Oil & Gas Industry: Understanding Indonesia's Cost Recovery Scheme
Because we have received quite some questions about Indonesia's cost recovery scheme in the oil and gas industry, we decided to devote an article to this topic. Simply put, the oil recovery scheme that the Indonesian government applies in the upstream oil and gas industry concerns the reimbursement of exploration and production costs to oil and gas contractors. This should make oil and gas exploration in Indonesia more attractive and thus stop the two-decade long decline in the nation's oil output.
In the upstream sector the Indonesian government owns the oil and gas resources. However, it needs contractors (either private or state-owned companies) to explore and exploit these resources. In line with the contracts signed between the oil and gas contractor and the Indonesian government, the former needs to bring capital in order to finance the exploration and exploitation activities. These expenses made by the contractor will be reimbursed by the central government using a specific government budget.
As such, from the viewpoint of the central government, the cost recovery scheme can be regarded an investment. It makes oil and gas exploration in Indonesia more attractive for private companies (once production starts the government can collect good earnings through the production sharing contracts). Moreover, a multiplier effect is felt locally as other sectors - related to oil and gas exploration - will also see more activity. This includes shipping, banking, and oil and gas support services companies.
Oil and gas exploration is a risky affair (and long-term in nature). It is estimated that between 2002 and 2016 nearly USD $4 billion was spent - in vain - by oil and gas companies in the exploration stage in Indonesia without finding reserves suitable for commercial exploitation. It is important to note that the government will only reimburse exploration costs under the oil recovery scheme in case the contractor indeed finds enough reserves that can be exploited. Without economically viable reserves the government will not reimburse anything (as such, all the risks are borne by the contractors).
In fact, the oil cost recovery comes in the form of production sharing contracts, not in the form of cash transfers. Under the standard production sharing contract, oil and gas companies will recoup their costs of exploration, development and operation out of gross production.
It is not a strange matter that Indonesia's oil and gas production declines while the cost recovery budget grows (although the House of Representatives and Ministry of Energy and Mineral Resources agreed to slash the cost recovery budget in the 2016 State Budget). Firstly, most of Indonesia's oil production originates from maturing oil fields that are characterized by declining output while production costs do not fall accordingly. Secondly, the oil recovery budget not only covers costs made in a specific year, but also costs in the preceding years (it can take several years of exploration and investment before production can start).
Indonesia's upstream oil & gas regulator (SKK Migas) monitors the cost recovery through the centralized and integrated vendor database (CIVD). Post audits are also conducted by the Supreme Audit Agency (BPK). Occasionally authorities and firms cannot agree on the amount of cost recovery. For example, earlier this year, the BPK reported that several oil and gas production sharing contractors deliberately inflated the reimbursement of their operating cost claims.