There are at least three reasons why the structure of the national oil industry today requires reform by improving or substituting the 2001 Law on Oil and Gas.
First, the application of this oil and gas law has proven to be highly unprofitable for the state. The sale of the LNG-Tangguh gas field at a very low price and the low production of crude oil are inseparable from the system developed under the law.
This is in spite of the fact that in order to increase production, the government issued a regulation in 2005 that changed the Technical Assistance Contract (TAC) between Pertamina (the state-owned oil and gas company) and ExxonMobil into the Cooperation Contract (KKS) between operators, comprising of both ExxonMobil and Pertamina on one side and the Oil and Gas Executive Agency (BP Migas) on the other.
Secondly, the law is in fact already legally "flawed" and paralyzed because the Constitutional Court has removed several main articles that conflict with article 33 of the Constitution.
Thirdly, politically the law no longer has a firm footing in the House of Representatives. The Special Committee for Fuel Price Increase Inquiry at the House has recommended the law be replaced.
According to article 45 paragraph 1 of the law, BP Migas as a signatory to the KKS is not a business entity, but rather a state-owned legal entity (BHMN). One of the consequences of this is that the agency is not eligible to conduct business operations such as processing, development, or the sale of the state's share of oil and gas derived from the contractors. This is stipulated in article 44 paragraph 3 of the law on oil and gas.
Undoubtedly, such a bureaucratic system is highly inefficient and unprofitable to the state. State income is prone to be reduced because state-owned oil and gas has to be sold through third parties. An empirical example is the development of LNG-Tangguh, which cannot be facilitated by BP Migas so it has had to name another party.
By the system based on the previous 1971 law, gas fields from foreign oil contractors were developed and sold in LNG form by the state-owned company or BUMN (Pertamina) as a signatory to the Production Sharing Contract (KPS) and holders of the Mining Concession (KP). This was the case in the development and sale of LNG-Arun and LNG-Badak, whose price formula was very profitable to the state.
Now the sale of LNG-Tangguh has proven to be very unprofitable as the price formula was linked with the crude oil price limit of US$38/ barrels of oil (bbl). As a result, LNG-Tangguh had to be sold flat at $3.35/mmbtu (million British Thermal Units) and no rise can be made although the present oil price is around $70/bbl. Meanwhile, LNG-Badak was sold at about $11/mmbtu. LNG-Badak's sale price will keep rising in line with the world oil price.
The potential losses from the sale of LNG-Tangguh may reach hundreds of trillions of rupiah in value, not to mention the long-term prospects of oil prices, which will certainly far exceed $38/bbl. The government acknowledged this potential by setting up a team for LNG-Tangguh renegotiation headed by the Coordinating Minister for the Economy.
Despite BP Migas' status as a BHMN, it has no supervisory body or trusteeship assembly of a state-owned entity like that of a state university. Consequently, BP Migas has no internal control mechanisms that can provide early warnings of its performance, particularly in relation to cost recovery management.
Actually, the entire process of cost recovery is under the authority of BP Migas. The value of cost recovery is significant. In 2009, for instance, it is valued at $12 billion (approximately Rp120 trillion). The process fully involves BP Migas from the approval of the Plan of Development (POD), the Work Program and Budget (WP&G), to that of expenses paid by the state through the Authority for Expenditures (AFE).
Structurally, the absence of the supervisory body in BP Migas has contributed to the tendency of annual hikes in cost recovery value amid plunging national crude oil production.
Since 1999, when the oil and gas bill was first deliberated at the House, the number of exploration drillings in new blocks had started declining as investors were anticipating the new law. It turns out that even after the bill was passed into law in 2001 and various government regulations were issued, total exploration drillings in new blocks remained very low.
The problem is the presence of BP Migas, which is not a concessionaire, inevitably extends to links in the system of the national oil business. Investors themselves have to contact so many institutions, such as the Directorate General of Oil and Gas, BP Migas, the state minister for BUMN, the National Land and Agrarian Agency, the Forestry Ministry, the customs and excise office, and the regional administration.
The low rate of exploration activities is also due to the existence of article 31 of the oil and gas law, which revokes the lex spesialis principle. Contractors have to pay diverse taxes even before production. This provision is diametrically opposed to the basic principle of KPS, thus increasing uncertainty. In fact, all oil companies in Indonesia operate on the basis of KPS, in which contractors pay taxes only after production because taxes are paid out of production proceeds.
Sadly, the annulment of the lex spesialis principle by article 31 of the law was remedied by a regulation issued by the Finance Ministry, which nota bene was effective for a year and was hierarchically below the law. Similarly, the promulgation of the value added tax law (PPN), which among other things stipulates import tax and PPN exemptions for oil and gas investors, was not the right and final solution either. The main impediment to oil and gas investment stems from the oil and gas law itself.
The oil and gas law and the PPN law have equal status. So the enforcement of the ministerial regulation and the PPN law was not correct and final. It can even create the problem of overlapping laws, as article 31 of the oil and gas law remains valid.
Contractors failing to pay taxes based on the regulation or the PPN law, while article 31 of the oil and gas law is still effective, could create an opening for criminalization.
This of course makes investors very anxious. No doubt, the lex spesialis principle cancellation by the oil and gas law has caused further uncertainty. In reality, investors want long-term business certainty.
Accordingly, the investment necessary to explore new reserves has been very low so crude oil production has continued to fall. In the meantime, the world oil price as the main factor encouraging oil and gas investment has since 1999 indicated a trend of price increases and geologically the oil and gas potential in Indonesia is very vast, covering around 80 billion barrels of oil and about 350 trillion cubic feet (tcf) of gas.
In 1999 oil production was still above 1,500,000 barrels per day. In 2009 only around 960,000 barrels per day were left. In 2010 production is targeted at about 965,000 barrels per day although the early-production project of the Cepu Block (after being put off several times) will begin producing around 20,000 barrels per day this October.
With the performance of the Cepu Block Operator, a significant production increase from the Cepu Block totaling 165,000 bbl per day will most likely occur after 2014. In this way, the decision to accelerate national oil and gas production that formed the basis of PP No.34/2005 on the change of the TAC scheme into the KKS scheme was not achieved. Therefore, the option of Pertamina to serve as an operator at a lower cost with a speedier production schedule should be given serious thought.
Unless President Susilo Bambang Yudhoyono introduces improvements to the national oil business system, the total oil output when the President ends his term in 2014 will only be about 850,000 bbl per day. That is very low! As recommended by the special committee at the House, the President is expected to promptly improve or replace the law on oil and gas in order to invigorate investment in the exploration of new oil fields to discover those of the Cepu Block class.
The writer is an alumnus of Colorado School of Mines, Denver and Ecole Nationale Superieure du Petrole et des Moteurs, Paris, currently a postgraduate program lecturer at the School of Economics, University of Indonesia.
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