Jakarta, Petrominer — In the arrangement pattern of upstream oil & gas business, there are several basic differences between the license regime and the contract regime. The license regime is preferred by companies, for the government is not involved in operational management. While in the contract regime, the government is involved.
The license regime also has a disadvantage for the company for it is relatively less stable compared to the contract regime. Moreover, a license can be revoked any time at a certain condition. In this pattern, the size of tax can be altered by the government depending on the situation, for instance oil price rise.
Whereas the contract regime is relatively stable, for, the government as the side that makes the contract is committed to maintain the provisions and requirements in the contract within the contract period.
In order to know more about the advantage and disadvantage of each pattern, following are excerpts of Petrominer’s interview with the Head of Program Control and Budget Division of SKK Migas, who was also the former of Petroleum Fiscal Policy Analyst at OPEC Secretariat, Benny Lubiantara.
How do you view the gross split model included by the government in the upstream oil & gas business regulation?
The construction of the gross split system is exactly like the construction of the royalty tax system, in which the gross split of government portion is identical with royalty. The two systems are also tax imposed after cost deduction. The main difference is that the royalty tax system constitutes a license (concession) regime, while in the gross split system the proposing side wishes it to remain in a contract regime form. This is because the Current Oil & Gas Law only regulates the contract regime, thereby proposing the license regime (concession) has a potential for violation of said Law.
The implementation of the gross split model is not as easy as people think. It is very difficult to determine the accurate size of the gross split between the government and the contractor in the initial contract considering the high uncertainty factor in the upstream oil & gas industry.
The gross split model is not known in the world of upstream oil & gas contracts. A country that happened to use it was Peru. But, since the 1970s this model was abandoned and was replaced by the royalty tax model.
India is studying a model that looks like this though it is not exactly the same, that they call it Revenue Sharing Contract (RSC), it also gets bitter criticism from oil and gas fiscal expert, Daniel Johnston in his paper in Oxford Institute for Energy Studies, that in essence states that model likes this discourages investment and extremely regressive.
Is it correct that with gross split investors automatically carries out efficiency, for, all will be cost investors in the beginning?
All investors will carry out efficiency whatever the contract arrangement be. The difference is, in the PSC system the government joins in playing the role of supervising the cost recovery. The government doesn’t look at investment merely cost, but the investment that encourages the development of supporting industry in the country. With the gross split model, the role of supervising becomes less.
Is it correct that with gross split state revenue becomes bigger because the government is no longer burdened with cost recovery?
This is a misleading opinion and needs to be straightened out. To compare whether gross split is better than the present PSC system, first we have to know how is the division of the gross split between the government and the contractor. The problem is so far the gross split figure does not reveal. If there is no figure, how could we compare them or say that state revenue is bigger?
My simulation and also many papers abroad say that this kind of model is regressive. The higher the profit the lower is the percentage of government portion. Conversely, when the profit declines for instance due to the plunging oil price, theoretically the government will be safe, for the portion of its gross split is not disturbed. But, this is only on paper for, the contractor will not execute the project that is not economically viable. The contractor will only run its business if the portion of its gross split has been risen in advance, and that certainly must change the contract.
Is it correct that financial transparency with the regime system is more closed than with the contract regime?
In the pattern of oil & gas arrangement there are a number of basic differences between the license regime and the contract regime. The license regime is preferred by the government for the government is not involved in the process of operational management, while in the contract regime, the government is involved.
But, the license regime also has a disadvantage for the company, for it is relatively less stable compared to the contract regime, because a license basically can be revoked any time at a certain condition, besides the size of ax can be altered by the government depending the situation, for instance a rise in oil price.
The contract is relatively stable, for the government as the party that makes the contract is committed to maintain the provision and requirements in the contract with the contract period.
In the license regime the government is relatively passive it is not involved in supervising the company’s expenditures. Therefore, the treatment toward an oil & gas company is exactly like other companies in general that can directly make cost deductions of their revenue portion. On the contract regime, such as the PSC commonly used abroad, the government joins in supervising the contractor’s expenditures; cost expenditure does not automatically be burdened as cost, but should be through the approval of the government known as the mechanism of cost recovery.
A number of circles observe gross split as an innovation of the government in enhancing the oil & gas investment climate. Will this be running effectively? Could you give us your opinion?
The gross split model, on the other hand wants operational management to be exactly like the license regime (no mechanism of cost recovery), but remains wanting to be categorized as a contract regime, which from the point of stability a contract is relatively better for the contractor compared to the license regime.
With the absence of cost recovery mechanism, automatically equipment become the property of contractor. But, on the other hand, the party bearer of gross split model proposed for the equipment to become state property; something unusual.
This gross split model needs to be studied further whether it is in contradictory to the regulation that currently prevails for upstream oil & gas industry. In that way, no impression will emerge that this is none other than ‘a license regime forced to become a contract regime’, taking the advantageous part from the two regimes, but refuses matters considered not good enough for the company/contractor, in this case the mechanism of supervising cost by the government. Although the gross split looks simple, preparing its implementing regulation is not so, just like the proverb: the devil is in the detail.
With this system, is PoD determined by the contractor?
PoD, wherever it may be has to be evaluated and approved by the government.
What about the system of Sliding Scale proposed by SKK Migas? What is the difference?
The proposal of SKK Migas remains in the framework of PSC to improve the economics the sliding scale profit split is used. In which several business processes should be changed thereby the process could be quicker.
What is the main issue of developing CBM Industry in Indonesia?
In the context of non-conventional gas such as CBM, the main issue is how to make the CBM industry immediately running, as the provisions and requirements in the current PSC are less attractive. In this context, basically all stakeholders, such as the Ministry of ESDM, the Directorate General of Oil & Gas, SKK Migas, CBM KKKS and professional organizations agree there should be a change so that CBM will be attractive for development. It is also necessary to observe that from the aspect of multiplier effects of this CBM industry is not exclusively from Government Take.
In aiming for quick win, SKK Migas views it can be improved by improving and simplifying the business process and proposing to change the provisions and requirements of PSC with sliding scale, either FTP and equity to be split, meantime from the Forum Group Discussion comprising of CMB players united in the FGD the majority remains wishing for the model of gross split where there is no cost recovery.
With this net sliding system, is it correct that the government can carry out supervision and control on cost including tax compared to gross split?
That is the usual PSC system that we practice all these years. Only the split is a sliding scale, the mechanism of supervision and control remains the same as it is today, only the business process should be adjusted with the need of the CBM industry.
The cost recovery system is considered much in the ‘grey area’ that caused plenty of mark ups. What is your comment?
Cost recovery is mostly due to misunderstanding. Cost recovery on the contrary ascertains that contractor should expend funds already approved by the government and not all expenses are automatically can be burdened as cost there is the process to be obeyed.
Imagine if there is no mechanism of cost recovery, quite likely all expenditures even those not necessarily relevant will be burdened by the contractor as cost. This matter will reduce the government sharing split and tax.
I’m very surprised if there is someone who wants the mechanism of cost recovery to be abolished. That’s certainly because someone who said it does not quite understand about PSC. (W18)
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