Andhika Anindyaguna, CEO, Sugih Energy; Jon Gibbs, President, ExxonMobil Indonesia; Lukman Mahfoedz, President, IPA & President Director, Medco Energi; Roberto Lorato, President Director, Premier Oil Indonesia; & Hardy Pramono: Interview

Interview: Andhika Anindyaguna, Jon Gibbs, Lukman Mahfoedz, Roberto Lorato, Hardy Pramono

Are regulatory changes and stringent anti-graft measures having an impact on investor appetite?

ANDHIKA ANINDYAGUNA: We are optimistic about the transition from BP Migas to SKK Migas, as the regulatory body is totally controlled by the Ministry of Energy, establishing a clearer chain of command, as well as a more transparent and accountable regulatory body. This will bring numerous benefits for both the investors and companies operating within this sector. If reforms continue, it will create a better political environment with the potential to facilitate greater investment.

JON GIBBS: Governments play a key role in the industry’s ability to expand energy supply in an environmentally responsible way. Policies that provide a stable regulatory and legal framework encourage the long-range thinking and investment decisions that allow the industry to excel. Recent efforts to streamline the regulatory environment in Indonesia are important steps in encouraging certainty in the business climate.

ROBERTO LORATO: There has been reduced appetite to take on risk, as regulatory changes have skewed the risk-reward balance. Established firms are striving to retain their market share, but in the long run exploration costs are rising and incentives are not materialising as we would hope. Removing taxes from the exploration phase, for which investors bear the whole risk, would drive greater exploration. For example, production-sharing contracts (PSCs) signed after 2010 carry the burden of the newly proposed land and building taxes.

HARDY PRAMONO: Indonesia has a long, successful history in oil and gas development. It was once an OPEC member, recognised as a centre of liquefied natural gas (LNG) development and a hub for international hydrocarbons players. This recognition was not without reason, with trust given to a stable regulatory environment, which is key to investor confidence.

This stable framework has begun to lose its reliability, creating increased uncertainty, with the lack of fiscal stability discouraging exploration. To illustrate this point, the GR79 government regulation created very strong uncertainty for investors, as it not only violates the sanctity of contracts that are otherwise grandfathered under the 2001 Oil and Gas Law, but also other laws, hence the filing of a judicial review by the Indonesian Petroleum Association against GR79.

While Indonesia is transforming to a clean government through corruption eradication, the industry has always acted in accordance with good corporate governance and integrity. The industry fully supports the government’s anti-graft policy.

LUKMAN MAHFOEDZ: Oil and gas development is a long-term, capital-intensive investment, requiring a legally stable framework. Current issues such as the cost recovery mechanism, the criminalisation of industry, and amendments to the existing oil and gas law are some of the major challenges that are confronted by the industry.

We support the implementation of the 3C principles (clarity, consistency and certainty) on all regulations applied to this industry, which are the key critical ingredients to attracting investors. Some industry concerns have been addressed by the government, such as the land and building tax on exploration, which we expect will accelerate exploration activity in the future. We also support stringent anti-graft regulations as we believe they would improve the governance and transparency of the management of the oil and gas industry.

How would you interpret the steep decline in the number of seismic surveys conducted since 2011?

PRAMONO: Over the last 10 years exploration results have been disappointing in Indonesia; there remain under-explored basins and frontier areas that have significant potential, particularly in eastern Indonesia.

The costs and risks of carrying out exploration in these areas have risen dramatically, not to mention access difficulties and permitting hurdles, including for seismic work. Such challenges are reflected in the departure of some exploration players from Indonesia. The disappointing results of the last bidding rounds demonstrate the need for a regulatory environment that encourages exploration. In addition to legal certainty and stability of fiscal terms, irregular provisions such as the land and building tax must be removed. We need to see the simplification and acceleration of all permitting processes impeding exploration, and a reduction in micro-management oversight, especially in procurement processes. Finally, several countries succeeded in revitalising their exploration bids through the creation of a corporate structure to pool resources between multiple PSCs operated by affiliates of the same company. This opened the possibility of buying seismic data as part of a commitment by PSCs to encourage more surveys. Without addressing these challenges to investor confidence, it will be difficult to replace Indonesia’s declining hydrocarbons reserves.

