Indonesia Briefing: Latest Changes in Energy Law

Indonesia Briefing: Latest Changes in Energy Law

The Indonesian government has recently passed new regulations introducing
significant changes to the power and upstream oil and gas sectors. In Part
1, we discussed the power sector. In this briefing note, Sean Prior, Counsel
of Mayer Brown JSM and Fadjar Kandar, Managing Partner of Kandar & Partners
highlight the latest developments in the upstream oil and gas sector and
their likely impact on Indonesian investment.

Introduction of Gross Split Method to Future Upstream Production Sharing
Contracts

WHAT NEW REGULATION HAS BEEN PASSED?

a. On 13 January 2017, Indonesia's Minister of Energy and Mineral Resources
of Indonesia (MEMR), which supervises the oil and gas, mining and power
sectors, issued Regulation No. 8 of 2017 on Gross Split Production Sharing
Contract (Regulation 8).

b. Regulation 8 changes the way in which upstream oil and gas contractors
obtain revenue from oil and gas sales under their Production Sharing
Contracts (PSCs), and in particular, how they recover their significant
upfront development costs.

IN COMPARISON WITH THE EXISTING SYSTEM, WHAT HAS BEEN CHANGED?

a. Existing system: Existing Indonesian PSCs are based on the principle of
cost recovery. Under this principle, provided a discovery is developed in
accordance with a government approved Plan of Development, the contractor
can utilise the proceeds of oil and gas sales to recover the costs it has
incurred in exploring, and then developing, the resource. The government
usually takes the first tranche of petroleum share (up to 10%), following
which the contractor has priority rights to sale proceeds until it has
recovered all of its permitted development costs. Following cost recovery,
the contractor and the government then split future sale proceeds based on
agreed profit shares in the PSC.

b. New system: Regulation 8 replaces this cost recovery mechanism with a
system where the contractor receives a gross split of production from the
start of operations (Gross Split), on which it pays income tax. Regulation 8
sets out a base production split (Base Split) of 57%/43% in favour of the
government for oil, and 52%/48% in favour of the government for gas. The
Base Split is then adjusted (following the approval of the contractor's Plan
of Development) by taking into account components such as local content,
availability of supporting infrastructure, changes to the indexed oil price
and the contractor's overall production volume (as further detailed in
Regulation 8).

WILL IT AFFECT EXISTING PSCs?

a. No. PSCs signed prior to the issuance of Regulation 8 will remain valid
until their expiration. A contractor may choose to change an existing PSC to
a Gross Split model, but it is not required to.

b. PSCs already approved for extension may continue to use the cost recovery
model, or the contractor may choose to convert to the Gross Split model.

c. Regulation 8 does not specifically require contractors to use the Gross
Split method for new PSCs, but we understand that the MEMR's current view is
that it will, as a matter of policy, require new PSCs to apply the Gross
Split method.

WHAT ARE THE LIKELY PRACTICAL IMPLICATIONS?

a. Whilst Regulation 8 provides broad guidelines, it does not detail how in
practice parties will agree the adjustments made to the Base Split.
Developers are likely to require clear procedures on this before they
undertake significant investment. The rules introduce greater potential for
uncertainty by allowing further adjustment to the splits if the field
characteristics turn out to be different during development.

b. Since a contractor will no longer have a priority right to use all of the
sale proceeds for cost recovery, it will calculate its initial economic base
case and sensitivities differently, as it will be "on risk" for recovering
the costs of development for a significantly longer time.

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John Diecker
APT Consulting Group Co., Ltd.

www.aptthailand.com