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Interview

with Ari H, Soemarno, Oil and Gas Consultant

14.02.2012 / Energyboardroom

As a former CEO of Pertamina would you begin by sharing your views on the operating environment for Pertamina in Indonesia?

Last week I was asked to give a talk to APINDO, the Indonesian Businessmen’s Association on the matter of competition. I advised them that the oil and gas business is not in its nature a competitive business, but is instead oligopolistic in nature because of its high capital intensity, whether this is capital investment or working capital. However, there are clear differences between upstream, midstream and downstream from the perspective of competition and there should not be a one size fits all model. Unfortunately, what is missing in Indonesia is a proper understanding of how much competition there should be in the oil and gas business at these different levels from upstream to downstream.

The Indonesian government has always treated the oil and gas industry as a single chain or process where the state produces oil or gas through the PSC (even though this is actually carried out by an oil company), the country owns the oil and derivative products and then distributes these to the general public. However, to be successful, Pertamina must be recognized as a business entity. Unfortunately, this is not fully understood by the political stakeholders.

As an example, when I was CEO of Pertamina, the government intended to transfer all its assets to Pertamina’s balance sheet, turning it from a normal state-owned enterprise into a giant warehouse for state oil and gas assets. The Indonesian state could no longer take care of the entire value chain, in fact this had been the case since the 1980s – the last time that oil and gas infrastructure was still entirely built by the state. The government therefore wanted to dump it on Pertamina a whole host of assets from LNG facilities to redundant offshore drilling rigs with disregard for whether these assets could benefit the company or whether they fitted within Pertamina’s strategy. The audit could not even be finished by the end of my time as CEO because the opening balance sheet was impossible to calculate. Accruing these various assets was very damaging for Pertamina’s return on assets and it all springs from a misunderstanding of Pertamina’s role in Indonesia. The audit was finally approved end of 2009, where all of those non generating revenue assets were excluded from Pertamina’s balance sheets. So it took over 5 years to complete it.

The 2001 law on oil and gas established the working environment for the industry. What is your perspective on this law?

I had already warned the government back in 2002 following the passing of the oil and gas law that the government should be prepared to modify the law after it was introduced. Generally speaking, I agreed with the principals of the law given that it was opening up competition. I knew that this law would make dramatic changes to the industry, but believed that we should always be prepared to make modifications should one thing or another not function correctly.

The inspiration behind the law was to create liberalization in the Indonesian industry and reduce the state functions of Pertamina in accordance with the advice of the IMF and World Bank. This was a perspective I agreed with. The IMF report advised that Pertamina cease functioning as the regulator, administrator and executor of the entire oil and gas industry. It claimed that the corruption and nepotism of the Suharto era was all reflected in Pertamina, and that this was probably because 80% of state revenue depended on this one company. However, the report also detailed that Pertamina should be split into several companies and these subdivisions should be sold, something with which I had a profound difference of opinion.

My perspective was that Pertamina should be made into a true corporation and another corporation, BP MIGAS, should deal with the concessions and contract signing. My belief was that, just like Pertamina, BP MIGAS should become a state owned company. A production sharing contract is a business contract made between companies. Making this contract with a state institution raises issues of sovereignty and liability – what happens in the case of a dispute? Would the government go to court? How would you go about confiscating a government asset?

I also believe that making BP MIGAS a special business entity would have made it more efficient. It needed to understand its KPIs to evaluate its performance, it needed to measure profit and loss. However, the government did not listen and BP MIGAS consequently became very bureaucratic and the target of many complaints concerning the PSCs.

The government has been talking about revising the oil and gas law and the role of BP MIGAS. Do you see this as a positive step?

There is discussion of revising the law but unfortunately the government does not wish to make BP MIGAS a company. As a result BP MIGAS will remain inefficient. If we take as an example the length of time required to get approval for a plan of development (POD) this inefficiency becomes clear. During Pertamina’s time as the regulator if the internal organization in Pertamina responsible for deciding the POD could not approve a plan inside of 3 weeks then the CEO of Pertamina would decide. There was a guarantee of finishing the POD inside of 3 to 4 weeks. When BP MIGAS took on the same responsibility it took the institution 6 months to do the same work. This resulted occasionally in budgets for the year’s development only being approved in September. This makes developing projects very difficult. I do acknowledge small steps towards improvement but because BP MIGAS is a state institution rather than a company, it is inevitably burdened by bureaucracy.

