Transparancy problems in oil and gas industry<\/p>\n
Parulian Sihotang and Alex Russell, Department of Accountancy
\nand Business Finance University of Dundee, United Kingdom<\/p>\n
Years of accusations of corruption, collusion and nepotism in
\nIndonesia's oil and gas industry have threatened the country's
\neconomic development. The legislature took the first steps
\ntowards repairing the damage by passing the oil and gas bill No
\n22\/2001 which became effective on Oct. 23, 2001. Its aims are
\nlaudable and modernist.<\/p>\n
It follows the premise that in order for an industry to thrive
\nand prosper, it should be freed from the bureaucratic fetters of
\ngovernment. The new bill aims to achieve this result by
\nestablishing an implementation agency (badan pelaksana) and a
\nregulatory agency (badan pengatur) which will assume duties
\npreviously assigned to the state oil and gas company Pertamina.<\/p>\n
The implementation agency replaces Pertamina in managing
\nProduction Sharing Contracts (PSC) with private oil and gas
\ncompanies, thereby eliminating the dual but conflicting role of
\nPertamina as regulator and player in the upstream petroleum
\nsector. The law also removes Pertamina's monopoly in the
\ndownstream sector by assigning responsibility for managing
\ndomestic fuel distribution and supply to the regulatory agency.<\/p>\n
The follow-up to the passing of the bill has, however, had
\nmixed success. Thus, although the implementation agency was set-
\nup on July 16 through regulation No.42\/2002, the government seems
\nto be unable to establish the regulatory body. Arguably, the
\ngovernment is moving in the right direction, albeit slowly.<\/p>\n
The first and crucial step, which is the macro-institutional
\nrestructuring process, has been achieved by implementing the new
\noil and gas law. However, it should be noted that micro-
\ninstitutional restructuring and redesigning is urgently needed in
\norder to guide properly the real day-to-day operational
\nactivities that create and add value to the industry.<\/p>\n
The urgency of the need for a revamping of the industry is
\nunderscored by the alarming revelation by Rachmat Soedibyo, the
\nChairman of the Implementation Agency, of the on-going declining
\ntrend of investment in the Indonesian up-stream sector (Kompas,
\nDec. 3, 2002).<\/p>\n
What reforms are necessary?<\/p>\n
Research by experts from the University of Dundee, UK, into
\nthe problems facing the Indonesian petroleum industry has shed
\nlight on the actions that need to be taken.<\/p>\n
First, there is a need to reform the requirement that all
\ncompanies operating in the Indonesian up-stream petroleum sector
\nmust adopt government-tendering procedures when procuring goods
\nand services. These outmoded requirements create an unduly
\nlengthy procurement process and have become a source of KKN.<\/p>\n
Further, they provide loopholes for oil companies to mark-up
\ntheir project costs by inflating their capital and operational
\ncosts. Currently, oil companies must use \"middle\" companies
\n(established under the Indonesian commercial law) as sub-
\ncontractors for the procurement of goods and services.<\/p>\n
This government-tendering requirement, as argued by Thomas
\nWalde in his book last year, The Indonesian Production
\nSharing Contract: An Investor's Perspective, has imposed
\ncontractors' Indonesian \"crony\" contracts on unwilling foreign
\ncompanies, that in the end makes Indonesia uncompetitive and
\nshifts income from the state to the crony-politician subculture.<\/p>\n
The process forces the oil and gas industry to subsidize
\nnoncompetitive companies. Redefining this tendering procedures
\nwould constitute a 30 per cent cost saving, according to Tengku
\nNathan Machmud in The Indonesian Production Sharing Contract: An
\nInvestor's Perspective (2000), while the Boston Consulting Group
\nclaimed that restructuring such tendering\/procurement processes
\ncould potentially benefit USD 16 billion for the industry over 5
\nyears period (BCG Report, 1998).<\/p>\n
Second, action must be taken to prevent petroleum companies
\nfrom overstating their costs and expenses by exploiting serious
\nambiguities in the current PSC cost recovery scheme.<\/p>\n
Under the PSC contractors recover all costs out of the cash
\nfrom the sale of crude oil. The remaining crude oil is then
\nshared between the government of Indonesia\/Pertamina and the
\ncontractors based on an agreed formula.<\/p>\n
The contractor's cost recovery mainly consists of the current
\nyear \"non-capital costs\" (i.e. the cost of day-to-day operations)
\nplus the depreciation for \"capital costs\" (i.e. the drop in the
\nvalue of their equipment for example).<\/p>\n
These terms look very straightforward in theory. In practice,
\nhowever, there are many gray areas that become a source of
\ndispute when determining the contractor's total costs. Senior
\ngovernment auditors revealed to the researchers that there is a
\ntendency for oil companies to accelerate cost recovery to get a
\npositive cash flow benefit by overstating the non-capital costs
\nwhile understating capital costs, or treating some of the capital
\ncosts as non-capital costs.<\/p>\n
The auditors had further concerns relating to the
\nmisclassification of certain costs (tangible versus intangible
\netc), the inappropriateness of certain overhead allocations, the
\nfraud possibilities relating to the technical fee charged by the
\nhome office, and undetected transfer pricing.<\/p>\n
Third, bureaucracy needs to be reduced. For example, the
\nprocedures for the Working Program and Budget (WP\/B) and
\nAuthorization for Expenditure (AFE) force any oil company to
\nprepare and submit at least 17 budget schedules, 16 financial
\nreports and 13 AFEs for obtaining government\/Pertamina approval.
\nSurely, government would not want this burden on the industry to
\ncontinue. Indeed, some oil companies claim that the
\ngovernment\/Pertamina can never evaluate these WP\/B and AFEs
\nproperly because they do not have key-performance indicators,
\nbenchmarks or other world-wide standards to match them against.<\/p>\n
Fourth, there is an urgent need for audit reform.<\/p>\n
Current host government audits focus too narrowly on financial
\ncompliance and concentrate only on companies' cost recovery. In
\nthe interests of sector efficiency there is a crying need for
\nperformance audits to be introduced.<\/p>\n
Accordingly, the host government audit of oil companies needs
\nto be risk-based and analytical utilizing key-performance
\nindicators including social and environmental performance.
\nFurther, the overlapping financial audit of oil companies
\nconducted by three governmental institutions (Pertamina, the
\nGovernment Internal Auditing Office (BPKP) and the Supreme
\nAuditing Office (BPK)) is ripe for rationalization.<\/p>\n
Finally, investors need to be reassured that a demand for
\nregional government participation in the industry, possibly
\nextending to participation in fiscal affairs, will not harm their
\ninterests.<\/p>\n
The reforms outlined above are based on developing best
\nindustry practice in Indonesia and are essential steps in
\ncreating a favorable environment for the much needed inward-
\ninvestment that is vital to Indonesia's economic future.<\/p>",
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