OBG talks to Lukman Mahfoedz, President-Director and CEO, Medco Energi Internasional; Roberto Lorato, President, Premier: Interview

Interview: Lukman Mahfoedz, Roberto Lorato

How would you assess the level of collaboration between public and private stakeholders?

LUKMAN MAHFOEDZ: With Indonesia’s demand for energy exceeding supply, the public and private sectors must work together so that the country can avert an energy crisis. Major oil and gas producers have called on the government to introduce a more flexible regulatory framework, in order to prevent an energy crisis that could occur in the future if no serious, meaningful, effective efforts are made to prop up the country’s declining oil output. Among the regulations that should be revisited to draw more investment is the production-sharing contract (PSC) scheme applied to exploration and production. Good coordination will help streamline the permit process and minimise overlapping regulations so that exploration projects can be executed on time. It will also help the government come up with a fiscal regime that will attract more investors.

ROBERTO LORATO: From an investor’s perspective, whether the new president will be more effective in attracting investments to the country will depend not only on the policies his administration will promote, but also on the support that it will be receiving from political parties and from parliament. Collaboration between the new administration and the oil and gas industry will be influenced by its ability to look at longer-term objectives rather than short-term gains. We understand the country’s urgent budget needs, but these should be met through economic reforms aimed at re-establishing an environment that is conducive to long-term investments. Indonesia as a country has grown remarkably well over the past 10 years, but the oil and gas and mining sectors seem to have gone the opposite direction.

STEWART: Over the last decade, the business environment for Indonesia’s oil and gas industry has become less favourable on issues like regulatory uncertainty, increased bureaucracy, slow approvals and decisionmaking, land access, and the complexity of dealing with many levels of government due to regional autonomy. This has made it much harder to execute exploration and development activities and has eroded investor confidence. It has also come at a time when Indonesia needs an increase in investment to meet its growing energy needs. Fortunately, the new government recognises this situation and knows that significant reforms are necessary to meet Indonesia’s energy needs. The new government has only been in place for seven months, but we are already starting to see actions to address some of the industry’s issues, such as better transparency, efforts to improve bureaucracy, a new ministerial regulation on expiring PSCs and the establishment of an inclusive national exploration committee.

PRAMONO: Indonesia has a long and successful history in developing oil and gas. This success was based on the trust engendered by a stable regulatory environment the key factor for investor confidence. Certain government regulations, however, have deeply impacted this stable framework, threatening the legitimacy of private sector contracts and discouraging investment in offshore exploration. Such exploration will require not only advanced technology and further industrialisation of operations, but also more effective communication between the government and private players, both local and international. It is essential for the oil and gas sector to show the government the benefits of sustaining a welcoming business climate.

How is protectionism impacting the energy sector?

LORATO: Many developing countries want to have a bigger role, and a bigger say, in all matters. Indonesia is not the only one, nor is this necessarily negative if properly directed. However, pushing the nationalist element too far could end up being counterproductive. The danger appears when the sentiment pushes large sectors of the economy towards a state-owned, government-controlled model that may result in excessive regulations and micromanagement by state agencies. This is not an efficient way to attract long-term investments in the energy sector. Also critical to success are contract sanctity and certainty in legislation.

PRAMONO: One of the most effective ways to generate new economic opportunities is to build international partnerships that leverage various strengths. Many multinationals, including Total, have been active in Indonesia for decades and now have an extensive local workforce. It is thus essential for the government to create a positive partnership environment in which these companies can have their place. There should be no difference in treatment for outside firms. Local companies should work to be the best possible hosts, as foreign firms work to increase skills-transfer.

STEWART: The government has a major initiative to increase local expenditures in the oil and gas industry. In general, this is in the interest of all parties, and in theory it should drive down costs, improve performance and make projects more economical. In the oil and gas industry, however, there are some high-tech services that are provided by only a handful of international companies. Other areas of the industry are very expensive to enter, such as offshore drilling rigs, specialised seismic vessels and other marine vessels that are only periodically used in Indonesia. The industry needs access to these vessels, which in all likelihood will not be Indonesian-owned. Cabotage laws need to allow this, to support the oil and gas industry.

MAHFOEDZ: Nationalist-inspired policies are common everywhere, but they must be balanced with investors’ interests and consistent with agreed contracts. In the upstream business, oil and gas companies are contractors for the government; only after discovery and production do they receive a return on their investment, in the form of cost recovery and a profit share based on the terms of the PSCs. This shows the importance of certainty in policy, regulation and contract sanctity.

Energy costs are a big obstacle to local small and medium-sized enterprises (SMEs) growing their businesses. How can this be solved in the long term?

