Jim Taylor, President Director, ConocoPhillips; Sammy Hamzah, CEO, Ephindo; Terry McPhail, President & General Manager ExxonMobil; and Hilmi Panigoro, President Commissioner, Medco

Interview: Jim Taylor, Sammy Hamzah, Terry McPhail, Hilmi Panigoro

How would you characterise the government’s plan to develop the energy mix and reduce the country’s dependence on oil and gas?

SAMMY HAMZAH: Our industry is a very dynamic one where continuous evolution takes place and where the implementation of a sustainable long-term energy policy is complex. The aim is to increase the use of alternative sources of energy such as geothermal, hydropower and coal bed methane (CBM) to reduce oil dependence to 20% by 2025. However, in order to achieve this target substantial efforts will be required in terms of coordination and execution of initiatives. As of today, the government has been very active in creating and communicating this road map via a number of initiatives. To achieve a timely execution though, it will be necessary to see more of these initiatives being implemented.

TERRY MCPHAIL: The government of Indonesia’s ability to achieve their targets in terms of their desired energy mix will greatly depend on its ability to attract the necessary investment required to pursue new exploration and production activity. While the oil and gas industry has been well established here for some time, and has enjoyed great success working in collaboration with the government for many years, like so many countries around the world, Indonesia’s oil and gas fields are now mature. The remaining resources are in much more difficult places to reach and their extraction requires the use of advanced technologies, resulting in higher costs for producers. Unquestionably, the landscape of the sector has become more complex in recent years.

However, overcoming technological, geographical and cost-associated challenges is what our industry does well. We have the experience that affords us the ability to implement new ideas and viable solutions that will provide mutually beneficial results for both the public and private sector.

Indonesia, from ExxonMobil’s perspective, ranks very well in terms of future prospects and we are deeply interested in continuing our investment in the country. Yet, for the industry to seriously impact production levels, independent studies have determined that investment will need to double in the next five years and triple in the next 10. Unfortunately, investment has not yet reached that pace and the decline in oil and gas production taking place over the past several years is likely to continue unless the country introduces improved mechanisms to foster a more positive investment environment.

HILMI PANIGORO: Under the current scenario, the energy mix targeted by the Indonesian government seems unreachable unless a number of measures are implemented. As the chairman of the renewable energy society, I have been very active during the last years in the development of road maps to achieve this target, but down the road the problem always resides in the execution of these plans.

However, it has not been a lack of willingness by the government that has resulted in the current situation. The political determination is there, and it is clearly stated that all ministers and regional governments will have to actively promote the utilisation of renewable energy nationwide. The main challenge for the development of renewable energies is subsidised oil. Whenever a company comes out with a proposal to develop any kind of renewable power, they are compared with the economics of subsidised energy developments, turning it into an impossible competition. The government is aware of the necessity to start developing renewable energy sources, but when developing it, they shouldn’t do it from a short-term perspective. They must look at these projects from a 10 to 15-year standpoint.

Often we see the state electricity company, Perusahaan Listrik Negara (PLN) blamed for the lack of renewable energy sources in Indonesia, but as a company, PLN always tries to get the best value for money. The ministry must take the lead by developing of its own renewable energy projects. The price per KW obtained through renewable energy will still be expensive, but when diluted with the rest of the KW generated using other sources, the average electricity bill would only be increased by around 3%.

How would you respond to those that claim Government Regulation 79 (GR79) regarding cost recovery will not affect the interest of investors?

