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New law hands Pertamina power as Indonesia dodge energy crisis

Indonesia needs investors to avert an energy crisis. But a proposed law, widely hoped to improve the fiscal and regulatory environment, appears disappointing

The new law being reviewed by Indonesia’s policy makers will unequivocally give state Pertamina significant privileges and establish a national operator to buy oil and gas, a draft proposal shows.

The moves show a greater desire for energy security, although analysts doubt if the law in its present guise will achieve that. They also reflect the government’s ambition to manage pricing.

This nationalist spirit in the proposed law is obviously worrying for foreign investors who have spent considerable sums investing in the sector, said Charles Ball, an energy specialist at law firm Reed Smith.

It is no surprise that investment has stagnated in recent years – direct investment stood at $19.4bn in 2014 – and as a result the production outlook is weak, particularly for oil. Investors remain interested in Indonesia’s geological potential, particular in the eastern basins.

But the cost to drill a single well in the technically challenging frontier region ranges from $100m to $200m, which is far beyond the reach of most local players, the Indonesian Petroleum Association’s executive director, Dipnala Tamzil, said.

Critically, “if the government does nothing (to attract investors) then there will be an energy crisis by 2019,” Tamzil told journalists during a round table discussion.

Nevertheless “the sense of urgency to get big projects going is not there,” warned Sacha Winzenried, an energy specialist at consultancy PwC in Indonesia.

Inpex’s Abadi floating liquefied natural gas project, Chevron’s Indonesia Deepwater Development (IDD) scheme and BP’s Tangguh liquefied natural gas expansion project, representing billions of dollars in potential investment, are all frozen by political indecision.

The country's 2001 oil and gas law has been awaiting key amendments since the constitutional court disbanded the former upstream regulator BPMigas in late 2012 for abusing its power.

The court set up a temporary upstream taskforce, SKK Migas, to carry out the regulator's role but as BPMigas' role in the upstream sector was at the centre of the oil and gas law, the constitutional court had to ask the government to amend the law to reflect the new reality and that process that has been delayed for several years.

Consequently, as Indonesia’s output continues to wane and demand rises, investment in the sector has slowed. Low levels of exploration reflect the uncertain business environment. The reserves replacement ratio for oil is dangerously low, and while it is better for gas, it’s still a declining trend, warned Tamzil.

Unfortunately, hopes that the new oil and gas law could kick-start investment appear dim.

Production-sharing contracts expire

The future of production-sharing contracts (PSCs) remains unclear. Some 27 PSCs are due to expire over the next five years, representing 30% of Indonesia’s total production. But Pertamina will get right of first refusal on the blocks as the law aims to tighten the state’s grip on the upstream sector.

The new draft law also establishes the compulsory sale and purchase of oil and gas, through a new state operator, in quantities that satisfy domestic market needs. This is set at 25% of production under existing PSCs. But it’s not clear how much production investors’ will be forced to sell – it seems it will fluctuate with demand – nor at what price.

Positively, the new law looks set to streamline the regulatory and supervisory roles of the various government agencies, which would have an immediately positive effect on production, said Winzenried.

Indonesia’s investment coordinating board (BKPM) will become a one-stop permitting shop for the industry, rather than operators having to obtain hundreds of permits from 17 government agencies, which has resulted in severe delays, as well as increased costs.

The draft law will also create a new ‘upstream cooperation organiser’ known as BUMN-K, which will take over the functions of SKKMigas. Private companies will enter into cooperation contracts with BUMN-K to explore and produce oil and gas in the working areas. However, the new draft is silent on any particular cost-recovery mechanisms.

Under the draft law, upstream oil and gas operations will be controlled through the BUMN-K, which owns the upstream business licence. As a result, private investors will see their activities severely curtailed, since they are limited to providing capital and technology under cooperation agreements, said Ball.

To boot, upstream licenses will no longer be awarded directly, but via individual special purpose vehicles, which limit investors’ legal recourse.

The Fraser Institute’s global petroleum survey found Indonesia’s oil and gas sector was among the worst in the world for investors, scoring even lower than neighboring Timor Leste, Dr Kurtubi, a lawmaker involved in assessing the draft law, told Petroleum Economist. The upstream sector will be hoping that Kurtubi will help revise the new law so that it attracts investment, rather than deters it. It is due to be implemented by 2016.

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