Fri, 01 Oct 2010

From: The Jakarta Post

By Winarno Zain, Jakarta
Amid declining oil production, a long-standing issue that the Indonesian government has not satisfactorily resolved is whether to continue to be tough against oil companies on the question of financial incentives or to be flexible.

Although the government recognizes that to boost oil exploration and production it needs support and cooperation from oil companies, relations between the government and the oil companies, especially foreign oil companies, is basically hostile, and lacks mutual trust.

Protracted negotiations four years ago between ExxonMobile and Pertamina on operating the Cepu Block on the border of Central and East Java reflected a hostile environment where political pressure placed on Pertamina negotiators forced them to be tough in negotiations, while Exxon insisted on fairness as the basis for agreement. Only after the intervention of President Susilo Bambang Yudhoyono did the two parties reach an agreement.

Mistrust was also evident when the government, after much pressure from House of Representatives members, decided to impose a cap on the recovery costs of oil companies that signed production sharing contracts with the government.

Recovery costs are the costs incurred by oil companies during exploration that could be reimbursed by the government once the company enters production.

The cost is deducted from revenue before it is split between the company and the government. Although returns may be huge if oil is found, oil exploration is basically a high risk venture.

A company could lose millions of dollars if drilling operations strikes dry holes. As the risk is high, no bank will readily lend for oil exploration activities. Only companies with huge financial resources can afford this gamble. The cost of recovery schemes are designed to acknowledge this risk, so oil companies feel it is unfair if a cap is imposed on their recovery costs.

Other contentious issue between the government and oil companies is the treatment of import taxes.

The import of equipment by oil companies has been granted a tax exemption.

The exemptions are issued on temporary not on a permanent basis. Oil companies have to pay import taxes on equipment imported for exploration even though there is no certainty that oil will be found.

The tax exemption is granted by the government but is subject to annual extension by the Finance Ministry. The industry wants long-term tax exemptions that provide long-term certainty for their operations.

The approach by the government in dealing with oil companies has come under question in the face of a significant decline in oil production over the last decade.

While Indonesia’s population increased by 20 million between 2000 and 2009, oil production has dropped from 517 million to 345 million barrels. Over the same period, proven oil reserves fell from 5.2 billion to 3.8 billion barrels.

As higher economic growth needs higher energy consumption, the government has to import more oil. In the third quarter this year, we spent US$7.2 billion for oil imports while our oil exports were only $6.4 billion.

After much complaining from oil and gas companies, the government planned to scrap the cap on recovery costs for oil and gas companies conducting exploration in Indonesia. The government has also decided to make tax exemptions permanent during the exploration stage. The decisions represent a belated recognition by the government that incentives and tax certainties for oil companies are the most serious issue in dealing with efforts to bolster oil exploration and production in this country.

The plan would contribute to the improvement of investment climate in oil and gas industry. There is still a long way to go to improve the investment climate for oil and gas industries.

‚ÄúIf returns on investment here are less attractive, then oil companies will skip Indonesia and go to other countries that are considered more attractive.‚ÄĚ

As with other companies, legal certainty in this country is a primary concern. It has been almost 10 years since the law on oil and gas, which opened more competition, was enacted in 2001. But ‚Äúresource nationalism‚ÄĚ in this country never dies down and would always pose a threat to legal certainty.

Proponents have brought the law to the Constitutional Court for judicial review, resulting in revisions of some of its provisions. House members may amend, once again, the law on oil and gas on the grounds that it has not completely confirmed the spirit of 1945 Constitution.

They want a bigger role for state oil company Pertamina in the oil and gas industry. When laws governing the oil and gas industry cannot guarantee continuity and certainty, it could disrupt operations in these industries.

Oil companies have also to deal with local authorities, who have more power since the law on regional autonomy was enacted in 1999. In matters of land acquisition and construction permits for instance oil companies depends on the goodwill of local authorities.

Local resistance and concern on environmental damage could result in a setback for oil companies.

ExxonMobil was reportedly planning to pull out from Gunting block, located in East Java, after locals, mindful of the nearby Lapindo mudflow disaster, cut the company’s seismic equipments several times.

Oil companies seem to have lost interest in exploration in Indonesia. Many oil blocks offered for biding by the government found no takers. The reasons could be lack of financial incentives or the blocks were too small to be profitable or they are located in remote areas that are technically more difficult to explore. It is important therefore that incentives given by the government should reflect various differences in each location.

The declining interest in exploration by oil companies take place in the face of increasing competition from other oil producing countries to attract investment. Indonesia has to compete with many countries that are offering more attractive incentives and investment climate.

If returns on investment in Indonesia are less attractive, then oil companies will skip Indonesia and go to other countries that are considered more attractive for investment. Improving the investment climate is the only way to prevent our oil and gas industries from being marginalized by oil companies.

The writer is an economist.