Cost Recovery Debate Hampers Investment

It takes costs to keep pumping oil

Quoted from the BPMIGAS website, the following article should be a big relief for investors as it shows that BPMIGAS is taking long-term impacts into consideration.

JAKARTA – The proposal to cut cost recovery by 15% may reduce the attractiveness of oil and gas investment in Indonesia. The cost recovery reduction may cut exploration costs, which will be followed by a sharp decline in national oil output in the future, BPMIGAS Deputy for Operations Eddy Purwanto said in Jakarta on Friday (08/1).
“It’s valid for the parliament or anybody to want a cut in cost recovery as monitoring here is very important. However, we also have to remember that the average cost recovery in Indonesia is 23% of revenue and if this is cut by 15%, the cost recovery will only be 19%,” Eddy said.
Professor Profesor Ong Han Ling from Bandung Institute of Technology, quoting a study from Johnston, said that the appropriate cost recovery portion in the world is 40 percent. The calculation is based on data that 75% of production sharing contracts in the world have a level of cost recovery of between 40-60%. Johnston said that lowering cost recovery to 20% would be “cruel”.
“If Indonesia continues to force a cut in cost recovery to 19%, there’s a big possibility that Indonesia will be unattractive for investors,” Eddy said.
Eddy said further that if these companies are asked to cut cost recovery to below the normal level, they will automatically cut costs that aren’t directly related to production, such as exploration bills. Indonesia needs US$3-4 billion of investment in exploration to replace pumped reserves, based on an exploration success ratio of 10-20 percent.
“If exploration activities are reduced, the oil and gas industry in Indonesia will surely lag in the next few years,” Eddy said.
With more than 100 years experiences in managing oil and gas resources, Indonesia is one of the most efficient countries in the world, Eddy said. The costs to find and produce oil and gas in Indonesia is among the cheapest worldwide.
“Again, cheap costs and reserve availability aren’t enough to attract investors. It’s everybody’s responsibility to improve the investment climate so that we can depend more on the oil and gas sector to support the state budget,” Eddy said.

How Attractive are the Indonesian PSCs ? – How Do We Compare With Others ?

The Indonesian PSC: fire-fighting before it's too late

A recent study on fiscal system competitiveness and attractiveness conducted by Wood MacKenzie found that the Indonesian PSC ranks at 88 amongst 103 countries. We are at the bottom quartile ! Now, let’s see the facts and figures to draw a conclusive conclusion if this is true or just a meaningless survey which we can easily ignore.

The last new PSC bidding round back in December 2007 took about 5 months to close, longer than usual. Part of the delay was caused by the changes proposed by the Government (MIGAS) with regards to ring fencing at PoD level rather than the PSC, title to assets and equipments before full cost recovery, etc. At some point there were time consuming debates on arbitration court, payment of taxes in kind rather than in cash, and so many other issues (which later on were mostly changed back or dropped). The delay was probably also intentional to wait for and lure more investors as well as to timely schedule the signing of the contracts at the opening ceremony of the 2008 IPA convention. Well, there were not that many signed. About 21 blocks oferred failed to attract favorable investors. Minister Purnomo was quoted today on daily Republika that the prospective investors on those 21 PSCs did not meet the requirements (on signature bonus and exploration commitments). We should ask the question whether probably it was the commercial and fiscal terms which did not meet the investors’ requirements !

Inability to attract investors amidst record-high oil price environment that we have today actually is straightforward and downright obvious. It is true that this also means that the prospects being offered are definitely not exciting at all, something on which we have limited control, but the fiscal and commercial terms are definitely within the government’s control. They should have been utilized to manage and compensate the fact that the exploration prospects were not attractive. We can always re-bid those blocks in the next round scheduled in October this year, but we have lost a timeframe in the momentum of this long-term business. Without changing the terms and managing expectation, we should not be surprised if a majority of those blocks will fail to find investors yet again.

