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Jakarta Post

New fiscal incentives to boost oil exploration

In order to attract oil and gas companies to invest more in the upstream oil and gas sector, the Indonesian government has planned to provide a set of new incentives for the industry

Madjedi Hasan (The Jakarta Post)
Jakarta
Mon, October 3, 2016

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New fiscal incentives to boost oil exploration

I

n order to attract oil and gas companies to invest more in the upstream oil and gas sector, the Indonesian government has planned to provide a set of new incentives for the industry.

The tax and non-tax incentives will be offered in the upcoming revision of Government Regulation No. 79/2010 on cost recovery and tax treatments for the upstream oil and gas industry. Also, the planned incentive in the revised regulation will include a progressive split sliding-scale concept.

With a progressive split concept, there will be a new regime in which the government and contractors can share the pain and the gains. This means that the government will receive a higher share of the revenues when the price of oil climbs, but will share in the losses in case the price plunges.

The idea and concept of the progressive split in the Indonesian production sharing contract (PSC) scheme is always good, although it is not new.

Such a scheme was actually applied in Indonesian petroleum contracts through a mechanism of additional payments and a progressive sharing formula based on oil prices and production rates following the sharp oil price increases during the Middle East War in 1973.

It was unfortunate that such additional payments and the progressive sharing formula were later exchanged for short-term gain following the government’s demand to have a higher share through a single sharing formula of 85/15 (effectively 88/12 when it included domestic market obligations) as an effort to cope with Pertamina’s financial crisis in 1976.

As stated by the finance minister and by the man who is both the coordinating minister of maritime and the minister of energy and mineral resources, the government expects the incentives to improve the economics of new oil and gas projects. This would make the oil and gas sector more attractive for new investments, which have declined sharply during the past couple of years because of low oil prices. However, the expectations may be over-optimistic, as discussed below.

The development of indigenous resources represents a major challenge, technically and financially. It is believed that foreign investment, together with the essential contribution of technology, remains important for the development of Indonesia’s petroleum resources.

Moreover, the decision to explore should be based on a comprehensive analysis involving prices, costs and taxes, which would determine whether the ventures are economically feasible.

In addition, investments in oil and gas still also depend on geological, technical and political risks.

To ensure the viability of the venture, which is not only capital intensive, but also long-term in nature, the industry should be able to forecast the future margins or to use the current margins as realistic indicators to determine the future margins.

In turn, they also need a commitment from the government that it will be responsive to a change that could occur because of a fall in oil prices, such as in adjusting the share of the earning for oil companies.

With respect to Government Regulation No. 79/2010, the proposed revision will effectively return some of the present production sharing contract terms to the original financial terms of PSC as agreed initially by the parties (government and contractor).

Also, under the doctrine of lex specialis derogate legi generalis (a law governing a specific subject matter overrides a law that only governs general matters), the revised regulation should not be applied to the PSCs that were signed before the change was made, as its implementation would change the commercial terms of the contracts. Accordingly, the planned revision of the regulation should not be considered as an additional incentive, but it merely as an effort to remove the disincentive that has been created.

Also, in addition to the revision of the regulation, there is also a need to change the paradigm of the long-term contracts in oil and gas exploration associated with uncertainties during the signing of the contracts and subject to economic influences throughout the contract duration.

The change in the paradigm can guarantee the rights and obligations set out in the contract as long as the economic background remains fair and appropriate and consistent with the economic interests and rationality of the parties involved, not just at the time of the signing but throughout its duration. This could be made possible, as there is now a growing reliance on behavior-linked standards like “good faith”, “fair dealing”, or “reasonableness”.

Renegotiation, particularly of fiscal terms, has been a feature of the natural resources industry for the past 30 five years. However, adaptation of a production sharing agreement to a change in economic circumstances can only be considered if the contract contains a renegotiation or stabilization clause.

The use of “freezing” in key contract terms over a long period of time has been in decline for many years, not least because of the difficulties of enforcing such a rigid approach that seems to be largely aimed at avoiding expropriation.

It has been noted that the renegotiation may only be applicable in commercial terms, as many governments will usually be reluctant to agree to a stabilization agreement in non-fiscal areas such as in environmental and safety and health matters.

Coincidentally, these are the areas where the risks to investors have grown considerably in recent years.

Indonesia’s oil and gas industry would certainly welcome the government initiatives to provide new incentives for accelerating oil and gas exploration.

However, the financial incentives are considered insufficient to attract foreign capital, as Indonesia is also competing with other countries for foreign investment.

As world wide data shows, Indonesia is geologically no longer a prime destination country for oil and gas exploration. As I said in my previous article in The Jakarta Post, this is attributable to the fact that there are a limited number of Indonesian discoveries that have oil reserves of more than 1 billion barrels. The majority of discoveries contain oil reserves of less than 100 million barrels.

The upstream oil and gas sector is capital and technology intensive and has higher risk, thereby a successful endeavor would also require a more conducive investment climate.

 An improvement in the investment climate is needed to eliminate excess bureaucracy and to control nationalist sentiment toward natural resources, which can take the form of nationalization, or merely be restrictive measures.
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The writer has a master’s degree in petroleum engineering and a doctorate in law. He has more than 56 years of experience in the oil and gas industry in Indonesia and overseas.

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