GIBBS: Exploration is at the highest end of the risk profile, so governments can encourage exploration investment by examining the most appropriate policy responses to incentivise those activities that are critical to finding new resources, such as encouraging seismic studies. As is evident from the fate of deep-water exploration over the last few years, without surveys such as these, results can be disappointing.

ANINDYAGUNA: Indonesia’s fundamentals as an energy investment destination are very strong. Yet there is still too much complexity surrounding the regulatory environment and the permitting process for onshore oil and gas operations – specifically land acquisition – which prevents many from investing in essential areas in the exploration process, such as seismic studies. To optimise Indonesia’s vast oil and gas resources, and facilitate greater investment in hydrocarbons exploration, we need to see greater synergies between the government, regulatory bodies, international oil companies (IOCs), and domestic oil and gas firms. All relevant stakeholders need to work together to simplify regulations, and to make exploration a more attractive and efficient activity for investors.

MAHFOEDZ: This steep drop off was partly driven by coordination issues among government institutions and regulatory measures causing delays in land acquisition.

The government plans to simplify the process by reducing the number of permits that are required for exploration and production. It is important to accelerate this long-awaited simplification.

LORATO: It is a combination of revised contract terms and a lack of additional incentives when we are evaluating more difficult basins. Removing taxes from the exploration phase would be a step in the right direction, and there has been a positive engagement with the government regarding these concerns.

How attractive do you think it currently is for IOCs to explore eastern and frontier areas?

MAHFOEDZ: Indonesia has abundant oil and gas resources that are still undeveloped, most of which are located in the east of the country, and the government has already facilitated a deepwater exploration programme. Given the technically challenging environment, the risks are great, as are the investments required. Balancing economic return with risk and investment is very important. Consistent government support, particularly in the domain of technology access and expertise, as well as more open data management systems, will be needed to encourage more exploration investment in such frontier areas.

LORATO: Eastern and frontier areas hold an allure but there are too many uncertainties. Recent examples of taxation imposed on the exploration phase have had a very negative effect. This is why I hope that ongoing discussions with the government result in a positive outcome for oil companies already facing numerous financial, geological and logistical challenges.

PRAMONO: The era of the easy oil find is over, but Indonesia is an “old” oil country, as there remain under-explored basins and frontier areas that have serious potential, particularly in eastern Indonesia. Unlocking this potential requires carrying out exploration in deep offshore and/or remote areas, bringing challenges in terms of costs, technology, logistics, permitting and ability to interact with communities not familiar with oil and gas activity. IOCs have a lead role to play in this frontier exploration, provided the business environment remains competitive enough to attract investment. Domestic firms are not equipped to assume the risk.

GIBBS: Exploration in frontier areas is challenging all over the world. The situation in Indonesia’s eastern frontier region is no different. For example, potential resources are remote, and moreover there is very little infrastructure. However, I remain very confident that such challenges can be overcome if the government is able to promote an environment where industry can carry out long-term, visionary projects.

ANINDYAGUNA: IOCs are attracted to offshore exploration in these frontier regions. After all, despite the higher risks and costs of drilling in deepwater basins, firms are able to conduct operations without facing the extensive local issues that they may encounter on land. However, despite the complexities of onshore operations, we believe that exploring proven basins in mature regions such as Sumatra is a preferable strategy for smaller oil and gas exploration companies.

What is the role of national oil companies (NOCs) likely to be in the future? How do you think they can best form partnerships with IOCs?

LORATO: The government wants to see the development of a more competitive domestic energy market in all phases, and NOCs such as Pertamina, Medco and Energi Mega Persada have demonstrated their ability to mitigate uncertainties and volatility in the regulatory environment which affect IOCs. Leveraging on the combined strengths of NOCs and IOCs will be key to unlocking new business opportunities for investors.

MAHFOEDZ: The role of IOCs is important in bringing technology, expertise and financial capability, especially in attempting high-risk investments such as deep-water exploration or unconventional hydrocarbons. There are numerous opportunities for both NOCs and IOCs to collaborate and achieve benefits for both sides.

It will be an important task for the host government to create a conducive partnership environment in which NOCs and IOCs can collaborate successfully.

ANINDYAGUNA: For exploration to move forward we need technology and capital, which is a challenge for smaller Indonesian firms. The government must incentivise local companies and try to grant access for funding via capital markets, banks and even a dedicated petroleum fund programme. We do, however, still need the support of big players in Indonesia. Our national companies have begun to expand into the international market, and they want to be treated well in other countries where they operate. This is why we must work closely with IOCs operating within Indonesia.

