Should We Leave the PSC Model?

(2010)
Benny Lubiantara *)

This article is written to discuss the issue of upstream petroleum contract, which is focused for
the case of Indonesia. This is motivated by the fact that there have been so many news in mass-
media covering the issue of cost recovery and the possibility of leaving our existing production
sharing contract (PSC) model.

Public pressure to review oil and gas contract is not only occur in Indonesia, during the period
of oil price increases (2003 to mid 2008), many host governments reviewed and changed their
fiscal terms. The main reason was simply the facts that their fiscal terms might have failed to
generate higher government take as the profit soared. However, this worldwide trends should be
carefully understood, most countries changed their fiscal terms not the type of model, some
changes include the increasing of royalty, introducing of windfall profit tax and other form of
taxes, etc.

The reality above show that designing fiscal system is a crucial task, the fiscal system should
align the interests of both parties (the host government and the investor); the list of each interest
may be summarized as follow:

The government’s interests include: increase financial resources for development,

stimulate exploration activities to increase the country’s petroleum resources and
reserves, achieve adequate control over resources and their optimal exploitation,
maximize the state’s share of petroleum wealth, encourage the development of domestic
industry, benefit from higher employment, benefit from technology transfer and know-
how, etc.

1
 The investors’ interests include: access to acreage, expand reserve base, access to new
long-term supplies of petroleum, achieve the highest possible return on their investment
and optimize portfolio, manage operations efficiently, minimize and mitigate risks, etc.

Besides the PSC model, there are two other models that are commonly used around the world,
concessions (royalty/tax) and service contract. It is no wonder then if we find some people who
may suddenly claim themselves as the oil and gas observers propose to adopt the royalty tax
instead of PSC with very simple reason; because (they thought) that the royalty tax model has
nothing to do with the cost recovery mechanism. There is also another idea, to introduce the
model in which the government directly obtains its share from the gross revenue. The purpose is
similar, to avoid the cost recovery mechanism.

Any model has shortcoming, PSC is not an exclusion; it is not necessary means that replacing
PSC with the new models automatically solves the problem. I am a bit concerned with the
statement made by some observers that we are unable to manage the cost recovery so that we
have to find other models without dealing with this (cost recovery) mechanism. The fact that
there are unique risks and rewards in oil and gas industry, the end result of the new model that is
introduced may produce less government share compare to the existing PSC model. The readers
who interest in detail explanation regarding this comparison may visit my blog at
http://ekonomi-migas.blogspot.com.

The issue of adopting a new model is also a hot issue in Brazil. Differ from Indonesia, the
Brazilian government proposes to switch to production sharing contract (PSC) instead of its
current concession (royalty/tax) for potentially world-class discoveries in Santos pre-salt basin.
Santos pre-salt basin is very important for Brazil oil industry, oil production from pre-salt basin
is expected to reach 528 thousands bopd by 2015 and then just over 1.8 millions bopd in 2020.
These projects will bring Brazil from net oil importing to a net oil exporting country.

Worldwide trends for the last decade show that terms and conditions in oil gas contracts are
becoming more sophisticated, in the context of project economics, whatever the model selected,

2
it may be the best from the perspective of the country (of course, one country may adopt some
type of models depending upon the geological and other factors). For example, in Russia,
majority of their contract models are concession with greater state participation for their
national oil companies, surely this will provide the bigger share of profit to the country as a
whole. At this point, I think the idea is clear, in the context of “division of revenue/profit
between host government and investor,“ the issue is not about the “labels“ (PSC, concession or
service) but the “content“ (terms and conditions).

There is also some critics on the poor practices of PSC in Indonesia, If there is a case in which
the government has never received its share from the gross revenue even though the field/block
has been produced for some years (since all revenue generated are used to pay for the cost
recovery); or another “extreme case“ like the old Natuna Block contract, in which the
government profit oil before tax is equal to zero; this kind of anomalies should not be blamed to
the PSC as a model, but to the parties that introduced the “new“ fiscal terms.

The responsiveness of the fiscal system to the oil price environment is important to consider. In
a situation of high oil prices, the system, while maintaining its attractiveness, should soak up the
resulting additional profits and obtain the maximum benefit for the interest of the host country.
The fiscal system should also protect the government revenues in case of a low oil price
environment. If we can obtain these objectives with the PSC model, or if we can simply modify
the PSC model to better reflect the dynamics of oil and gas industry, should we replace with the
new one?

*) Benny Lubiantara has been working as a Fiscal Policy Analyst, Research Division in OPEC Secretariat
in Vienna since January 2006;. He previously worked for Maxus/YPF (now CNOOC), Unocal (now
Chevron) and BPMIGAS. He manages his personal blog on Petroleum Economics at http://ekonomi-
migas.blogspot.com/

Benny graduated in Petroleum Engineering from ITB, Economics and Master in Management, both
from Universitas Indonesia.