RECENT ENERGY NEWS

IMI: New Oil and Gas Bill Proposes Major Sector Restructuring

November 21, 2000 

Summary:  The GOI submitted an oil and gas bill to Parliament in late October that promises to open up the petroleum sector to market competition.  One key step will be to transform state-owned oil company Pertamina to a limited liability corporation (Persero) by stripping it of its governmental regulatory functions and responsibilities for administering Indonesia’s Production Sharing Contracts (PSC’s).  The bill establishes a new Implementation Agency to award PSC’s and regulate Production Sharing Contractor activities, while a new Regulatory Agency will control downstream activities through the issuance of business licenses.  If the bill passes, the GOI will have one year to establish the Implementation Agency and two years for the Regulatory Agency.  The GOI must move domestic fuel prices to market levels in order to lay a solid foundation for the oil and gas bill’s intended reforms.  End summary.

 
In its September 7, 2000 Letter of Intent to the IMF, the GOI said it would “improve competition in selected sectors, especially energy,” by submitting an oil and gas bill “in the August to October” timeframe to Parliament.  The GOI submitted the bill in late October, just under the wire.  This message discusses Pertamina’s current central role; provides a brief history of an earlier oil and gas bill submission and reasons for its failure; outlines main objectives and provisions of the current draft law; and lays out next steps in revamping Indonesia’s petroleum sector.

Current Legislative Basis

 Article 33 of the Indonesian Constitution states, “All natural resources in the soil and the waters of the country are under the jurisdiction of the State and shall be used for the greatest benefit and welfare of the People.”  Three laws implement this provision in the oil and gas sector:

-- Law Number 44/1960 on oil and gas mining which states that only national enterprises may exploit petroleum and natural gas;

-- Law Number 15/1962 concerning the obligation of oil companies to meet domestic demand; and

-- Law Number 8/1971 as amended by Law number 10/1974 concerning state-owned oil and gas mining companies.

If passed, the draft oil and gas law would supplant all three of these laws.

Pertamina: Big Business

The bill now before Parliament proposes to change the status of state oil and gas company Pertamina, an entity which has enjoyed a privileged status for decades.  In 1968, President Soeharto signed decrees merging Indonesia’s two oil companies to form Pertamina and uniting all elements of Indonesia’s oil industry under one umbrella.  By the mid-1970’s, Pertamina had grown into one of the largest corporations in Asia, with an empire encompassing refineries, petrochemicals, shipping, fertilizer, steel, and other non-petroleum businesses.  As the price of a GOI bailout in 1976, Pertamina was redirected back to its primary petroleum and gas business, although it still retains a few subsidiaries in ancillary services, real estate, and agrobusiness.

According to its audited annual report, Pertamina had net profits of Rp 4.98 trillion (US $566 million at Rp 8800/$) for the 1999/2000 fiscal year, nearly quintupling the Rp 1.05 trillion (US $119 million) that it earned in the previous fiscal year.  Sales in 1999/2000 amounted to Rp 143.09 trillion (US $16.3 billion), up from Rp 16.95 trillion (US $13.3 billion).  Exports topped Rp 53.70 trillion (US $6.1 billion), up from Rp 42.53 trillion (US $4.8 billion).  Pertamina’s recent performance was a result of the recovery in crude prices, a mixed blessing.  The Ministry of Finance reported that the subsidy for petroleum fuel products in fiscal year 1999/2000 was just under Rp 10 trillion, or $1.14 billion, while, according to the Central Bureau of Statistics, oil and gas imports for calendar year 1999 amounted to $3.68 billion.  Sustained high world oil prices in 2000 continue to deliver a revenue windfall.  They also swell the cost of the domestic fuel subsidy, estimated to reach Rp 43.21 trillion ($4.9 billion) in the nine-month (April-December) fiscal year.
 
Pertamina receives a major share of its revenue from its Production Sharing Contracts (PSC’s) with private sector oil companies, a system that it pioneered in 1966.  Pertamina’s own crude and condensate production made up only 3 percent of Indonesia’s total production in 1999.  The profit sharing split is a net income basis of 85/15 (government/contractor) for oil, and 70/30 for gas.  The “net income basis” for profit sharing is an important qualifier, which is Pertamina’s justification for closely monitoring contractors’ operations.  Its Foreign Contractors’ Management Body (BPPKA – Badan Pembinaan Pengusahaan Kontraktor Asing) scrutinizes and approves all contractors’ planned outlays.  The final revenue split is determined after deduction of various expenses -– taxes, recovery of prior operating costs before start of operation, depreciation, etc.

Since the fall of President Soeharto, Pertamina has struggled to revamp itself as a leaner, more profit-oriented concern.  A PriceWaterhouseCoopers audit found that Pertamina had lost billions of dollars between April 1996 and March 1998 through corruption and inefficiency.  As part of the government’s anticorruption drive, Pertamina canceled or retendered over 150 contracts with former Soeharto family members and associates, and ordered them to sell any stakes in oil and gas projects.  In October 2000, Pertamina’s Board of Commissioners submitted to the President a blueprint for Pertamina’s restructuring which would be carried out upon issuance of a presidential decree.  With the authority of the Presidential Decree, Pertamina could accelerate its reform in advance of passage of the oil and gas bill into law.

