Southeast Asia Mar 17, 2006

Indonesia opens a gusher

By Bill Guerin

JAKARTA - Spurred by the personal intervention of President Susilo Bambang Yudhoyono, Indonesia has brought to a dramatic end a four-year dispute between US oil giant ExxonMobil, the world's largest oil company, and Pertamina, Indonesia's largest state enterprise. The dispute involved rights to a massive oil discovery.

The Cepu oil-and-gas block, Indonesia's largest oil discovery in decades, has estimated recoverable reserves of as much as 600 million barrels of high quality reserves and 2 billion barrels of lesser-quality reserves. The field is also estimated to hold 11 trillion cubic feet of natural gas. Tapping the find promises to return Indonesia to the status of a petroleum-exporting country,


and Yudhoyono's bold intervention in the deal was interpreted widely as a signal move towards a more foreign investment-friendly policy regime.

Exxon, which joined with Mobil Oil in 1998 in the largest industrial merger ever, has been operating in Indonesia since 1898. Its local operations are integrated under the subsidiary ExxonMobil Oil Indonesia Inc, which currently operates Indonesia's Arun gas field and is also developing a huge contested gas field near the Natuna Islands in the South China Sea.

Yudhoyono, who pledged early in his term to settle the protracted negotiations surrounding the Cepu contract, intervened in big-bang fashion last week, which came in the middle of a high-profile visit to Jakarta by US Secretary of State Condoleezza Rice.

The president fired six of Pertamina's seven directors and appointed Ari H Soemarno as the new director, replacing Widya Purnama, who was widely viewed to be at the core of the disagreement with ExxonMobil. Washington had lobbied heavily for a resolution, and the new contract signed on Wednesday gives Exxon the lead role.

The deal simultaneously represents a defeat for nationalist elements in Indonesia's legislature, suggesting that, contrary to the claim of his critics, Yudhoyono does indeed have the political will to take decisions in the national interest - even if it means siding with foreign investors.

Dwindling reserves
Although Indonesia is Asia's only member of the global Organization of Petroleum Exporting Countries (OPEC) cartel, dwindling oil output and decades of mismanagement at Pertamina has reversed the country's energy fortunes, making Indonesia a net oil importer for the past two years. While the 2006 state budget assumes oil production of 1.075 million barrels per day (bpd), the actual figure dropped to an average of around 970,000 bpd throughout last year.

Contradictory regulations, security problems, bureaucratic tangles and corruption, not to mention years of well-documented mismanagement at Pertamina, have stymied investment in new exploration in the oil and gas sector and led to declining output - although the Cepu agreement should go some way towards restoring the global oil industry's faith in Indonesia.

At a time when domestic fuel consumption is growing annually at 4%-5% and export demand for Indonesia's oil and gas is up almost 20% year-on-year, the urgency for a settlement with ExxonMobil was paramount. Current crude oil reserves are expected to be depleted by 2018, and Indonesia is in desperate need of new sources to boost production and resume its position as a net oil exporter. Last year the country had a massive US$7.3 billion oil trade deficit.

At full production capacity, which would require about $2 billion in new investments, it is estimated by 2008 Cepu could produce around 180,000 bpd. Analysts estimate that once Cepu is fully online, it would increase national production by some 20% and would restore Indonesia as a net oil exporter.

In Indonesia, the state owns all rights to petroleum and mineral finds. Foreign companies participate in the industry through production sharing and work contracts, which historically have often been prone to disagreement. Oil and gas contractors are required to finance all exploration, production and development costs in their contract areas, and are entitled to recover those expenses through sales revenues.

The enactment of new oil and gas legislation in June 2003 ended Pertamina's long-running regulatory role in the sector, which critics said often led to a conflict of interest with its production activities. The law effectively ended the state concern's upstream monopoly on handling exploration and refining contracts, and last year its longtime control over domestic distribution of fuel and petroleum-based products came to a close. Pertamina's regulatory role in the upstream sector was taken over by the state-managed Upstream Oil and Gas Implementing Body (BP Migas).

