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2 May, 2017
INTRODUCTION
After almost 50 (fifty) years of the traditional Production Sharing Contract (“PSC”) being applied in oil and gas contracts (PSC), where government and contractors’ revenue share is split after deducting the production costs (cost recovery), the Minister of Energy and Mineral Resources (“MEMR”) as the party responsible for determining the final form and provisions of PSC, has issued Regulation No.08 of 2017 concerning Gross Split Production Sharing Contracts (“MEMR Reg. 08/2017”), effective on 16 January 2017.
Actually, the gross split scheme is not a new term in the oil and gas sector in Indonesia. In 2015, the government introduced a gross split sliding scale PSC as an option for production sharing contracts for non-conventional oil and gas (i.e. shale oil, shale gas, tight sand gas, coal bed methane and methane-hydrate, using specific technology such as fracturing) under MEMR Regulation No. 38 of 2015 regarding Expediting Non-Conventional Oil and Gas Operations (“MEMR Reg. 38/2015”).
However, this regulation did not provide any mechanism for the implementation of the gross split sliding scale PSC. Therefore, by the issuance of MEMR Reg. 08/2017 which applies to both conventional and non-conventional oil and gas, MEMR Reg. 38/2015 is revoked and declared no longer in effect.
FEATURES OF GROSS SPLIT
The Gross Split PSC must at least contain the following conditions: (i) oil and gas remains the property of the state until the delivery point of production; (ii) the Upstream Oil and Gas Regulatory Special Task Force (“SKK Migas”) retains management control of operations (but limited to policy formulation toward work plans and budgets and also ensuring compliance with the approved work plan), while PSC contractors still need to prepare work programs and budgets for SKK Migas’s approval; and (iii) the required capital and risk of operations is to be fully borne by the PSC contractor.
At the time of the approval of the first plan of development, MEMR with a recommendation from SKK Migas will determine the split with an initial base split for oil is 57% to 43% for the government and contractors respectively, and 52% to 48% for natural gas.
The base splits are adjustable by incorporating other metrics, which are called variable and progressive components. Variable components include the block status, the field’s location, the reservoir depth and type, the availability of supporting infrastructure, the content of carbon dioxide and hydrogen sulfide, the oil’s weight, local content and stages of production. These variable components can adjust contractors’ base splits negatively and positively. Each component’s adjustment varies, but it may range from 16 % to minus 5 %. For progressive components, there are 2 progressive components, namely oil price and cumulative production.
The first PSC under the new scheme was a renewal of the Offshore North West Java (ONWJ) PSC with PT Pertamina (Persero), Indonesia's national oil and gas company, which was signed on 18 January 2017.
The ONWJ block has been in production for many years and was first awarded in 1967.
THE DIFFERENCES FROM THE OLD SCHEME
It is clear from MEMR Reg. 08/2017 that the mechanism of the gross split PSC removes the cost recovery concept so that the contractors will be responsible for the upfront costs of exploration and production.
In a traditional PSC, expenditures of investment and operating costs in the PSC had to receive the approval of SKK Migas because after the contractors started commercial production, the contractors had to be reimbursed for the costs they had expended to conduct the exploration and exploitation in accordance with the work plan and budget and authorizations for financial expenditure approved by SKK Migas. Cost recovery was essentially the capital and operating expenditures of an upstream operation, which were paid and assumed in advance by the contractors.
In a gross split PSC, although contractors still have to submit the work program and budget to SKK Migas, SKK Migas will evaluate of the work plan where the budget submission is for the supporting data of the work plan. The contractor take in a gross split PSC is calculated based on gross production after deduction of income taxes. Article 14 of MEMR Reg. 08/2017 provides that the operating cost spent by contractors is the basis to calculate their income taxes. With this provision, we could say that although the gross split PSC makes contractors bear all the costs (including procuring all upstream operational equipment which automatically belongs to the state) in turn for a higher share of the output, the capital and operating expenditures are factors which reduce contractors’ income tax in return for eliminating cost recovery terms and procedures. In the traditional PSC, the cost recovery (from the capital and operation expenditures) was deducted from the whole oil and gas production in order to determine the amount of production to be shared between the government and the contractors. Afterwards, contractors paid their income taxes on their share of production after it was split.
The economic benefit from the gross split PSC is that it awards share of production, bonuses, income taxes and indirect taxes (in this case value added taxes) to the state, while contractors receive a share of the production according to the percentage of their gross splits less income taxes, bonuses, and indirect taxes.
Aside from the gross split mechanism, there are no other fundamental changes in the gross split PSC. Data obtained during the implementation of gross split PSCs remains the property of the state, including the existing strict confidentiality and the disclosure regulations and the 25% domestic market supply obligations will continue to apply. The gross split scheme will also still require the contractors to comply with local content (TKDN) as well as the deployment of national workers. Other provisions in the standard PSC, such as those relating to mandatory relinquishment of working area, minimum work and expenditure commitments, restrictions on assignment, 10 % Indonesian participation rights, conditions for contract extension, and creation of a reserve fund for abandonment and rehabilitation, still have to be incorporated in the gross split PSC in accordance with the prevailing regulations.
IMPACT FOR CONTRACTOR
Basically MEMR Reg. 08/2017 aims to make the exploration and exploitation activities more effective and efficient, eliminate the government bureaucracy, and also encourage PSC contractors to have more flexibility in carrying out exploration and exploitation.
Further, as there will be no cost recovery under the gross split PSC, this scheme is designed to eventually reduce the burden on the government Indonesia's budget.
As mentioned above, the split for contractor may be increased due to several components, such as for the first plan of development, the contractor will get an additional split of 5% while there will be no 5% uplift for subsequent plans of development or for additional work under an existing plan of development. On the other hand, if the field commercial calculation does not achieve a specific economic level, MEMR can provide an additional split by 5% to the contractor while if it is exceeded, the government may take an additional share of up to 5 % from the contractor.
For the progressive components, a lower Indonesian Crude Price (ICP) than US$40 per barrel will improve contractors’ base split by 7.5 %, but if ICP increases to $115 per barrel (or above), the contractors’ base split will be cut by 7.5 %. For the cumulative production, greater production means a greater reduction of the contractors’ production split. This means that the contractor will receive an adjustment in its favor when a field is first producing, and as cumulative production from the field increases, that favorable adjustment reduces until it ceases once cumulative production reaches 150 MMboe.
IMPLEMENTATION OF GROSS SPLIT PSC
The issuance of MEMR Reg. 08/2017 indicates that the PSC for an upstream activity must follow the new scheme that MEMR has
proposed, namely the gross split PSC. Hence, the new scheme is mandatory for all PSC entered into after the effective date of this
regulation.
For existing PSC, the transitional provision of MEMR Reg. 08/2017 provides that contractors in existing PSC that are expiring and being approved for extension have the option whether to use the gross split PSC or to use the original PSC cost recovery and profit split scheme.
This option also applies to contractors whose PSC were signed before the regulation came into effect: they can propose converting the PSC scheme to a gross split PSC at any time.
In the event the contractor proposes to convert to a gross split PSC, all operating costs incurred but not yet recovered (unrecoverable balance) under the previous PSC terms can be added to the gross split in favor of the contractor’s share. Any proposal to change the scheme to a gross split scheme would be subject to approval, but the regulation is silent on
the mechanism of the approval process.
This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions or matters.
For further information, please contact:
Al Hakim Hanafiah, Partner, Hanafiah Ponggawa & Partners
ahhanafiah@hplaw.co.id
