As hydrocarbons production in maturing blocks has declined and domestic energy consumption has increased, the Indonesian government has been looking for ways to boost investment in the country’s upstream oil and gas sector. Some of the measures the government has undertaken have proved effective at attracting investors, including increased incentives and a more flexible production sharing contract (PSC) framework introduced in 2008. However, regulations that were implemented in early January 2011 may have the opposite effect.
Production agreements between the government and oil and gas production companies are generally carried out via a PSC in which both sides agree to a specified split of production revenue. The PSC also determines which operating costs may be recovered by the company and guarantees the right of the company to dispose of its share of oil and gas produced.
Under the fifth and current generation of such contracts, the post-tax equity ratio is negotiable, whereas it was set at a fixed rate in previous versions. In addition, incentives in the form of investment credits are now offered. Under this more flexible regime, revenue splits have become more favourable for the oil and gas production companies, increasing from 15% to 25% for oil contracts and from 30-35% to 40% for gas.
However, other legal changes implemented in recent years have proved to be divisive, including Government Regulation 79/2010, issued in December 2010. Generally known as “GR79”, this regulation concerns recoverable operational costs and income tax treatment for the upstream oil and gas industry.
Intended to clarify the cost recovery and taxation rules that affect the upstream oil and gas sector, the new regulation has generally been poorly received by the oil and gas producers operating in the country. The primary areas that GR79 sought to simplify were contractual issues between the government and upstream oil companies pertaining to the laws governing revenue, cost recovery, tax deductions, indirect taxes, tax calculation, payment and audits, non-lifting income, bookkeeping and tax registration, and other matters.
The dissatisfaction among producers has centred around two focal points: provisions regulating cost recovery and the possibility of retroactive application of the new rules to existing contracts. Regarding the first point, GR79 identified a total of 24 items that were classified as not cost recoverable, a so-called negative list. While some of these items were included in a previous list that had been drawn up by the Ministry of Energy and Mineral Resources, there were seven new additions under GR79.
“The cost recovery structure signed in our contract with the government incentivises companies in the oil and gas industry to explore with the guarantee of recovering their investment,” Sammy Hamzah, the vice-chairman of the Indonesian Petroleum Association (IPA), told OBG. “By capping it, the government is cutting down the production of oil by reducing the interest of domestic and foreign investors in the oil and gas sector in Indonesia.”
The IPA has been among the most vocal critics of the new regulation. The industry association went so far as to call for a judicial review of GR79 by the Indonesian Supreme Court in June 2011. The primary complaint of the IPA is that the regulation contravenes previous and higher laws.
Second, it argued that the articles relating to unilateral alterations of existing PSCs within three months of the regulation’s implementation were unfair. The final point of contention was that the law created uncertainty within the investment climate, which would lead to a decline in investments within the sector and could cause the country to forgo at least 150,000 barrels per day of its existing hydrocarbons production.
As of December 2011 the law was still under review, as various government bodies including sector regulator BPMigas and the Ministries of Finance and Energy and Mineral Resources considered revising GR79. Although the outcome remains uncertain, there is some basis for optimism. In September 2011, Hatta Radjasa, the coordinating minister for economic affairs, said that the government would endeavour to review and revise the regulation, and would welcome input from members of the energy sector in doing so.