Mark-up practice

Several reports on alleged mark-up practices in the exploration and production (E&P) sector, and the result of a survey conducted by ReForm, a consultancy company led by Laksamana Sukardi, have prompted me to describe the general working mechanism of foreign companies and state oil company Pertamina in prospecting/producing crude oil.

In the upstream sector, E&P, foreign contractors (KPS), have, in principle, a standard operating procedure (SOP) from Pertamina for the implementation of their operations. This SOP requires that in carrying out their activities, the KPS must take the "one-door policy", namely BPPKA-Pertamina. This institute coordinates and monitors KPS in terms of all E&P activities, which encompass, among others, geophysics, geology, operations, logistics, finance, environment, laws and human resources.

If the KPS are still at the exploration stage, the expenses, no matter how large they are, will be borne by the foreign parties. In implementing the contract, a KPS will always adhere to a Work Program and Budget (WP&B) signed by both sides. If oil is found and is declared commercial, all costs incurred in the exploration activities and also for the field development activities will be reimbursed by the proceeds from selling the newly discovered oil. This is known as the recovery of operating cost (cost recovery). To get an approval of cost recovery, a KPS will have to go through a long parallel process, namely: (a) certification must be obtained from a foreign independent institute (D&M); (b) the size of the oil reserve must be evaluated and approved of by Pertamina.

If a KPS is already at the production stage, the WP&B put forward by the KPS must obtain the approval from BPPKA-Pertamina every year, while reports on oil production output must be made on a daily basis so that the production kept in storage may be monitored (including the schedule of lifting and production allocation for KPS or Pertamina). After WP&B gains approval, the KPS will itemize the production costs, including those incurred in the drilling activities, and then the costs will be presented in the form of Authorization for Expenditure this stage, KPS and Pertamina "sit together" to evaluate and justify the cost recovery which will be calculated in future.

The point I wish to emphasize is that, in essence, KPS will first spend money after WP&B approval. As it is the KPS that forks out the cash from its own pocket and bears a high risk, it is against lock that it will mark up its own spending.

On the one hand, Pertamina also has a cost estimate for on/offshore production and drilling. It is next to impossible for a KPS to undertake illegal activities because a KPS will always adopt an open management system and transparency in its relation with its partners, most of which are multinational companies. On the other hand, KPS, in undertaking its production, always implements the SOP, which has as its guideline the American Petroleum Institute, among others, the technical aspect in the process and handling of oil production, drilling, safety and environment, technology and use of chemicals. These elements will finally be linked with production and operation costs. As for the goods available linked with the said elements, most of them can be imported from the U.S. Additionally, it must be noted that a KPS has a number of obligations to fulfill, such as the provision of exploration funds, allocating work areas, fulfilling the domestic demand for oil (domestic market obligations), paying corporate taxes, taxes on interests, dividends and royalties.

The presence of KPS operating in Indonesia, despite the possibility of failure in oil prospecting, must be viewed in a spirit of cooperation on the basis of a mutually beneficial partnership.

DIRGO D. PURBO

Oil Industry Observer

Jakarta