Cost recovery in upstream oil and gas industry

The Jakarta Post ,  Jakarta   |  Wed, 09/13/2006 8:31 AM  |  Opinion

T.N. Machmud, Jakarta

On Sept. 5, Metro TV aired an interview on the subject of cost recovery in the upstream of the oil and gas industry, within the context of its Economic Challenges reporting. The guests were Kardaya Warnika, head of the Upstream Oil and Gas Executive Agency (BP Migas), Supramu Santosa, the CEO of Star Energy, and Dito Ganinduto, a member of House of Representatives Commission VII.

It was a good interview and about time such an interview was presented to the public, which is generally ignorant about the real issues surrounding cost recovery. It was just unfortunate that the interview was too short to bring other relevant aspects of cost recovery out in the open.

For example, Kardaya explained the process of cost recovery. He said the role of BP Migas was to carefully examine all elements of cost and compare them to prevailing market prices before granting approval to purchase any goods and services. The Government Development Comptroller (BPKP) audits those costs and may reject all or part when they conduct current audits and post audits. The partners of the investor companies themselves conduct audits all the time.

Then there is the Supreme Audit Agency (BPK) which may step in and conduct an audit. If there is any indication of wrongdoing there is still the Corruption Eradication Commission (KPK), Attorney General's Office and the National Police.

Cost control is a primary function of BP Migas. It is a tight system. So tight, as a matter of fact, that it often delays work in the field with companies sometimes having to delay carrying out operations while waiting on approval.

BP Migas already stands accused of being ""too soft"" on cost control, but still it has to do that as well as its other, probably most important task, namely managing upstream oil and gas activities. It has to be both watchdog and manager, which is a tough assignment if the ultimate goal is to maintain operational efficiency.

Supramu pointed out that keeping cost down is as much in the interest of the company as it is for BP Migas. The companies working in the upstream have a 15 percent working interest in oil development and a 30 percent working interest in gas operations. It stands to reason that they also need to be working efficiently by keeping cost down.

Not brought out in the interview, because of a lack of time, was the real impact on upstream operations anywhere by the Sarbanes-Oxley Act in the United States, which came out in 2002 as a consequence of the Enron and Worldcom debacles. As a result, all U.S. companies now have to conform to Sarbanes-Oxley accounting guidelines to make very sure that a company's books reflect the true financial situation of that company. Violations are severely dealt with. If proven guilty, a company may see its stock taken off the exchange and its management go to jail.

These companies are not about to endanger their existence by ""marking up"" their costs. The consequences are too severe. Sarbanes-Oxley has meanwhile spread to Europe and to Asia (Singapore). Soon it will be impossible for a company to do business in this globalized world if it can not prove that it complies with the new accounting environment. Having said that, we will not deny that BP Migas controls are still necessary as there will always be those companies who do not feel bound by Sarbanes-Oxley and will try to cut corners.

However, those companies will be few in number and we have reason to believe that most of our national companies believe in observing the new accounting rules and conduct good corporate governance, and, therefore, avoid ""mark-up"" situations.

The main thing in business is to trust one's partner. Trust is the cornerstone of all business. Without trust we will not go anywhere. Unfortunately it seems that in Indonesia today public opinion about business has deteriorated to the extent we do not trust anyone anymore, including ourselves.

Another aspect that did not come out in the TV interview was the real need for conducting safe operations. Dito from the House said that the bottom line of cost recovery was to make sure the country's profit share of production, after cost recovery, is maximized. While this is a true statement, we must never lose sight of the fact that safety is a number one consideration.

It is absolutely crucial that an upstream oil and gas project be conducted safely, even if several layers of safety protection are required. This will cost more money but it will be money well spent. It is meant to put a facility in place that will last and will prevent accidents and loss of life down the line.

The notion, therefore, that cheap is good and that the lowest bid should be entertained is wrong. Our tendering rules may contain a flaw in that they seem to favor the lowest bid. The lowest bid is not necessarily the best bid. Always shoot for a professional bid with built-in safety precautions. If need be, choose the next low bidder if in doubt about the safety aspects. This issue has bothered and still bothers the operators in the field because if an accident does occur, everybody points a finger at the operator.

These were some additional thoughts that came to mind after watching the TV interview. I applaud the effort to inform the public better about oil and gas affairs. This happens to be an industry that does not come out to defend itself very well when under attack.

More often than not they shrug it off and go on with their lives. Cost recovery and ""mark-ups"" are persistent and bothersome issues that will not go away. There will always be cost recovery because it is an integral part of a commercial deal.

In any corporation, taxes must be paid and when one pays taxes it is measured by profit. Profit is what is left of gross revenue after deducting expenses. It is exactly like that in the oil industry. Cost recovery is nothing but a deduction of expenses from gross revenue. Supramu explained that during the interview.

There is nothing sinister about cost recovery. It is business as usual. Somehow the government and the companies have to come to grips with these misconceptions and decide how to address them. TV interviews are an excellent vehicle for ""socialization"". There should be more sessions like it so the public gets more balanced information about the industry.

The writer is an oil and gas industry observer and the former CEO of ARCO Indonesia.

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