Oil contractors' warning

Foreign oil and natural gas companies' warning of the worsening investment climate in Indonesia served only to substantiate the complaints domestic and foreign investors in other industries have often raised.

Issues related to uncertainties about bureaucratic, regulatory, fiscal and legal environments that the Indonesian Petroleum Association brought up at its meeting in Bali over the weekend have been besetting most investors during the country's current transition from an authoritarian, centralized government into a democratic, decentralized one.

The plight of the oil contractors clearly shows that the bold reform the government so painstakingly launched in late 2001 to fully liberalize the hydrocarbon industry turns out to be far from adequate to maintain the country's advantage in attracting oil and natural gas investors.

The 2001 law on oil and natural gas is supposed to have fundamentally improved the attractiveness of the hydrocarbon industry to new investors because the legislation will abolish the monopoly of the state oil and gas company Pertamina in the upstream industry later this year, and in the distribution of oil products in 2005.

The rationale of the liberalization measure is that, like in other industries, the greater is the degree of competition and the more flexibility enterprises and investors have in the way they organize their operations, the greater will be the benefits for the consumers.

As investors will be allowed to get reasonable margins from both crude oil mining and refining and final products, unlike now whereby oil contractors are restricted only to crude oil production, they will be encouraged to increase investments in explorations. This in turn will increase the volume of proven hydrocarbon reserves, thereby prolonging the period of sustainable oil production. Most analysts have predicted that without significant findings of new reserves, Indonesia will become a net oil importer by 2010.

The gradual phasing out of fuel subsidies by 2004 by floating domestic fuel prices on the oil product price quotations in Singapore has also been designed to attract investors.

But the liberalization measure seemed unable to woo new investors to the high-risk, capital and technology-intensive industry, as can be noted from the number of new concessions awarded to contractors. Last year, for example, only one new oil and gas contract was signed, compared to eight in 2001 and several dozens annually in the period before the 1997 economic crisis.

This reiterates that without legal, regulatory and fiscal certainty the rich natural resources and low-cost labor a country offers do not count much for investors. Strong legal and regulatory frameworks are particularly vital for investors in the upstream segment of the hydrocarbon industry that covers exploration, mining and refining crude oil as this business not only involves high risks and requires big capital but also has a very long payback (gestation) period.

The complications caused in the early implementation of the decentralization of government have made things even more uncertain for mining companies and other resource-based ventures that are located mostly outside Java.

Most local administrations, in exercising their newfound authority, have emphasized imposing new local taxes or levies on businesses, instead of introducing pro-business measures to attract new investment. This has caused fiscal uncertainty.

The local autonomy should have instead encouraged local administrations to woo more investments to oil and natural gas mining as well as other mineral prospecting because, different from the period before 2001, they are now entitled to a sizable share of revenues from all mining activities in their areas.

Moreover, as the oil industry association noted in Bali, the steering body (BP Migas) which now awards oil exploration blocs and oversee explorations and mining by foreign and domestic investors and administers contractors' operations seemed to lack a clear-cut authority.

Yet more discouraging is the inadequate preparations for the establishment of a regulatory body through which the government will oversee wholesale and retail oil and gas markets and maintain strategic oil reserves. Both functions are now conducted by Pertamina.

Needless to emphasize the vital role of the steering and regulatory bodies in determining whether the oil market will really be fairly competitive, especially after 2004 when domestic fuel prices will be let on par with international prices.

Since it usually takes about five to six years for an oil concession to produce -- one or two years for seismic surveys, two to three years for exploration and one to two years for the development of production facilities -- it is most urgent for the government to address the problems raised by the oil and gas companies, otherwise the doomsday scenario of Indonesia turning into a net oil importer could materialize.