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JAKARTA – Well before Covid-19 torpedoed growth, exports and investment, it was already dawning on Indonesians that resource nationalism policies are coming at a high and rising cost to the country, both in capital expenditure and lost revenues.
President Joko Widodo’s government’s impending move to assume control of Sumatra’s Rokan Block, previously the country’s largest producing oilfield, was panned in a recent Tempo magazine editorial as a “misguided takeover” that it claimed will result in significant losses for at least the next three years and perhaps even longer depending on when global oil markets return to normality.
Located onshore in the southern Sumatran province of Riau, Rokan will pass from Chevron Pacific Indonesia (CPI) to the state-owned Pertamina oil company when the US firm’s contract expires next year, part of a national strategy to take ownership of many of Indonesia’s oil and gas assets.
Oil industry experts fear, however, that Rokan may follow the same pattern as the offshore Mahakam gas block in East Kalimantan where production has yet to recover since the French oil company Total was forced to relinquish its controlling stake to Pertamina in early 2018.
Similar controversy surrounds the government’s purchase of a majority share in PT Freeport Indonesia (PTFI), a subsidiary of Phoenix-based Freeport McMoRan Copper & Gold (FCX), which has been mining in the Papua’s Central Highlands since the early 1970s.
Last month, Orias Moedak, the respected managing director of state holding company MIND.ID, sparked a heated parliamentary exchange when he was unable to explain how long it will take the government to pay off the 51.23% stake in PTFI.
The sharp rebuke by Mines and Energy Commission member Muhammad Nasir, a three-term legislator in former president Susilo Bambang Yudhoyono’s centrist Democrat Party, shone a renewed spotlight on the negative short-term financial fallout from the FCX deal.
Indonesia’s media has usually focused on mismanagement or suspected corruption in the nationalization of resource assets. But in addressing the Rokan case, Tempo homed in on the policy itself and how it often ignores technical and business calculations that will inevitably result in a decline in state revenues.
“In future, economic management must be based on business calculation to bring maximum benefits to the state,” it said, adding that nationalistic rhetoric proclaimed during elections campaigns that lead to losses to the state should be abandoned.
Pertamina paid a signing bonus of US$783 million, much higher than Chevron’s offer, in the August 2018 takeover of the Rokan block, which has produced 11.5 billion barrels of oil over a lifetime that goes back to the early 1970s.
The state-owned oil company estimated at the time that Rokan’s Duri, Minas and Bekasap fields will need $70 billion in investment over the next 20 years to maintain production at acceptable levels and save an annual $4 billion in oil imports.
But once it was decided not to renew Chevron’s contract in 2021, the US energy giant predictably called a halt to further enhancement drilling. Production has since fallen from 200,000 to 180,000 barrels a day, with a further slide predicted this year.
That is less than the 200,000 barrels flowing from ExxonMobil’s Cepu field in East Java, which first came on stream in 2008. The two blocks contribute about two-thirds of the 781,000 barrels Indonesia produced last year, a steady and significant fall from the one million barrels pumped a decade ago.
Without a budget to take up the slack, Pertamina is now in discussions with Chevron to work out an arrangement that will make it worthwhile for the company to invest during the transition period and slow down Rokan’s rate of decline.
In the meantime, Pertamina must master the tricky technique of steam-driven enhanced oil recovery (EOR), which has allowed Chevron to achieve a 60% recovery rate since the mid-1980s to extend the life of the maturing block.
While it will take on Chevron’s existing field staff, the key to enhancement lies not only in the amount of drilling but also in the design and placement of the wells, relying on new technologies and chemicals developed by the Californian company.
Over the years, EOR has become a highly-specialized sub-industry, integrating chemical design and manufacturing, logistics, reservoir management and complex systems to keep fields producing well beyond their natural decline curve.
In one of the largest developments of its kind, Chevron has been applying those techniques at the Duri field since 1985, with hot steam injection reducing the viscosity of the heavy crude and allowing it to flow freely into production wells.
Costing at least $5 per barrel of oil, the chemicals developed in Chevron’s laboratories to assist in that process are unique to Duri and will require separate negotiations to permit their continued use and address intellectual property rights issues.
