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Rethink of oil and gas production sharing contract regime in Indonesia might be needed to spur investment, says expert

Out-Law News | 23 May 2017 | 2:43 pm | 2 min. read

The Indonesian government may need to rethink the way it supports international investment in its oil and gas industry after it received a lukewarm response to making 15 oil and gas blocks available for production sharing last week, an expert has said.

The new blocks being made available will be governed by a new form of Indonesian petroleum contract, the 'gross split' production sharing contract (PSC), which was introduced earlier this year.

However, the gross split PSC regime could see contractors take on the majority of risk and costs, deterring interest in the projects, said oil and gas expert Steve Potter of Pinsent Masons MPillay, the Singapore joint law venture partner of Pinsent Masons, the law firm behind Out-Law.com.

According to a report by Reuters, the Indonesian government is open to negotiation with oil and gas contractors on the terms of sharing production costs for the new blocks.

Under the new gross split PSC regime, contractors 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.

Potter said: "The new gross split scheme, under which all of the new blocks are offered, sees the complete elimination of cost recovery, removing the need for related project budget scrutiny by Indonesia’s upstream oil and gas regulator SKK Migas. The government and PSC contractors will instead split gross production without any deduction of exploration, development and production related capital expenditure, operating costs and taxes. The ultimate 'split' will be adjusted based on field characteristics, oil price and cumulative production, among others. The PSC contractor will – at least in theory – be allocated a greater share of gross oil and gas production."

Potter said that the gross split PSC may not spur investment in every oil and gas exploration project. Recent analysis by Pinsent Masons, in partnership with Wood Mackenzie (17-page / 5.9MB PDF), showed that the level of interest and investment from contractors would be likely to largely depend on the type of project and the PSC operator’s ability to substantially reduce operating costs, Potter said.

"For most projects types, particularly marginal fields, mature fields in need of enhanced oil recovery, projects located in frontier areas and gas projects, petroleum economists at Wood Mackenzie found that the gross split PSC may ultimately deter investment unless operators can make additional cuts to costs of between 10% and 20%," Potter said. "We are therefore not entirely surprised by the lack of enthusiasm following Friday’s announcement. This lack of enthusiasm is also consistent with our understanding that no current PSC contractors have approached the government requesting to transition across to the new regime."

Potter said that, while some aspects of the gross split PSC are to be welcomed, it may need to be amended to make oil and gas projects in Indonesia more attractive to international investors.

He said: "The removal of the ever growing bureaucracy around cost recovery has been welcomed positively by the industry and the new regime does go some way in providing a suitable framework for a new and potentially more attractive PSC model. Unfortunately, the production splits and accompanying adjustment mechanisms included under the proposed scheme are unlikely to sufficiently incentivise much-needed investment into Indonesia’s upstream sector. It is hoped that the Ministry of Energy & Mineral Resources will be accommodating in amending and adding to the new regime going forward, as industry players experiment with its implementation in relation to different types of projects."