JIM TAYLOR: From an investor perspective, GR 79 introduces more uncertainties, adversely impacts economic returns to existing investments and transfers control of cost recovery issues from the oil and gas regulator to the tax authorities, which are not responsible for oil and gas activities. It exposes the industry to broad government discretion which makes investment returns more difficult to estimate. Due to the impact that it will likely have on future investment, it appears to be working against the government’s effort to increase oil and gas production. To create a strong business environment in the high-risk and capital-intensive oil and gas sector, any regulation should not be applied retroactively to existing production-sharing contract (PSCs) – otherwise it threatens agreed contract terms and can result in conflicts and legal disputes, further slowing down the pursuit of oil and gas production growth. It is predicted that the implementation of the regulation could cause a decline of government revenues from existing PSCs by as much as 20%, as well as precipitating a drop in future investments. Cost recovery is a fundamental aspect of the PSC mechanism which has served the sector and host governments well over many decades, successfully attracting enormous investment into the exploration and production of hydrocarbons resources. Moreover, cost recovery is not a reimbursement of contractor costs. It is the government’s agreed share of the investment necessary to explore, develop and produce oil and gas only after it has been found and the geologic and commercial risk have been overcome in a project. It creates entirely the wrong perception and expectation if this is considered as part of the state budget because it will likely restrict costs from being recovered in the year that the contract allows such an action to occur.

Finally, it needs to be clearly understood that the cost of unsuccessful exploration is entirely borne by the PSC contractor, and this can amount to hundreds of millions of dollars for a single well in the remote deep waters of Indonesia.

MCPHAIL: Clarity is only a part of the issue. The industry’s primary concern is the sanctity of existing contracts. Given the time horizons for investment realisation in the upstream energy business, the existence of long-term stability is crucial to entice significant investment. GR79 has language that raises serious doubts over whether existing agreements will be respected. The proposed regulations provide the government with the ability to alter terms on which original investment decisions were based.

Of course, the government can establish whatever conditions they feel appropriate. As long as such new or revised legislation pertains to future opportunities, investors can take decisions based on those parameters. However, to maintain a stable climate, existing contracts must be honoured.

PANIGORO: There are different opinions in interpreting some of the cost recovery mechanisms. If this new regulation does not conflict with existing contracts and is created to provide more transparency in classifying the costs, it will be welcome.

However, if the proposal caps the cost recovery in contracts that have already been signed, that can be considered counterproductive at the very least. The investment climate will worsen, slowing the willingness of industry players to invest in the country. For local companies like us, this will be a short-term matter, but when it comes to foreign investors this regulation could be an immeasurable step back in their eagerness to pursue investment in Indonesia.

HAMZAH: As oil and gas revenue is one of the main components of the state’s income, the government looks at the cost recovery as if the money being spent actually belongs to the state and needs to be controlled and reduced as it is considered expenditure. The fact is, however, that cost recovery funds not taken from the state budget belong to the investor which brought investment into the country and utilised it to operate the fields.

The big inconsistency here is that under the contract the operators signed with the government there is no clause related to possible capping or decline on recovery expenditure (cost recovery). If the purpose of cost recovery is to facilitate petroleum spending, the contract already has a mechanism where all expenditure will have to be approved by the regulatory body, whether through a work programme and budget mechanism or an individual expenditure approval.

What the government doesn’t realise is that GR79 may well serve the state budget, but as soon as investors are rejected from recovering their spending they will start limiting that spending, especially on exploration. This will ultimately mean that the industry will not grow as quickly as it would otherwise, were this not an issue.

What changes and investments need to be implemented to encourage the development of unconventional energy such as CBM?

MCPHAIL: There is an active and healthy dialogue taking place in terms of establishing a fiscal and regulatory framework for the development of CBM. However, that still needs to be finalised and put in place before we have clear definitions of the terms under which CBM will be developed and produced. ExxonMobil is just getting into our field activities and therefore, along with many other companies, is testing the waters of the CBM market and has adopted a very deliberate approach in determining how to make it work. While there is great potential for CBM, and progress has been made in terms of developing the resource, additional efforts are still needed in order for CBM to become a significant component of the overall energy mix.

PANIGORO: Medco is the pioneer of CBM in Indonesia. We drilled the first two wells in the country as a pilot project, and from that experience we concluded that the yield is as good as the one you get in places such as the US or Australia.

