing reserves which until recently were considered unrecoverable. According to the oil and gas consultancy firm McKinsey, Indonesia possess a “significant” amount of these “tight oil” and “shale gas” reserves (“Shale gas and tight oil: Framing the opportunities and risks”, McKinsey & Company, 2012).
However, because the oil prices are now so low, the western oil companies that Indonesia depends on for finding and extracting the crude oil not interested in coming to Indonesia – unless Indonesia pays them billions, which the country currently doesn’t have. This is also waste because Indonesia companies and the Indonesian people need the energy that is in the crude oil (and natural gas). Producing these resources and making them available to industries in Indonesia would make these companies more competitive across the world. It would enable development of new industries. All this would mean growth, growth in jobs, growth in salaries.
The Khilafah’s Oil & Gas Management Vision
The Islamic oil & gas resource management policy build on the saying of Prophet Mohammed (saw) “The Muslims share in three things, water, pasture lands and fire” (Abu Dawud). The meaning of this narration is that oil & gas resources are part of what in Islam is called “public property”, i.e. that which is owned by all people together, is free for each of them to use, while none of them has the right to limit the usage by others. In other words, the oil & gas resources of Indonesia belong to the people of Indonesia.[1] Because it is not easy for individuals to benefit from the oil & gas resources in the ground, Islam has given the state the responsibility to manage these resources and ensure they are utilized in a way that maximizes the benefit in them for the community.[2]
In order to maximize the benefit in Indonesia’s oil & gas resources for the people of Indonesia, the state must manage production of oil & gas itself, possibly through a state-owned company, as this would bring the produced hydrocarbons under full control of the state. In addition, it would keep the billions of dollars that the foreign oil companies currently make on Indonesian oil & gas in the country.
Following this, the state should make the produced hydrocarbons available to local industries, rather than exporting them in their raw form. This would enable the development of extensive refining and petro-chemicals industries in Indonesia, since their products would be highly competitive on the international markets due to the low cost of their raw material inputs. Similarly, industries that use a lot of energy in their production processes such as steel and aluminum smelting would flourish. Together, the development of these industries would enable a comprehensive economic development of Indonesia since the goods critical for this – both those used in physically building an industry and those consumed in the industry – would become cheap in Indonesia as compared to most other countries in the world.
This would create an enormous amount of jobs in the country. It would also transform Indonesia from an exporter of low price raw materials and importer of high price finished goods into an exporter of high price finished goods, thereby greatly reducing the country’s dependency on foreign goods and improving the Current Account Balance. And, the development of this industrial base would give Indonesia a practical ability to undertake R&D and become an innovator and leader rather than a copycat and follower.
Managing Indonesia’s current oil & gas challenges using Islam: “Wave 1”
Under the Islamic oil & gas resource management policy a state oil company like Pertamina would immediately be made the operator for all onshore Indonesian oil & gas fields. Pertamina has been doing onshore oil & gas production since the 1960’s, namely, so even in its current sub-optimal state Pertamina will be more than capable to handle the onshore part of Indonesia’s oil & gas production.
This first change by the Islamic oil & gas resource management policy would have as an immediate consequence that the resources available to the country will increase. The profits currently made by foreign companies on the production of onshore Indonesian oil & gas will become available to the country. And the oil & gas molecules currently produces onshore will come under total control of the country, rather than only partial control as presently is the case. Since most of Indonesia’s current oil & gas production comes from (relatively old) onshore fields, the increase the resources available to the country will be substantial.
If this first change by the Islamic oil & gas resource management policy is accompanied by the application of modern performance management processes at Pertamina, then is could be ensured that Pertamina uses it greater responsibility for faster learning.[3] Pertamina’s experiences from the additional fields would then drive improvements in its capacities and capabilities, i.e. the skills and technologies it possesses.
This learning process for Pertamina could be “fast tracked” further if some of the financial resources that have become available to the country through the transfer of responsibility for the onshore oil & gas fields from the foreign oil companies to Pertamina were invested in R&D, for instance in Enhanced Oil Recovery (EOR) techniques, oil & gas exploration techniques and drilling techniques.
Dedication to learning and improving together with investment in R&D would make Pertamina the “first choice employer” again for the thousands of Indonesians that currently work for foreign oil companies the world over in both technical and managerial positions. Their return would still further increase Pertamina’s capacities and capabilities.