How do we actually compare in general with PSCs in other parts of the world ? In reality, we should compare our terms with any types of petroleum contracts, not just PSCs, in any countries. The race for finding new reserves should be at its peak today. Major oil companies are making highest-ever profits, and they are looking at their extensive portfolio to re-invest their returns. Projects which were previously not economic suddenly look pretty enough to throw money in. These giants always manage their reserves like an assembly line on a conveyor belt. If they decided to develop discovered reserves, they have to make sure new discoveries are being added to secure a sustainable reserves replacement ratio ensuring long-term growth. The oil companies do compete with one another to bid for new exploration blocks, but we should always note that governments of the countries offering contract areas are also competing with one another. Uncontracted blocks tell us the strong message that we are not winning the race, at least it looks like we are behind, or even worse: we probably have not started when others have accelerated at full steam ahead leaving the launching pad. The current confusing development on limitations of cost recovery, threats to impose new taxes (windfall profit, crude export), or changing the format of the contract (to a non PSC type, or a PSC without cost recovery) only worsens the situation. In a world-scale race like what we have in this industry, less certainty spells trouble and investors will walk away from countries which can not even guarantee certainty in fiscal, commercial, and legal systems.

To narrow the scope, let’s have a peek on PSCs in other countries and see how much better they are compared to ours. Angola offers uplift on new development, allowing contractors to cost recover more than what they spend as an incentive to invest in new projects. See the contrast to what we do today in Indonesia, basically trying to do the exact opposite: allowing less cost recovery relative to what the contractors actually spend (recent disallowance of recovering community development costs is a good example). The Angolan PSCs use sliding scale Rate of Return for profit split: the lower the RoR, the higher the contractor’s share, ranging from 80% at the highest when RoR is low to 30% at the lowest when RoR is at its maximum high (a most likely scenario when production and price are high, provided that most costs have been recovered). With a 50% tax rate, the worst after tax split is hence 15% which in reality is more than that given the uplift.

Azerbaijan offers similar incentive for capital expenditure uplift, and the profit split is also based on RoR but further adjusted for inflation. The highest split for the contractors is 70% and the lowest is 20%. With a tax rate of merely 25%, the lowest after tax profit split is 15% which again in reality is higher considering the uplift.

Looking at the typical Indonesian PSC for oil, the profit split after tax is 15% in general, but in reality the investors actually get less as the Domestic Market Obligation (DMO) is compensated by the government at a much lower price ($0.2 or 10% of ICP or 20% of ICP per barrel). We do have capex uplift in the forms of investment credit (for oil) and Interest Cost Recovery (ICR, for gas) but they are very selectively given. Once granted, those incentives sometimes are still questioned and challenged as certain parties misunderstand them as recovery of financing costs which contractually is not consistent with the PSC itself or the premise that the investors should be financially capable and hence no financing costs shall be chargeable to operating costs. Those parties do not understand that it’s not about how financially capable the oil company is, it’s all about how economically viable the project is. An incentive is given to stimulate investment and to improve project economics, something which we MUST do to compete globally.

In reality, of course, it’s not about the format of the petroleum contract or the fiscal or commercial terms which lure investors. It’s more about the hydrocarbon prospect, which when combined with the contract terms, gives a favorable bottom line economics for the investors. If we have a giant reserve with low cost operation, less favorable terms are still acceptable for them. But then again, when was the last time we had a giant discovery in excess of 2 billion barrels comparable to those in Angola or Azerbaijan for example ?  

We are shouting panicly about imposing windfall profit taxes or crude export taxes amidst the high oil price we have currently. Why don’t we look around and see if any other PSC countries do anything like that at all, considering they have similar arrangement and comparable profit split with the PSC contractors. I suspect that obviously we’re the only one making a big fuss about it. Indeed certain non-PSC countries have imposed higher petroleum taxes, but those are in the tax & royalty petroleum contracts where the governments truly get less than the oil companies, not in a PSC where the government already takes 85% of the windfall profit. As I raised over and over again in other articles, we are mixing state budget issues with the aspiration to have a bigger government take in the oil & gas industry.

We surely don’t want to miss the train nor to completely blow up the race to find more reserves and fully take advantage of the record-high oil price. We should quickly get our acts together, resolve all disputes, drop all controversies, and immediately launch our departure to catch up with others and re-claim our position in the global oil & gas industry.

 

PSC Forum – Site Updates

A site that sheds a light in the dark

It’s been exactly a week after the “official” launch of this site. I would have to say that the response so far has been wonderful. The site reached 800 hits within a week, averaging more than a hundred a day. I would like to thank everyone for publisizing and endorsing this site to the wider audience within the oil & gas industry, especially in Indonesia. I would really appreciate if you continue to socialize this site to even more people. I know for sure that various people from different backgrounds visit this site: BPMIGAS, International Oil Companies, general public, scholars, and many others.

