Can a Special Business Entity Answer the Problems of the Oil and Gas Sector?
Note: This article reflects the personal opinion of the writer and does not represent the views of CNBCIndonesia.com’s editorial team.
Indonesia’s upstream and downstream oil and gas (migas) sectors face a number of structural problems. In the upstream sector, there has been a natural decline in production, a scarcity of large-scale new reserve discoveries (giant discoveries), and slow conversion of resources into proven reserves.
In the midstream and downstream sectors, infrastructure development has progressed slowly due to the dominance of a natural monopoly market structure and the application of pricing instruments that limit the economic viability of investment.
Under the new Oil and Gas Bill (RUU Migas), the establishment of a Special Business Entity (Badan Usaha Khusus, BUK) for the oil and gas sector has been proposed. Upstream, the presence of BUK is designed as a more permanent holder of Mining Authority and Mining Business Authority, replacing the role of SKK Migas.
In the midstream-downstream segment, BUK could serve as an extension of the state in controlling infrastructure and the chains of transportation, storage, processing, trading and distribution.
Upstream Sector: Entrepreneurship DNA
The current condition of Indonesia’s upstream oil and gas sector can be categorised as a pseudo state-led market. Within this structure, the state desires full control and oversight, but does not make direct investments.
Upstream investment relies entirely on the interest and willingness of business actors or investors to participate, whilst state-owned enterprises (BUMN) invest on a limited scale with certain privileges. Competition between business actors is confined to the auction process and the management of Working Areas (WK).
From a pricing policy perspective, the upstream sector currently applies rigid intervened market pricing in certain cases. Although crude oil follows international benchmarks (ICP), upstream gas prices are fixed by the government (for instance through the HGBT policy), which has the potential to suppress the Internal Rate of Return (IRR) of Production Sharing Contractors (KKKS).
The decline in investment competitiveness in the upstream sector is closely linked to the loss of three main elements of upstream governance which, prior to Law No. 22/2001 on Oil and Gas, constituted the distinctive strength of Indonesia’s upstream sector:
Separation of PSC Finances from State Finances: Merging the financial administration of the Production Sharing Contract (PSC) into the state financial system has increased bureaucratic complexity and the auditing of cost recovery.
Application of the Lex Specialis Principle and Assume and Discharge: The removal of special tax treatment has brought upstream tax rules in line with the general tax regime, affecting the legal certainty of contracts (the sacredness of contract).
Single-Door Bureaucracy: Upstream operational licensing has become fragmented and involves numerous layered agencies.
Normatively and conceptually, BUK Migas is being introduced to transform the upstream structure into a state-led competitive market. Under this concept, BUK could be designed not only to restore the separation of finances, the lex specialis principle and single-door licensing, but also field-by-field economics-based pricing flexibility.
Beyond that, the state-led market model enables the state, through BUK, to invest independently, so that upstream management no longer depends entirely on private investors or International Oil Companies (IOCs).
However, given its position to take an active investment role, the success of this model is very much determined by the institutional entrepreneurship DNA — and, of course, by that of its managers. This DNA is necessary so that BUK possesses corporate agility, including the capacity to undertake mergers and acquisitions (M&A) on a regional and global scale.
Moreover, an entrepreneurial spirit is key if BUK is to partner with IOCs under risk-sharing schemes for exploration activities and the development of unconventional oil and gas fields (Low-Quality Reservoirs/LQR and Unconventional Oil and Gas/MNK), which represent potential game changers for national oil and gas production.
Without this DNA, BUK will merely become a new rigid bureaucracy and upstream problems will persist. Without business instinct, the ability to manage investment risk, and efficient execution flexibility, BUK risks encountering the same bureaucratic obstacles and may be unable to carry out its investment role optimally.
Midstream and Downstream Sector: Strengthening Regulation
In the midstream and downstream chains, the current market structure exhibits natural monopoly characteristics. Transport infrastructure, gas pipeline networks and storage facilities are largely controlled by a single or dominant player. This creates high barriers to entry owing to the large capital requirements, and limits open access for third parties to existing pipeline networks.
In the downstream segment (trading and distribution), the supply of fuel and LPG is dominated by state-owned enterprises through subsidy assignments and an integrated logistics system. Downstream pricing policy applies a distorted dual-pricing system, in which subsidised fuel and LPG are rigidly fixed below economic cost, whilst private operators have a limited market share in the non-subsidised segment.
On the midstream side, pipeline transport tariffs (wheeling fees) are set in a fragmented manner per route without price aggregation, resulting in disparities in gas prices at the consumer level between regions.
The draft Oil and Gas Bill does not yet clearly direct the midstream and downstream sectors towards a regulated competitive market. The regulatory framework for the midstream and downstream segments should encompass the mandatory separation of operational and trading functions (unbundling), mandatory open access, the appointment of state-owned enterprises as Gas Aggregators, and a transition towards targeted direct subsidies.
The effectiveness of BUK or a regulatory body in the midstream and downstream sectors depends heavily on the existence of regulatory instruments and the resolute, empowered DNA of the regulatory institution. A regulator with strong technical capacity and resources, and a high degree of independence, is required so that it can steer market policy and avoid becoming conditioned to depend on the natural monopoly. The regulator must have the capacity to:
• Issue Assignments with Fair Compensation: A strong regulator can issue infrastructure and distribution assignment schemes accompanied by economically fair compensation guarantees, so that the regulated market framework can work effectively to overcome market failure.
• Condition Open Access: Compel the Business Entity holding the natural monopoly to open access to third parties based on business-to-business (B2B) mechanisms that meet economic viability.
• Enforce Price Transparency: Set transparent rate-of-return-based transport tariffs (wheeling fees), and oversee the determination of ceiling prices and floor prices.
Without a strong and empowered regulatory body — not de facto dependent on the business entities and the natural monopoly market — distribution barriers and market distortions in the midstream and downstream sectors will persist.
Closing Remarks
The establishment of BUK Migas under the Oil and Gas Bill provides a new institutional foundation with the potential to reduce dependence on external investors through a state-led investment model and to address market distortions in general. However, BUK is merely an initial precondition for institutional reform, and not the single factor that will automatically resolve the structural problems in the oil and gas sector.
Solving upstream problems depends on the institutional entrepreneurship DNA of BUK and its managers in making independent investments and running upstream oil and gas management competitively and efficiently.
Meanwhile, solving midstream and downstream problems depends on the capacity and empowerment of the regulatory body, which must be able to steer the market more independently, without depending on the reactions of the business entities or the existing natural monopoly conditions.