Thursday, July 03, 2008 Vincent Lingga, The Jakarta Post, Jakarta
We find it hard to understand why it has taken more than two years for the Indonesian government to enforce strong budgetary discipline on its oil and gas production-sharing contractors as its own fiscal situation has rapidly deteriorated.
We badly need new investment to develop our hydrocarbon resources and to increase proven reserves, and most of the investment is expected to come from foreign oil companies. But this should not mean giving them a blank check.
Energy and Mineral Resources Minister Purnomo Yusgiantoro confirmed Monday the government will soon impose stronger spending discipline on oil and natural gas companies by revising their cost-recovery mechanism and the classification of expenses they can book as costs.
The Supreme Audit Agency's (BPK) auditing of several major oil contractors in 2004-2005 found almost US$1.5 billion in potential losses to the state caused by what its auditors called excessive cost accounting.
Finance Minister Sri Mulyani Indrawati had alleged as early as October 2006 that oil production-sharing contractors used cost-recovery accounts as a dumping ground for expenses, irrespective of their relevance to exploration or production costs.
As the minister in charge of state revenue, Sri Mulyani should have been worried by reports from tax officials that the government's split of each barrel of oil pumped by contractors had declined steadily over the past three years because of the steady, unusually high increase in production costs.
But Purnomo and the upstream oil and gas regulatory body, BP Migas, which oversees oil contractors and approves their annual work plans and budgets, and gives authorization for every item of their expenditures, seemed unaware of the urgency of the problem.
According to the minister of energy and mineral resources, the new regulation will specify in detail those activities that can and cannot be refunded under the cost-recovery program.
As reported earlier, the BPK found that in 2005, oil and gas contractors claimed expenses under the scheme for such goods and services as DVDs, parties, dance courses, charities and haj pilgrimages to Saudi Arabia.
Many expenditures the new regulation will no longer classify as recoverable costs are simply strange and unreasonable, such as public relations and community development costs, technical training for expatriates, personal income taxes, long-term incentive plans, hiring legal consultants for unrelated legal matters, tax consultation fees, borrowing costs and others.
These expenditures have so far been borne by Indonesian taxpayers because they are always deducted from the oil output before it is split between the contractors and the government.
Public relations and community development costs should not have been counted as a component of production or operating costs by oil contractors because they are part of their corporate social responsibility (CSR).
CSR activities reflect a profit sharing by a company. If such expenditures are accounted as costs, thereby deductible from taxable income, that is no longer an act of CSR, which basically means the sharing of profits with the community, but simply the practice of sharing the costs with taxpayers.
A company that spends on CSR activities but deducts these expenditures from its taxable income simply usurps the government's right to decide on where to spend its taxpayers' money.
Likewise, the costs of technical training for expatriates do not make any sense. Why, after all, would a company hire expatriates if they still require additional technical training? The case would be different if the training was for locals.
The removal of 14 other categories of expenditures from the new cost-recovery mechanism also makes sense under the standard oil and natural gas production-sharing contract.
Oil firms will not abandon Indonesia because of the tighter spending regulation. Nor will the new cost-recovery mechanism make the country's hydrocarbon resources less attractive to oil companies.
Like a good manager that detects a steady decline in income due to higher production costs, the government needs to make a comprehensive review of the structure of exploration and production costs, as accounted by mining contractors, to ascertain as to whether they are reasonable.
The rationale is that the government's take (share) of the oil or natural gas from a production field is based on output after the costs are recovered. Of greatest importance is that the new regulation should clearly define the terms of reference or directives on what expenses oil contractors can claim as exploration or production costs. Oil companies simply need certainty as regards the accounting of expenses.
Unclear provisions on recoverable costs would leave oil contractors constantly embroiled in disputes with auditors from BP Migas and the tax office. Such bickering would only slow production and discourage new exploration.
Given the specific characteristics of hydrocarbon prospecting and development, the new cost-recovery mechanism should be commercially viable for the petroleum industry, but should not cause additional bureaucratic harassment of oil contractors.
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