With regards to content and design, the site now has 9 articles/postings and links to other related sites have been added. The intent is to post new articles at least on a weekly basis, so please visit this site regularly.

Some people asked why the site has to be in english as they believe it would have been more effective if it’s in Bahasa, at least for the discussions. First of all, there are other similar sites in Bahasa and some of them are really good (and I have to admit are much better than this site), for example Benny Lubiantara’s blog (I put the link to his blog on the blogroll on the side bar). The second reason is of course to reach the key players in the oil industry, the foreign investors represented by the expatriates assigned to Indonesia in the IOCs. I know for a fact that some expatriates do visit this site. Last but not least, for a certain extent, we should be accessible to people in other countries, more particularly those with similar issues in their oil & gas industry. English is kind of the “official” language anyway in the PSCs and also to a lesser extent in the industry.

However, the original purpose of creating the site has not been fully achieved. The level of discussions have been relatively low. Hence, I encourage you to comment more on a posting or get involved in a chain of comment. There will be a new tab / page created solely to take general comments not related to a particular article, hence you can put your comments there about anything at all related to PSC issues.  I would like to re-iterate again that you can post a comment anonymously if you do not wish to disclose your identity, you can use a pseudoname as you wish. Your e-mail address is required to write a comment, but it will not show up publicly and people will not be able to write directly to you. The whole thing is completely anonymous !

Of course as the site administrator, I reserve the right to delete or edit inappropriate comments, even if I do not moderate them firsthand. Please note that this site was created to promote healthy discussions and objective opinions, and that should be done without taking sides or by being offensive to one another.

Again, thanks a lot for being a part of this site in any which way you are.

Shall We Nationalize (Expiring) PSCs ?

Nationalization doesn't always mean lower standards

On daily Suara Pembaruan yesterday, Chairman of the Indonesian Association of National Oil Companies (Aspermigas) was quoted as urging the government to reduce the domination of international investors in the oil & gas industry. He said that the foreign domination was against the constitution and had contributed to the increase of domestic fuel and electricity subsidies. He also pushed the government not to extend 28 PSCs operated by international oil companies (IOCs) which are soon expiring over the next few years. Nationalization of course doesn’t always necessarily mean a take over by the National Oil Company, Pertamina. He suggested that some local private companies such as Medo and Energi Mega Persada (EMP) are more than capable to operate producing oil & gas fields.

Well, first of all, it should be clarified that there is no real foreign domination. The PSC concept puts the IOCs as contractors to BPMIGAS rather than having full ownership of the reserves. Management of the PSCs is also with BPMIGAS, not with the contractors who act as operators on behalf of the government. If we look at the bottom line, in any case the government always gets a bigger share of the economic value (note that cost recovery has negative value while it’s the profit oil which generates positive economic value). We should conclude that the industry is not dominated by the IOCs but rather by the government as it should be. There should be no inconsistency with the constitution either.

The comment that “foreign domination” contributes to the increase of domestic fuel and utility subsidies is taking it a bit out of place. I would not bet that if those PSCs were “nationalised” by being taken over by the NOC or moreover by the national private companies, then the state budget issue of subsidizing non-industrial fuel and electricity prices would get resolved. The increase of subsidies, as I wrote in my other articles, is related to high market price for crude oil, increasing domestic consumption relative to production, and the government budget policy itself.

Decision to “nationalize” a contract area should simply be based on economic evaluation, which should be straightforward. In reality, operatorship by a private local company will probably give the same bottom line to the government assuming the same profit split should be applicable to both a local company and an IOC, if not even less considering the potentially lower dividend taxes relative to the branch profit taxes paid by the IOC. Of course, as the PSC operators are just contractors, the government should always appoint the best contractors regardless the fact that they are local companies or IOCs. Definitely there are always arguments about going for the national private companies (keeping the value inside the country, the re-investment impact of profits hence generating domino economic effects, development of national employees, etc), but all these should be carefully evaluated and valued. We have done this in the past and we should learn and conduct an objective assessment whether the decisions to nationalize or localize PSCs were indeed the best for the country. Good examples would be Coastal Plain Pekanbaru (CPP) and the former Stanvac fields in Riau and South Sumatra, as well as many other fields. It shouldn’t be too difficult to conclude whether or not the costs of giving away 15% of the profit to an IOC outweighs the benefit gained by the government from discovering more reserves, maintaining production level, application of state of the art technology, world class expertise, and cost efficiency (yes, national companies are not always more efficient even if they tend to have no expatriates, in most cases it has to do more with effectiveness). The last thing you want is that the government end up with less even after taking over the 15% share previously “paid” to the IOCs. Note that if the national private companies which take over the PSCs rather than the NOC (Pertamina), then the government will still have to give away the 15%.