PRAMONO: Affordable energy is hard to come by in Indonesia due to inefficiencies in the value chain. For instance, some local partners have failed to carry out their contracts simply because they did not have the capacity or skills to deliver on their obligations. These unreliable partnerships have been costly. Still, we ask those partners to do what they are capable of efficiently while bringing in more skilled players to complete other parts of the project. Also, regulations have made it hard to provide surplus oil and gas to the market.

STEWART: To facilitate growth and competitiveness, ensuring competitively priced and reliable energy should always be a primary focus of the government, and our industry plays an important role in this. Indonesia has significant energy resources – natural gas, coal, geothermal, biofuels – and therefore the potential to achieve this. But one must also strike a balance by managing the increase in greenhouse gas emissions for a rapidly growing economy. To this end, using a mix of energy resources is important, and natural gas is essential to balance the plan to build coal power plants. The key to delivering competitively priced gas to the enduser is to make the industry more attractive by addressing the issues previously mentioned which are driving up costs. One must also make sure that excessive rentseeking is not occurring along the gas value chain in areas like gas transmission, transport and marketing.

MAHFOEDZ: Instead of providing them with cheaper energy through subsidies, the government should allow companies to become more competitive by helping them create and market their products. In this regard, Indonesia must implement the “3Cs” of clarity, consistency and certainty if it is to attract the investment it needs to overcome energy shortages in the short and long term. Energy demand is predicted to rise rapidly in line with Indonesia’s fast economic growth and expanding middle class. By 2022 energy consumption is predicted to triple to 8.3m barrels per day (bpd), and by 2030 the gap between supply and demand for oil and gas could exceed 3m bpd. Keeping up with this rise in demand requires investment of $28bn a year in new exploration. Energy is one of the basic requirements of economic development. Indonesia needs more investors to produce energy for the nation, and investors need support from the government to do so. We all share the responsibility of providing energy for the nation.

LORATO: Indonesia needs to be able to produce energy at competitive prices for SMEs to consume it in a reliable manner. These SMEs in turn will transform this energy into services or goods that can be more competitive on the market. Reliability is largely a matter of infrastructure, which is still underdeveloped in Indonesia– both the power grid and gas distribution networks. The country has the potential to supply more gas to the market, but still lacks the ability to transport and distribute it. This is an area that requires strong government support, not only financial, but also in providing access to land, permits, and licences to operate.

In parallel, substantial investment in exploration and development will be required. Yet the terms of Indonesia’s current PSCs are not considered particularly attractive; in fact, various analyses show them to be among the toughest in the world and therefore not very conducive to larger investments. Upstream oil and gas companies in Indonesia need to have more attractive and competitive terms to be able to explore for new oil and gas resources in the archipelago.

To what extent is Indonesia ready to play a larger role as a regional and global supplier of energy?

STEWART: Indonesia has long been a major provider of energy to other countries, selling natural gas to Japan, Korea, Taiwan and Singapore, and coal to China and India. These energy exports have brought significant state revenues and been critical to the country. As Indonesia has developed and its economy grown, the need to use more of that energy domestically has become imperative, making it a less significant exporter of energy over the years – a trend I see continuing given domestic needs. However, with its existing energy resources and potential, Indonesia can continue to reap the benefits of both in the coming years.

MAHFOEDZ: Indonesia has abundant natural resources, with the eighth-largest gas reserves in the world and the third-largest reserves in the Asia-Pacific region after Australia and China. Nevertheless, it may turn into a net energy importer by 2019, as demand for energy continues to rise, driven by industrialisation, a shift to gas by major industrial users and increasing connectivity to the electricity grid. Energy demand is forecast to reach 6.19m barrels oil equivalent per day (boepd) in 2019, while supply will reach 6.04m boepd. By 2025, oil and gas demand will reach 3.6m boepd, compared to supply of only about 1.1m boepd – a gap of 2.5m boepd. Indonesia therefore needs to boost exploration activity immediately in order to increase the country’s oil and gas resources. Programmes to convert fuel oil to gas and other energy sources are among the main strategies for reducing dependence on oil.

LORATO: Geologically, Indonesia is blessed to have so many mineral and energy resources. Geographically, it is in a very strategic position, close to some of the world’s fastest-growing markets. Internally, it has an economy that is hungry for energy, with a young and growing population. As a result, Indonesia has all that is necessary not only to meet growing local demand but also to become a regional energy producer. What it needs at the moment are larger investments in exploration and infrastructure, and more attractive and stable commercial and fiscal terms.

PRAMONO: As the largest member of ASEAN by both GDP and population, Indonesia’s crucial challenge is to satisfy local demand. The energy balance in the region will be greatly impacted by Indonesia’s growth and the resources it uses to provide energy to its citizens. Over the years, the contribution of gas to its energy mix has increased significantly, and it will continue to do so in future. Given the magnitude of Indonesia’s reserves and the resources yet to be found, gas should be consideredas a substitute for oil consumption. To this end, significant domestic and international infrastructure will be needed, such as a concentrated pipeline network.