Mutable tax policy and investor uncertaintyOctober 20, 2017
Sacha Winzenried, PwC Indonesia’s energy, utilities and mining leader, talks to TOGY about the government’s plans to revise PSC terms and the future potential for hydrocarbons development in the country. PwC has been active in Indonesia for more than 40 years.
PwC Indonesia provides audit, tax and financial advisory services to Indonesia’s oil and gas industry. In terms of forward motion, business consulting and strategy consulting have grown in past 3-4 years both with state-owned enterprises like Pertamina and corporates firms as well as other operators. While the fall in oil prices has rocked the island nation, Indonesia’s hydrocarbons market remains an attractive prospect for investors.
• ON PERCEPTION AND UNCERTAINTY: “Sometimes the perception is worse than the reality. Whilst the regulatory hurdles are difficult, usually there is a way to get through those in commercial discussions with SKK Migas and the ministry. But if an investor purely looks at it from a regulatory point of view, as a lawyer sitting in the USA or somewhere else, there is a lot more uncertainty than investing in the Gulf of Mexico, for example. This is the challenge – to make the regulatory environment competitive with other jurisdictions.”
• ON RENEWABLES: “In the long term it is going to move in that direction. We see a lot more investment in renewables now. Obviously, Indonesia has a lot of renewables potential. Geothermal resources are huge, and probably an opportunity that should have been taken up a lot earlier than this. Even Pertamina itself is heavily involved in geothermal [energy production]. Its geothermal subsidiary will soon be the biggest geothermal producer in the country.”
Winzenried also discussed the potential of IPOs as a funding mechanism for major development. Most TOGY interviews are published exclusively on our business intelligence platform TOGYiN, but you can find the full interview with Sacha Winzenried below.
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What is happening now with the energy sector in Indonesia?
Obviously, at the end of 2015 and into 2016, we saw the big fall off in oil prices, which had an immediate impact on investment appetite. International players globally and local players here stood back a bit and looked at what their plans were for the coming years. Basically, investors put capex and expansion of projects on hold. The end of 2015 and first half of 2016 was very much a wait-and-see game for everybody.
Recently, we have seen some recovery in oil prices, which has meant that mature players with ongoing projects have been able to ramp up production, with some additional capex. Pertamina has been working on that in different fields across the country.
Even though oil prices have picked up a bit, we still have not seen a lot of new projects or large expansions in the Indonesian market, even in the past year. Interest in recent tender rounds for new PSCs has also been muted. We are still dealing with a perception issue compared to some other oil and gas locations around the world about whether the investment terms are currently competitive enough for expansion or new investment in this market. This goes for both the international players and local investors, that need to attract funding for investment. This means that we have not seen a lot of new projects. The key exceptions in recent times are probably ExxonMobil’s Cepu project, which is the largest new oil development in recent years, and train 3 of the Tangguh LNG project operated by BP [Indonesia].
In your opinion, are Indonesia’s new PSC, taxing mechanism and gross-split schemes attractive enough to attract foreign investment?
The general industry response to the new gross-split PSC arrangements has not been very positive. There are questions about whether the mechanism will provide sufficient return to investors over the life of the PSC, which of course is highly dependent on the share of production allocated to the investor. There are also questions about whether the tax impacts of the new scheme could cause issues for investors who need to use the tax credits in their home country. Another issue is that aggressive audit activity by the Indonesian tax office may eat into investor returns, even if SKK Migas or other regulators are no longer involved in approving costs, as occurs under the current cost-recovery system. The Ministry of Energy and Mineral Resources believes that the gross-split system is effectively a simplification of the existing process. Some of the roadblocks that come with bureaucracy for approvals will be removed so that projects can progress to development more quickly. This should serve to offset some of the industry’s concerns. One positive effect is that the Ministry has taken some of this feedback, and made some adjustments to the original gross split regulation. Time will tell whether this is sufficient to attract more investment to Indonesia or more interest in upcoming tenders of new exploration areas.
How has the industry reacted to these proposals?
The feedback we hear from the industry, including the IPA [Indonesian Petroleum Association] and others is that they do not yet see this as an incentive for further investment. They would rather see more certainty around the existing PSC system. In some ways, it is causing a bit more uncertainty rather than spurring investment. The government is probably aware of this and is looking at ways to further clarify the regulations.
The bottom line for an investor is whether it improves the economic return on investment. If existing PSCs were required to move to the new terms when their existing contracts expire, it could have a significant negative impact on the present value of the projects, which would have had a lot of money spent on exploration and development that may not have been fully recovered yet. This is of course very dependent on the individual circumstances of each project, so it is very hard to say that the new gross split mechanism is good or bad overall, because it depends on many technical and economic factors specific to each project.
