Off to a New Start: The Oil and Gas Industry in Indonesia

Rig II by Tuftronic 1000

The Oil & Gas Year has published its 2013 report examining the oil and gas industry in Indonesia. Michael Twomey, a senior foreign adviser at SSEK who has been recognized as a leading lawyer in the oil and gas field, was interviewed for the publication. He spoke about the regulatory and legal challenges for oil and gas companies in Indonesia, what happens now that BP Migas has been disbanded and the  issues of land acquisition, procurement and cabotage.

The full interview is below:

THE OIL & GAS YEAR: The Indonesian Constitutional Court recently declared the establishment of BP Migas unconstitutional. What effect has the ruling had on Indonesia’s oil and gas industry?

MICHAEL TWOMEY: The effects and ramifications of the Constitutional Court’s decision are still in the process of being understood. The Court’s ruling surprised everyone in the industry, including the Government. The Court did, in fact, disband BP Migas and ordered the Government to pass a new law to establish BP Migas’s replacement. While the ruling created a great deal of uncertainty going forward, at least the Court affirmed the validity of the acts and decisions of BP Migas that had occurred prior to the Court’s decision.

TOGY: What have been some of the immediate consequences of the Court’s decision?

MT: At the risk of oversimplification I’d break down the consequences of the ruling into two broad areas:  its effect on how approvals would be obtained by a Contractor under a Cooperation or Production Sharing Contract (PSC), including approvals of Work Plans and Budgets (WP&Bs) and Plans of Development (PODs), and its effect on the party entitled to enter into long-term, material contracts on behalf of the Government, particularly PSCs and extensions of PSCs.

With respect to the former, it appears that the quick response by the Government with its issuance of regulations transferring the authorities of BP Migas to SK Migas has been effective and the industry is accepting SK Migas as the Government body entitled to issue approvals under PSCs, including approvals of PODs and WP&Bs.

However, the Court’s ruling expressly requires the Government to pass a law to establish an entity to replace BP Migas. Pending issuance of the law, there is no certainty as to who is authorized to sign PSCs, amendments to PSCs and extensions to PSCs on behalf of the Government. Until the law is passed it is doubtful any new PSCs or extensions will be signed. As a result, a new law must be passed as soon as possible for new developments to commence and for the negotiation and signing of PSC extensions to occur.

TOGY: Would such a law end the present uncertainties in Indonesia’s regulatory environment?

MT: The passage of a new law would not necessarily end uncertainty as to what body or entity should represent the Government in this regard.  According to press reports, the parties who petitioned the Constitutional Court to review the provisions of the Oil & Gas Law concerning BP Migas have indicated they plan to file further petitions questioning the constitutionality of other provisions of the Oil and Gas Law.  Furthermore, it is certainly possible these parties, or others, may question the constitutionality of any new law, regardless of its provisions.

One other issue raised by the Court’s decision that does not appear to have received much attention is its annulment of Article 63 of the Oil and Gas Law – the provision that grandfathered PSCs in effect at the time of its passage.  How this annulment will affect those PSCs is a question that will need to be addressed.

TOGY: What are some of the major regulatory hurdles for the oil and gas industry in Indonesia right now?

MT: The replacement of BP Migas by SK Migas has not changed the fact that it still takes a lot of time and effort to get projects approved by and obtain other required approvals from regulators, both at the national and at the regional level.  In addition, procurement has also not gotten any easier despite the issuance of new procurement rules in 2011. Similarly, land acquisition remains a serious problem, notwithstanding the Government’s recent enactment of a law that is intended to facilitate land acquisition for infrastructure projects.

There also appears to be a growing tendency for a number of individual Ministries and Regional Governments to issue regulations that impact on the oil and gas sector without sufficient appreciation of how their regulations will affect the oil and gas industry. I realize that overregulation and the failure to coordinate the issuance of regulations is not an Indonesia-specific problem. However, given the size and complexity of many of the projects in this industry, further emphasis needs to be placed on the coordination of the issuance of regulations affecting the industry, both within the central Government and between the central Government and the regional Governments.

TOGY: How has the transition to democracy affected the oil and gas industry?

MT: I have already alluded to what I believe are two of the biggest effects – the increased willingness to challenge laws and regulations at the Supreme and Constitutional Courts and the rise in the importance of regional governments. Unfortunately, the increased number of successful challenges to legislation, especially in the natural resources sector, leads to an increased level of insecurity for investors and, as indicated previously, the rise in the importance of regional governments has further complicated the permitting and approval process that needs to be completed before a project can get off the ground.

TOGY: How is the rise of nationalist rhetoric impacting business, particular across the oil and gas industry?

MT: As you have indicated, there does appear to be a rise in nationalist rhetoric in Indonesia. On a practical basis this leads to a preference for use of local products and the giving of priority to local companies – both of which are understandable objectives. However, these policies must be implemented fairly, consistently and transparently. Two of the biggest concerns in this regard are the local content preference given to Indonesian companies that are majority Indonesian-owned over Indonesian companies that are majority foreign-owned in the procurement process and what appears to be a tendency to award extension of PSCs to local companies, and not to the current holder of a PSC.

TOGY: What are the ongoing problems with Indonesia’s cabotage laws?

MT: Indonesia’s cabotage laws require, with limited exceptions, all vessels conducting activities in Indonesian waters be Indonesian-flagged and owned by an Indonesian company with a limit on foreign ownership of 49 percent.

The problem for the oil and gas industry is that a number of specialty vessels, as well as FPUs and drilling rigs, cost millions of dollars and foreign principals are concerned that their local partners will not have the financial capability to contribute the 51 percent of the cost of such expensive vessels.

In addition, foreign investors are concerned their local partners will not have a credit rating sufficient for lenders to accept credit support from them so that all of the credit support will need to come from the foreign investor, notwithstanding the fact it is a minority shareholder.

As for a couple specific concerns, some of the exemptions to the flagging requirement contained in Minister of Transportation Regulation No. 48 of 2011 are scheduled to expire in the next several years and, in particular, the ability to obtain an exemption from cabotage for drilling rigs varies from time to time and the increasing uncertainty as to whether an exemption will be granted or extended is a significant risk that drilling owners and PSC Contractors need to be aware of, especially since the exemption needs to be renewed every three months.

For more information on the oil and gas industry in Indonesia, see:

One Response to “Off to a New Start: The Oil and Gas Industry in Indonesia”

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