People Innovation Excellence

Future oil and gas development: Some harsh realities

No matter who wins the presidential election, the winner will have to tackle the harsh realities now faced by the oil and gas industry. These realities, in a nutshell, are: oil production is declining, gas production is stagnant. The present infrastructure for gas distribution is inadequate.

The legal framework for future development is in dire need of immediate repair, and the much-discussed draft bill amending the 2001 Oil and Gas Law does not provide any encouragement about the future.

Many of the production-sharing contracts (PSC) are expiring in the next five years. Together, these production blocks amount to about 80 percent of our current total national production of oil, which now stands at a mere 820,000 barrels of oil per day (bopd).

Resolving the issue of contract extensions is long overdue if we want to avoid an even steeper production decline in the near future.

We have not even touched upon the ever increasing price tag of fuel subsidies, which are bleeding and crippling our economy.

These are such deeply disturbing realities that even the most optimistic among former oil and gas
executives like myself become dismayed by the apparent lack of urgency about tackling these harsh realities. But rhetoric and politics seem to take priority over the reality in the field.

At the recent Indonesian Petroleum Association (IPA) Convention these concerns were again voiced during the keynote speeches. This country is still a major hydrocarbon province. The remaining potential is still considerable. But one can not eat potential. The potential needs to be monetized.

That interest will not be be served if that mineral wealth stays in the belly of the earth. In the 1970s that goal was nearly achieved. In 1966, when Indonesia launched the PSC concept, our national production stood at 500,000 bopd. Ten years on, in 1977, our national oil production had reached 1,683,000 bopd! We had more than tripled production within 10 years by 1977.

With the tripling of production and quadrupling of oil prices in the late 1970s, we were economically and financially in great shape to join the ranks of other Asian tigers.

We had become the world’s number one exporter of liquefied natural gas (LNG). But instead of continuing on this upward trend, we fell off, because we started to bureaucratize the industry and virtually stopped exploring.


How can we so easily discount the remaining oil potential without really scientifically evaluating it?


Consequently, we failed to embark upon more field development, to offset the decline from major
existing fields.

The reason for the reversal was the reluctance of investors to spend exploration dollars in the absence of long requested incentive programs and due to crippling micro-management. Today we are down to about 820,000 bopd. Cepu is said to be our only near-term hope for reversing the trend.

According to the existing wisdom among oil and gas pundits, it will take one new production block the size of Cepu to be put on stream each year for at least the next five years to reverse the decline.

I am not a geologist but I am an optimist and I do not agree with a pessimistic prediction.

Since only about 50 percent of the known sedimentary basins have been touched by the drill, how can we so easily discount the remaining oil potential without really scientifically evaluating it?

Remember, back in the 1980s people were inclined to write off Papua as a viable oil and gas province having not found any hydrocarbon potential to speak of since up to that point only minor discoveries had been made.

Then, in 1990, ARCO discovered huge gas reserves at Wiriagar, which later became Tangguh. Of course such developments will carry a much higher risk and consequently require a much higher level of funding.

In order to define remaining conventional and non-conventional oil and gas potential we need to do three things immediately — namely, explore, explore and explore.

But exploration is high risk. There’s only a small chance that a dollar spent on exploration will turn into a commercial venture.

That means that the banks will not touch it with a 10-foot pole. You can not go to any bank to borrow money for exploration.

Banks are risk averse. So where does one go to find the exploration dollar? We have two choices: use your own funds (equity) or find a willing investor.

Fortunate for us there still are investors willing to risk their own money on Indonesian exploration, despite the minimum government encouragement and support.

We need all the collaboration we can get. The future developments are going to be expensive! Of course there is a price to pay for collaboration as well but under the PSC system it is paid back, in kind, out of production, if there is production. Not out of the state budget.

The going wisdom is never risk your own money! If there is a guy out there daring enough to risk his own money who is prepared to swallow his losses if exploration is not successful, by all means use him. It would be foolish not to.

Which brings me to the next point. Why were we so successful back in the 1970s? What was the “secret”? I have been asked that question frequently because I worked in that era and became the CEO of a major producer at that time.

There was no “secret”, no magic potion. What happened in the 1970’s was that the companies that had secured a PSC were all genuine explorers and developers.

Real oil field hands who had worked oil and gas fields all over the world from the Middle East to Lake Maracaibo in Venezuela.

They were used to hardships and difficult government relations and uncertain oil prices. They were bonafide investors. Gas was not even on the radar screen then. Gas was a by-product of oil that needed to be flared.

These companies came to stay, not for a year or two but they signed up for 30 years and most of these early PSCs got extended by another 20 years because they kept finding new fields. These were the Conocos, ARCOs, Unocals, Chevrons, Totals of this industry.

They were all here and most are still here. They are proven friends and love this country. They provide the exploration dollars.

They are prepared to provide the funds to drill in deep water and in remote areas. Because of their early successes, others followed in the late 1980s and 1990s thinking it was easy money.

These followers were often broker types, both foreign and local, looking for a quick profit, in and out, not planning to dig in for the long term. Some secured a PSC through political connections, thus blocking potential acreage by not spending enough, just biding time to peddle the asset not much later for a handsome profit.

This is one reason why our national production declined, because so many of the followers did not intend to stay for the duration. I hasten to add that this episode had a positive side also in that certain national companies like Medco, Star Energy and EMP were born in that same period and they did well and we should respect them for their enterpreneurial attitude and for their contribution to the country.