What is needed in Indonesia is more decisive action. There have been no new reserves found in Indonesia for the last 10 years because there is very limited investment in exploration, even on existing fields to enhance recovery. The truth is that upstream oil and gas projects are becoming more challenging and investment is consequently less appealing. As may be the case worldwide, the era of easy oil in Indonesia is now in the past. Production facilities developments are needed to be built in more remote locations as is the case with Abadi-Masela or Natuna gas fields. E&P projects are also, dealing with increasingly difficult formations involving complex compositions of oil, gas and CO2 such as the Cepu block near Java with close to 30% CO2. The production environment is more challenging, has higher risks, and requires more time, more advanced technology and this all costs more for oil and gas companies.

Creating an attractive investment environment is not only about changing the PSCs to 65:35, 60:40 or even a 50:50 agreement. There are a host of bureaucratic problems which harm the attractiveness of Indonesia. A good example would be the issue of extending PSCs. At one time Total wanted to invest in the infrastructure of a block but only had 7 years left on their PSC. Investing and creating the infrastructure would take around 5 years so naturally Total asked the government for an extension of the PSC. BP MIGAS replied that they would discuss it closer to the end of the PSC which clearly does not give any incentives to invest. Sadly this type of practice means that Indonesia is still not one of the priority countries for oil majors.

Only a limited number of oil and gas companies can perform E&P operations in remote deep sea regions, such as Total, ExxonMobil, Statoil, Shell etc. Companies like Total have the necessary capabilities, experience, research budgets and technology which is necessary. Medium-sized companies simply do not have the capabilities. These capabilities are still concentrated within the oil and gas companies themselves rather than oilfield service companies – the executors of projects – like Halliburton of Schlumberger. These service companies may have the technology in drilling but not the expertise in geological analysis for example.
In the shale gas revolution it has been the shale gas companies and not by the services companies or the drillers who have created this industry. Chinese companies like Sinopec recognize this and are spending billions of dollars buying American shale companies because China has very large shale gas reserves.

The challenge before Indonesia is one of attracting advanced IOCs to invest in Indonesia. Unless there is investment, Indonesia is fated to declining production. According to BP figures there are only around 3.8 billion barrels of reserves left. Malaysia nw has higher proven reserves and is constantly increasing these reserves. The only new production field capable of producing a sizeable quantity of oil in Indonesia is Cepu so I predict that in 2-3 years time production will be lower in Indonesia than in Malaysia.

What would be your solution to this situation?

When I was in charge of Pertamina, I already proposed giving preemptive rights to oil and gas fields to Pertamina. Pertamina would then go and find a business partner. My perspective is that this would create greater confidence for the partner because they would be dealing with a business entity rather than a state institution. They would be assured by the fact that Pertamina is also concerned about profit margins and overall returns. This right has never been given to Pertamina.

It was even the case that Pertamina was losing tenders to new fields in Indonesia. In 2008 I was in negotiations with the Chairman of the Board of Shell, Mr. Van Der Veer to enter into a production partnership for a deep sea block in South Papua, giving the majority share to Shell. Shell predicted that the block was very prospective but challenging. After initial study we submitted a strong proposal to the government with an investment commitment of $240 million over 5 years, and a signature bonus of $12 million – a relatively lower signature bonus but a high commitment. In the end, the government gave the contract to Hess who proposed only $140 million in investment, but gave a $20 million signature bonus. Choosing Hess was incomprehensible to me given our much greater commitment to the project. I took my concern to Energy Minister Purnomo an explained that letting Indonesia’s state oil company in partnership with a super-major lose in such a tender sent a very bad message to international investors, was a bad promotion and would stop companies like Shell from wanting to work with us in the future. However, there was no movement from government.

In my view, the policy does not make sense because you need to have a strong national oil company which can secure Indonesia’s energy supply in the era of net oil imports. Even if everything were liberalized now oil production will not increase until 5-6 years from now and there will be a supply gap over this period. Ultimately, I feel that it is a problem of short terms interests over long-term strategy or even corruption.

How do you regard government strategy regarding Indonesia’s downstream?