It is true that it makes more sense to nationalize expiring producing PSCs rather than exploration PSCs, as in a producing PSC the risks are more with regards to operation and technology which hopefully can be covered by having the facilities in place and the employees working in the original (and the first extension, if applicable) contract period(s). Meanwhile, in an exploration PSC, the biggest risk is of course related to (not) finding commercial reserves, a risk that the IOCs argueably can still carry better especially given the technology, the expertise, and the financial capability. However, we have to admit that nationalization of expiring producing PSCs will in reality to some extent have an impact on the foreign investors’ willingness to invest in new exploration blocks (long term relationship with the majors, etc). The other thing that we should not forget, as I briefly said above, is the fact that the business of a producing PSC is not just about cash cowing the existing fields. That is not good enough. Further exploration within the block, maintenance of production decline, maintenance of production facilities, application of enhanced recovery methods, first-hand access to new technology (the list goes on and on) all are required if you really want to optimize the economic value of the contract area.

Another factor we should focus on is the possibility of the government insisting on better terms and imposing new commitments to the IOC when negotiating an extension, which may be more affordable for the IOC to take relative to a new national private company taking over the block which has to start from scratches. We also tend to forget that there will always be an “investment black-out” period in between the decision not to extent the PSC and the contract expiration date. Nobody wants to invest in the final years of the existing contract knowing that there will be no extension granted, as the economics will be completely off. Meanwhile the new party which will take over can’t really start investing until after the current contract expires. Giving away an extension (well in advance) is good for economic certainty and will secure continuous investment which in the end is also good for the industry and the country.

I’m not saying that nationalization is always bad, as in some cases we also have success stories which we are definitely so proud of. We just have to be sure that it’s well thought of and evaluated, not a decision made in a rush based on public or political pressure, which could back fire in the end.

Indonesia Should Adapt to a Changing Petroleum World – ASAP

Do the Indonesian PSCs Carry Too Much Weight ?

One participant in the Cost Recovery Seminar held by PII (Indonesian Engineer Association) last week asked a very simple question: why Indonesia sees increasing oil price as a disaster when other oil producing countries tend to see it more as a blessing.

The straightforward answer was also very simple: because we consume more oil than what we produce. However, the detailed analysis on the issue was not a walk in the park, as the whole problem is actually a complex web relating to supply, demand, state budget policy, socio-politics, and macroeconomics.

From the oil industry side alone, increasing oil price is of course a tremendous blessing. Even with hyper inflation in the industry caused by a sudden rush of investment (steel, drilling rig, technology, human resources), the bottom line financials are still improving.

On the domestic oil demand side, however, the thirst for oil is ever increasing as well. Coupled with the state budget issue due to the (social & political) policy to subsidize domestic non-industrial fuel, the blessing morps into a disaster. The underlying root causes can probably be segregated into several bullets:

• Declining domestic oil production: this is probably the main root cause attributable to the oil industry in the country. Hence, if we want to solve the big national problem, we should strive for more production by encouraging investments in exploration and exploitation of new reserves. Focusing on getting a bigger state take by imposing additional taxes or by disallowing recoverability or deductability of certain costs could be discouraging instead.
• Increasing domestic demand  for energy: which is not bad at all as it’s a reflection of a growing economy (especially if it’s for industrial rather than for consumptive needs). What’s bad about it is the fact that most of the growing demand is still in the form of oil which then has to be imported at the sky-rocketed price. What we should do is to convert in a large scale to gas, hydro, and geothermal. Coal might do as well, but it’s not exactly environmental friendly. If we can reduce the demand for oil amidst declining supply, we will be able to (at least partially) manage the national concern.
• Economic, political and social policy to subsidize non-industrial domestic fuel price: which definitely is burdening the state budget. I prefer not to comment on this one as my opinion wouldn’t count anyway.

