Legal Guide to Oil and Gas Regulation in Indonesia: Development of Oil and Natural Gas

This is the second post in our 2013 Legal Guide to Oil and Gas Regulation in Indonesia. Fitriana Mahiddin and Syahdan Z. Aziz will address a new topic each week.

Development of Oil and Natural Gas

Oil and natural gas development in Indonesia is governed by Law No. 22 of 2001 regarding Oil and Natural Gas (Law 22) and its implementing regulations, Government Regulation No. 35 of 2004, most recently amended by Government Regulation No. 55 of 2009 regarding Upstream Oil and Gas Business Activities (GR 35), and Government Regulation No. 36 of 2004 regarding Downstream Oil and Gas Business Activities, as amended (GR 36).

Law 22 and these government regulations substantially changed the existing business structure for both oil and gas activities, especially for downstream oil and gas activities. While Law 22 changed the regulatory framework for the oil and gas sector in a number of significant respects, two changes need to be highlighted. Law 22 dramatically changed the role of the state-owned oil and gas enterprise, Pertamina, and it liberalized the natural gas business.

Law 22 grants the government the exclusive rights for oil and gas exploitation and requires all private companies wishing to explore for and exploit oil and gas resources to enter into cooperation contracts, based upon a production-sharing scheme with the government (through the Minister). These cooperation contracts were previously entered into with BP Migas.

Exploration, development and production (i.e., upstream) activities are conducted by foreign or domestic companies acting as contractors to the government under cooperation contracts. Cooperation contracts grant contractors exclusive rights for up to 30 years to conduct upstream activities within a defined area under the control of the government (through the Minister). This right does not encompass any surface rights to land, which must be acquired through negotiations with owners and occupiers. All the financial risks of operations conducted under the cooperation contract are to be borne by the contractor. Any oil and natural gas produced is shared between the contractor and the government in the proportions specified by the cooperation contract. The cooperation contract may be extended for up to 20 years.

Regulation and Supervision

As the production, transmission, distribution and supply of natural gas can be considered as either upstream activities or downstream activities, they may be regulated and supervised by the government, as well as either SKSPMIGAS, as defined below, under the Minister (upstream), or BPH Migas (downstream). The government (represented by the Directorate General of Oil and Gas (Migas)) issues the required business and technical licenses, while the government (through the Minister and BPH Migas), among other activities, supervises and regulates the distribution, transportation and marketing of natural gas through pipelines.

Under Law 22, as implemented by GR 36, downstream activities are carried out by private entities based on licenses issued by the government under the supervision of the government and BPH Migas. In addition, BPH Migas issues special rights required by private companies intending to distribute or transport natural gas through pipelines.

In late 2010 the government issued Government Regulation No. 79 of 2010 (GR 79) on operating costs that can be recovered and the income tax treatment of the upstream oil and natural gas sector. This regulation came into effect as of December 20, 2010, in order to implement Article 31d of the Indonesian Income Tax Law. While initially questioned by the oil and gas industry, this regulation is now expected to encourage investment in the oil and gas industry in Indonesia.

However, some provisions of GR 79 may create uncertainties for the existing PSCs. GR 79 is applicable to PSCs and service contracts in the upstream oil and natural gas business sector. GR 79 aims to further govern what costs can and cannot be recovered. GR 79 also regulates the
calculation of income tax associated with PSCs, service contracts and other income outside of PSCs. Importantly, GR 79 provides contract sanctity for existing PSCs signed before GR 79 was enacted. However, matters that have not been regulated in such PSCs must be adjusted to comply with GR 79 within three months (i.e., March 20, 2011).

In a recent unexpected development, the Indonesian Constitutional issued Decision No. 36/PUU-X/2012 (Constitutional Court Decision 36/2012) that annulled several provisions in Law 22 and disbanded BP Migas. In response to the Constitutional Court Decision, the President issued Presidential Regulation No. 95 of 2012 that temporarily transfers the responsibilities of BP Migas to the Minister while the government amends Law 22 or issues a new regulation.

The Constitutional Court decision provides that existing PSCs remain in effect until they expire or until such other date as may be agreed. The Presidential Regulation similarly provides that all existing PSCs remain in effect until their expiration. The Presidential Regulation also provides that all operating processes handled by BP Migas will forthwith be handled by the Minister. The Minister also issued two decrees that transferred the responsibilities of BP Migas to the Temporary Unit of Upstream Oil and Gas Activities (Satuan Kerja Sementara Pelaksana Kegiatan Usaha Hulu Minyak dan Gas Bumi or “SKSPMIGAS”) under the Ministry of Energy and Mineral Resources.

Transfer of Oil and Gas Rights

As the exploration and exploitation of oil and natural gas are upstream activities, the only government authorization required to carry out such activities is a cooperation contract with the government through the Minister (previously BP Migas). Due to the recent Constitutional Court Decision, there are still uncertainties about who will be signing new or amendments to cooperation contracts. The determination of the contract area is subject to the cooperation contract and the initial development of the field must be approved by the Minister and in consultation with the relevant provincial government. Any subsequent development must be approved by the Minister. Notification of executed cooperation contracts must be sent to the House of Representatives (DPR) and the People’s Legislative Assembly, even though they have no approval authority.

The day-to-day conduct of exploration and production activities requires obtaining permits and approvals from agencies within the applicable regional and provincial governments, as well as the national government.

