Legal Guide to Oil Regulation in Indonesia: Licenses, Royalties and Contracts

This is the fourth post in our 2014 Legal Guide to Oil Regulation. Fitriana Mahiddin and Syahdan Z. Aziz will address a new topic each week. Under the Oil and Gas Law, entities in the form of a state-owned enterprise (SOE), regional-owned enterprise (BUMD), a cooperative, small business or private business entity may enter into a production sharing contract (PSC) with Special Task Force for Upstream Oil and Natural Gas Business Activities (SKK Migas) to undertake upstream oil and gas business activities. Pertamina, as an SOE and the state oil company, can hold participating interests in numerous PSCs as a contractor of SKK Migas. There is no maximum limit on the participating interest that an SOE, BUMD or Pertamina may hold. Further, a contractor is required to offer a 10% participating interest in the PSC to a BUMD after obtaining approval for the first plan of development of a field in the work area. The BUMD may accept or reject the offer based on its financial capability. Royalties and other payments PSC contractors do not pay royalties, though the first tranche petroleum (FTP) arrangement in later generation PSCs is considered similar to a royalty. FTP is the first take of oil or gas immediately after production in a work area in one calendar year that is received by the state prior to cost-recovery and profit calculation. FTP therefore secures the state’s minimum income. The amount of FTP is determined in the PSC. In addition to taxes, contractors are required to pay non-tax state revenues such as exploration and exploitation fees and bonuses, which consist of a signing bonus and production bonus, regulated by the relevant PSC. The proceeds from the sale of oil and natural gas produced under a PSC are shared between the government and the contractor. The PSC may stipulate whether the tax laws and regulations applicable at the time of the execution of the PSC shall apply (stabilized) or whether the PSC shall follow every tax law and regulation issued over time. Duration of oil leases, concessions and licenses The term of a PSC may be up to 30 years, inclusive of exploration period and exploitation period, and may be extended for a maximum of 20 years. To extend a PSC, a contractor submits an application for extension to the Ministry of Energy and Mineral Resources through SKK Migas within two and 10 years prior to the expiration of the PSC. SKK Migas will evaluate the application and provide its opinion to the MEMR in deciding whether to grant the extension. Factors to be considered by the MEMR include the oil reserve potential in the concerned work area, market needs or potential and technical or economic feasibility. Onshore and offshore regimes Onshore and offshore exploration and exploitation are regulated by the same laws, regulations and governmental authorities, namely, MEMR and SKK Migas, except for regulations concerning specific aspects such as environmental and safety requirements and dismantling obligations. Likewise, the rights to explore for and exploit crude oil, gas and shale gas are generally governed under the same regime. However, due to their distinctive natures, several aspects may be individually and differently regulated, such as the offering of a work area for conventional and non-conventional gas. Entities that can perform exploration and production activities Upstream activities can be carried out by a business entity or Permanent Establishment (PE). Business entities include SOEs, BUMDs, cooperatives or small businesses and private business entities. A foreign incorporated PSC interest holder is required to set up a branch office in Indonesia, which would create a PE. As a PE, the foreign incorporated PSC entity is required to register for tax purposes. Accordingly, the PE shall set up and maintain an office in Jakarta and obtain a taxpayer identification number (NPWP). Joint ventures Upstream oil and gas business activities can be carried out directly by a foreign entity as a PE. Foreign companies may not directly engage in downstream activities, although they may establish subsidiaries to engage in these activities, the establishment of which requires the approval of the Capital Investment Coordinating Board (BKPM) and obtaining the requisite downstream business licenses. Presidential Regulation No. 39 of 2014, which contains the Negative List that regulates certain limitations on foreign direct investment for businesses in Indonesia, was recently issued. It provides certain restrictions for foreign investors engaging in the downstream oil and gas business. The restrictions vary depending on the specific business that is intended to be undertaken. The Oil and Gas Law restricts companies from engaging in both upstream and downstream activities at the same time. Reservoir unitization Under Government Regulation No. 35 of 2004, as amended several times, lastly by Government Regulation No. 55 of 2009 regarding Upstream Oil and Natural Gas Business Activities (GR 35), in the event of discovery of an oil reservoir that overlaps with another PSC's work area, an open area or the territory or continental shelf of other states, the contractor must notify the MEMR through SKK Migas. Unitization must be conducted if the oil reservoir overlaps with another PSC contractor’s work area. If the reservoir extends into an open area, unitization must be conducted if such an open area becomes a work area, provided that the open area is designated as a work area within five years. Unitization requires the approval of the MEMR, which will then appoint a unitization operator from among the unitizing contractors. For cross-border overlaps, the MEMR shall settle the issue in accordance with the continental shelf agreement between the government of Indonesia and the relevant foreign government, with due observance of the maximum benefit to the state. Liability Indonesian laws and regulations are silent as to the allocation of liability of PSC contractors. If there is more than one contractor in a PSC, the liability of each PSC contractor will be stipulated in the Joint Operating Agreement. Parental guarantees and security deposits Parental guarantees may be required by SKK Migas for a company that intends to acquire a participating interest in a PSC upon SKK Migas's assessment of the company’s audited financial statements. Further, PSC contractors must provide a performance bond by the time of the execution of the PSC. The performance bond guarantees a three-year firm commitment. Based on Article 41 of MEMR Reg. 35/2008, for open areas, areas that are left out of the PSC and work areas for which the PSC has expired, the performance bond amounts to 10% of the total commitment value, with a minimum sum of US$1.5 million. For areas that have never been developed or are being produced or have been produced, the performance bond shall equal 10% of the budget for the work plan for the first two years of the exploration period, with a minimum sum of US$1 million. Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through – Oil Regulation 2014. For further information, please visit www.GettingTheDealThrough.com. This article is intended for informational purposes only and does not constitute legal advice. This article should not be acted upon in any specific situation without appropriate legal advice.