The costs they cause: The government enacts new rules on cost recovery

On June 15, 2011 the Indonesian Petroleum Association submitted to the Indonesian Supreme Court a petition for judicial review against Government Regulation Number 79 Year 2010 concerning Recoverable Operational Costs and Income Tax Treatment for the Upstream Oil and Gas Industry, because certain provisions of the regulation have seriously taken a toll on the upstream industry in Indonesia. Once enacted in December 2010, the regulation sparked a public outcry, especially within the country’s oil and gas circles.

OIL AND GAS ISSUES: In the petition, the Association identifies at least 27 legal problems within the regulation that negatively affect the industry, ranging from the issues of cost recovery and income tax treatment, to government authorities in charge of both matters. The new regulation provides that its guidelines be applied to all kontrak kerjasamas (KKS) – or cooperation contracts – including existing and future KKSs. This contravenes previous and higher laws, as well as provisions in existing KKSs governing similar matters.

Guidelines in the regulation will also contravene the well-established legal principles of non-retroactivity, legal certainty, pacta sunt servanda (sanctity of contract), and lex superiori derogat legi inferiori (a superior law derogates an inferior law), all of which are enshrined in the Indonesian Constitution, the Indonesian Civil Code and many other Indonesian laws. The regulation also raises serious concerns in the face of Law Number 10 Year 2004 concerning Law- and Regulation-making Process, thereby calling into serious question the regulation’s legitimacy.

COST RECOVERY: The regulation is problematic; one that is based on, among other things, the assumption that cost recovery means the state pays all costs incurred by the extractive industries in their exploration, thereby enabling and encouraging the extractive industries to arbitrarily charge the recoverable costs to the government and to reduce profits shared with the state. This method of cost recovery, however, means these costs are cut from a concession area’s production results, the remaining of which will be shared by the company and the state under a profit-sharing scheme.

It is true that the government has the authority to enact this controversial regulation. However, it should only apply to future KKSs. By applying the regulation to existing KKSs, the government’s defined position as a party to a KKS and a regulatory authority become less clear. This will greatly affect Indonesia’s economy as a whole. It will also serve to confirm the image of Indonesia being a country lacking legal certainty — an image that has taken its toll on Indonesia’s competitiveness in attracting foreign investment.

WIDESPREAD EFFECTS: In fact, many within the extractive industry circles and several Indonesian economists have repeatedly expressed their grave concerns over the detrimental effect the regulation would have on Indonesia’s investment climate in the upstream industry and, in turn, Indonesia’s economy as a whole. Such concerns are corroborated by findings in several publications of independent studies. And it requires no emphasis to convince one of the importance of the oil and gas industry in the country’s economic structure. At present, despite a steady decline, the industry still accounts for 40% of the country’s state income.

Many Indonesian oil wells have matured or are starting to mature. Discovery of major oil fields trails far behind the maturation process of existing wells. It is along this line of development that Indonesia’s competitiveness in the extractive industries is declining. Amidst the aggressively growing competitiveness of neighbouring economies, this regulation has the potential to further spoil the country’s competitiveness in the field where it may have the most advantage; and, worse, one that is fading away. However, it is worth noting that Coordinating Minister for Economic Affairs, Hatta Radjasa, has provided some hope. In September 2011 he said that the government would endeavour to review and revise the regulation, and would welcome input from the energy sector. The final outcome remains to be seen, but there is a slight air of optimism.

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This article is from the Legal Framework chapter of The Report: Indonesia 2012. Explore other chapters from this report.