Unfortunately, it has not created an immediate positive impact. It creates a little bit more uncertainty, which is really the enemy of investment. In the surveys we have done over the years, the number one issue raised by investors in the oil and gas sector has been uncertainty due to regulatory changes. Investors are looking for consistency and long-term regulations that do not change over the life of a project. The other key issue raised is co-ordination between the different arms of government and the central and regional governments. The third is contract sanctity. Companies with existing contracts want to know that the contract terms will be honoured regardless of what new regulations come, which I think the government agrees with.
What are the main hurdles and opportunities that you see for new investment and newcomers?
If we start with the opportunities, most people accept that there are still significant hydrocarbons opportunities in Indonesia. There are large parts of Indonesia, particularly Eastern Indonesia, which have not been fully explored. There are opportunities particularly in gas and deepwater, and potentially in LNG development to support Indonesia’s planned expansion of electricity generation in the country, as an alternative to coal.
The opportunities appear to be predominantly in gas rather than oil. Indonesia has many of the ingredients necessary for a strong oil and gas industry: The opportunities are there from a geological perspective. Technical capabilities are quite strong in Indonesia. This has been a significant oil and gas player for more than 50 years, so there are good people with good technical know-how. You find Indonesians working all over the world in the oil industry for that reason, particularly in LNG where Indonesia was a pioneer. That is a big positive.
The negatives include the uncertainty around regulation, which is what investors are always concerned with. Many of the majors are still operating in Indonesia, so maintaining those relationships is very important. Sometimes the perception is worse than the reality. Whilst the regulatory hurdles are difficult, usually there is a way to get through those in commercial discussions with SKK Migas and the ministry. But if an investor purely looks at it from a regulatory point of view, as a lawyer sitting in the USA or somewhere else, there is a lot more uncertainty than investing in the Gulf of Mexico, for example. This is the challenge – to make the regulatory environment competitive with other jurisdictions.
Do you think the new energy mix proposed for 2025 will succeed?
Clearly, Indonesia is already a net importer of oil and will probably soon be a net importer of energy, if gas production does not continue to increase. I think the government statistics say the same thing. We could become a net energy importer even considering gas and coal. That is a big challenge for a country with a growing population. Investment in development of new oil and gas reserves is key.
The message to the market sometimes seems to be that Pertamina, as the national oil company should be able to handle most of this, which is not necessarily the best way to guarantee that there is adequate development of resources here. That is not because Pertamina lacks capability. It is just the size of the challenge, and the fact that the country should want to spread the risk. Relying on the state oil company for everything is a risk, and requires a huge amount of investment. Whether that funding is available in the local market is also a big question.
Do you think the country is prepared to raise renewables from 6% to 25% and decrease oil production from 32-33% to 25-24%?
In the long term it is going to move in that direction. We see a lot more investment in renewables now. Obviously, Indonesia has a lot of renewables potential. Geothermal resources are huge, and probably an opportunity that should have been taken up a lot earlier than this. Even Pertamina itself is heavily involved in geothermal [energy production]. Its geothermal subsidiary will soon be the biggest geothermal producer in the country.
There is also ongoing investment in other renewable energy sources. Whether it is solar, hydro or wind, there are projects happening all over Indonesia, predominantly focused on power generation. The country has already moved significantly away from using oil for power generation, replaced by coal as the main fuel source. This is likely to remain the case for the next 20-30 years. Gas will start to play a bigger role, and renewables, according to the government’s plan, should get up to 20-25%. That is going to take some effort and support from government, because the investment cost for renewables is greater.
How is the investment in renewable energy being allocated?
Most of the renewable investment happening now is in regional areas disconnected from the Java-Bali grid. Players can invest in small-scale mini-hydro, mini-LNG or wind farms to service just an island or small town. As these smaller projects start to add up, renewables will become a more significant piece of Indonesia’s energy mix. When will it actually be servicing the grid and large cities? I think that is a big question that is still to be planned. The government is aware of the challenges, but I am not sure there is a clearly written strategy on how they are going to manage the deficit of production against demand for hydrocarbons and how renewables will fit into that. There is a national energy policy, but whether it is in line with the reality of today is a question.
Do you see IPOs and mergers and acquisitions happening in Indonesia in the short term?
We have just seen a lot of activity in geothermal. Chevron recently sold their geothermal assets to a consortium including Star Energy, which is a big Indonesian geothermal producer.
A little bit of activity is starting again in the oil and gas industry because some analysts and investors are beginning to change their views on oil prices. There is more interest now in some of the smaller projects that probably were not feasible several years ago.
IPOs definitely have potential. The local market is interested, but in almost all cases, significant fundraising requires foreign investors in the IPO. We saw that with all the coal companies over 2008-2010, with most of them being listed very successfully here. A local listing is also encouraged by the government, in general. If an investor really wants to develop in Indonesia, a local listing makes a good contribution to the country through supporting the capital markets. This simultaneously helps relations with the government and other stakeholders, because it makes a difference to have a locally-listed entity.
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