In January, a high-powered business delegation from the US, including representatives of oil companies ExxonMobil, ConocoPhillips and mining giant Freeport McMoRan, had pressed the Indonesian government to review its taxation policy on production sharing contracts and provide better incentives for their exploration activities. Specifically, they requested that the government give a clear-cut policy and explicit job descriptions for BP Migas and Pertamina, towards the aim of preventing future conflicts of interest.

BP Migas had earlier cited the Cepu difficulties as motivation for a new government plan to force foreign oil and gas investors to provide multimillion dollar performance bonds before they be allowed to sign production sharing contracts. The state agency now must approve all work and spending plans of production sharing contractors, including the Pertamina-ExxonMobil deal, and is responsible for determining what expenditures can be counted as expenses for oil and gas production operations.

New age contract
The Cepu deal cuts across Indonesia's geography in complicated ways. Part of the Cepu block is in Blora regency, Central Java, while another part is in Bojonegoro regency, East Java. Under the new agreement, Pertamina and ExxonMobil will each have a 45% equity holding in the block, with the remaining 10% - legally considered a participating interest - going to local administrations in East Java and Central Java, distributed 6.7% and 3.3% respectively.

ExxonMobil's local subsidiary, PT Mobil Cepu Ltd, will operate the block under a 30-year production-sharing contract with the government, under the supervision of the so-called Cepu Operation Committee (COC), drawn jointly from officials from ExxonMobil, Pertamina and local administrations. The committee will be empowered to take decisions on operations, development and budget, while Pertamina's subsidiary, PT Pertamina EP Cepu, will be the deputy operator of the block.

The ExxonMobil deal had featured prominently in Indonesia-US bilateral relations. On a visit to Washington last year, Yudhoyono told US oil executives that amendments to current laws governing oil and gas deals were in the works, which would offer more lucrative fiscal incentives, including a revision of the current 15% to 85% revenue split between oil producers and the government, as well as changes to the 35% to 65% split on natural gas deals.

For the Cepu deal, Exxon's take will range from 6.75% to 13.5%, depending on global oil prices. Although the contract's production split will give the government and local contractor the same 85% and 15% shares, the deal stipulates that global oil prices must average $45 per barrel or higher to maintain that pay structure, an unprecedented clause for an Indonesian energy deal. If world prices fall below $35, the split would diminish to 70% and 30% respectively.

Political energy
In August 1990, Pertamina, which was the governing Golkar Party's cash cow under former president Suharto, granted a 20-year concession to operate the Cepu block field to Humpuss Patragas (HPG), then owned by Suharto's youngest son, known locally as "Tommy", who is currently serving a jail sentence for ordering the murder of a supreme court judge. That deal was in cooperation with Australian Ampolex, which at the time owned a 49% stake in the field.

The deal was that HPG would get 35% of its production costs rebated after production. Pertamina and the contractor, HPG, would split the revenue from any excess oil produced over the agreed limits in the contract on a 65%-35% basis. But after years of unsuccessful exploration activities, HBG ran up severe debts and encountered cash flow problems, and was later forced to sell its 51% holding in the Cepu block to the Indonesian Bank Restructuring Agency (IBRA), a state-run asset rehabilitation agency established in the wake of the 1997-98 Asian financial crisis.

ExxonMobil Oil Indonesia bought both HPG's and Ampolex's stakes reportedly for around $90 million, through Mobil Cepu Ltd, acquiring 100% ownership. Soon thereafter, ExxonMobil discovered a huge reservoir of oil, the largest found in Indonesia for decades, that Pertamina had failed to hit on after nearly 30 years of plumbing the site.

Exxon said it was willing and able to invest $2 billion to develop the potentially lucrative field, but because the initial work contract was due to expire in 2010, the company sought a 20-year extension under the original terms. Pertamina proposed to act as the project's sole operator during the first five years under a new contract, a suggestion that Exxon flatly rejected unless the state-owned company put in half the development costs.

