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Jakarta Post

Energy crisis: Needs urgent action now

  • Lukman Mahfoedz

    The Jakarta Post

  /   Thu, September 18, 2014   /  03:42 pm
Energy crisis: Needs urgent action now

Unless the government incentivizes exploration, Indonesia will suffer from a lack of new reserves.

Nearly half of the 7.7 million barrels oil equivalent per day (boepd) of primary energy that Indonesia needs in 2025 will have to come from petroleum products. To be precise, the National Energy Policy allocates 25 percent to oil and 22 percent to gas. Present day oil and gas production levels, which are around 2.2 million boepd, and declining, should alert the government that urgent action is needed to secure Indonesia'€™s future energy supply if the country is to avoid getting deeper into the energy crisis being driven by the ever-widening gap between demand and supply.

The oil and gas sector has been the major contributor to state revenue since the early 1970s. Attention is given to the output side, i.e. production. Efforts have been mainly concentrated on increasing oil production, at the expense of exploration. Indonesia has out-produced its ability to add new reserves. In 2013, Indonesia'€™s reserve replacement ratio for oil was a dismal 47 percent, while gas has started to dip to 90 percent '€” we cannot fully replace the oil and gas consumed. On the production side, the reality is not encouraging either. Output of oil continues to decline to the current level of 788,000 barrels of oil per day (bopd) as of July 2014, half of the peak production of 1.65 million bopd in 1977.

We cannot stress more the strategic value that the upstream oil and gas sector holds for the future growth of Indonesia, as it has to provide 47 percent of total primary energy needs in 2025, or 3.7 million boepd.

Current estimates put a 2.5 million boepd gap between demand and supply in 2025, which would severely stress energy resilience as shown on the chart overleap.

The upstream petroleum industry needs urgent measures from the government to perform its strategic duty, i.e. securing future energy needs while reducing dependency on imports and ensuring more efficient domestic energy consumption.

The Indonesian Petroleum Association (IPA) believes the following actions would energize the performance of the upstream oil and gas industry.

Indonesia needs to look at and learn from other countries'€™ experiences in boosting the performance of their upstream oil and gas sectors by successfully attracting significant capital and technology investments in exploration and production activities.

The United Kingdom is a mature oil province with declining production after reaching two production peaks. Three key factors have always been critical to the success of the North Sea: oil prices, an attractive fiscal regime and technology. The second oil peak was achieved when oil prices were lowest, due to the country'€™s fiscal regime, which is arguably the most attractive in the world. In fact, its attractiveness has been maintained until now through thriving enhanced oil recovery (EOR) investment to optimize the recovery.

Norway successfully ramped up its production and new reserve booking after declining in 2010. A key contributor was positive change in its fiscal regime '€” not only a clear and stable regulatory platform, including fiscal arrangements, but also further de-risking exploration by refunding up to 78 percent of exploration expenditure, encouraging further investment.

In Malaysia, the combination of tax and fiscal incentives as well as government participation in initial exploration risk has led to significant new reserve discovery, the largest in Southeast Asia (in 2012, Malaysia discovered 1.4 billion barrels of oil equivalent (BOE) or 72 percent of total discovery in Southeast Asia, while Indonesia only discovered 0.2 billion BOE, or 14 percent).

The aforementioned examples clearly show that stable, clear and certain regulations, combined with attractive fiscal arrangements, boost investments and technology uptake to deliver top industry performance.

Removing barriers

Kuntoro Mangkusubroto, the chief of the Presidential Working Unit for the Supervision and Management of Development (UKP4), lists 69 different types of permits needed in the upstream oil and gas sector involving 284 processes in 17 government agencies.

The IPA supports the UKP4 proposal on the establishment of service-level agreements (SLA) between the Upstream Oil and Gas Regulatory Special Task Force (SKKMigas) and other related agencies to facilitate quality and efficiency, and at the same time improve governance and transparency of the permitting processes.

The IPA believes that policy and regulation, including permits and licenses, should never be an impediment to investment and business. Therefore, the IPA expects that the government will deregulate and streamline business processes for a more efficient upstream petroleum industry.

Presidential Instruction No. 2/2012 must be used as starting point, in which the roles and accountability of each ministry and government agency are set in order to achieve the common objective of national oil production increase. This is an example of good affirmative policy.

The IPA supports the implementation of this presidential instruction in its entirety, as momentum to review all related administrative procedures with the full intention of making them simpler, more open and transparent, as well as to add value. The directive also instructs the Energy and Mineral Resources Ministry to conduct an inventory and assessment of the laws and regulations that hinder efforts to increase national oil production and propose changes to the regulations. This is urgent homework for the new government and its Cabinet.

Clarity, consistency and certainty

In a regulatory landscape, investors expect nothing less than clarity, consistency and certainty of laws and regulations '€” even more so in the oil and gas sector, a long-term industry with high risks, massive capital, technology and people investments.