Let us not forget that one other big reason for the production sharing contract’s (PSC) popularity was that it advocated collaboration, instead of expropriation that had been the norm in the Middle East in the 1970s. The PSC had reduced the position of the investor to that of a contractor but it was elegantly handled and the investors still felt secure despite having given their management rights away.

The management prerogative was — then — being executed in a manner that was acceptable to the investor. The PSC was hailed as “an elegant alternative” to expropriation efforts in other places. Because of the success of the early PSCs, those major foreign operators are now being accused by certain elements of our society of dominating the industry and therefore robbing the country of its sovereignty over its mineral resources. Personally I think that is an unfair and misleading verdict.

These producers actually became the victims of their own success. They had no intention of dominating. They were quite willing to submit to the management and control of Pertamina, the Upstream Oil and Gas Executive Agency (BP Migas) or the Upstream Oil and Gas Regulatory Special Task Force (SKKMigas).

However, they now feel frustrated and believe they are no longer welcome as their contracts are not being extended and their complaints about heavy-handed micro-management are not being heeded. They are increasingly more concerned about the negative attitudes and overtones in the media against the oil and gas investor community. There is no reason to believe that under the PSC concept this country has lost its sovereignty over its resources. If anything, it is the other way around because the government is now perceived to be over-controlling, over-regulating and under-managing.

What about gas? Well, gas is now very much on the radar. We no longer burn gas, if it can be avoided. We now utilize the gas and it has emerged as our prime energy source. The wisdom on the street is that we have enough gas to supply our energy needs for the near future. I agree with that statement.

However, the problem with gas is that we do not have sufficient infrastructure in place. Gas is normally found in places far from the market. Companies like state-owned enterprise PT Perusahaan Gas Negara (PGN) have become gas producers in their own right and proceeded to build a floating storage and regassification unit (FSRU), which has now been completed and is parked in Lampung to commence conversion of liquefied natural gas (LNG) into pipeline gas as we speak. It sends a message to all parties, including traders, that infrastructure is key.

That said, it needs to be understood at least that the PSC has a “cost recovery” scheme, allowing it to recoup most of its expenditure from production, although cost recovery is still being attacked from all sides. To those downstream players trying to turn a profit in the downstream business of building and operating pipelines, there is no guarantee that an investment in the downstream will ever be recovered. The regulatory system in place for pipelines provides for the application of a toll fee, which only provides for a very marginal return. Hence, the investor bears most of the risk, but the upside is tightly capped.

Further, there is no guarantee that the gas transported through that pipeline will be allocated to the party that built the infrastructure, although it should be. As things have turned out, brokers and traders end up getting allocations of gas, rather than the infrastructure builders and investors. These factors, among other things, have raised very minimal interest in infrastructure projects.

Those who are involved in the domestic gas trade should also be obligated by regulations to build the much-needed infrastructure, as without that they will just be a broker and not support the government’s effort to create more gas infrastructure. We do not need brokers, we need explorers and developers. The future government needs to define the criteria that has to be met by those who wish to “play” in the oil and gas industry, like performance bonds for participants in tenders for new blocks. The challenge before the new government in regards to oil and gas is to regulate a more level playing field, and provide a higher sense of urgency at all levels in all matters related to oil and gas development.

It goes without saying that oil and gas remain a prime source of revenue for the state. It is still the single largest source of revenue and we have to keep it that way. But how? We already flagged exploration as an absolute requirement. But exploration is only one of the many problems.

First order of the day, therefore, is for the new government to immediately sit down with the major producers in this country, local and foreign, and to start a meaningful dialog on a regular basis. Be a good listener. Keep the group small. Set up a task force that is empowered on both sides to bring things to a close. Put a timeline on it. The deliverable at the end of the timeline is a document that in no uncertain terms outlines a mutually acceptable action plan designed to get the industry moving again.

This action plan must be endorsed at the highest level of government. The purpose of this effort is to get the industry back on track after it derailed a long time ago. This effort must, therefore, be directed from the very top and it must be a collaborative effort between stakeholders. It may call for allowing producers more latitude to run with the ball, to do what they do best, without intervention. Try to significantly improve the investment climate and the operating environment. Cut the bureaucracy down to the very minimum.

It will call for “fast track” development and aggressive de-bureaucratization and de-regulation. Design incentive packages to the producers for any field brought on production within the timeframe. This must be a collaborative effort that, at the end of the day, will hopefully restore trust and rekindle a spirit of partnership. The key word is trust.

Without trust, business cannot exist. Starting a serious dialog is a wise way to start. The next steps will flow from that dialog. It is imperative that the media must be transparently involved to counter some of that past misinformation about the industry, a poison that has already influenced the mindset of the man on the street.

Strong and out-of-the-box leadership will be called for, as there will be strong resistance against such measures from vested-interest groups. However, even if all of the above is implemented next week (which it will not be), its results will not become noticeable until many years later. We have lost that much momentum. Hopefully from this effort, a new era will be born. An era of a level playing field. An era based on mutual respect and of a true spirit of partnership. Let us give it a try. We are flat out of time.


The writer is the former president and resident manager of ARCO Indonesia. He also served as president commissioner of PT Perusahaan Gas Negara (Persero), Tbk. He is a senior advisor at the Law Office of Hakim dan Rekan in Jakarta. He teaches business subjects at the Business School of Binus University in Jakarta and remains an industry observer. The opinions expressed are his own.


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