Despite the deadlock, Pertamina had said it was willing to go it alone in developing Cepu - even at the risk of facing a protracted arbitration lawsuit. Widya Purnama, Pertamina's president director at the time, said in October 2005 that the state oil firm had set aside $120 million to start drilling 30 wells in the Cepu's Sukawati and Banyu Urip fields.

Indonesian vested interest groups famously run exclusive agendas, aiming to bolster narrow personal benefits over broad national interests. Pertamina has neither the capital nor the expertise needed to develop such a major oil project, analysts say, and Hestu Bagyo, head of Pertamina's Cepu block exploration and production unit, has conceded this point in public.
Still, nationalistic sentiments have run on high since the 1997-98 Asian financial crisis, often ensnaring foreign investors. Other high-profile business disputes with foreign investors, such as with Mexican cement producer Cemex, US gold miner Newmont and the one brewing with US mining giant Freeport, reflect the risk to foreigners doing business in Indonesia. But with global commodity prices spiking up, foreign investors are nonetheless seeking new deals in Indonesia's resource rich territories, and hopes are that Yodhoyono's recent intervention will mitigate the political risks to new and existing investments.

Analysts say the resolution of the ExxonMobil deal, which is expected to start production in about 2.5 years, will bring massive benefits to the central government and also shore up newly-autonomous local regions. At peak production, citing the conservative future estimates of global oil prices averaging $35 per barrel, the government would earn as much as US$1.5 billion a year from the deal - excluding the revenues that would go to Pertamina as contractor.

"The project will create jobs, and of course it will bring benefits to the local economy," says Energy and Mineral Resources Minister Purnomo Yusgiantoro. Exxon has said it also plans to build roads, schools, medical clinics and other infrastructure for the project.

Marginal dissent
Nationalistic commentators had demanded that Pertamina maintain sole control of the Cepu block for the first five years of the project, and thereafter manage it with ExxonMobil managers on a rotating basis. American control would amount to another form of colonization, they claimed, and in any case they argued that Pertamina's local staffing expenses would keep down costs.

Although Yudhoyono's intervention has broadly cheered foreign investors, it's not yet clear that the nationalists have been completely pushed into the shadows. Over 400 Muslim protesters staged a rally in front of the US Embassy on Tuesday, slamming what they said was US interference in Indonesia's domestic affairs, citing in particular ExxonMobil's deal in Cepu and Freeport's investment in Papua. The protesters were predominantly from the Muslim radical Islamic groups Hizbut Tahrir and Majelis Mujahideen, led by convicted cleric Abu Bakar Baashir, the alleged leader of the militant Jemaah Islamiyah organization accused of masterminding the Bali bombings.

It's not just Islamic radicals that are making nationalistic demands, however. Sutarjo Suryoguritno, deputy speaker of the House of Representatives, warned that a ruling in favor of ExxonMobil would be tantamount "to us being colonized again ... I urge the government to return to the true path. We should take a firm stance, that the oil block is the right of Indonesia and its people," he told reporters. "We'll take every means, including legal and political measures, to fight the decision," echoed Tjatur Sapto of the National Mandate Party.

Yudhoyono, with his strong democratic mandate, at least for now is firmly in control and has shown no sign of being influenced by the nationalist opposition. He has important backing for his pro-foreign investment decisions from the secular-minded Golkar Party, which commands the most seats in the House of Representatives.

Agusman Effendy, chairman of the commission responsible for mining and energy and a political heavyweight from the secular Golkar Party, recently said that it was essential that the Cepu block start production as soon as possible. "We should not lose the momentum."

<i>Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 20 years, mostly in journalism and editorial positions. He has been published by the BBC on East Timor and specializes in business/economic and political analysis related to Indonesia. He can be reached at softsell@prima.net.id.
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