First and foremost is the revision of Law No. 22/2001 on oil and natural gas, in compliance with the Constitutional Court'€™s decision. It is fundamental to establishing a certain legal framework for the governance of the upstream oil and gas sector. The IPA expects the government to show a sense of urgency in finalizing the revision, which, apart from providing certainty on the governance structure, would also provide for the sanctity of all previously signed production sharing contracts (PSCs).

Further challenges to the industry include a multitude of regulations that are detrimental to investment. The property tax (PBB) on exploration contracts is one example. For the 2012-2013 fiscal year, the bill for exploration PSCs signed post-2011 was Rp 3.2 trillion (US$277 million) in terms of whole area, surface and subsurface.

This huge PBB assessment against the new PSCs has effectively discouraged exploration in Indonesia, which is contrary to the government'€™s vision of ultimately increasing exploration activities and production. As intended in Presidential Instruction No. 2/2012, it is necessary for the government to introduce tax incentives to boost exploration investment.

Government Regulation No. 79/2010 on cost recovery and income tax treatment for upstream oil and gas, to some extent, is in conflict with other regulations and is prone to multi-interpretation. It opens the opportunity for imposing additional costs and taxes, which in the end will discourage investment.

The recent Presidential Regulation No. 39/2014 on the negative investment list will also affect upstream oil and gas operations in a similar way to the unintended effect of the cabotage regulation. Restricting participation of foreign investment in the many technical support services needed in drilling, operating, producing and maintaining oil and gas wells will impede efforts to increase reserves and production.

The above examples are not consistent with Presidential Instruction No. 2/2012, which mandates collaboration between all relevant government agencies to increase oil and gas production.

The inclusion of cost recovery in the state budget, and State Budget Law, has caused many misconceptions. In this case it is a '€œstate loss'€. Cost recovery is an investment of contractors in carrying out petroleum operations under PSCs and work programs and budgets. It should not be regarded or otherwise treated as part of the state budget. Should there be any unsettled disputes pertaining to the execution of PSCs, such disputes should be handled and settled as per the provisions of the contract, i.e. under civil law, as opposed to criminal law such as in the recent Chevron bioremediation case.

The uncertainty on PSC extension may impact directly on the continuation of investment and national production. At least 20 PSCs, accounting for 20 percent of national oil production, will expire within the next five years. In the next 10 years, the figure will increase to 60 percent of national production. These are significant numbers that mandate swift action from the government, i.e. to issue a regulation providing transparency and clarity for the PSC extension process.

Boost discoveries of new reserves

Indonesia'€™s reserve replacement ratio sits at a low 47 percent for oil and 90 percent for gas. We consume faster than we can replace the resources. However, Indonesia does not only suffer from low activity, but also from inefficient exploration results.

In the period of 2004-2013, Indonesia discovered 3 billion BOE of new reserves, compared to two to three billion BOE in Malaysia, Vietnam with 7 billion BOE, and 6 billion BOE for Brunei. Without significant new additions, Indonesia is practically just depleting its existing reserves '€” the result of exploration investment in the last 30 to 50 years.

Exploration is the highest risk phase in the quest for sourcing hydrocarbon, with intensive capital and technology investment. Throughout 2009-2012, investors burned $1.9 billion of losses due to sub-commercial discovery in the eastern part of Indonesia. Unless the government incentivizes exploration, Indonesia will suffer from a lack of new reserve reserves, hence jeopardizing future supply capability.

Era of easy oil and gas is over

According to a WoodMac study, 75 percent of the potential resources are located offshore (shallow and deep water) in the eastern Indonesian region, the likes of which will need technical expertise and huge funding. Furthermore, around 85 percent of the existing reserves of hydrocarbons are of gas while only 15 percent are of oil, which means the country needs the necessary infrastructure to develop them. In addition, the hydrocarbon sources identified in several blocks contain significant amounts of CO2, requiring expensive treating infrastructure.

Looking into success stories in other parts of the world, the IPA estimates that exploration activities must increase threefold from current levels, at the minimum, to meet half of the 2025 oil and gas supply and demand gap.

The realization of exploration activities until the first half of 2014 was also not encouraging '€” with only 40 exploration wells able to be drilled of the planned 130 wells '€” and it will be very difficult to achieve the 2014 target of 206 exploration wells in the remaining six months. Meanwhile, as the exploration expenditure realization until June 2014 is only about $1 billion, more efforts are needed to pursue the 2014 exploration budget of $3.8 billion.

The SKKMigas deputy chairman for planning control said the cause of the lack of new exploration drilling is that many officials do not dare to make decisions and fear being criminalized. The second is that many permit requirements must be met to execute drilling activities in Indonesia, as a result of increased requirements due to local autonomy in the last two to three years. This leads to a less attractive investment environment for investors.

The IPA suggests that the government increase incentives for investing in exploration activities. Considering the risk, the equity split of PSCs in frontier areas can be revisited with higher takes for investors. Tax and other fiscal incentives are also needed. Investment in initial data acquisition, national data repository, support services and infrastructure will further enable robust exploration activities.