PRAMONO: It is fully legitimate for NOCs to grow their businesses in the country. However, there are many international companies that have been active in Indonesia for decades and employ nationals as more than 95% of their workforce. It will therefore be an important task for the government to create a conducive partnership environment in which NOCs and IOCs can collaborate successfully. All companies have a role to play in the future of Indonesian oil and gas.

Only a very limited number of Indonesian firms are active in frontier exploration, where there is surely a larger role for them in the future. NOCs will need to grow their financial and technological capacity, as well as their risk appetite and exposure to large projects.

To that end, partnerships with IOCs are chances for them to learn and develop. However, systematically prioritising NOCs in oil and gas is not desirable, as it may divert investment from the country. The amount of revenue for the state under a PSC is related only to the performance of the contractor, rather than where its funding comes from. That said, we welcome NOCs increasing their role on a level playing field.

GIBBS: One of the most effective ways to generate new economic opportunities is by building international partnerships that leverage different strengths. For instance, over the years, NOCs have demonstrated a wide range of capabilities as strong partners in energy development, including secure access to resources, detailed experience operating in specific environments, and a first-hand understanding of the local and national governments’ regulations and requirements. Meanwhile, IOCs have an unparalleled breadth and depth of experience of taking on energy challenges around the world, developing new approaches and best practices across a range of conditions that can be brought to new partnerships and countries. As we look at the energy needs in the decades ahead, it will take our entire industry combining the strengths of both NOCs and IOCs to meet growing demand.

What challenges are preventing gas from playing a larger role in Indonesia’s energy sector?

PRAMONO: Gas is underutilised in power generation, mostly due to competition from cheaper fuel, such as coal. Lack of infrastructure also represents a hurdle. Use of compressed natural gas or LNG for vehicles can be a source of rising demand, but would require distribution infrastructure and modifications to cars and trucks, and this cannot happen overnight. Also, it is probable that Indonesia will further develop its palm oil resources to produce biofuels. Commercial development of coal-bed methane (CBM) and shale gas will need to be demonstrated, and such resources are in their infancy in Indonesia. Material contribution to gas demand from unconventional gas is likely to be a long-term objective, and in the short term I believe Indonesia will continue to rely on conventional gas, along with a growing share of LNG imports.

MAHFOEDZ: The most pressing challenges are gas pricing policy and the availability of infrastructure, as gas resources are widely spread out in Indonesia. There are also other challenges, including access to technology and expertise in handling gas resources such as unconventional hydrocarbons, gases containing high levels of impurity or stranded marginal gas. Social issues and long processes for permit and land acquisition may also hinder successful development of unconventional gas, including CBM and shale gas.

GIBBS: ExxonMobil foresees global gas demand rising by 60% by 2040. By then we expect that natural gas will account for more than 25% of the world's energy, and will have overtaken coal as the second-largest energy source. The main driver of this growth globally is from the power-generation sector, and we see this same trend being replicated here in Indonesia. When you consider that Indonesia’s electricity demand growth rate is expected to be among the highest in the region, with international energy agencies forecasting demand to nearly quadruple by 2040, there is little doubt that there is a strong and growing future for natural gas in Indonesia. Turning this potential into a reality will require Indonesia to develop its endowment of gas resources safely and economically, and this will in turn require partnerships between government and industry to create the right business environment for this to happen.

ANINDYAGUNA: As Indonesia is one of the few countries in Asia with favourable geology for potential shale gas production, we are optimistic for the future of unconventional gas. However, we are still in the early stages of unconventional gas development, as this resource has not yet been proven in Indonesia. Efforts to monetise unconventional gas will require substantial investment in advanced infrastructure, specifically for distribution and refining projects. This will require close cooperation between the government and players across the oil and gas industry.

LORATO: There is an understanding that oil and gas production is decreasing and, more worryingly, that the reserves replacement ratio is well below 100%. This may even call into question the ability of the oil and gas sector to contribute to the Indonesian economy in the future. Indeed, particularly for gas, more flexible contractual terms and improved distribution infrastructure will be required to attract more investment in the exploration for, and development of, new resources.