Looking at the three bullets above, the Indonesian oil industry is responsible and probably should be held liable only for the first one, but somehow is being targeted and expected to also carry the weight on the other two (hence the proposals to impose windfall profit taxes, export taxes, and the squeezing of cost recovery). Even if all three are argueably related and associated, fixing the problem requires careful separate considerations. Definitely, you don’t want to (again, partially) fix the issues on the other two by destroying real value on the first.

BPMIGAS is Evaluating Three Options to Increase State’s Take in PSCs

Big waves pounding on the Indonesian PSCs

Head of BPMIGAS was quoted on daily Kompas yesterday that his team is currently in the process of evaluating three options to help increase state revenue from the oil & gas sector: application of windfall profit tax, control on cost recovery, and application of export tax on contractor’s share of crude oil. He also said that the impact on investment climate in the industry should be taken into consideration before implementing the options.

The whole industry indeed is closely watching the actions taken by the government (MIGAS, Ministry of Energy and Mineral Resources, BPMIGAS) related to the public, press, and parliament pressures to increase state revenue and to reduce cost recovery. Careful consideration as he mentioned is a must before making a decision to change the existing system or merely to provide a detailed guideline which is not entirely the same as the current common practices.

For example, applications of windfall profit and crude oil export taxes have never been done before. It is yet to be seen that the government has a solid legal and contractual basis to enforce them. The last thing we want is creating unnecessary controversy which is detrimental to investors’ trust on the legal and fiscal systems in Indonesia.

In a seminar on cost recovery held yesterday by the Petroleum Engineering Chapter of the PII (Persatuan Insinyur Indonesia – Indonesian Engineer Association), it was disclosed that a recent study conducted by Wood Mackenzie on fiscal system competiveness and attractiveness concluded that the Indonesian PSC ranks at 88 amongst 103 countries. That’s shocking and alarming: we are at the bottom quartile. If we really want to increase state revenue from the oil & gas sector, the best way is of course not by taking more from the smaller pie but rather we should do our utmost to increase the size of the pie by attracting more investors to explore and develop more reserves. In the petroleum business, there are no shortcuts to success nor easy wins , but surely there are a lot of potentials to make high impact blunders that back-fires instantly. A good move we make today (by improving the fiscal attractiveness of our contracts) will reap the benefits several years into the future, while a bad move today will have negative impacts on both time dimensions (short and long term).

If any, rather than making a big fuss about taking more from the contractors at their expense, we should probably focus our attention on improving our competitiveness so that they will be more than happy to give us more without us taking more from them.

New Type of Petroleum Contract To Be in Place by October 2008

The PSC is on Fire, It's Time to Build Something New ?

Director General of Oil & Gas, Ministry of Energy and Mineral Resources, was quoted today that a new type of petroleum contract in Indonesia is expected to be oferred to investors in a bidding round scheduled to take place in October this year. She explained that this contract will have no cost recovery as part of the mechanism.

In total, there will be 25 new blocks being oferred. Historically, all blocks have always been under the existing format of PSC. “We are currently evaluating the possibility of oferring a different type of petroleum contract of which there’s no cost recovery, ” she said.

However, Head of BPMIGAS assessed that a new contract format with no cost recovery will be literally detrimental to the domestic oil & gas supporting businesses as the government will have no more intervention to the oil companies’ operations and could not encourage use of domestic goods and services. He also said that in a contract with cost recovery, the government has a leveraging position relative to the oil companies while without it the government will have to lose direct control. “Without cost recovery, the government can only receive taxes and royalties without supervision and management. If that’s the case, what would happen to our sovereignty on mineral resources ?”

In my personal opinion, setting such a tight timeline to come up with a new breed of petroleum contract to (probably partially) replace the 40-year old PSC, is a bit of a rush. All aspects will have to be carefully evaluated and well thought thru, especially the implication on the investment climate in the oil & gas sector. Ideally, the new format should still be conducive with regards to attracting foreign investors, and on the other hand is also still consistent with the spirit of the Constitution (note that Tax & Royalty system is not exactly a reflection of state sovereignty over mineral resources). If the intent is to have more government take and avoid the alleged abuse of the cost recovery concept, the solution could simply be a PSC with adjusted terms and conditions where allowances for cost recovery, its limit, and control are better clarified and tightened.

