ENERGY NEWS

Indonesia 2003 Oil Production Drops 8 Percent

Summary:
 Indonesian gross oil production declined for the tenth straight year, dropping by eight percent to an average 1.1 million barrels per day in 2003. With the exception of France's TotalFinaElf and Indonesia's Pertamina, all major producers reported lower numbers. Three companies -- PT Caltex, Exspan and the Chinese National Offshore Oil Corporation (CNOOC) -- accounted for 95% of the production drop. Aging fields, lower exploration spending and bureaucratic delays by the upstream regulator were key factors behind the decline. Reversing this trend in the near-term is unlikely. In order to generate significant new production, the GOI will need to provide greater regulatory clarity and take stronger steps to improve the industry's investment climate. End summary.

Continuous Declines Since 1993 

Indonesia currently ranks seventeenth in world oil production. The country produced a gross average of 1.146 million barrels of oil per day (bopd) in 2003, down eight percent from the previous year's average of 1.251 million bopd. The Energy Ministry reported that crude oil accounted for 1.013 million bopd of the total, while condensate production averaged 133,800 bopd. On a monthly basis, crude and condensate production declined from 1.187 million bopd in January to 1.106 million bopd in December 2003. This marks the tenth straight year of production declines, down from 1.528 million bopd produced in 1993.

Sumatra Accounts for Majority of Oil Drop 

Three oil producers accounted for 95% of the production decline. PT Caltex Pacific Indonesia (CPI), the country's largest oil producer, accounted for two-thirds of the drop, or about 71,000 bopd. Half of CPI's reduced production is due to the August 2002 GOI transfer of the CPP block to state-owned oil company Pertamina and the Siak regional government in Sumatra. Natural depletion of CPI's 50-year old Duri and Minas fields accounted for the remainder of the decline. Indonesia's Exspan dropped 19,000 bopd due to lower production in its eight-year old Kaji-Semoga field in South Sumatra. The company estimates the field is 50% exploited with at least four years of proven reserves remaining. China's CNOOC, which entered the industry when it acquired YPF-Repsol two years ago, dropped 20,500 bopd in 2003. Lower than expected production at its 35-year old SES field in South Sumatra in 2002 caused the company to cut back its in-field drilling program last year.

Crude and Condensate Production by Company 

The following shows gross crude and condensate production by company (in thousands BOPD):

Notes: * Caltex average production at CPP until August 2002. **PT Bumi Siak average production from August 2002.

Reasons for Production Decline 

Aging fields, lower exploration spending and bureaucratic delays are some key reasons for Indonesia's declining oil production. More than 80 percent of the country's commercial reserves come from oil blocks signed before 1971. Blocks signed after 1990 account for only five percent of oil reserves. The GOI reported that oil and gas exploration drilling investment dropped from $500 million in 2002 to $207 million in 2003. The number of wells drilled also fell, from 102 in 2002 to 54 last year. Bureaucracy may partially account for the lower drilling numbers. Several companies told us that authority for expenditure (AFE) processing by upstream regulator BP Migas has slowed dramatically, delaying numerous development projects. Although the GOI originally envisioned this regulatory body to be lightly staffed and more efficient than its predecessor Pertamina, the reverse has been true. BP Migas staffing is now four times greater than planned and companies regularly complain the body's decision-making apparatus is unwieldy, inconsistent and slow.

Some Interest in New Exploration 

The GOI is taking steps to correct some of these problems. After making small improvements to new revenue sharing terms, Indonesia signed 15 new exploration blocks in 2003, up from eight contracts in 2001 and only one new contract in 2002. However, none of these new blocks had sufficient potential to attract the participation of major international petroleum companies. The GOI plans to average 10 new exploration block offerings per year over the next five years. Additionally, it has streamlined the bidding process and created a special mechanism for companies to bid on new blocks without waiting for a formal bidding round. The reserve potential and revenue sharing terms of these new blocks will determine who bids and whether new exploration investment will increase.

Lack of Regulatory Clarity 

This positive news is offset by industry concerns over the lack of regulatory clarity. The GOI missed its self-imposed December 2003 deadline to issue new oil and gas implementing regulations. The draft regulations could violate the sanctity of existing production sharing contracts by requiring companies to offer 10 percent participating interest to regionally-owned companies. The draft also creates a new domestic market obligation for gas (one already exists for oil) and contains new tax provisions from the Ministry of Finance that are inconsistent with existing contract terms. (Note: The Energy Ministry may provide some relief. Energy Minister Purnomo has said that if the GOI does impose new taxes on petroleum companies, he will offset the hike by adjusting the current revenue sharing terms in favor of the companies.) The Indonesian Petroleum Association (IPA) is urging the GOI to add language to the draft regulations that would exempt existing (pre-2001 Oil and Gas Law) contracts from the new regulations.

Weak Investment Climate Hurts Production 

Industry analysts also believe the GOI must improve the investment climate in order to reverse the production decline. Both the IPA and the American Chamber of Commerce have provided the GOI concrete recommendations on renewing investor interest in Indonesia. In addition to sanctity of contract, these recommendations include improved fiscal incentives - Indonesia's standard oil contract terms are rated the third worst globally, after pre-war Iraq and Venezuela. Inconsistent labor laws and a notoriously corrupt legal system add to investor concerns. The industry also notes the GOI's limited success in extending contracts. Oil production at the CPP block in South Sumatra has dropped nearly 10,000 bopd since the GOI ended PT Caltex's extension bid in 2002. Significant new oil production at ExxonMobil's Cepu oil and gas block in East Java also remains undeveloped due to lengthy negotiations over contract extensions.

Comment 

Indonesia's oil production will continue to decline for at least the near-term. Even if new investment poured in tomorrow, it would take several years for greenfield projects to begin production. The age of the vast majority of the country's existing fields means that their production will continue to drop without greater investment in oil recovery. It is within the government's capacity to turn things around - clear and fair regulations, less bureaucracy and improved fiscal incentives are some attainable goals that would generate the investment necessary to increase oil production. However, we note that oil and gas investment actually declined during 2003, Indonesia's so-called "Year of Investment." Therefore, it is unclear whether the government has the will to enact these changes. It may require a wake-up call, such as a major company pullout or a change from oil exporter to oil importer status, for the GOI to turn things around.

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