Some Considerations for New Regulation in Indonesia’s Oil and Gas Sector

This article originally appeared as an op-ed in the Jakarta Post on 8 July 2015.

Successful governance of the oil and gas sector requires strong organizations to design the rules by which the players operate and to oversee their activities.

Thus, when the legislation for the oil and gas sector is revised and launched by the House of Representatives, the key question will be how to organize and manage the sector in order to maximize the public benefit derived from oil and gas resources. In particular, what role should state oil company Pertamina, the Energy and Mineral Resources Ministry (ESDM), and other governing bodies have?

It is not our intention to assert that institutional structure is the only, or even the dominant, determinant of a country’s success. The broader political context, including overall levels of transparency and the government’s commitment to accountability, also plays a determining role. But as a state thinks about how to manage the resources it does have in light of its political and economic context, institutional structure can have a major impact on performance.

The most important lesson for the government to consider in deciding where to house regulatory responsibilities — including the allocation of licenses, signature of contracts and enforcement of laws and regulations — is that the scope and limitations of each body’s authority should be explicitly defined and clearly communicated, within government and to oil companies.

There are two models that some countries have followed in allocating regulatory responsibilities. First is vesting regulatory responsibilities in a largely bureaucratic regulator outside the ministry’s structure (2001-2012).

This option represents a slight variation on the system that was put in place in Law No. 22/2001, wherein a body that closely resembles the Upstream Oil and Gas Regulatory Special Task Force SKKMigas would retain responsibility for executing most regulatory/oversight responsibilities.

Through this system, the government could limit the risk of conflict of interest, if each institution has a specific role and the regulator is specifically charged with making sure Pertamina and other players are following the rules.

The new SOE would be a participant in the joint venture as the representative of the state.

It could enable Pertamina to focus on its commercial performance rather than devoting resources to regulation.

More problematically, it may not comply with the Constitutional Court’s mandate if the regulatory body cannot in some ways be endowed with business activities — the complete separation was judged to result in the “degradation of the powers of the state”, though the legal form of the regulator may be able to be altered to be a state-owned enterprise (SOE) in order to be in line with the Constitutional Court’s mandate.

The second model would feature the creation of a new non-operating SOE with regulatory responsibilities and limited business activities. There would be a new SOE as a state-owned company, whose mandate would be to participate in the business activities of every oil project and deliver the maximum benefits from each project to the Indonesian citizens.

The company would be a signatory to contracts, a partner in the joint ventures that carry out operational activities, and a participant in the business decisions of those joint ventures.

The company’s mandate would be oriented to the needs and priorities of Indonesia and its citizens, so its number one priority would not be its own profits but delivering benefits to the state.

But in addition to these activities, the new SOE could also engage in other activities that would be more traditionally profit-oriented. The criteria of business activities that they can create are a conflict of interest between the function of supervisory and regulatory body and a business entity has a low cost.

The State-Owned Enterprises Ministry would have the final decision of choosing business activities by coordinating with the Energy and Mineral Resources Ministry.

In order to promote a strong role for Pertamina as the national champion traditional oil company, this model could include special access to exploration and production projects for Pertamina. One approach would be to allow Pertamina to have first rights to all new projects, with a presumption that Pertamina will be the operating company whenever it has the ability.

This would help the company continue to develop its abilities to manage and execute exploration, development and production activities.

But in order to maintain strong incentives for Pertamina to improve its performance, and to reduce the risk of underinvestment in exploration and production, Pertamina’s access would not be unfettered.

For new concession, Pertamina would make a recommendation to the ministry — either it would propose to do the work itself or that the project should be auctioned to other potential companies. Pertamina would make an operational and economic case to the Ministry, which would decide whether or not to follow Pertamina’s recommendation.

And where there is an auction for private partners—either to join Pertamina in an operating group or to control the project more thoroughly in the event of Pertamina’s absence — the ministry would conduct it.

In every case, whether Pertamina would be the operating company or not, the new SOE would be a participant in the joint venture as the representative of the state. The ministry would have a meaningful role and can see overall and overseeing, because a new SOE will be in the contractual relationships.

This system would reduce the risk of conflict of interest and build in checks and balances while enabling the regulatory function to be executed by personnel benefitting from a business-oriented structure and incentives.

More importantly, it is in line with the Constitutional Court’s ruling, since an SOE would be carrying out the regulatory function and would be able to be the legal party representing the state’s interests in oil contracts. However, this is still untested innovation.

To sum up, Indonesia has the option of returning to one of the two models that it has employed to date, or developing an innovative new system that builds upon the experiences of other oil producers.

In the face of declining petroleum reserves and production, rising consumption, costly fuel subsidies and a desire to boost the performance of Pertamina, Indonesia needs an institutional structure that enables the country to execute a coherent strategy and that empowers the assigned entities to manage exploration, production, relationships with contractors, tax collection and the enforcement of Indonesia’s laws and contracts.

Effectively allocating roles and responsibilities among ministries, Pertamina and other government agencies is crucial if Indonesia is to tackle the challenges the country faces in reinvigorating its oil and gas sector.

Poppy Ismalina is an associate professor, at the School of Economics and Business, Gadjah Mada University, Yogyakarta. Patrick Heller is director of legal and economic programs at the Natural Resource Governance Institute., New York.