Indonesian crude is generally sweet crude which is expensive and 90% of Indonesian refineries use this type of crude, yet even now there is a general perception that if a country produces oil then it should be cheap for the country’s consumers. No one in the political sphere is fully making the effort to change this perception. We must educate the people that we are not rich anymore and this socialization is not taking place. Indonesia is a net importer not only in oil but in oil products; the country is not rich, yet it is pretending that it is. This residual perception is why the subsidy issue has never been tackled appropriately and this is the main issue taking this country hostage.

Regarding the issue of subsidies, there is no system to limit consumption, which would require infrastructure, regulations and many other elements to be in place. The only option is therefore to increase the price, which was my recommendation when I was consulted on the issue.

Increasing the price from 4,500 to 6,000 Rupiah should not be a huge issue because Indonesia had already experienced these prices before. However, the price was reduced to 4,500 Rupiah because of the fall in oil prices in end of 2008. If you increase the price to 6,000 Rupiah then you can save around $6billion and people will accept this because they have already paid this amount.
Ultimately, Pertamina is paying a premium to government on the crude it is producing which is a burden to the company. The premium is based the differential between sweet and sour, and the Indonesian Crude Price determined by the government. Pertamina is therefore losing out and cannot compete with other refineries in the region. The state claims that it needs this price for their budget but it is Pertamina who make the sacrifice.

Currently the government is trying to depress Pertamina’s profit margin to save on subsidy spending. Pertamina is therefore indirectly contributing to subsidies. Even regarding the use of LPG, Pertamina is not allowed to sell at market price and so Pertamina’s subsidy on LPG is around $100 million per year.

The subsidy issue is keeping the entire industry hostage for the sake of political popularity. How can you endure a subsidy which is 165 trillion rupiah ($18.5 billion) at an oil price of $100? On top of this there is a further 80 trillion rupiah ($9 billion) in electrical subsidies. This amount of money is lost every year and could be put to much better use. Subsidies are just to finance the 50 million car users in Indonesia but the remaining 190 million do not have cars or motorcycles. Undoubtedly there would be social implications because of the fuel price rise but the total of 250 trillion rupiah could provide adequate compensation. This issue is holding back Pertamina and the development of Indonesia’s infrastructure.

There are also errors in policy regarding the modernization of our downstream infrastructure. Pertamina’s refineries are very old even though I began a modernization program when I was in charge. My project to modernize the Cilacap refinery was to be a joint project with Mitsui. However, this program was reviewed they asked why Mitsui was asking for a project return of 15% and when I left Pertamina the government cancelled the program. The best way to finance these projects is through joint ventures, pouring corporate money into downstream infrastructure is misguided. Cilacap represents a $1 billion project and still does not have the project financing in place. The trouble is that Pertamina plans but few people are really looking at the realization of these plans. As another example, the 10,000 MW program was initiated 5 years ago but is currently only at 40% of its targets.

What is the key to implementing projects correctly in Indonesia?

Leadership and the flexibility to adjust in the implementation of projects are the elements required. One example I would like to draw on is the program of converting kerosene to LPG. This idea came from Pertamina and I asked the company to fulfill a pilot program. The company decided on small compact cylinders so that street vendors could sell the cylinders everywhere. The project which worked well.

We proved to the government that 40% of kerosene is being misused because in one area of Jakarta the use of LPG was 40% less than it was supposed to be because of people siphoning off kerosene. The government was losing huge amounts of money through this.

I explained to the government that Pertamina needed 6 years to implement the scheme across the whole of Jakarta and most part of Indonesia. I was asked to do it in 3 years and we compromised on 4. Pertamina made a presentation to the Vice President of Indonesia and many government stakeholders where we explained what was required and lead directly by the Vice President it became a government program implemented by Pertamina which has saved 8 million kilolitres. In 2009 we managed to save around 29 trillion rupiah already from the subsidy of kerosene. What we need today is this type of leadership and decisiveness.

To implement these changes you need an efficient company. Do you see Pertamina as an efficient company today?

When I became CEO I stated clearly that I needed a free hand to make changes, and to transform the company into an efficient business entity. I explained that without this freedom, I should not be made CEO. Many fundamental changes were implemented during my time which sadly are not being fully continued today. In my opinion the culture of change is actually reverting to a type of stagnation.

The first requisite for building an efficient company is having a leader surrounded by capable directors. I was very fortunate to have an exceptional director of downstream distribution and an extremely capable financial director when I was CEO. Unfortunately these two people have since left their positions and Pertamina has lost out as a result.

