Part 2 of 2: Bad proposition for oil mining contractors

Part 2 of 2: Bad proposition for oil mining contractors

T.N. Machmud, Jakarta

The operating agreement is an internal agreement between the
PSC partners. The Government or Pertamina (in the past) and BP
Migas (at present) do not get involved in an operating agreement
as it is strictly internal PSC.

The operator, however, cannot make a different operating
agreement with one partner (for example only because he happens
to be an Indonesian regional company) than for other partners.
They all execute the same operating agreement. It has to be a
level playing field or else the operator may get sued for
favoritism.

The operating agreement and its cash call provisions may have
to be explained carefully to the regions if the government is
serious about this 10 percent offer as it may quickly become a
financial nightmare to those regions instead of the bonanza they
are looking forward to.

The capital outlays in an oil and gas venture are quite
substantial. For example, the foreign partners may decide on a
major exploration or development program and a majority vote may
vote the national regional partner into accepting the program. By
voting in favor of a project, the foreign partners could even,
albeit unintentionally, "vote the national partner into
bankruptcy", so to speak.

Also, very importantly and often overlooked, the national and
regional partner can not "cherry pick" projects. All partners
participate in all projects that the partnership votes to spend
money on. There may be a development project with relatively low
risk but there may also be exploration on the block, which is
always high risk. One can perhaps go to a bank to borrow for the
development capital but the banks will shy away from exploration
risk. The latter is strictly equity funding.

All partners are therefore required, proportionate to their
respective working interests, to participate in all projects and
to meet the cash calls on all projects in the Work Program and
that includes exploration programs. These respective working
interests are called undivided interests. Partners can not cherry
pick projects.

The above describes, in a nutshell, the situation faced by a
would be partner, any partner, whether regional or foreign. There
are sufficient examples around to prove that this is not the
Disneyland that many believe it is. The deputy head of the
Bodjonegoro regional legislative council quoted in the Post
article may want to seek expert advice before he gets his region
involved in a business venture which is financially prohibitive
to the region.

It is, therefore, a matter of grave concern that the notion of
giving priority to a national partner in a farm-out and the
notion of offering a 10 percent share to regional companies may
result in massive underestimation of the real problems in the
field.

Let us take inventory of the 10 percent offerings to
Indonesian Participants in the past and see how many have been
successful. That ought to be an indication of where to go instead
of making politically expedient statements.

We may suggest that at this early stage of the regions'
autonomy, the regions be satisfied with their share from the
distribution of oil revenues from the central government to the
producing regions under Laws 22 and 25 of the year 2000. That
money is indeed the region's entitlement.

By forcing a new rule of an additional 10 percent sharing
onto PSC's plus taking away the freedom in farm-outs, the result
will be to heap more frustration upon a group of important
investors than they can bear. Already additional tax burdens,
labor troubles, insecurity, loss of control are weighing heavily
on the PSC.

We caution the conceptors of the RPP Hulu that this very well
could be the straw that breaks the camel's back. All that the PSC
needs now is one more burden and we could, as a nation, lose all
goodwill from our oil and gas investors. What we need is the
opposite...

We need to do everything in our power to remove the obstacles
in the way of the investors and listen to their complaints and
act upon them.

At the very least, if all else fails, we should make the new
farm-out provision and 10 percent rule applicable to future PSC
contracts only and not make that rule retroactive. This would
still be a disaster scenario but at least somewhat mitigated by
the fact that present contracts remain unaffected.

We may respectfully suggest that, for a change, the government
be firm and educational in dealing with pressure from the
regions. We suggest to tell them we can not take a chance. At
least not at this time. Your investors will salute you for your
moral courage.

The writer, formerly CEO of Arco Indonesia, is now Executive
Director of the Graduate School of Business of Bina Nusantara
University