It is now futile to debate the government’s decision of July 2015 not to renew the production sharing contract (PSC) of Total Indonesie of France and Japan’s Inpex for the Mahakam oil and gas block in East Kalimantan and instead award the concession to state-owned Pertamina oil company.

The decision did end several years of uncertainty about the future status of the giant gas concession after the expiry of its PSC at the end of 2017, but the most pressing challenge now is how to ensure a seamless transition of the operational management to Pertamina. This is vital to maintain the smooth operations of the Mahakam Block, which accounts for almost 30 percent of Indonesia’s gas output and 7 percent of its oil production.

Excluding the administrations of East Kalimantan province and Kutai Kartanegara regency from the negotiation loop regarding the participating interests (shares) in the gas concession could set off social and political turbulence and even protest demonstrations.

Regional administrations have often demanded shares in resource-based businesses, such as mining ventures located in their areas, even though they simply do not have the financial capacity, or the managerial capability, for buying assets worth hundreds of millions of dollars.

But the factor of regional administrations cannot be just sidelined because although oil extraction companies operate under the concept of the PSC with the central government (through the SKKMigas regulatory body), oil contractors still have to obtain from the local administration dozens of permits related to the various aspects of mining operations.

However, these issues are only some of the challenges Pertamina is facing in managing the transition of management until the full takeover in January 2018.

Certainly Pertamina, despite its decades of experience in the petroleum industry, still needs technical and managerial assistance from major foreign oil firms as partners to operate the giant oil and gas field.

Given the complexity of the operations and logistics, many analysts have raised concerns about the big risk of output disruption if Pertamina takes over the block without the assistance of foreign partners for at least five years.

According to Total Indonesie, during its peak operations on the Mahakam Block as many as 100 wells per year should be drilled and about 10,000 well interventions performed annually to maintain daily production of 1.7 billion standard cubic feet of gas and condensate of about 62,000 barrels of oil equivalent. The concession also requires more than 700 logistical support vessels to operate and can on any given day employ more than 20,000 workers.

The state oil company needs foreign partners with experienced management, high technical competence and expertise and, no less important, with high credit ratings because the operations of the Mahakam Block require US$2.5 billion in working capital and investments every year.

Since most domestic banks shun lending to oil companies, Pertamina will have to seek loan financing from foreign creditors. The problem, though, is that Pertamina’s credit rating is not high enough to secure such a huge amount of foreign loans.

In this context Total Indonesie, the current operator of the block, and Inpex should naturally be the best suited for that role to secure a smooth transition.

But negotiations for Total and Inpex participating interests still failed to reach transfer and commercial agreements even after the June 30 deadline because of the combination of the persistently weak oil market that has pressed international oil prices to below $50 per barrel and the worsening business climate in Indonesia’s hydrocarbon industry.

Hydrocarbon prospecting is capital and technology intensive and highly risky and oil companies operating under Indonesia’s PSC concept are required to fully bear all the risks related to exploration. Production sharing takes place only after commercial volumes of reserves are discovered for further development.

It comes as no surprise therefore that the number of drilled exploratory wells in the country has fallen steadily from as much as 100 a year in the early 2000s to about 50 last year and oil production fell to 820,000 barrels per day at present from as high as 1.25 million barrels in the early 2000s.

Yet more discouraging is that the success ratio of oil explorations fell further to as low as 15 percent from 20 percent in 2014 and more than 50 percent in the early 2000s.

Set against the negative factors cited above, the terms and conditions offered by Pertamina for a minority interest (maximally 30 percent) in the Mahakam Block for both Total and Inpex seem not attractive. These foreign oil contractors will have to calculate the risks to their investments as minority shareholders under the management of national oil company Pertamina.

The biggest lesson from all these problems is that the government should enact a firm regulation on clear-cut rules and step-by-step procedures for the termination or renewal of the PSC. To put it briefly, the PSC should stipulate clear-cut provisions for a transition period of at least five years to ensure a smooth transfer of operations and management.

The crucial point is that taking into account the complexity of operations and the big investment needed for production development, the future status of the PSC should have been decided at least five to seven years before its expiry, not less than three years as the government did with the Mahakam Block.

The uncertainty about the mechanism and procedures for the extension or termination of the PSC will haunt about 20 other contracts that will expire between 2016 and 2019. These concessions account for 30 percent of the national oil output. For the next 10 years, PSCs that account for 80 percent of oil production will expire.

The writer is senior editor at The Jakarta Post.

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