In my time as CEO the company was upbeat about making changes and Pertamina was in high spirits and highly motivated. I should say that when the transformation process started only around 25% of the people supported the program but by 2007 more than 50% were in favor and this figure rose higher in 2008 to 70%. Pertamina was driven by efficiency and these transformations were designed to pay for themselves in efficiency savings. We implemented KPI and a whistle blowing system with a multinational company in Singapore as the custodian. As a result of efficiency measures, in 2007/8 Pertamina managed to save around 2.7 trillion rupiah ($303 million).

My aim was to make Pertamina a “non-listed public company”. This means that the company should follow all the rules of a listed company including transparency, reporting etc but not be listed yet. After implementing these practices then the company could then be listed and the mark up would be much better as a result. Of course, listing a state asset like Pertamina would be a very controversial issue. I drew up these plans with PWC and McKinsey and took them to the Minister of Finance, who agreed in principal. This was at the end of 2007. The Minister said they would put the regulation together in 2008 but this never occurred and by 2010 the government decided that Pertamina would not be listed.

I believe that some stakeholders were worried about the Pertamina becoming too transparent and reporting of transactions would not be in line with their interest. It could also be that listed companies are entitled to a reasonable margin. Although I was repeatedly insisting that larger margins are needed not to line the pockets of the board of directors but for the future expansion of the organization.

The most important element in changing an organization is having a person ultimately responsible for driving the efficiency of the organization. One of the things about which I was adamant when I was in charge, was the necessity of having no intervention in Pertamina’s internal affairs from government apart from threw me. If government, national or regional, approached my staff and they responded to this then I would fire them. The buck always had to stop with me.

A corporation is not a democratic society but is by nature a closed entity. By nature a CEO is almost like a dictator. This is because we serve the interests of the shareholders who require profit. It is not about having many opinions. There are targets and ultimately I was responsible for meeting those targets.

Of course there needs to be delegation. Anything above 500 billion rupiah ($56 million) I would review but below this the director would have accountability. However, I always knew that if something went wrong then it was my responsibility.

Last time we spoke to you, you talked about Pertamina taking an international direction. Do you still see this happening?

Unfortunately this work is not moving. One of my final acts as CEO was to push for the acquisition of Medco which ultimately did not happen. It is something I regret because Medco was a very good asset with a 50% stake in a Libyan field with 500 billion barrels of oil (50% of the entire concession).

Pertamina was interested in 2008 in acquiring the other 50% of this Libyan concession belonging to a Canadian company and I remember asking Libya’s Oil Minister Shokri Ghanem whether the Libyan government would exercise its preemptive right to the field. Mr. Shokri said that considering our long friendship, this would not happen. Verenex the owner of the 50% interest issued a tender and Pertamina bid for $390 million as a first bid. 3 companies made it to the final round: Gazprom, Pertamina and CNPC.

Finally, the Canadian company did not invite Pertamina and Minister Shokri asked me if Pertamina was still interested in the acquisition. I was then released from my position as CEO by the government and Pertamina did not push to make the acquisition. The Canadian company chose CNPC but then Libya exercised its preemptive right.

I think it will take a long time before Pertamina is a successful international company. The trouble is that the government interferes too much in the workings of Pertamina. The board of commissioners is filled with bureaucrats who exert too much weight on the company. Governments have to let national oil companies develop themselves and if not, the companies will go nowhere.

Pertamina is an exception compared to most other NOCs. Petronas is very successful because it is afforded a great amount of freedom to operate. The four main Chinese companies CNPC, CNOOC, Sinopec and PetroChina have all been told by the Chinese government that they are responsible to supply energy to China and are not there to be the revenue earner of the government. In the case of PTT the government only collects money in the form of tax. The exception is Pertamina where the government relies on non-tax revenues such as dividends in addition to tax.

Pertamina will be able to develop once the government has a clear energy policy in Indonesia. My conviction is that you cannot develop a cohesive oil and gas policy unless you view it as an economic commodity. The price must be world market price and subsidy has to disappear. This takes political will and courage.

What would be your piece of advice to international oil and gas executives many of whom are dealing with similar challenges?

A company is not a democratic society or entity. Gathering opinions is good for making a decision but no one lower down should influence your vision on what is best for the company. The only limits for a company are its KPI. If you do not achieve your targets then you must leave. There is now a global tendency for Chaimen and CEOs to merge into one position to create greater accountability. I view this as a positive step.

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