Indonesia's Oil Quandary

Vandana Hari, Platts News Director Asia, with Dave Ernsberger, Platts Senior Editorial Director Asia

Since the turn of the century, a relentless decline in Indonesia's crude production has turned the country into a net oil importer. In that time, the government of the ASEAN giant has watched in frustration as rival exporters around the world, particularly Algeria, have cheerfully and capably assumed a large portion of its production quota within the Organization of Petroleum Exporting Countries.

INDONESIA'S TOP LAWMAKERS ARE STARTING to ask difficult questions about the nation's production-sharing contracts (PSCs), which have been unable to stem a steady decline in its crude production—most of which comes from mature fields. Will the new attention from the government put the archipelago's oil production on a road to recovery, or shove it another step towards a gloomy future?

The nation's crude output currently languishes at just above 820,000 b/d, compared with as much as 1.5 million b/d in the late 1990s, when Indonesia was actually exceeding its OPEC production quota. Since 2005, Indonesia has been second only to Venezuela in missing its production quotas.

What is worse, in its latest production cut rounds of November 2006 and February 2007, OPEC appears to have effectively adjusted Indonesia's production "quota" to a new reality of low production and bleak outlook for investment.

By putting in place cuts based on actual production levels, instead of using the quotas as its starting point, OPEC's leadership effectively handcuffed Indonesia to the grim reality and consequences of years of ineffective or insufficient investment.

But most painful of all, two years after first becoming a net oil importer, Indonesia is increasingly buying more barrels from overseas than it exports as its products appetite balloons while crude production wanes.

An analysis of statistics from the country's central bank show that Indonesia was a net importer of about 167,900 b/d of crude and refined products in the first four months of 2007. Using final data for January and February and preliminary figures for March and April available from Bank Indonesia, Indonesia's net imports were more than double the January-April 2006 average net oil imports of 72,540 b/d.

As the country feels the pinch of sinking oil production and billowing imports, the Indonesian government is looking to rationalize expenses that production-sharing contractors can claim under cost recovery in a bid to increase its profit from oil and gas.

The topic has been a gathering storm over the past few months, and parliamentarians have turned up the heat on the government to ensure that PSCs do not overstate their expenses and that there is full transparency in the cost-recovery claims process.

The recent run-up in the costs of materials and services used in exploration and production has added fuel to the fire, prompting some lawmakers to question why the country is not seeing results, despite the increased money being spent and reclaimed by the contractors.

Under Indonesia's PSC system, after the contractor recovers costs, the remaining output—which is the profit—is split between the government and the contractor in a predetermined ratio, typically 85:15 for oil and 70:30 for gas.

As an incentive to upstream investors, the government has allowed recovery of some expenses incurred during the exploration phase, although these can be claimed only after the start of commercial production.

Indonesian lawmakers took up cudgels after the country's Supreme Audit Agency, commonly known by its Indonesian acronym BPK, said late in 2006 that it had found suspicious mark-ups and other irregularities in some of the cost-recovery figures submitted by production sharing contractors in 2004 and 2005.

The oil and gas ministry, the BPK, the finance ministry, industry experts and representatives of the lower house of parliament's Commission VII, which oversees the oil and gas sector, met on August 2, 2007 to thrash out the thorny and multi-faceted issue, but emerged with few answers. They recommended that the government increase its monitoring of the contractors' cost recovery claims and improve the efficiency of implementation of the PSC system, but did not spell out details.

The officials also appeared to have sidestepped one of the debate's central and contentious issues, which was recovery of contractor expenses categorized as "corporate social responsibility." These refer to contractor spending on charity or community work away from contract areas, and symbolize a grey area in the current system, which was being targeted for removal.

For the time being, Jakarta has avoided an overhaul of the country's cost-recovery system, which might have put more oil and gas profit into the government coffers but risked further alienating the major foreign oil and gas producers in the country. Cost recovery is not at the center of the malaise in Indonesia's upstream sector, these contractors argue, but rather the lack of sufficient incentives and a favorable investment climate.

The exploration blocks put up for bidding in recent years have attracted only local minnows, untested on their financial and technical capabilities.

At the end of 2006, upstream regulator BPMigas celebrated the fact that Indonesia had slowed down the rate of decline in its oil production. But to really turn things around, BPMigas is cracking the whip over international oil majors to speed up production from several oil and gas fields in the coming four years.

These include Chevron's Gendalo in East Kalimantan, ExxonMobil and Pertamina's jointly operated Cepu on the border of Central and East Java, as well as Australian Santos' Jeruk and Oyong fields in East Java.

For 2007, at least six oil and gas fields were slated for development — Hess' Ujung Pangkah in East Java, Chevron's Seturian in East Kalimantan, PetroChina's Wakamuk in Papua, Total's Sisi and Nubi fields in East Kalimantan, and Medco's Kaji Semoga in Sumatra.

But several mega-projects, particularly the enormous Cepu field, have announced delays and problems since the start of 2007, most lately because of problems with clearing land that would set the project back by as much as ten months.

With such elemental challenges hindering the jewel in the crown of Indonesia's future oil production, concern continues to grow among Indonesia's neighbors and traditional oil customers over the country's crude oil production prospects in the years to come.

1. Production Compared to Quota. OPEC-10 country-by-country (barrels per day) Source: Platts