By Emily Chow and Fransiska Nangoy

SINGAPORE/JAKARTA, March 7 (Reuters) - After a decade of false starts, Indonesia is rolling out a $1.5 billion project to distribute liquefied natural gas $(LNG)$ on a small scale to feed dozens of power plants now running on diesel via a unique hub-and-spoke model across its vast archipelago.

The project aims to cut expensive diesel imports and boost national energy security, shrinking Indonesia's fuel import bill as the power plants switch to run on domestically produced gas.

PLN EPI, a unit of state power firm Perusahaan Listrik Negara $(PLN.AU)$, has taken over leading the project from earlier plans involving state oil company Pertamina, which failed to go ahead due to LNG pricing risks and a lack of capacity financing support.

The main challenges facing PLN EPI are to line up LNG supply and manage the costs of building the infrastructure needed to deliver LNG in small volumes and regasify it for the power plants.

A successful rollout raises the risk that Indonesia, the world's seventh-largest LNG exporter, may need to start importing LNG later this decade.

"We are obliged to provide the LNG ... And we are keen on securing more domestic LNG for the project," Rakhmad Dewanto, director of fuels and gas at PLN EPI, or PLN Energi Primer Indonesia, mandated to procure fuel for PLN, told Reuters.

PLN EPI currently receives long-term supply of about 60 LNG cargoes per year to feed its gas-fired power plants, said Rakhmad. However, its demand last year was 84 cargoes, with the shortfall filled by spot supply from Indonesian gas projects.

The fuel conversion project will more than double the supply gap, requiring at least a further 29 cargoes, he said. That is about 2 million tonnes of LNG, which would boost Indonesia's gas demand by 6% from last year's level, based on Reuters calculations.

"We are talking to local project operators now. Otherwise, if there is still a shortage, we will need to request for an import permit from the government," Rakhmad said.

Indonesia exported about 15.3 million tonnes of gas last year, mostly as LNG, government data shows.

Most output from LNG projects, including Tangguh Phase 3, Bontang and Sengkang LNG, has been reserved for domestic use, say analysts.

HUB AND SPOKE PLAN

The project will distribute LNG to islands mainly in east Indonesia, grouped into clusters. Each cluster will have a main receiving terminal from which small tankers will transport the super-chilled fuel to regasification sites, which will feed gas to power plants.

To date, PLN EPI has awarded tenders for infrastructure at four clusters, targeting 41 existing and new power plants with a combined capacity of 2,148 megawatts (MW). It is set to award at least one more tender for a fifth cluster next year, and aims for operations to begin between late 2026 and 2027.

Rakhmad estimates the four awarded clusters, which are expected to make final investment decisions this year, will displace 2.3 million kilolitres of fuel, saving around $300 million annually, or 6% of the country's diesel import bill last year.

AG&P LNG, involved in one of the clusters, expects Indonesia's gas demand to grow "extremely fast" and the country may eventually need to import LNG.

"We see further growth prospects in demand for gas, and hence LNG infrastructure and supply," said AG&P LNG's chief executive, Karthik Sathyamoorthy.

Consultancy Wood Mackenzie expects Indonesia to become a net LNG importer by the early 2040s.

BUILDOUT RISKS

The economics of small-scale distribution can be a deterrent to investors. Supply chain costs in small-scale projects can reach 30-40% of the delivered gas price, versus 10-20% on a typical LNG project, estimated Putra Adhiguna, managing director at think tank Energy Shift Institute.

"Indonesian gasification projects that have been successful have been those close to a gas pipeline. But to establish small-scale LNG has been challenging," he said.

Additionally, there is a risk of infrastructure underutilisation due to a lack of power demand or steady supply, said Johan Utama, principal analyst at S&P Global Commodity Insights.

Putra said he is not confident the small-scale LNG projects will be fully delivered. "A few clusters may pass through the bar, but full-scale implementation will be dragged down for a while."

(Reporting by Emily Chow in Singapore and Fransiska Nangoy in Jakarta; Editing by Sonali Paul)

((emily.chow@thomsonreuters.com; Reuters Messaging: emily.chow.thomsonreuters.com@reuters.net))