Oil & Gas Investment and the Gross Split Scheme
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For the last 17 years, Indonesia\'s oil reserves and production have been declining consistently. Production in 2000 totaled about 1.5 million barrels per day (bpd), and has now dropped to only 800,000 bpd.This decline is mostly due to natural depletion of the country’s oil fields, while new fields have not been able to supplant the decline in production.
Natural gas production, though relatively better, has also shown a declining trend in recent years. The lack of new reserves is caused by an unfavorable investment climate that has resulted in declining interest, especially in the exploration of new reserves.
The implementation of Law No. 22/2001 on Oil and Gas in fact made the implementation of upstream oil and gas policy highly bureaucratic, under which approval and licensing are extraordinary slow.
In addition, the implementation of the Government Regulation (PP) No. 79/2010 also resulted in a high-cost economy in the form of tax burdens and guarantees of contract (sanctity of contract). All of which frustrated investors. Even those who already operated here began to leave Indonesia.
This was reflected in the fall in the discovery of new oil and gas reserves in Indonesia from 2003-2013 to the lowest in ASEAN (even below Brunei). At that time, the price of oil and gas was increasing, with even the spot price reaching US$140 dollars per barrel in 2008. Oil and gas companies recorded significant profits during that period, and carried out aggressive worldwide investment in the upstream oil and gas sector, but not in Indonesia.
At the beginning of the President Joko “Jokowi” Widodo administration, the oil and gas industry hoped conditions would improve. However, three years later, the opposite has happened. Just look at the realization of investment commitment, which is very low. As of end June 2017, realization was only 30 percent for exploitation and 3 percent for exploration.
Indeed, there have been efforts at change with the introduction of Government Regulation No. 27/2017 to replace Government Regulation No. 79/2010. Although there have been some positive things, they have not been well received by investors because some important issues are not accommodated. The investment climate has not improved, and has been exacerbated by the low price of crude oil since 2014. This has made investors very selective in their investment.
Indonesia is currently considered one of the most unattractive countries for investment in the upstream oil and gas sector. The Energy and Mineral Resources Ministry recently issued Ministerial Regulation No. 08/2017 and No. 52/2017 on the new profit-sharing scheme, the gross split scheme, replacing the current net split scheme. However, it received a cool and even negative welcome from investors.
Net split vs. gross split
The net split scheme under theProduction Sharing Contract (PSC) was created by Indonesia and was first applied in 1961 in an oil field in Aceh. In essence, the contractors bear all costs and investment risks under a net split scheme.
If oil and gas reserves are found and are commercialized, then all investment and production costs are replaced (cost recovery). From the reserves’ net output (including taxes), the government receives between 60 percent and 85 percent (depending on oil or gas and location). If no commercial reserves are found, all costs are borne by the contractor.
The scheme was developed in lieu of the royalty & tax system, similar to a mineral mining contract, in which the net split under PSC was considered to be the most appropriate for Article 33 of the 1945 Constitution. This scheme has become the reference of upstream oil and gas contracts in many countries of the world.
Within 55 years of implementation, the scheme had made Indonesia the world\'s largest producer of oil and gas, and the sector an important contributor to state revenues.
Under the gross split scheme based on Ministerial Decrees No. 08/2017 and No. 52/2017, the government doesn’t need to reimburse investment and operating costs incurred by the contractor. It means that cost recovery no longer exists.
The contractor gets a base-sharing amount plus the possibility of a split adjustment. Investors will also be taxed on their profits. Theoretically, it is so much simpler. The fiscal incentives in oil and gas and certain tax rates may be similar to the net split scheme, but some provisional elements have become obstacles.
First, the size of the final split cannot be ascertained from the start, because the base split will be adjusted on the basis of 10 variable components that are only negotiable after the technical specifications of the oil and gas reserves are known. This makes it difficult for potential investors to explore new reserves as regards risk calculations and returns forecasts.
Secondly, there are three components of another variable (progressive component) on which the minister has a one-sided discretion, and may adjust the split at any time. This provision makes the security of the contract vulnerable.
Third, is a provision to limit contractors\' profits upon external factors such as oil and gas price movements.
These three points are unrealistic for upstream businesses, which are high capital, technology intensive, high risk and long-term activities. This especially occurs in business patterns in which investors must provide all investment and working capital amid the fierce competition among countries to attract investment.
If all three points are removed, it would probably be an interesting scheme, but the gross split is basically different from the royalty and tax under the net split in the PSC. The gross split concept looks to combine the royalty and tax with the PSC net split schemes. This is impossible, because the two have different rationales.
Future steps
The implementation of gross split schemes as it is, can worsen the investment climate even further. The current condition is been already at the lowest point in the history of our country\'s oil and gas upstream sector.The government should sit together and speak with business players and experts, and adopt the input given.An attractive and competitive investment climate is absolutely necessary, and therefore, profit sharing for oil and gas should be attractive and can compete with the prevailing schemes in other countries.
In the upstream oil and gas sector, we no longer possess comparative advantage. Therefore, we must be able to show our competitive advantage. Oil and gas is a very strategic energy commodity and dominates the livelihood of almost everyone. It has a multiplier effect and great added value to economic activity and growth. This is what distinguishes it from other natural resource commodities. Even if the investment climate is conducive and has strong competitiveness to attract investment, it will take at least 10 years to see results.
Meanwhile, oil and gas production will continue to decline, while consumption will continue to increase. As a result, the dependence on imports will continue to swell. Has the issue of how to secure securities and supply continuity, which would require tens of billions of US dollars in downstream infrastructure investment and working capital, been considered? I think not.
The challenges in the energy sector are big, but we must not fail. It takes professionalism, deep understanding, experience, courage, and togetherness to face these challenges. There must be breakthroughs, and not trial and error.
ARI SOEMARNO
Former President Director of Pertamina; Oil and Gas Consultant