It would then be just a matter of time before Pertamina becomes able to take over Indonesia’s technically more complex and difficult to manage offshore oil & gas operations as well. In the meantime, the offshore oil & gas production could continue to be managed by foreign oil companies since the Islamic oil & gas resource management policy in principle has no problem with foreign involvement. It just has a problem with foreign involvement on the basis of PSC agreements, because these give the operator part of the oil & gas production in return for its efforts. And since according to Islam the government is not the owner of the oil & gas, but just its custodian, the government can not give the oil & gas away as is done in PSC’s. However, under the Islamic oil & gas resource management policy the government could contract work out through real Contract of Work agreements, under which the operator receives a pre-agreed amount of money in return for the services it provides. Iraq currently utilizes such Contract of Work agreements to manage the production of its oil & gas, paying the foreign oil companies a fixed amount per barrel of production.[4]
The Contract of Work agreements could be made to include an obligation for the foreign oil company to actively engage Pertamina’s most-talented engineers and managers in its Indonesian oil & gas operations, to help Pertamina reduce the time it needs to learn and develop to world-class standard. In fact, the secondment of national oil company employees at international oil companies as part of PSC or Contract of Work agreements between them is nothing strange in the oil & gas industry, so the government could easily make this happen. This way event the operations run by foreign oil companies could help Pertamina to increase its capacities and capabilities.
Managing Indonesia’s current oil & gas challenges using Islam: “Wave 2”
Following the above approach it would take Pertamina just a few years to learn how to operate Indonesia’s technically more complex and difficult to manage offshore oil & gas operations effectively and efficiently. And at that stage Pertamina should take over responsibility for all oil & gas operations in Indonesia.
This would even further increase the resources available to the country, both the financial resources and the oil & gas resources.
Some of the additional financial resources should then be invested in the introduction of Enhanced Oil Recovery (EOR) techniques at Indonesia’s existing oil & gas fields. A majority of current production operations do not use Enhanced Oil Recovery (EOR) methods, however, leaving substantial opportunity for either improved production from these fields, or extended production from these fields, or both.[5]
The additional financial resources should then also be invested in exploration and development activities. As mentioned, Indonesia has in total 60 oil & gas basins, of which just 36 have been well explored and 24 remain under- or unexplored. For as far as the explored basins are concerned, 14 of them are actually in production.[6] Most of the under- or unexplored basins are offshore in the east of the country, and are a geologic continuation of the onshore producing areas displaying many of the same reservoirs and trap configurations.[7]
This way Indonesia could substantially increase its oil & gas reserves.
Managing Indonesia’s current oil & gas challenges using Islam: “Wave 3”
Clearly, therefore, the Islamic oil & gas resource management policy would have no problem managing Indonesia’s current situation. And following this policy Indonesia will over time develop the ability – technical, managerial and financial – to increase production.
At that stage the utilization of Indonesian oil & gas should be optimized, so rather than exporting the oil & gas in its raw material form it should be made available to local industry. Refining and petro-chemicals industries could then be developed, as well as steel and aluminum smelting. Electricity could then be produced cheaply, boosting to the entire Indonesian economy and transforming it from an exporter of low price raw materials and importer of high price finished goods into an exporter of high price finished goods.[]
[1] “From [the Prophet’s (saw]) permission to individuals to possess water, it can be deduced that the illah (reason) of partnership in the water, pastures and fire, is their being of the community utilities that are indispensable to the community. The criteria for determining things to be a public utility is that it is anything which, if not available to the community, whether the community was a group of bedouins a village, city, or a State, would cause them to disperse in search of it, then it would be considered of the community utilities, like the water sources, forests of firewood, pastures of livestock and the like.” From: “The economic system of Islam”, Taqiuddeen an Nabhani
[2] “Funds in the Khilafah State”, Abdul Qadeem Zalloom
[3] See, for instance, “The Toyota Way to Continuous Improvement: Linking Strategy and Operational Excellence to Achieve Superior Performance” by Jeffrey Liker and James K. Franz for an explanation of the Toyota methodology to translate experience in continuous learning and continuous performance improvement, and how this methodology can be implemented in industries other than the car industry
[4] See “Iraq’s Technical Service Contracts – A Good Deal For Iraq?”, www.iraqoilforum.com/wp-content/uploads/2009/12/Iraqs-Technical-Service-Contracts.pdf, for an explanation of how the Iraqi Contract of Work agreements benefit the state in comparison to PSC agreements
[5] “Indonesia government to boost oil production by 2014”, RigZone, www.rigzone.com/news/oil_gas/a/121878/Indonesian_Government_to_Boost_Oil_Production_by_2014
