On 16 January 2017, Indonesian Ministry of Energy and Mineral Resources (MEMR) issued Regulation No. 8 of 2017 regarding the Gross Split for Production Sharing Contracts (MEMR Regulation 8/2017) which introduces an important new government revenue split system for certain oil and gas up-stream operations in Indonesia.
Under MEMR Regulation 8/2017 all new production sharing contracts (PSCs) awarded by the Indonesian Government will be subject to a new gross revenue split system and the existing cost recovery regime will no longer apply. Under this new system, PSC contractors will be entitled to a significantly larger revenue share from oil and gas production but all risks and costs (including exploration and operations costs) will be the sole responsibility of PSC contractors.
The first new PSC under this new gross revenue split system was awarded by the Indonesian Government on 18 January 2017 in relation to the Offshore North West Java (ONWJ) working area which is currently managed by a subsidiary of the Indonesian state-owned oil and gas company, Pertamina.
1. Gross revenue split mechanism
Under the existing PSC regime, PSC contractors can apply for cost recovery for certain qualifying exploration and operational expenses which have been incurred by the PSC contractor whenever the field(s) can be commercially produced. In addition to this cost recovery, existing PSC contractors are typically entitled to a revenue split with the Indonesian Government of 15% for oil production and 30% for gas production.
Under the new scheme, PSC contractors will not be entitled to cost recovery for their exploration or production costs. Instead, contractors under new PSCs will be subject to a gross revenue split determined by MEMR. This new gross revenue split for the PSC contractor will have a base of 43% for oil production and 48% for gas production which can be adjusted up or down by MEMR based on prescribed variable and progressive components for the relevant field.
The actual gross revenue split for each oil and/or gas field will be determined by MEMR when the plan of development (POD) for that field is first approved by MEMR. The prescribed variable and progress components for determining the actual gross revenue split (as adjusted from the base gross revenue split) includes factors such as: (i) the status of the working area; (ii) the location of the field; (iii) the depth of reservoir; (iv) the global price of oil; and (v) the total cumulative production of oil and gas. In addition, if a field cannot achieve economic feasibility, MEMR may grant up to an additional 5% gross revenue split to the PSC contractor. On the other hand, if a field exceeds a certain size (and achieves a certain economy of scale), MEMR may decide to reduce the PSC contractor’s gross revenue split by up to 5%.
Also, following the commencement of commercial operations under the POD, if it is discovered that the actual physical condition of the field is different to the prescribed variable and progress components used by MEMR in calculating the relevant gross revenue split, then the gross revenue split can be amended accordingly.
Once a PSC contractor has applied the relevant gross revenue split, the PSC contractor will still be liable to income tax but will remain entitled to apply for tax facilities and other incentives in accordance with the existing regulations for the oil and gas sector. Under the new gross revenue split system, the operating costs incurred by the PSC contractor can be included as a deduction against the contractor’s income tax.
2. Application of the new gross revenue split scheme
MEMR 8/2017 and the new gross revenue split system will automatically apply to all new PSCs awarded by the Indonesian Government after 16 January 2017. In practice, except in relation to the new gross revenue split system, the general terms and conditions of these new PSC are generally consistent with the terms and conditions of existing PSCs, including in relation to domestic market obligations, prioritization of local goods and services and work program and budget approvals. It also appears that under the new gross revenue split system the involvement of SKKMIGAS (as the Indonesian Government unit who manages the oil and gas business activities in Indonesia) will be significantly reduced in terms of control and supervision authority. For example, under MEMR Regulation 8/2017, SKKMIGAS will not have involvement in the procurement of goods and services by PSC contractors as these activities may conduct independently by PSC contractors. Under MEMR Regulation 8/2017, the role of SKKMIGAS will be more focused on formulating policy, reviewing the work programs and budgets submitted by PSC contractors and supervising the realization of exploration and exploitation activities in accordance with the approved work programs and budgets.
All existing PSCs (including PSCs whose extensions have already been approved) shall remain in effect on their current terms and conditions until their expiry date. However, each existing PSC contractor can (at its discretion) elect to amend its existing arrangements to become consistent with the new gross revenue split system. If a PSC contractor elects to convert to the new gross revenue split system, then any unrecovered operating costs under that PSC will be taken into consideration by MEMR as an additional adjustment to the base gross revenue split.
3. Implication for the oil and gas industry
The existing cost recovery system has long been criticized by the oil and gas industry in Indonesia as being administratively burdensome and uncertain. The eradication of the existing system should lead to increased efficiencies, less bureaucracy and allow greater discretion and innovation by PSC contractors in the conduct of their operations.
For existing oil and gas producers, the option to convert to the new gross revenue split system may come as a welcome relief (particularly for mature fields with a relatively high degree of certainty in relation to the prescribed variable and progress components which will be applied). Of course, it remains to be seen whether the Indonesian Government will apply the new gross revenue split system in a way that fairly allocates the efficiencies, risks and cost savings under this new system.
However, one of the key benefits of (and policy reasons behind) the cost recovery system, is that it allows PSC contractors to somewhat de-risk their exploration costs and to promote oil and gas exploration activities. At a time when Indonesia’s oil and gas production is rapidly declining and investment in oil and gas exploration is low, it is a curious decision by the Indonesian Government to eliminate the cost recovery system for new PSCs. The Indonesian Government is now facing the challenge of finding other ways to promote new and much-needed investment into oil and gas exploration.