The future of the oil and gas industry in Indonesia

By Ronald G. Pate

The pioneer of the Indonesian oil business, A.J. Zijlker, was shown an oil seep in North Sumatra in 1883 and after a sample was analysed in Batavia, he founded Voorloopige Sumatra Petroleum Maatschappij (VSPM). Two years later, VSPM drilled the Telaga Tunggal-1 well to a depth of 121 meters. The first oil well in Indonesia flowed 150 liters of oil and the Telaga Said field was discovered.

The age of the automobile was in the future and what ships traveled the seas unaided by wind burned coal for power. Oil was used in various remedies and thanks to the vision of George Bissel, an American scholar and businessman who financed the Edwin L. Drake oil discovery in Titusville, Pennsylvania, in 1859, it was also being widely used as a luminant. The future of the oil industry was unknown in the later part of the 19th century, but the industrial revolution on the horizon would ensure its continued growth and importance in the approaching century.

Now, some 140 years on, it is reasonable to question the future of the business, especially in Indonesia, where its direction has such a huge economic impact.

Geographical description

The islands of Indonesia stretch from the continental shelf of northern Australia to the continental shelf of Southeast Asia. Indonesia has a total area of 9.8 million square kilometers, of which more than 7.9 million square kilometers are under water. The total land area of approximately 1.9 Million square kilometers is distributed among 13,667 islands. Of these, there are five major islands, Sumatra, Java, Borneo (Kalimantan), Sulawesi and New Guinea (Irian Jaya), and about 300 smaller island groups.

Sumatra, Java, Kalimantan and the smaller islands between are part of the Sunda Shelf of the Asian Continent. To the east, Irian Jaya and the Aru Islands lie on the Sahul Shelf of the Australian Continent; water depths on these two shelf areas are less than 200 meters. Between these two shallow water provinces are the islands of Sulawesi and the island groups of Nusa Tenggara and Maluku. These islands are located in deep seas where depths reach to 5,000 meters.

Geologically, Indonesia can be divided into two regions at the Makassar Strait between Kalimantan and Sulawesi. Sixty sedimentary basins of Tertiary Age have been identified throughout the archipelago. The 21 sedimentary basins of western Indonesia are relatively large and mostly located onshore or in shallow water. Conversely, the 39 sedimentary basins in eastern Indonesia are generally smaller and predominantly located in deep water. Fourteen basins produce oil and gas, 11 in western Indonesia and three in eastern Indonesia. Most of the producing basins are considered to be mature from an exploration viewpoint, leaving eastern Indonesia with most of the exploration potential.

Business considerations

Longman's Dictionary of Contemporary English offers a very simple definition of business -- the activity of buying and selling goods and services. Though not explained, clearly the motivation behind the activity is profit -- buying at a cost lower than the sales price. In terms of the oil and gas industry, the cost of buying goods would ultimately be the cost of finding the resource, producing it and getting it to market.

In remote and inhospitable environments of Indonesia, drilling costs can run from US$15 million to more than $40 million. Not many companies have the resources for entry into this kind of business, and fewer still have the stomach for the risk. The author is uncertain of the current statistics, but typically, rank wildcats (exploration wells drilled in remote areas) are successful less than 8 percent of the time. The measure of success being finding hydrocarbons in sufficient quantities to warrant installing pipelines and production facilities required to get them to market.

When the oil price is high enough, companies can hazard monies to drill exploration wells -- ever mindful that oil prices fluctuate and a severe downturn can make a scientific success into an economic disaster.

Before these factors are considered, the company must understand the Indonesian Production Sharing Contract (PSC). Oil and gas operations in Indonesia are controlled by the PSC under the control of the state oil company, Pertamina, with the contractor responsible for operations. In 1976, the government adjusted the production split to 85 percent for the government and 15 percent for the contractor (85:15) for oil and 70:30 for gas after cost recovery. Costs are recovered by the contractor from Pertamina's share of production provided the contractor has followed guidelines established by the government's coordinating agency, BPPKA.

In February 1989 incentives were introduced for frontier areas. Equity splits for frontier areas and pre-Tertiary production in older areas were adjusted to an incremental sliding scale - 75:25 for production up to 50,000 barrels of oil per day (BOPD), 80:20 for 50,000 to 150,000 BOPD and 85:15 for production over 150,000 BOPD.

Then there are taxes to consider. Tax rates are progressive with the top bracket for businesses outside mining, oil and gas sectors of 30 percent for income above Rp. 50 million ($6,250 at exchange rate Rp. 8000/$1). In addition to corporate taxes, there is a Value Added Tax of 10 percent, sales tax on luxury goods and the usual taxes on land, facilities, etc.

