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Energy & Mining | Challenges in Indonesia’s Oil and Gas Industry

The greatest challenge facing the oil and gas sector is the lack of logistical infrastructure available to support distribution and commercial exploration. The main production sites are located in areas situated a substantial distance from the electricity grid network and the main population centres of Java. The Indonesia Economic Corridors Master Plan to 2025 aims to address this by positioning refineries and industrial production sites at the sources of primary energy production but this will only materialise in the long term. PGN operates more than 3,100 miles of gas distribution pipelines made up of 9 networks across the country with 4 more being added as part of the Integrated Gas Transportation System that would connect across all the islands. Construction of some parts of the network is being held back due to lack of funds such as in East Kalimantan. Transport of LNG between the islands requires costly LNG plants to liquefy the gas and terminals at the destination point to receive it which is not on the priority list for national infrastructure. It is the lack of connectivity between the islands and primary energy production centres that keeps transport costs high and thus results in import of other energy sources to meet domestic needs.

Exploration and incentivising investment are a further challenge considering oil production is declining by 12% each year according to the National Statistics Agency. This is due to the ageing fields such as Minas and Duri in Sumatra and the decline in exploration from the end of the 1990s in the lead up to the new oil and gas law of 2001. In gas too, only a third of known gas basins have been explored meaning that potential reserves could well be the largest in the region. According to BP Migas, out of the 107 oil and gas blocks offered from 2002 to 2008; 77 have yet to begin exploration as per May 2011. While there have been some new oil discoveries in the past decade in the western part of the country; it is the eastern part of the country that holds huge potential in deep sea reserves of oil and gas that are costly to explore. Energy companies face regulatory hurdles, stalled coordination between ministries and local government as well as an unconducive environment for taking on risky exploration. Difficulties in land acquisition and lack of government assistance in the process stall energy companies’ plans to move forward with projects, while land prices continue to increase.

New regulations introduced at the end of 2010 were designed to encourage more investment into the sector, but provided a mix of both new benefits and disadvantages. Ministerial Regulation No. 6/2010 introduced a 5% tax on transfers of contracts during the exploratory stage thereby penalising companies trying to share the risk. The ring fencing principle whereby only one Production Sharing Contract may be issued per business entity is a further hindrance that requires the set up of separate commercial bodies to take on new blocks. There have been some improvements made to the investment climate such as the decision to introduce direct bidding as opposed to tendering blocks and the increase in production splits for companies to 25% for oil and 40% for gas. The abandonment of the proposed $12 billion USD cap on cost recovery that could be claimed by companies in the exploratory stage was another welcome move by energy companies looking to bid on new blocks. Uncertainty remains over regulations as discussions by the House of Representatives were underway in mid 2011 on changes to the Oil and Gas Law No. 22/2001. Articles undergoing debate include Article 22 Paragraph 1 on the domestic market obligation of 25% of production as well as Article 12 Paragraph 3 on the term ‘provided with authorisation’ in relation to working areas given the current overlap between the Ministry of Energy and Mineral Resources and other bodies.

Fuel subsidies continue to plague the commercial viability of new projects for independent power producers; such subsidies cost the government $5.9 billion in 2010. Investors are therefore required to propose a price that is affordable for the domestic market for purchase by PLN, which is often an impossible task and renders the project unworkable due to costs for not only exploration but infrastructure to support exploitation. While the government aims to remove such subsidies by 2014, it is highly unlikely to happen within that time period and caveats regarding certain subsidies have already been stated. Revisions to the pricing system and a braver approach by the government towards the cost of energy for the domestic market are needed to unleash the potential of unexplored blocks.

Indonesia Oil and Condensate Production Forecast

Indonesia Oil and Condensate Production Forecast

Source: Directorate General of Oil & Gas (MoEMR) 2008-2009 (actual) 2010.

Proven Oil Reserves
Proven Gas Reserves Asia Pacific

Source: BP World Energy Statistics 2011

Laws & Regulations on Oil and Gas

  • Article 33 of the Indonesian Constitution which states that all natural resources must be used for the welfare and benefit of the Indonesian people. This translates into the government taking a stake in all oil and gas related activities through Production Sharing Contracts.
  • Law No. 22/2001 governs the activities of the oil and gas sector in Indonesia as well as Law 22/2001 that states that BP Migas is the regulatory body for upstream activities in oil and gas such as exploration and exploitation through Production Sharing Contracts between BP Migas and the company involved which may be state owned, branch of a foreign company or private local company. BPH Migas covers the downstream sector such as processing transport and storage through joint cooperation contracts which are normally PSCs. Foreign companies with a representative office in the country may engage in both upstream or downstream but cannot be involved in both areas. The law also states the preference for use of local manpower and expertise in execution of projects as well as environmental standards that must be met by companies.
    Law No. 22/2001 icone pdf
  • Energy Law No. 30/2007 requires that the country maintains ‘energy stockpiles’ to mitigate against shortages and heighten energy security. The law also marked a shift in the country’s attitude towards energy reserves by establishing the National Energy Council aimed at furthering the exploitation of renewable energy sources and reduce reliance on fossil fuels by 2025.
  • Investment Law No 25/2007 and Company Law 40/2007. Companies engaging in oil and gas activities must be set up as a Permanent Entity and branch of a foreign company. Set up as a company domiciled in Indonesia is only available for Indonesian companies and investors. As per the ring fencing principal, business entities may only enter into one PSC and must therefore set up separate bodies to take on further PSCs. The law also details how dividends may be taken by business entities by allowing the transfer and repatriation of profits. Capital goods imports of machinery and equipment for production needs, are subject to exemption of VAT while goods for production are subject to exemption or postponement of VAT.

Global Business Guide Indonesia - 2012

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