Another major problem confronting Pertamina is environmental restoration. When Chevron signed its Rokan contract in 1971, it did not include any provision for post-operation rehabilitation which, according to some reports, could now cost as much as $1.5 billion.
Although Pertamina also wisely kept on Total’s Indonesian management, the Mahakam block’s production has fallen dramatically since 2018. That’s because it has only had funds to drill 15-20 of the 100 new wells needed each year to maintain the field at near the same levels.
“If they want to drill a well, they have to go through several levels of Pertamina management before going on bended knee to Parliament,” says a former Total executive. “They shouldn’t have to do that for operational costs. It isn’t state money because it will be reimbursed from production.”
The East Kalimantan field still has proven and probable reserves of about 3.8 trillion cubic feet of gas, requiring a budget outlay of $1.5 billion a year just to maintain gas production at an originally targeted 910 million cubic feet a day (MMSCFD). It has now slumped to 660 MMSCFD.
Regulatory and bureaucratic obstacles have long been seen as the key factors in the steady decline in investment in Indonesia’s oil and gas sector, whose contribution to state revenues has slumped from 20% ($26.1 billion) in 2010 to 7.4% ($10.1 billion) in 2018.
In the mining sector, Freeport had always been the main prize, generating $756 million in state revenues in 2017 – including $135 million in dividends to the government – and lining the pockets of influential businessmen-politicians who crowded around to share in lucrative supply contracts.
But the nationalistic chest-thumping that greeted the government’s purchase of a controlling interest in the company after prolonged negotiations has now given way to a more sober assessment of the benefits it is expected to bring.
That will be considerable when miners still have to find the bottom of one of the world’s richest mineral deposits. But in the short term, in a country where rent-seeking is ingrained into the business culture, Indonesian managers face the consequences of owning a mine long-regarded among nationalists as Corporate Enemy No 1.
“They have gone from being an antagonist to an advocate,” says one former Freeport employee, pointing to Moedak’s roasting in Parliament. “They’re learning what it is like to be in a risky business and not just sitting back and collecting royalties and taxes.”
With production and revenue sinking to an all-time low as Freeport transforms its fabulously rich Grasberg mine from an open pit to a block caving operation, MIND.ID has deferred the payout of dividends until at least 2021 to partly meet billions of dollars in capital and operating costs.
Indonesian governments have never been good at clear-eyed technical or financial explanations, so the negative emotional response in Parliament was probably inevitable when the Indonesian public has been told for years that buying Freeport would see cash pouring into state coffers.
Freeport McMoRan mine managers anticipated the slump 20 years ago, given the finite nature of an open pit operation. But it did not foresee the nationalization of the Grasberg, nor a coronavirus pandemic that has set back a return to full production until 2022-23.
Even then, engineers are faced with unprecedented technical challenges that could still present further setbacks for the two Australian and Canadian contractors undertaking much of the underground work under and around the pit.
The government raised $5.2 billion from a consortium of 11 foreign and local banks to cover the $3.85 billion purchase price and additional capital expenditure, a package concluded in July 2018 just a day after the deal was sealed.
Four months later, MIND.ID, then known as PT Indonesian Asahan Aluminium (Inalum), sold another $4 billion in US bonds in four separate three to 30-year tranches, again for what was reported to be the express purpose of funding the Freeport purchase.
Analysts assume now the extra $5.3 billion raised in loans and bonds will be used to fund the Grasberg’s operations, a new $2.7 billion smelter and the sub-surface expansion, which involves an extensive electric rail network to tap into three new deposits.
Only last October, MIND.ID also laid out $392 million for a 20% stake in PT Vale Indonesia, owner of the country’s oldest nickel mining operation in Central Sulawesi, now the site of a major Chinese nickel pig iron complex.
Under the 2018 agreement, if the state holding company can’t come up with the cash for its share of Grasberg’s expenditure – as may be the case in this difficult year – FCX undertakes to pay the balance, but at 6% over the inter-bank interest rate (LIBOR).
“The accounting mechanism for this is really complicated and FCX has built in a number of ‘time bombs’ that I suspect are going off right now,” says a financial and legal expert familiar with the complexities of the 2019 agreement.
With the Covid-19 pandemic applying intense pressure on the state budget, all this focuses renewed attention on what one analyst calls the “political orientation” of Pertamina and MIND.ID and the interest groups that lie behind them.