Indonesia: Resource nationalism threatens interest in oil and gas bidding round


26 Aug 2015

Indonesia: Resource nationalism threatens interest...

The Indonesian government announced in mid-August that it would auction 11 oil and gas blocks, as it seeks to increase long-term production and attract investment amid low oil prices. A previous auction in March 2015 secured investment from international oil companies (IOC), but concerns among investors over the aggressive acquisition strategy of state-owned oil and gas company Pertamina raise questions around long-term prospects for IOCs in the country. Pertamina’s expanding influence, combined with an already-complex regulatory environment for foreign investors and the low price of oil, threatens to diminish IOCs long-term presence in Indonesia as well as decrease the re-sale value of existing assets held in the country.

 

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In an effort to boost investment, the government is introducing changes to contracting terms. These will offer an alternative method to recover exploration costs when production begins, an option that operators can choose in lieu of existing “cost recovery” schemes. Under the new legislation, which is expected to be passed in August, operators will be offered a larger share of production until the cost of exploration is recouped. Under the proposals, once operators have recovered initial costs, the government then takes a larger portion of production than under existing Production Sharing Contracts (PSC)—a move in line with Jakarta’s longer-term goal of increasing control over Indonesia’s natural resources and shifting a greater share of production to Pertamina.

The government says the new contracting option encourages efficiency among operators and could reduce the time gap between exploration and production. From an operator’s perspective, this measure could help alleviate previous concerns over contract sanctity that emerged under the “cost recovery” schemes, including the Suspense Account regulation in 2012 that allowed the government to defer cost recovery of exploration expenses, delaying payment to operators. The new legislation may reduce some of the uncertainty of previous contracting terms, but presents larger upfront financial costs for operators. It also raises questions over long-term profitability due to the planned shift in the production share after exploration costs are recovered.

Furthermore, political trends and Pertamina’s growing role in national production are changing the operating environment in Indonesia and could dampen investor appetite in the country. Legislation introduced in May 2015 allows Pertamina to take a 15 percent stake in all expiring PSCs at the point of renewal, a move that is in line with the government’s plans to increase the company’s share of national production from 23 percent to 50 percent over the next five years. This policy will likely reduce the long-term production shares of IOCs in Indonesia, including the country’s three largest producers—Chevron, Total and ConocoPhillips—and significantly influence their decisions about investment in blocks where they have existing operatorship rights. In June 2015, Pertamina in partnership with several Indonesian firms was granted a 70-percent majority stake in the Total-operated Mahakam block at the expiry of its PSC in 2017, despite Total’s attempts to extend the contract on existing, or similar, terms. The same month, Pertamina also expressed interest in a stake of the Masela block’s Abadi floating liquefied natural gas project, currently being developed by Japanese Inpex in a joint venture with Royal Dutch Shell. Illustrating concerns among operators about long-term feasibility of operations at a time of strain on the sector, in August, ConocoPhillips announced that it was looking to sell its 40 percent interest in the 15-17,000 barrels per day South Natuna Sea Block B in 2016, despite a contract to operate it expiring only in 2028. 

Political efforts to widen the government’s involvement in natural resources have been witnessed elsewhere in the gas and mining sectors. State-owned gas distributor PGN and Pertamina’s gas arm Pertagas have already implemented controls on pricing and gas transportation infrastructure and are anticipated to expand their role in the gas sector. A ban on mineral exports in January 2014, higher royalty fees in January 2015, and stricter restrictions on the use of foreign workers announced in March 2015 have all affected mining companies in Indonesia. 

Operators of existing PSCs nearing expiration are now less likely to continue investment, with the number of exploration projects already in steady decline since 2013. In that year, 101 of 258 exploratory wells were drilled, dropping to 83 of 250 planned wells in 2014, although this was in part influenced by the drop in the price of oil. In 2015, major contractors including BP and ExxonMobil, as well as smaller operators like Swedish Lundin Petroleum, have given up exploration efforts in Indonesia, reflecting concerns over resource nationalism, complex regulations and long-term profitability. Deep-water and more complex capital intensive projects are likely to be particularly affected. Uncertainty around contract extensions and Pertamina’s automatic 15 percent claim on contract renewal will increase investment risks, making operators who control near-depleted blocks more likely to wind down investment earlier than before. If companies are accused of reneging on contractual investment commitments, the government will have a stronger resolve to claim back operatorship rights, thus weakening re-sale options for operators.

A series of uncoordinated regulatory changes being introduced by various government ministries are currently compounding an already-complex operating environment for foreign companies and could further damage investor appetite. These actions are complicating contract negotiations and financial considerations, negating pre-election commitments by President Joko Widodo to simplify the investment process for foreign companies. The prohibition of all exports without the use of letters of credit (L/C) in April 2015 has imposed controls on the flow of foreign currencies and exemplifies the types of policy changes affecting the profitability and speed of operations. This measure was further strengthened in July 2015 with restrictions imposed on the use of foreign currencies in transactions within Indonesia, making the use of the rupiah mandatory. In the mining sector, US-based miner Freeport McMoRan halted exports in August 2015 after the government failed to renew a suspension of the L/C requirement, which Freeport says violates its contract with Jakarta.  Such changes are adding to an already-complex regulatory environment, which includes restrictive local content obligations, complex administrative requirements influenced by tensions between central and local level authorities, and banking regulations that require the use of foreign exchange banks in Indonesia to process export proceeds.

With the price of oil below USD 50, these political and regulatory trends threaten to weaken short-term interest in Indonesia’s oil and gas bidding rounds and undermine efforts to reverse Indonesia’s long-term decline in production. These constraints will particularly affect technically challenging and capital intensive projects that require the specialist expertise offered by major IOCs.

 

Operating in Indonesia or seeking to enter the market? Concerned about exposure to regulatory and political risk? To discuss your interests or request free access to a Country Profile on Indonesia,   visit the PGI Risk Portal or contact us at:   riskanalysis@pgitl.com

 

 

 

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