As pointed out above, mineral rights (i.e., the right to mine oil and gas) remain with the government. Private companies may engage in the exploration and exploitation of oil and gas through a cooperation contract with the government through the Minister (previously BP Migas). However, such cooperation contracts do not transfer the mineral rights to the private entities.

Development of Reserves

The PSC includes exploration and production stages. The initial of the exploration period is six (6) years and may be extended for a maximum of four (4) years, which is subject to the approval of the government (through the Minister) until a new oil and gas law is issued. The PSC itself is valid for a period of thirty (30) years and may be extended for a maximum of twenty (20) years. The PSC provides that annual expenditure requirements for the initial six years and the four-year extension and the related work program and budget must be approved by the government (through the Minister) until a new oil and gas law is issued.

In addition, the contractor is required to prepare an Authorization for Expenditure (AFE) for each of the projects in the exploration and exploitation phase for approval. The first Plan of Development (POD) for a commercial discovery of a particular field must obtain approval from the Minister, based on the considerations of SKSPMIGAS (previously BP Migas).

As mentioned above, ownership of oil and natural gas remains with the Indonesian government throughout production until delivery to a third-party purchaser. With regard to the right of the government to participate in the development of Indonesia’s natural gas reserves, Law 22, GR 35 and the PSC require the contractor to offer a 10% participating interest to a Regional Government-Owned Enterprise (BUMD) after the first POD has been approved.

Contractors are required to pay the State taxes and non-tax revenues. The taxes consist of income taxes, VAT, import duties and tariffs, regional taxes and other levies. Non-tax State revenues consist of the State’s share of fixed fees, exploration and exploitation fees and bonuses, which consist of a signature bonus and production bonus, regulated by the relevant PSC. The proceeds from the sale of oil and natural gas produced under a PSC are shared between the government and the contractor.

Historically, the general after-tax split between the government and contractors for oil has been 85:15, while for natural gas it has been 70:30 after a contractor has recovered its costs in accordance with the provisions of a given PSC. Generally, the split for oil is between 65:35 and 85:15, while for natural gas it is between 60:40 and 70:30, and, at least theoretically, the split for any given cooperation contract is subject to negotiation.

Restrictions

On June 28, 2011, the government enacted the Currency Law. The Currency Law provides that it is mandatory to use Rupiah in any transaction conducted within Indonesian territory, except for certain specified transactions that are normally associated with foreign
currencies and involve foreign parties.

There is no specific regulation on restrictions of the transfer of funds derived from production out of the jurisdiction. Under GR 35, any direct transfer of a contractor’s participating interest in a PSC must be approved by the Minister, based on the recommendation of SKSPMIGAS (previously BP Migas). From 2007 onward, PSCs have stipulated that transfers of participating interest to affiliates and a change of control in a party to a PSC require prior written consent of the Minister. GR 35 also imposes a requirement that if all or a portion of the rights of the contractor are transferred to a non-affiliate or to another company that is not a partner in the same working area, the Minister can ‘request’ that the contractor offer the interest to a national company.

In addition, during the first three years of the PSC (firm commitment), the initial contractor must remain a majority holder of the participating interest and remain the operator of the PSC.

Security and Guarantees

Minister Regulation No. 35/2008 requires PSC contractors to provide a performance bond to guarantee the PSC’s first three-year
commitment in the exploration phase. The performance bond shall amount to 10% of the total first three-year firm commitment and is
effective for a period of three years as of the date of the PSC.

The value of the performance bond can be reduced in phases, in accordance with the work plan and budget, as well as the instruction
of Migas. Migas is entitled to draw down the bond if the PSC contractors fail to fulfill the three-year firm commitment.

Under the applicable laws, ownership of oil and natural gas remains with the government until the point of delivery.  Therefore, a participating interest under a PSC cannot be pledged for security.  Despite the fact that GR 35 and the PSC may permit a contractor to transfer and assign its participating interest to other parties with the Minister’s approval, the government or the Minister will not approve a contractor pledging its participating interest for security.

In conducting petroleum activities, PSC contractors are required to comply with the provisions of occupational health and safety, environmental management and community development regulations. In the exploration phase, PSC contractors must conduct an environmental monitoring/environmental management (UKL/UPL) report. During the exploitation of the proposed development, PSC contractors must further conduct an environmental assessment (AMDAL), which is subject to the relevant government authority’s approval.

PSC contractors are also required to make periodic reports to the relevant government authorities regarding their compliance with the UKL/UPL and AMDAL. In addition, the Environmental Law enacted in 2009 also requires companies to obtain an environmental license.

Decommissioning Physical Structures

Upon the relinquishment or abandonment of any field or well, or of a PSC, the PSC contractors must remove all equipment in a manner acceptable to the Minister, as well as all necessary site restoration activities. The PSC contractor is obligated to provide reserve funds for the abandonment and site in a joint account with the government through the Minister (previously BP Migas).

In the event that the total realization cost of the well/mine plugging and restoration is smaller larger than the reserve fund, the balance will be a deducted or to cost recovery from the respective work areas or fields, approval by the government through the Minister (previously
BP Migas).

There are no specific laws or regulations regulating gas storage Gas storage facilities are subject to the general law requirements relating to environmental management.

This article appeared in the 2013 edition of The International Comparative Legal Guide to: Oil & Gas Regulation, published by Global Legal Group Ltd., London.

For Part One of our series, see:

Overview

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