Indonesian Oil and Gas Regulator Held to Be Unconstitutional

November 15, 2012

On 13 November 2012, the Indonesian Constitutional Court held that the Upstream Oil and Gas Regulator in Indonesia, commonly known as BP MIGAS[1], was unconstitutional. The landmark decision sent shockwaves through the oil and gas industry in Indonesia as it effectively means that the regulator has now been abolished.

Natural Resources and Indonesia’s Constitution

Islamic organizations and community interest groups expressing nationalist sentiment had applied for judicial review of certain provisions of Indonesia’s Oil and Gas Act 2001[2]. They are believed to hold the view that BP Migas was awarding too many lucrative resources-based contracts to foreign investors to the detriment of the Indonesian population. The Constitutional Court (chaired by the chief justice of the court) determined that issues such as the extent of state control over natural resources and the existence and powers of BP Migas were constitutional issues that fell within its jurisdiction, and in granting part of the judicial review effectively revoked part of Oil and Gas Law of 2001.

The 1945 Indonesian constitution provides that natural resources are to be controlled by the State and must be used in such a way as “to provide maximum benefit to the people”[3]. This provision tends to be restrictively interpreted in the Indonesian courts.  In this case, the Constitutional Court effectively held that “maximum benefit” could only be delivered if the State exercises “full control” over natural resources extractive industries by being directly involved in their exploration and extraction through state-owned enterprises and making related policy decisions.  In other words, mere State regulation and supervision of these industries was insufficient.

Indonesia’s Oil and Gas Regulator

BP Migas was set up in 2002 as an independent, non-profit state owned legal entity to replace the regulation and licensing function of state-owned oil company Pertamina.  It managed and controlled the development of the Indonesian upstream oil and gas industry (exploration, production, exploitation and marketing activities) as well as Liquified Natural Gas (LNG) production.

Given the Constitutional Court’s ruling as to the State needing to exercise “full control” of the upstream oil and gas sector, it went on to rule that the regulator itself was thus unconstitutional. There was one dissenting judgment amongst the eight member judicial panel. The Constitutional Court alluded to the following reasoning for its decision:

• The State is not directly involved in the upstream sector as the regulator only has a supervisory function.  Actual exploration and extraction are carried out by private companies through a production sharing contract (“PSC”), typically with BP Migas. This was held to not provide the State with sufficient control of its own natural resources.  Instead, the State should re-establish full control by granting exploitation rights to state-owned enterprises. These state-owned enterprises would then enter into PSCs with the private sector.
• The act of BP Migas entering into PSCs directly fetters the discretion and sovereignty of the State by restricting it from issuing new regulations or policies that conflict with those PSCs.
• The creation of BP Migas was part of a proliferation of governmental bodies that creates inefficiency and results in greater bureaucracy and potential for corruption.

The Constitutional Court encouraged the Government to table new legislation to reassert full State control of the oil and gas sector.

What Does the Decision Mean?

The critical impact of this case concern what happens to those PSCs already entered into by BP Migas and what happens going forwards.

The Constitutional Court stated that its ruling should not take effect retroactively.  As a result all existing PSCs should, in theory, remain valid and binding.

The effective abolition of BP Migas creates something of a legal vacuum which the Constitutional Court stated should be addressed by BP Migas’ powers transferring to the Ministry of Energy and Mineral Resources.  This was later confirmed by Indonesian President, Susilo Bambang Yudhoyono and Deputy Energy Minister Rudi Rubiandini following the ruling, who stated a new unit would be established within the Ministry to administer the transition.  The new unit will assume responsibility for approving the development of new fields and operator budgets, and approving oil and gas exports.

The identity of the long-term successor to BP Migas’ rights and obligations under PSCs is to be either the Government or a state-owned enterprise (which in all likelihood would be Pertamina). How the latter would assume these functions is unclear.  Pertamina is widely considered to have neither the expertise nor financial resources for the exploration and development needed to maintain or increase production. Indonesia has been struggling to increase production through a combination of aging fields becoming drained and a lack of foreign investment. Increasing domestic consumption led to Indonesia becoming a net oil importer in 2004. Indonesia withdrew from the Organization of Petroleum Exporting Countries in 2008, previously to which it had been the only Asian member since 1962.

Whilst the Government’s short-term assumption of BP Migas’ operating procedures is intended to minimize disruption, in reality disruption and uncertainty are inevitable given how integral BP Migas’ functions were to the functioning of PSCs in Indonesia.  Every PSC operator must have its budget approved by BP Migas so as to ensure cost recovery entitlements.  As a result no operator is likely to be motivated to make any major operational decision that would have an effect on previously approved budgets.  Future and ongoing PSC negotiations are also likely to be impacted by the legal uncertainty that now exists.