Oil contractors' warning

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.