Wednesday, August 7, 2013

Criminalization in the Indonesian oil and gas sector: A nightmare for investors?

Never before has a court trial been focused on and questioned by so many circles like that of the case of Chevron’s bioremediation, among others by such a professional association as the Indonesian Petroleum Association (IPA) as well as other government agencies and even Cabinet meetings.

The United Indonesia Cabinet was arranging coordination to make its handling more conducive to the continuation of the bioremediation case, which should not have entered the criminal sphere (May 8).

Support also came from the peers of defendants like the Bandung Institute of Technology’s Alumni Association, the Bogor Institute of Agriculture and the University of Indonesia, which certainly was not due to esprit de corps, but was more prompted by the propriety of the substance and process of trial in the corruption court.

On Twitter, the verdict on Chevron was even discussed more than 4,000 times, while the case of Djoko Susilo was only thrashed out 339 times.

Finally justice prevailed over the Indonesian oil industry, as the judicial panel of the corruption court sentenced two defendants in the Chevron bioremediation case to five and six years in prison respectively and forced them to pay compensation worth about US$10 million, while in material terms the state has not yet incurred losses, because cost recovery is still put off by the Upstream Oil and Gas Regulatory Special Task Force (SKK Migas) through the under lifting and over lifting mechanism as stipulated in the production sharing contract (PSC). Instead of dealing with the verdict of the court, this article will address its impact on a national scale, especially on energy resilience and oil and gas sovereignty.

The PSC was developed by the New Order regime in 1968, when it merged Pertamin and Permina state-owned enterprises into Pertamina, which was then validated by Law No. 8/1971 on the basic functions of Pertamina. Law No. 8/1971 was later replaced by Law No. 22/2001 on oil and gas, which reduced Pertamina’s authority to purely an oil and gas company without “government” power and particularly that of PSC control and supervision, which in 2002 was delegated to a new body, the Upstream Oil and Gas Regulating Agency (BPMigas). This agency was unexpectedly dissolved 10 years later by the Constitutional Court (MK), on Nov. 13, 2012.

The MK decision to disband BPMigas more or less disgraced the Indonesian oil and gas industry. The oil community did not expect that within such a short time BPMigas would be considered “unconstitutional” to the point where it had to be dissolved. This gave rise to “legal anxiety” over the legitimacy of PSC contracts already signed previously.

BPMigas was replaced by a new one, the Upstream Oil and Gas Regulatory Special Task Force (SKK Migas), formed on the basis of Presidential Regulation No. 9/2013, but this government decision cannot yet dispel the fear of investors because the status of SKK Migas has yet to be determined by a revision of the Law No. 22 on oil and gas. This worry is just reaching its peak with the corruption court’s decision on the Chevron bioremediation case. Legal and business certainties are felt by investors as increasingly less conducive to the development of Indonesia’s oil and gas industry.

The Chevron verdict indicates that the judiciary in Indonesia does not understand the essence of PSC, including the meaning of cost recovery, which is paid through the oil and gas lifting mechanism, rather than in cash.

PSC tend to be easily criminalized through a different way of legal interpretation to pursue a target. The head of SKK Migas has made no denial that the criminalization of civil cases including the Chevron verdict considerably disturbs national upstream oil and gas activities and has the potential for significant output reduction (May 10).

From the beginning, the presence of foreign investors has only been a temporary choice, and as the state is financially and technologically capable later on, it will have to opt for a policy enabling direct and independent management. The question is when the state and state-owned company will be considered capable of bearing a huge fund burden and taking big risks, which is certainly for the government and SKK Migas to answer, not the judiciary.

As an illustration to gauge the capacity of the state and state-owned company, below are statistical facts of exploration activities particularly in East Indonesia, notably in the frontier region of Papua and deep-sea area of Makassar Strait. Since 2009 the exploration drilling of 22 wells have been finished, with contractors’ investment totaling around US$1.8 billion.

But sadly, the exploration activities have discovered no economic oil and gas reserves, which based on production sharing contracts the entire loss becomes the risk to be borne by contractors, especially the foreign side.

If the loss of about $1.8 billion were to be borne by the state or state-owned company, the objective of achieving “maximum welfare for the people” as required by the Constitutional Court would be farther away from reality.

The people need oil and gas now, it’s impossible to wait until the state and state-owned company are really capable of facing the funding, technology and high risks.

The conclusion is that Indonesia still needs foreign investment in oil and gas, and one of the targets of investment is exploration and exploitation activities to cover the swelling oil and gas trade balance deficit, reaching $5.6 billion in 2012. Yet, investment will only come if legal and business certainties are guaranteed.

Wood Mackenzie oil consultants issue annual ratings of around 100 oil and gas producing countries having contracts with foreign investors, which are fiscal-term ratings of oil and gas contracts giving the largest profits to states as well as contractors. The Wood Mackenzie ratings serve as one of the references for prospective oil and gas investors to decide their investment in a country.

Investors are inclined to choose a country with a more profitable contract model and fiscal term compared to the potential for success and the risk of failure.

It is widely known that after over a century of exploitation, Indonesia’s oil and gas prospects are shifting toward East Indonesia and deep-sea zones so that far greater investment costs are demanded. For example, the cost of an exploration drilling project is around $20-$200 million per well.

In 2008 Wood Mackenzie put Indonesia in the 24th place with an average government take of 86 percent of the revenue and 14 percent for contractors, but in 2012 Wood Mackenzie ranked Indonesia number 5 with its average government take rising to 90 percent while contractors’ share decreased to 10 percent. In other words, within five years the government take increased in percentage but investors’ income was reduced, so that PSC contract model and fiscal term in Indonesia are deemed even more “taxing” by investors.

The modification of rules and PSC contracts are seen as more favorable to the Indonesian government and less siding with contractors. Ironically, this fact was ignored by the Constitutional Court, leading to the dissolution of BPMigas that was just considered more “pro-foreign” (Dr. HL Ong, March 13).

The court verdict imposition on the Chevron bioremediation case will definitely increase the anxiety of old investors and induce the reluctance of would-be newcomers to invest in Indonesia, especially in oil and gas explorations most vital to the energy resilience of Indonesia. At least six international oil companies have announced their plan to leave Indonesia shortly. Meanwhile, Chevron has ceased the operation of three of 11 drilling rigs following the fear of any recurrence of criminalization of civil cases like bioremediation (May 14).

A nightmare of the arrival of “oil and gas emergency” seems to be even harder for the Indonesian
nation to avoid.

Written by Eddy Purwanto, an oil and gas practitioner and deputy of BPMigas for 2002-2009.

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