BPMIGAS To Post Sr. VPs in PSCs

A Breakthrough Move to Break the Spell on PSCs ?

Last week, it was announced that BPMIGAS will post some of its senior officers as Sr. Vice Presidents of Project in certain PSCs. So far, there have been 8 PSCs mentioned publicly: Pertamina E&P, Total, ConocoPhillips, Chevron, Medco, BP, Inpex, and ExxonMobil. There could be more to come.

Some articles quoted BPMIGAS’ explanation about this breakthrough move as a way to bridge the PSCs and BPMIGAS with regards to control on cost recovery and to help facilitate the work program and budget approval process. This person technically will be an official representative of BPMIGAS in the respective PSC. However, on daily Business Indonesia today, Head of BPMIGAS is quoted as further explaining that the VPs will answer structrurally to the top management of the PSCs where they are placed. “We have asked contractors management to evaluate their performance,” he said.

The exact terms and forms of this placement are yet to be laid out and clarified, but it should be really interesting to see how it evolves. This has never been done before, at least not this type of placement. In the past, some retirees from Pertamina BPPKA / MPS (BPMIGAS’ predecessor) joined the PSC companies as executives but they were all hired as full time employees of the oil companies after they left Pertamina. On the other hand, this new move is more like secondments of active BPMIGAS officers.

There are a few things to watch and note out of this new development:
1. The legal contractual and conceptual basis
2. Potential conflict of interests and confidentiality issues

On the conceptual side, this placement should not be in a context of secondment per se, as secondment is generally applicable to a joint venture where there are more than one party owning the legal entity. In a joint venture, the employees are mostly hired by the joint venture itself as a separate and independent legal entity, while there could be some secondees working in and for the joint venture being placed by the owner companies which have ownership shares of the joint venture. Secondees in a joint venture are paid by the joint venture, working for the joint venture on a temporary basis, but still retain long term employment with the parent companies. Note that almost all PSCs in Indonesia are operated not by a joint venture, but rather by a company which usually (but not always) has the most working interests in the PSC. The PSC itself is not a joint venture and no legal entity is set up for the PSC. For example, if ExxonMobil owns 60% of the working interests in the Soandso PSC while Chevron owns the remaining 40% working interests in that same PSC, then usually both ExxonMobil and Chevron each sets up separate companies to hold their respective interests in the PSC. In this case, it is fair that ExxonMobil Soandso Ltd (owned 100% by its ExxonMobil parent company) becomes the operator of the PSC, while Chevron Soandso Ltd is a partner in the PSC. All employees then are those of ExxonMobil Soandso Ltd, and generally Chevron Soandso Ltd can not place their secondees in the PSC operator as they have no ownership of ExxonMobil Soandso Ltd (even if they DO have working interest ownership of the PSC). Again, the PSC itself is not a legal entity in the form of a joint venture. It is probably most suitable to classify the PSC as a JANE (Joint Asset Not an Entity, which is not operated jointly).

Now, let’s step back and see if BPMIGAS can actually arrange for the postings of their officers in the PSCs as secondees. Definitely, BPMIGAS or the government does not have share ownership of the PSCoperator companies. They do have “ownership” of the PSC, even if it’s not “working interest” ownership, but certainly not in a way where business-wise they can place their people in the formal structure of a Chevron or a Total company and be part of the management. I tend to see that this angle does not work.

Another way to look at this situation is by reviewing the principle of a PSC operator which is basically none other than a contractor to the government (BPMIGAS). That is exactly why the term used for a PSC operator is KKKS (Production Sharing Contract Contractor). A simple example would be you assigning Schlumberger Indonesia as your contractor to shoot a seismic program in your block. Indeed, you pay Schlumberger for doing the work, but that does not mean that you can place one of your staff as a Sr. VP inside Sclumberger Indonesia Ltd and become part of its management and fully paid by them as well. What we can do probably is to post one of our staff as a coordinator of the seismic program, be co-located in the Schlumberger Indonesia office if necessary, become your representative but not exactly part of that company’s management structure. The person then shall not be able to make business decisions for Schlumberger Indonesia, but rather for your own company who owns the program and has the management right to control, monitor, and review the program (but not to control and manage Schlumberger Indonesia).

