T

he long debate on development options for the Masela block in the Arafura Sea has finally ended with President Joko '€œJokowi'€ Widodo'€™s recent decision to build the LNG plant onshore.

This is a political decision based on the consideration of boosting regional economic development. In fact, the decision is at odds with the President'€™s own vision of Indonesia as a global maritime axis.

The argument that the onshore plant will boost the regional economy is certainly debatable, as no comprehensive review has been made.

All benefits and investment costs for the onshore development have been grossly assumed as no surveys or detailed studies have been made to substantiate the assumptions.

The debate on the cost calculation for the gas processing and transportation facilities could actually be resolved by looking at a report form Poten & Partners, a consultancy firm appointed by the government to carry out a comprehensive review, and which reported that an offshore installation would cost less than onshore.

The President'€™s decision annuls Upstream Oil and Gas Regulatory Special Task Force'€™s (SKKMigas) plan of development (POD) approval, given in September last year. Now, operator Inpex has to review the project plan and prepare a new POD.

The process will be long; one cause for technical delay will be finding a suitable site for the LNG processing facility. In addition to technical issues, the issues will involve socioeconomic and cultural issues, as well as religious backgrounds.

A survey will require considerable time to determine the pipeline route, given an ocean trench between the field and processing facility. Equally important, the process for onshore development will not be free from rent seekers.

Energy and Mineral Resources Minister Sudirman Said has said that he will adhere to the President'€™s decision and ask SKKMigas discuss with Inpex to review and change the POD. The negotiation process may take considerable time, as it may repeat the feasibility study, POD and environmental impact analysis.

With a change to a pipeline scheme or onshore LNG facilities, the production from the Masela block (initially targeted for 2024) will be delayed for at least two to four years.

Also, an important and essential factor affect the execution of the plan is securing financing for the project. The President'€™s decision will certainly create negative sentiment for Indonesia'€™s investment activity in the near future.

The decision to choose an onshore LNG plant shows that the government is not consistent in soliciting business in oil exploration and production.

Furthermore, given the high capital requirement, it is anticipated that the Masela development project will be funded using a project finance scheme, i.e. a method of funding in which the lender looks primarily to the revenues generated by the project, both as the source of repayment and as security for the exposure.

In Indonesia, the use of project financing schemes began in the mid-1970s for the construction of LNG in Arun and Bontang, and the scheme grew rapidly in power plant construction in the 1990s, when the government opened a power generation market for private business.

As it will involve foreign creditors, this would be easily secured if the product that will be the source of loan repayment is exported under a long-term sales contract at the market price, rather than sold domestically at subsidized price.

Another pertinent matter to be considered is the potential litigation by the contractor in the international arbitration, in case government and contractors fail to agree on the execution of the President'€™s decision. This should not be a surprise, given the myriad contractual relationships and the immense sums spent to find the resource.

The contractor usually believes that it should have a determining vote in deciding how the field is developed in order to recover its exploration expenditure plus some profits.
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Now, operator Inpex has to review the project plan and prepare a new POD.

Indonesia has some experience in international arbitration dealing with geothermal and oil and gas contracts. In the geothermal sphere, two phenomenal cases were centered on claims arising from projects cancellation as a result of the Asian financial crisis.

To cope with the crisis, at the suggestion of IMF the government issued a series of presidential decrees declaring that a number of international infrastructure projects including geothermal would be '€œreviewed'€ or '€œpostponed'€.

The Arbitration Tribunal found PLN and Pertamina had breached their contracts and the duty of good faith, and awarded the project companies a total of US$572 million and $261.1 million, respectively, in damages in the cases of CALENERGY and KBC.

In the oil case, the dispute dealt with Pertamina'€™s continued refusal to grant commercial status to several oil fields in Lirik under the Enhanced Oil Recovery contract.

In the award, the Arbitration Tribunal decided that Pertamina should have acted in good faith in granting the commercial status of a field to be developed.

From the three cases, one can see that the dispute is one of the classical issues in international law relating to sovereignty over natural resources versus contractual rights under an investment contract. In all cases, the Arbitration Tribunals have applied rigidly the principle of pacta sunt servanda, a Latin term which means '€œagreements must be kept'€.

In the case of geothermal disputes, the very real economic pain Indonesia was going through as a result of the financial crisis of 1997-1998 has not been taken into consideration in the proceedings.

This would mean that economic downturns are simply a contractual risk that parties should take into account when negotiating their long-term contracts.

The energy business, like petroleum and geothermal, invests in large, complex, capital-intensive projects that have long life-spans. Circumstances, the economy, governments and parties invariably change in these long-term projects, which can often lead to disputes.

Therefore, both parties need to continually manage that risk from the inception of the deal to the point where a dispute arises and is eventually resolved.

Under such circumstances, the government should minimize the involvement of individuals or groups with vested interests in making the decision for the Masela block.
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The writer has a master'€™s degree in petroleum engineering from the University of Oklahoma and a doctorate in law from Padjadjaran University in Bandung. He has over 50 years'€™ experience in oil and gas and geothermal projects in Indonesia and overseas. Since 2006, he has also served as an arbitrator.