The First Round

In February 1999, the GOI first submitted an oil and gas bill to the Indonesian Parliament (DPR).  After protracted debate, the DPR rejected the draft law on September 23, 1999.  The Government’s bill proposed a drastic relaxation of Pertamina’s control of upstream and downstream activities.  Pertamina submitted its own version of a bill under which it would retain some of its authority over the petroleum sector.  During the DPR debate, various legislators expressed concern that Pertamina would not be ready to compete under the Government’s proposed timetable and recommended that Pertamina be given more time to adjust.  Legislators also objected to opening up downstream oil product distribution and marketing to foreign firms for fear that remote areas might suffer supply shortages.  

The Second Round

The current bill envisions opening both upstream (defined as exploration and exploitation, field processing, transportation, storage and sale of oil and natural gas resources) and downstream (defined as processing, transportation, storage, and trading) activities to business competition.  It clearly states that any company having the requisite financial, technical, and operational capabilities may conduct upstream and downstream activities.  Such firms can be state and regional government-owned companies, cooperatives, or private companies.  Company is defined as any legal entity established in accordance with the applicable Indonesian laws and regulations.  “Permanent Establishments,” on the other hand, are business entities established and having legal status outside the territory of Indonesia and conducting activity within Indonesia.  The oil and gas bill permits foreign “permanent establishments” to operate directly, i.e., without the need to form Indonesian subsidiaries, to carry out upstream activities.
 
Regulating Upstream: Like its predecessor, the current bill revamps the PSC system, but now establishes a broad “cooperation contract” which encompasses the PSC.  The oil and gas bill continues to recognize oil and natural gas as strategic resources controlled by the state, and directs the GOI to establish an “Implementation Agency” to regulate its upstream oil and natural gas mining authority via the cooperation contract.

Downstream: Downstream activities will no longer be a Pertamina monopoly, according to the draft legislation.  Instead, an independent “Regulatory Agency” will issue “business licenses” to ensure the availability of petroleum fuels throughout the country and the safety of natural gas transportation activities.  The bill further stipulates that a single company or permanent establishment may not engage in both upstream and downstream activities (although it appears that a company or permanent establishment can own subsidiaries that operate in each area).  

Next Steps

This time around, the Ministry of Energy and Mineral Resources (MEMR) has been careful to consult with Pertamina.  Pertamina has been considering how to enhance its exploration and production role in Indonesia’s petroleum industry for several years.  The bill would potentially remove some of the limitations under which Pertamina currently operates.  These include restrictions on Pertamina’s exploitation of offshore oil and gas resources, an inability to set its own prices freely, and a provision that Pertamina must turn over its revenues to the government after which it is reimbursed for its expenses.  Pertamina also complains about a level of taxation imposed on Pertamina roughly twice that of its private sector competitors.

If the oil and gas bill leaps the significant hurdle of obtaining a favorable vote in Parliament, the GOI will still have much work to do.  The transformation of Indonesia’s petroleum sector will probably take place at the direction of an interministerial “Steering Committee” chaired by the Finance Minister and also including the Minister of Energy and Mineral Resources and Minister of Industry and Trade to oversee the transitional process.  Pertamina must be transformed within two years into a state-owned limited liability company (Persero) under government regulation.  All of the substantive and procedural changes will require promulgation of a detailed implementing regulation for the new law.

Presidential Decrees will need to be issued to establish both the Implementation and Regulatory Agencies, with the Implementation Agency established within one year of the law’s entry into effect and the Regulatory Agency within two years.  The GOI must decide who will lead the Implementation Agency and which of the old BPPKA personnel to transfer into it.  Decisions regarding the Implementation Agency will largely determine whether upstream oil and gas companies will be better off under the new regime or operate under the same restrictions as before, but under a new master.

Problem Areas

If the oil and gas bill is passed in its present form, the effectiveness of the reforms it embodies will depend on the details of its implementation.  One issue is how upstream exploration and production blocks (“operational areas” in the terminology of the bill) will be allocated.  While there are general provisions to conduct transparent public auctions, a draft regulation now being finalized permits some operational areas to be assigned on the basis of direct negotiations.  The draft regulation also establishes a timetable for interim measures to keep the transition on track, but this could slip.

Oil and gas bill reforms will depend further on the removal of domestic fuel subsidies, an issue that the oil and gas bill does not directly address.  Until the price of heavily subsidized fuel rises to market levels, the competition and open access targeted by the oil and gas bill will not come about.  Pertamina’s natural competitors will not be tempted to invest in the downstream sector to add needed refining infrastructure or seek to market natural gas or refined petroleum products domestically.  In the interim, MEMR intends to maintain unitary fuel pricing for the Indonesian archipelago.  On this latter point, MEMR is mulling the possibility of having the Regulatory Agency provide advisory opinions on the level of subsidy to support its responsibility to “ensure the availability of fuel throughout Indonesia.”  The question of security of supply will certainly be an issue again in the parliamentary debate.

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