The second issue to watch out is conflict of interests and its consequences on confidentiality for both sides. It is undeniable that oil companies are here doing business for profits as justified within the legal and contractual boundaries. If the placement is more on the operation side, there should be minimal conflict as operation should be run in a prudent manner based on general oil & gas production and operational practices anyway. But you could imagine a conflicting situation if the BPMIGAS person is somehow involved in government audit resolutions, or incentive negotiations, or any other financial and commercial related matters. The person can easily be in a position where it’s not appropriate for him/her to be in as the interests of the two parties (the PSC operator company and BPMIGAS) are not just different but even conflicting and opposing to each other. The other thing related to this is confidentiality. A full time employee signs confidentiality agreement with the company on the premise that the person works permanently for a long term. How could you share company confidential issues (and not all are related to the PSC as some could be related to the company, the corporation, strategy, etc) with someone who represents BPMIGAS and is in your business environment only on a temporary basis. Note that this confidentiality issue is true both ways, as likewise the BPMIGAS representative may not share sensitive and confidential government and BPMIGAS matters to the company. I could imagine how awkward the atmosphere a business meeting would be if you have the conflict of interest and confidentiality issues to deal with, while on the other hand the person is part of the company management and needs to be included in the discussion and decision processes.

There is no doubt about the noble and great intent of this breakthrough move to post BPMIGAS officers in the PSCs. But, we should be careful about how to package it so that no bad precedents are being set, no contract sanctity is being crossed, and no misunderstanding is being blown out of proportion. I still believe this is doable and we can work the terms and conditions out, but this requires a completely different approach to be successful and should be based on agreements by both parties rather than a one-sided direction.

Just my 2 cent thought. Would really appreciate your comments and ideas.

Indonesian Government Requests Oil Companies to “Share the Pain”

The Indonesian government, including the President himself in a gathering a few months back attended by elites from the petroleum industry (ministry of energy, BPMIGAS, MIGAS, oil company executives, etc) requested the oil companies to “share the pain “. It was a reference to the “pain” currently suffered by the government as a result of the high oil price environment which triggers a significant increase in domestic fuel subsidy (due to the fact that the country is a net importer of crude oil).

Preceding and subsequent to that event, certain parties raised concerns about the oil companies operating and producing the Indonesian PSCs enjoying significant windfall profits from the high oil price environment, something which the government on the other hand do not have due to the increasing fuel subsidy. Some parties then proposed the idea of applying some kind of a windfall profit tax to the oil companies, an idea which will help “share the pain”.

In reality the PSC mechanism in Indonesia is not about “sharing the pain” at all. As a matter of fact, “the pain” in a PSC is never shared, it’s always borne by the investing companies and never by the government. “The pain” that I refer to is of course the losses suffered by investors (oil companies) in the exploration stage where all costs in unsuccessful efforts are all absorbed by the companies with no cost recovery nor tax deductibility, not even by cross PSCs financial consolidation due to the restriction under the “PSC ring-fence” regulation.

Producing gain

It is widely understood that PSC is all about the concept of “sharing the gain” and far from “sharing the pain”. Once you have a commercial discovery, oil and gas are shared between the two parties, a reflection of “sharing the gain”. Note that cost recovery volume is given to the contractors as it’s not a reflection of “gain”, but rather a compensation for the costs incurred in generating the “gain”. The split in Indonesian PSCs is based on the profit barrels after cost recovery, which, again, is a fair reflection of “sharing the gain”.

In a high oil price environment, all things being equal (volume and cost recovery), actually the government takes 85% of the additional “windfall profit”, while the contractors only take 15% on an after tax basis. Hence the government takes almost 6 times more than the contractors. It is true to say that both parties enjoy the “windfall profit” when you talk just about the oil production side. The “pain” that the government complains about is all related to the state budget which happens to be consumed for fuel subsidy, while the oil production industry itself is actually very healthy financially. To request the oil companies to “share the pain” on a state budget issue hence is a bit irrelevant and out of place, since they have done their duties with regards to “sharing the gain”.