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Indonesia moves to gross split mechanism in attempt to boost investment

FOCUS: Indonesia has announced plans to adopt a new "gross split" production sharing contract (PSC) for conventional oil and gas this year to replace the existing cost-recovery system, in an attempt to re-invigorate investment in upstream oil and gas development and production in the country.20 Jan 2017

According to reports, contractors under new PSCs will be responsible for the upfront costs of exploration and production and retain a larger portion of the oil and gas recovered, with government reimbursement of contractor costs being removed from the equation. This change, designed to reduce the burden on Indonesia's budget, will reportedly only apply to new PSCs. 

While certain supermajors such as Chevron, ExxonMobil and Total are long-established in Indonesia, the country has struggled to attract international investment particularly in oil and gas exploration. A combination of uncompetitive fiscal terms, government bureaucracy and the gradual chipping away of exploration, development and production related costs which are available for cost recovery has seen Indonesia fall behind other regional oil and gas producing countries in its attraction of much reduced exploration budgets. While much depends on the detail, any flexibility which allows Indonesia to better tailor a financial model that attracts investment has to be positive.

The traditional PSC concept that has been used in Indonesia for many years sees government and contractor revenue share split after first tranche petroleum and subtracting certain recoverable costs. In recent PSCs for conventional oil and gas the government typically received around a 70% share for gas and 85% for oil.

This week, Indonesia's Energy Minister Ignasius Jonan said that the base split under the new contracts would be 52% for the government for gas production and 57% for oil. It was also reported that contractors could be awarded a greater share of production in relation to more difficult and expensive blocks. 

While this is clearly a very substantial change, 2015 had already seen Indonesia move away from the traditional model for non-conventional oil and gas operations, when the government introduced a gross split sliding scale PSC as an option for such operations. The latest change will also apply to new PSCs for conventional oil and gas exploration, development and production in Indonesia.

The first PSC under the new scheme was a renewal of the Offshore North West Java (ONWJ) PSC with PT Pertamina (Persero), Indonesia's national oil and gas company. The ONWJ block has been in production for many years and was first awarded in 1967. Reports indicate that under the new production splits for ONWJ, the government take is 37.5% for natural gas and 42.5%for oil produced from the block. 

Some observers have opposed the plan, arguing that it could eliminate state control over national oil and gas assets as it removes the requirement for government agency SKK Migas to approve annual contractor budgets While we have yet to see details of the regulations implementing the new scheme, if SKK Migas no longer has to spend time and resources reviewing contractors'' annual budgets it will be able to focus more on issues such as improving efficiencies in dealing with consents and approvals as well as working with contractors to better ensure health, safety and security issues in upstream oil and gas operations in Indonesia.

Steve Potter and Ashley Wright are oil and gas experts with Pinsent Masons MPillay, the Singapore joint law venture partner of Pinsent Masons, the law firm behind Out-Law.com. If you'd like to know more you can read a more in depth analysis (17-page / 6MB PDF) of the changes.