Based on that, some estimates were done and the volume identified happened to be astonishing. Consequently we believe CBM can be a good business in Indonesia. However, there are two main challenges that are facing developments when it comes to CBM: taxes and environmental issues.

On the first point, we strongly believe the CBM model should not have a split of the benefits, giving the government the opportunity to obtain its economic return through the corporate taxes on benefits. On the second matter, Indonesia has huge CBM potential from a geological point of view, but environmentally, the geography is not the most appropriate for the current CBM extraction techniques. This is still very a tough challenge that we have to face.

HAMZAH: The government has decided to explore and establish unconventional sources of energy for the country, something that will surely attract new investors and boost demand for these resources.

CBM, a relatively new source of energy for Indonesia, has received the attention of both government and private investors during the last three years, with nearly 40 PSCs signed by 2011.

Although this could be seen as a great step towards the use of new unconventional sources of energy, the fact is that many of the licence-holders are still not operating the fields they were awarded. The government should ensure that the investors are meeting their commitments, and if they are not, each specific case should be analysed to decide whether to revoke the licence. In terms of the changes that need to be introduced, we are asking for two things. One is to give CBM producers the possibility to sell electricity other than just hydrocarbons (this will allow flexibility for PSC holders to develop their field). The other is fiscal incentives, in the form of tax holidays or better splits, especially during the first years of operations, to encourage the owners of PSCs to develop their fields.

TAYLOR: The government has recently begun to view CBM as having significant potential to help secure the country’s future energy needs. Investment in CBM is likely to increase over the next few years, but will require much more time and capital before it can become a significant contributor to Indonesia’s energy mix. Support is needed to get CBM started in Indonesia, and the challenges will likely mean it will require more favourable fiscal terms.

If the right fiscal terms and a competitive price can be achieved, the industry has usually found ways to bring CBM to the market, as seen in other countries such as the US and Australia. It is important that the interest of existing oil and gas PSCs is respected where CBM PSCs overlap with oil and gas working areas. Clear guidelines must exist to avoid disputes and allow operations to continue unimpeded.

What measures should be introduced to improve the open accessibility of the existing gas chain as a means to increase domestic utilisation?

PANIGORO: The biggest consumer of gas in Indonesia is PLN, which insists on buying subsidised fuel as its main source of energy. If PLN is ready to buy gas at market price, the shortage of gas for electricity will be mitigated substantially.

But even if that occurs, we will still not be able to deliver gas from Sulawesi, since Java still doesn’t have the oft-discussed Regas terminal. And even if the Regas terminal is built, and PLN is willing to buy at the right price, we will have trouble financing the $3bn investment we need to make in the liquefaction process. To remedy this situation, the government should give a financial guarantee, which at present they are not willing to provide.

HAMZAH: The question that has to be asked is whether gas is the right energy for Indonesia and whether the gas produced should be designated for domestic or foreign consumption.

If the government wants to use gas for domestic energy or fuel, it has to create a competitive domestic market free from any intervention or subsidy that might hamper the economy in the long run. If it does not manage to create a competitive market then it is time for the country to begin to look at and consider international markets.

In a global economy, when you are able to produce a certain commodity in an efficient manner you can sell it overseas and meet your domestic demand by importing cheaper resources from countries which specialise in other resources. Self-sufficiency is not a smart strategy when you can maximise the value of your resources in other markets.

TAYLOR: There are two major priorities for increasing domestic utilisation of the existing gas chain: the development of gas pipeline infrastructure and a market-driven gas price. The installation of much-needed pipeline infrastructure will enable widespread domestic distribution of gas from existing and future gas fields for domestic consumption.

These should be open-access pipelines that have a competitive cost of service and are operated in the public’s best interest. Open access to pipelines should prevent monopolistic commercial behaviour and should be based upon a cost of service model.

The main driver is a market-based price mechanism. It is important for business-to-business gas negotiations to guide market behaviour. Subsidies and regulated prices distort market decisions and can sometimes become an obstacle in regards to investments in upstream projects and initiatives.