Existing production comes from many mature fields already past their heyday of primary and secondary recovery stages. The estimated average recovery factor is less than 40 percent, but there is still the potential of left-behind hydrocarbon. Enter the tertiary recovery stage, to maximize the recovery of hydrocarbon.

Tertiary recovery, or EOR as it known, utilizes chemicals or other substances to ease remaining hydrocarbon into production. No single recipe fits all. EOR is a massive undertaking of technical and capital deployment. This is where certainty and clarity in PSC extensions come to play. EOR comes toward the end of PSCs. Without guarantee of extension, investment will not be made.

To fully realize production increase from EOR, the government must seriously look into providing transparent processes for PSC extensions. At the same time, the government should allow innovative partnerships between PSCs and other reputable parties, such as technical service providers, to address the technical and financial challenge of implementing an EOR project.

Go gas!

Indonesia should reduce its dependency on oil. With 85 percent of the remaining resources to be explored and developed being in gas, it makes business sense to focus on increasing domestic gas utilization. In fact, domestic demand for gas has been increasing significantly, mostly coming from power generation and industry, not discounting the potential of household and automotive markets.

Pricing and gas infrastructure such as pipelines are two key factors in increasing gas uptake, including liquefied natural gas (LNG), in domestic markets. Pricing policies must take into account upstream project economics. The process for pricing approval by the government, if required, must be done in a transparent and timely manner. The government must also ensure the availability of reliable (open-access) and efficient infrastructure.

Given Indonesia'€™s geographical conditions, the development of integrated infrastructure with open-access pipelines and inter-island infrastructure is key. This needs to be backed up by an enabling regulatory environment, which touches upon gas/LNG domestic allocations, permits and import licenses.

It is imperative for the government to streamline the regulations and provide better business assurance for infrastructure development. This would boost investor interest, as the infrastructure business is a high-risk business that requires substantial, long-term investment and is critical for the timely commercialization of discovered reserves. The commercialization policy and process must also be streamlined to align with infrastructure development or availability.

There is an increasing number of gas projects that require higher prices to support their economics, including coal bed methane (CBM) and shale gas. Ideally, there would be a gas-pricing policy that did not distort the economics of the upstream projects, and gave clear signals to the end users of the possibility of higher gas prices borne by consumers. This transition will have to be managed properly '€” and the government'€™s role will be crucial.

In addition, the government needs to make breakthroughs for accelerating the approval of oil and gas projects currently still in planning, such as Indonesia Deepwater Development (IDD), Abadi Masela, Tangguh Train III and East Natuna. These oil and gas megaprojects are needed immediately to minimize the future oil and gas demand and supply gap.

The government needs to make an inventory of marginal oil and gas reserves (small or uneconomic to develop reserves) due to the lack of gas infrastructure as well as market unavailability. SKKMigas data shows there are more than 80 marginal field oil and gas reserves totaling more than 2 trillion cubic feet (TCF) that are still undeveloped and are scattered from western Indonesia to eastern Indonesia.

Providing incentives for marginal field development and building more infrastructure surrounding oil and gas reserve areas are the main prerequisites for marginal reserves'€™ monetization and contributing energy supplies to surrounding areas.

Expectations for the new government

Energy investors, both foreign and domestic, expect solid business foundations to be built from a stable and transparent implementation of rules for all. Clarity, consistency and certainty are of utmost importance to provide a predictable business climate.

Investors look forward to a bold and innovative vision from the new government to build Indonesia'€™s energy resiliency, one part of which is by renewing the commitment to enhancing the upstream oil and gas sector in line with its long-term strategic value for the growth of the nation.

Increasing production, simplifying bureaucracy, enhancing exploration, as well as legal and regulatory reform are four focus areas to impact and elevate our upstream oil and gas industry'€™s competitiveness on the global stage.

Urgency is needed to immediately ensure the implementation of Presidential Instruction No. 2/2012 on a national oil production increase, to conclude the revision of the Oil and Gas Law, to incentivize exploration, marginal fields and EOR, to issue regulations on PSC extension processes, to amend the property tax regulation, to accelerate approvals on major projects, to amend Government Regulation No. 79/2010 and to remove cost recovery from the State Budget Law. SLAs between related ministries and government agencies are to be implemented.

The government needs to have a new paradigm in the control of the downstream sector. The downstream sector must be controlled by the government in order to improve national energy security, especially in terms of improving the security of the fuel supply and crude oil for domestic consumption.

The government should maintain strategic reserves at a safe level to ensure the availability of domestic supply, as well as improve the control and supervision of oil and gas distribution in the downstream, especially maintaining the level of subsidized fuel utilization.

The IPA is committed to being the contributing partner to the new government in advancing the upstream oil and gas industry, for the greater benefit of the people of Indonesia.

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