Indonesian court decision casts uncertainty over legal basis of Indonesian oil & gas sector

The oil & gas industry in Indonesia has functioned via a production sharing contract ("PSC") regime since the 1960s and has enjoyed a period of relative stability in recent years. A decision by the Constitutional Court of Indonesia has cast doubt over the current functioning of the PSC system and the key government administrator of the oil and gas industry in Indonesia, BPMIGAS.  Please click here to read a web version of this post in English or Chinese.

 

On 13 November 2012, the Constitutional Court of Indonesia (the "Court") issued a decision which annulled articles within the Indonesian Oil & Gas Law 22/2001 (the "Oil & Gas Law").  The two key take-way points from the decision are that: (1) BPMIGAS, the Government body in Indonesia regulating the upstream oil & gas sector, is to be dissolved with immediate effect; and (2) the Court indicated that, for consistency with the Constitution, the current "private law" PSC model (whereby the Government, via BPMIGAS, enters into PSCs directly with private entities) should not be used going forward and should be replaced with a "public law" concession / licence based system whereby the Government awards concessions / licences directly to a State Owned Enterprise (BUMN).  This State Owned Enterprise would then be free to enter into PSCs or other cooperation contracts (such as service contracts) with private entities for exploration and development of relevant work areas.    

In its ruling, the Court declared BPMIGAS "unconstitutional", noting that any sections in the Oil & Gas Law relating to the "executive agency" concept (which was the space BPMIGAS was created to fill) are not legally binding.  The Court ordered the immediate dissolution of BPMIGAS and stipulated that its functions would need to be administered by the Government, in this case via the Minister of Energy and Mineral Resources ("MEMR").  In addition, all rights and powers of BPMIGAS in relation to PSCs, should be carried out by the Government or a State Owned Enterprise determined by the Government. 

The Constitutional Court has specific powers in relation to the review of legislation and the decision of the Court is not open to appeal.  Indonesian President Susilo Bambang Yudhoyono has responded to the decision swiftly, passing a regulation overnight (Presidential Regulation No. 95 of 2012) which serves to assign all duties, roles and functions of BPMIGAS over to the MEMR; to confirm the effectiveness of existing PSCs; and to make it clear that all management roles performed by BPMIGAS in relation to upstream oil & gas in Indonesia will be transferred to the MEMR.  So, BPMIGAS will now effectively be a part of the MEMR.  This will be a stop-gap measure until a more permanent solution can be implemented.  President Yudhoyono has indicated that, given this decision, BPMIGAS will not need to be dissolved, as it is now effectively part of the Government.  He has also ordered an audit of BPMIGAS to ensure outside parties of its transparency.  This is a positive step, and the speed of it demonstrates that the Indonesian government is taking investors' concerns regarding the uncertainty surrounding the Court's decision seriously. 

The references in the Court's decision to the functions of BPMIGAS being transferred to a "State Owned Enterprise" are interesting.  Up until 2001, Pertamina (the Indonesian National Oil Company) played the equivalent role of BPMIGAS as government administrator of the Indonesian oil & gas sector.  The regulatory function of Pertamina was abolished in 2001 in order to separate the functions of owner and regulator and to create a level playing field for holders of oil & gas interests in Indonesia.  There is no suggestion that Pertamina would ultimately be appointed to replace BPMIGAS in relation to its government administrator role for PSCs, nor to act as the state Owned Enterprise mentioned above.  Indeed, the 2001 reforms were aimed at removing this dual role held by Pertamina previously.  However, the Government has indicated that all options will now be considered in determining how to deal with the administration of the sector going forward.  

Implications for Indonesian oil & gas interests 

This Court's decision will potentially have far-reaching implications for Indonesia's oil & gas sector.  BPMIGAS is one of the key players in the sector and is the main body executing new oil & gas contracts, advising the Government on extensions of PSCs, approving transfers of PSCs, administering various approvals under PSCs and overseeing sales of the Government's share of hydrocarbons. 

The Court was clear that existing PSCs are to remain in force in their current form: in giving the Court's ruling, the Chief Justice, Mahfud MD declared that “all of the existing oil and gas contracts will be unaffected until they expire”.  President Yudhoyono has also been quick to confirm that this is the case.  However, the replacement of BPMIGAS by the MEMR as administrator of PSCs has the potential to have wide-ranging practical implications for parties to PSCs, in particular, in areas such as cost recovery, approval of work programs and budgets, approvals of plans of development and hydrocarbon sales, where BPMIGAS's function has been central to the system.  BPMIGAS's key role in approving data disclosure and approving transfers also means that this decision could have implications for current and future disposal and acquisition processes involving Indonesian oil & gas interests and may cause delay and uncertainty in those processes.  The impact of the transition of BPMIGAS's function to the MEMR will depend largely on the extent to which the MEMR (and any subsequent body) continues to follow past practices of BPMIGAS in relation to administration of the Oil & Gas law and PSCs.     

It is also unclear how extensions of existing PSCs and grants of new oil & gas interests will now be dealt with in Indonesia.  This will have implications for parties who are in current PSC negotiations, as there will now be no clear legal basis for BPMIGAS to execute PSCs and so this will need to be performed by MEMR.  But, given the Court's comments regarding new grants of PSCs by the Government, it may take some time for a clear process for granting new interests to private investors to be determined.  This is something that any new oil & gas law would need to address. 

Background to Constitutional Court ruling 

A judicial review challenging the Oil & Gas Law was filed by several Non-Government Organisations. The plaintiffs alleged that the existence of BPMIGAS violated Article 33 of the Indonesian Constitution, which states that "the land, the waters and the natural resources within Indonesia shall be under the powers of the State and shall be used to the greatest benefit of the people". In the plaintiffs' view, BPMIGAS treated foreign investors favourably and did not adequately safeguard Indonesian resources for Indonesians. 

In giving its ruling, the Court granted part of the plaintiffs' judicial review claims by revoking certain articles of the Oil & Gas Law relating to BPMIGAS.  The majority of the Court also challenged the constitutionality of the Government's direct participation in production sharing contracts and indicated that a concession regime, via a State Owned Enterprise, would be more consistent with the Constitution. There was a dissenting view from Justice Harjono, who did not agree with this majority view.     

Outlook 

It is too early to assess the impact of the Court's ruling on existing and future investments in Indonesian oil & gas interests (including transfers of existing interests).  Much will depend on the regulatory regime that will replace the current set-up and how quickly the government can respond with a sensible long-term solution.  Once the Court's decision is digested, we expect that a number of changes to the 2001 Oil & Gas law and its implementing regulations will be required.   Indeed, President Yudhoyono indicated yesterday that the Government will start drafting new legislation to address the issues immediately. 

There are some parallels here with recent developments in the Indonesian mining sector, as the system of granting interests in that sector to foreign investors was over-hauled in 2009.  As subsequent changes in the Mining Law and their impacts have demonstrated, these changes have meant additional uncertainty for foreign investors.  Note too that it is now 3 years since these changes to the Mining Law took effect and there is still no system in place for granting new licences.  Although the cooperation contract system will remain in place under the 2001 Oil & Gas law, the indications from the Court that (in order for such contracts to be valid) a concession would need to be granted to a State Owned Enterprise, who could then enter into cooperation contracts with private investors, leads to uncertainty over the process for granting new oil & gas interests to private investors.

The Government's swift response to the Court's decision indicates that it recognises the importance that investors' place on certainty and that it will do all in its power to return this certainty to the oil & gas sector in Indonesia as soon as it can.   

Herbert Smith Freehills and Hiswara Bunjamin & Tandjung will monitor developments closely and will issue updates as the situation evolves and more information becomes available.