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ndonesia has been active in oil and gas for more than 125 years and is a significant player in the industry. Oil and gas is a vital part of the Indonesia economy. It is the largest contributor to state revenues.

However, as oil and gas development has stalled, state revenue has declined and industry has experienced a dramatic backtracking. This is now tempered by the dissolution of BPMigas on Nov. 13 by the Constitutional Court. The Court has ruled that the articles governing BPMigas run counter to the Constitution and have no binding legal force.

Oil and gas in Indonesia is controlled by the government through the Production Sharing Contract. Indonesia was the first country to offer Production Sharing Agreements (PSAs) and is one of the most active countries with regard to this contract worldwide. The government wanted to develop and control oil resources but had neither the money nor the technological know-how to do so.

PSAs allowed the government to maintain national ownership of resources, the foreign company had no equity in the venture, and the state owned enterprises (SOE) had full managerial control.

One specific feature of the mineral sector is that exploration and development of resources must take place where the resources are located. The must drill exactly where the oil is. These ventures are risky in the physical, commercial and political sense. It is difficult to determine in advance the existence, extent and quality of mineral reserves let alone production costs or the future price in the market.

Profitability is not assured and the resource is finite, so discovery and acquisition of new deposits is continual. Since virtually all mineral ownership regimes are based on state sovereignty, companies are at the mercy of government policy and regulations to a much greater extent than in other sectors.

The government decides whether resources are privately owned or whether they are state property. If state owned, development can be by a state company or contracted to a private firm.

The most common combination of agents in mineral development is a host government with one or more mineral resources and a multinational company. It is not surprising that the objectives of the parties frequently clash. The main aim of the multinational firm is profit whereas the government is interested in revenue. Since the objectives of the firms and the government do not necessarily coincide and indeed may diverge substantially, it is all the more important that they identify the likely sources of conflict and write a contract that is as comprehensive as possible.

This divergence of objectives is frequently manifested in a lack of trust. The relationship worsens if the government changes existing legislation and applies new rules to contracts agreed under the old regime.

In oil and gas, considerable time may elapse between investment and profit. The relative bargaining positions of the two parties change throughout the stages of the project. The government may find it difficult to access risk capital. It may also lack expertise. Furthermore, governments may be unwilling to take the necessary risks.

Mineral development is a long-term investment whose benefits are usually reaped well into the future. It forms, or should form, part of an overall economic strategy. As the host country, Indonesia’s objectives fall into three categories: sovereignty, economic growth and the environment.

Some of the sub-objectives are the optimal use of resources, earning foreign exchange, satisfying domestic demand, the effects of exploitation on the environment, direct and indirect employment, accumulating expertise and so forth. These goals can only be achieved within the framework of an explicit energy and mineral policy.

As BPMigas has negotiated contracts on behalf of government with the foreign company or contractor, as stipulated in Law No. 22/2001, the contracts should be negotiated between the contractor and the state-owned oil company, rather than the government. The state-owned oil company has the power to negotiate due to either legislation and regulation or because it controls the mineral reserves.

It is easy to see why a state-owned oil company should replace the government in negotiations with a foreign contractor.

First, the SOE is likely to possess more and better information about mineral deposits, the technology best suited for exploration, and the ability of the foreign company to conduct the required work.

Second, the SOE will be perceived as less political than the government.

Third, the usual goal of the SOE is eventual control of the entire exploration and development activities in the domestic mineral sector, so cooperation with foreign companies will involve nationals in the operations of the foreign company and thus increase their expertise.

As stated before, mineral resources are usually owned by the state which then decides whether development and exploration rights will be granted to publicly owned or private companies or combination of the two.

The next amendment of Law No. 22/2001 is intended to guide the high-level institutional design of the regulatory framework by the government.

The new institutional body (post-BPMigas) should clearly define, articulate, prioritize statutory responsibilities and focus on outcomes.

The writer is senior policy expert at INPURI – Infrastructure and Public Utilities Research Institute.