In the oil and gas sector, the composite tax rate applying to contracts signed before 1984 is 56 percent (45 percent basic income tax and 20 percent withholding tax on the balance). Contracts from 1984 pay 48 percent tax (35 percent basic income tax plus 20 percent withholding tax on the balance).

Companies that can afford to take the risks associated with oil and gas exploration are mostly multinational companies with worldwide operations. Consequently, subsidiary companies operating in Indonesia are competing with subsidiaries in the U.S., the UK, South America and Africa for corporate dollars to spend on exploration. The ability of the Indonesian subsidiaries to compete depends very much on how well Indonesian tax laws and contractual regulations stack up against those of other governments.

For the past few years, Indonesian tax laws and PSC terms have not been the most attractive.

Add to all these considerations the perceived political uncertainties of the present government and the uncertainties associated with the devolution of certain authority and responsibility to the regions plus the risk of having operations suspended, or shut down all together, by militant locals without fair and equal treatment under the law (the Manulife situation -- currently being discussed on international business news TV broadcasts -- is the latest of many situations when multinational companies have been denied equal treatment) and it becomes very difficult to convince corporate management to spend money on exploration in Indonesia.

Trends in exploration

Operating companies in Indonesia present work programs and budgets to Pertamina for approval in the fall of each calendar year. In Table 1, the oil price drops from about $30/bbl at the end of 1990 to about $16/bbl in the first half of 1994 and the number of exploration and delineation wells tracks the trend. When the oil price started rising, so did the number of wells. The correlation is very poor after the middle of 1997.

What is clear from the table is that exploration drilling is not tracking the price of oil. Part of this could be the uncertainties that companies have about the ability of the Organization of Petroleum Exporting Countries (OPEC) cartel to maintain production discipline. The spike in oil prices at the end of 1990 was certainly short lived. With OPEC's historical lack of production discipline, it is understandable if companies presented pessimistic work programs for 2000, expecting once again to see a retreat in prices. However, the performance of the oil price this year and the forecast of continued global demand should have given some reassurance of relative stability in oil prices in the near term.

Pete Stark of IHS Energy presented a paper at the AAPG/IPA Convention in Bali in October which demonstrated that activity has been picking up in Indonesia. Simon Crellin of Arthur Andersen showed a similar trend in an article published in the SEAPEX Press. It will be interesting to see the drilling totals for this year and learn what has been budgeted for next year. That will give an indication of what the near term future will be for the sector.

Data from the Ministry of Mines and Energy published on the U.S. Embassy website indicates that average daily crude and condensate production fell 3.7 percent from 1,556,600 barrels per day in 1998 to 1,500,300 barrels per day in 1999, an annual decline of 13.7 percent.

While production was declining, crude oil imports rose 17 percent in 1999 to meet a 6 percent increase in demand for fuel products. Minister of Mines and Energy Susilo Bambang Yudhoyono, in a keynote speech at the Energy and Mining Investment Opportunities in Indonesia conference, explained that Indonesia's oil and gas resources are estimated at 73 billion barrels and 308 trillion cubic feet (TCF), respectively. The proven and potential reserves are 9.7 billion barrels of oil and 160 TCF of gas. At current production rates (549 million b/d for oil and 3 billion SCF for natural gas), proven and potential reserves will last another 18 years for oil and 53 years for natural gas.

Without getting into a discussion on the "goodness" of the potential reserves estimates, Indonesia clearly has to consider carefully the management of its hydrocarbon resources, including the future management of the Coastal Plains Pekanbaru oil block (Caltex contract to expire in 2001). Unfortunately, at this critical time, when so much depends on good management and decision making, Pertamina is in the midst major procedural reforms and restructuring (both long overdue) to curtail corruption and improve efficiency.

Considering the remaining exploration potential for producing basins, the only way for Indonesia to significantly increase its proven and potential oil reserves is to encourage investment in eastern Indonesia. Unfortunately, the most prospective basins in the east are in the middle of extreme sectarian violence or escalating separatist sentiment.

To reverse these downward trends and improve the prospects of the oil and gas industry in Indonesia will require recognition of the situation by the government and Pertamina and strategic initiatives to solve the social/political/security problems in the country and improve the tax and contractual environment to stimulate investment. How well the government and Pertamina management cope with these complex issues, only time will tell.

The author has been an explorationist in the oil and gas industry for 36 years, the last 20 in Indonesia.