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Client Alert

Oil and Gas New Rules on Domestic Content: Hard Headed Pragmatism or Impossible Dream?
Introduction
The Ministry of Energy and Mineral Resources ("MEMR") has recently issued new regulations on local content requirements for upstream oil and gas procurement. MEMR Regulation No. 15 of 2013 ("Reg 15") was passed on 22 February 2013 and will become effective in May 2013. In general, the new regulations codify the oil and gas local content guidelines set out in BPMIGAS' (as was) No. 007/Revisi-II/PTK/I/2011 ("PTK 007").

April 2013

What's Changed?
Listed below is a summary of some of the key provisions of this regulation.

New Local Content Targets and "Roadmap"

Reg 15 provides new more stringent local content requirements to be applied through to 2025. Previously, almost all oil and gas services were subject to a minimum local content requirement of 35%. The new key targets include:

Oil and gas activity

Drilling Offshore EPCI Shipping Services Survey, Seismic and Geology Studies Other services

Current Target
35% (land) 35% (sea) 35% 35% 35% (land) 35% (sea) 35%

New Target
70% (land) 45% (sea) 45% 75% 90% (land) 35% (sea) 75%

Implementation Period
After 2016 After 2016 2013 After 2020 After 2020

To achieve the above targets, the Director General of Oil and Gas will establish a "roadmap" to implement the targets. It is unclear what this roadmap will set out. Reg 15 also raises the domestic content threshold for certain equipment. For example, the targeted local content requirement for wellheads and christmas trees - starting from 2021 - is 40% offshore, 70% onshore; that required for electrical submersible pumps is set to increase to 35% starting from 2021.

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In the meantime, the procurement of oil and gas goods / equipment will still need to follow the domestic content thresholds set out in the Domestic Products Appreciation Book (Buku Apresiasi Produksi Dalam Negeri) issued and periodically updated by the DGOG.

Calculation of Local Content

It is important to recognize that the calculation of domestic content is based, not on ownership (subject to our comments below), or on final contract price, but on the origin of input costs. For the provision of goods, these costs include material, labour and indirect manufacturing costs (but would seem to exclude certain transport costs). For services, these include material, labour and 1 equipment used in the provision of services. Excluded from this determination are profits, company (HQ) overhead and VAT. In assessing domestic content for services, it will be necessary to burrow down to 3 levels of contractor (i.e. to sub-sub-contractors).

Price Preferences
Under Reg 15, the maximum available price preference based on domestic content consistent with PTK 007 is 15% for goods, 7.5% for services. In addition, previously, under PTK 007, companies supplying goods or services were entitled to an additional price preference if they were Domestic Companies - the applicable price preference percentage could range between 5% to 7.5%, depending on whether the company had entered into a consortium arrangement with a foreign company / Indonesian foreign investment company. A Domestic Company is an Indonesian limited liability company majority owned by an Indonesian individual, the Government of the Republic of Indonesia, a regional government, a State-Owned Enterprise or a Regional Government Owned Enterprise. Reg 15 now scales back the extent of this preference, so that it only applies to suppliers of goods (that are Domestic Companies) reaching the relevant domestic content threshold, and is capped at 2.5%.

Enhanced Supervisory Powers of the Government

One of the key focuses of Reg 15 is compliance, and the expansion of the Government's authority in supervising local content compliance. Under PTK 007, BPMIGAS' supervision over local content compliance was somewhat limited, with the obligation to police compliance with domestic content requirements being passed onto oil and gas companies.

The costs of equipment that are: produced domestically and owned by Indonesian persons or Domestic Companies shall be valued as 100% domestic content; produced domestically and owned by majority foreign-owned PMA companies shall be valued as 75% domestic content; produced domestically and owned by foreign companies (providing services in a consortium) shall be valued as 50% domestic content; produced outside Indonesia and owned by Indonesian persons or Domestic Companies shall be valued as 75% domestic content; produced outside Indonesia and owned by majority foreign-owned PMA companies shall be valued as 50% domestic content; produced outside Indonesia and owned by foreign companies shall be valued as 0% domestic component.

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Reg 15 increases the Government's supervisory role over local content by way of, among other things, the following: (i) the Directorate General of Oil and Gas ("DGOG")'s authority to witness production processes (if required) previously, the obligation to supervise local content rested primarily with oil and gas companies; compulsory verification process to certify the achievement of the requisite local content previously, oil and gas companies could opt to verify their contractors' local content levels. Verification is now compulsory for procurement activities over a certain value. This obligation sits with the oil and gas company and/or the goods/services provider. Further, the DGOG will determine the institutions / parties able to conduct such verification; granting SKKMigas authority to determine the total local content level that will need to be achieved by an oil and gas company under a Work Program and Budget and/or a Procurement Plan.

(ii)

(iii)

Sanctions
As mentioned above, previously, oil and gas companies were required by PTK 007 to drive the enforcement process of local content obligations and apply the sanctions applicable to any breach of these guidelines. Reg 15, however, introduced new sanctions to be applied by the Government, e.g. the revocation of a manufacturing company's SKUP (Supporting Services Capability Statement / Surat Kemampuan Usaha Penunjang Minyak dan Gas 2 Bumi). The regulation also makes express the ability of the oil and gas companies to withhold payments under their procurement contracts in the event of a contractor's failure to satisfy domestic content.

Impact on PTK 007?

Reg 15 does not expressly revoke the local content provisions of PTK 007. However, to the extent that they contravene the provisions of Reg 15 (or any other regulations referred to by Reg 15), these provisions should be deemed to no longer apply.

Conclusion
In general, Reg 15 does not significantly alter the local content regulatory framework set out in PTK 007. However, oil and gas companies and contractors will need to be aware of the following: Oil and Gas Company Need to ensure procurement process follows domestic content requirements set out in the APDN. Need to verify contractor's local content. Failure to prioritize domestic goods/services in a procurement Contractor Contractors should be prepared to be audited for local content. Contractors, especially services suppliers, will be expected to increase their local content level during the next few years.

An SKUP is a license issued to manufacturing companies that have demonstrated that they supply goods satisfying the relevant domestic content thresholds. It is not clear what will flow from the revocation of the SKUP presumably, this document will be required to participate in tenders, however.

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process may be subject to sanctions from SKKMIGAS. Any services agreement to be entered into by an oil and gas company with a service company should provide the right to set off penalties due to contractor's noncompliance with local content requirements against the total contract value.

Manufacturing companies will be required to obtain an SKUP. Contractors will need to provide bi-annual reports on domestic content capability.

News Alert
The decision of the World Trade Organisation in Canada Certain Measure Affecting the Renewable Energy Generation Sector was issued at the end of last year, but has only fairly recently been publicly available. While, at first blush, the contents of this might seem to be of little relevance, the decision should be of interest to oil and gas (and other) suppliers in Indonesia. In its decision the WTO panel affirmed that domestic content requirements, which entitled electricity suppliers to certain feed-in tariffs for the sale of electricity in Ontario, were contrary to Article III.4 of the General Agreement on Tariffs and Trade 1994 ("GATT"). This was the case even where these requirements had the laudable aim of encouraging green energy generation in Ontario. Article III.4 of the GATT stipulates that: "4. The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use." In this connection, it might be possible to argue that the provisions of Article III.4 are not applicable, to domestic content requirements in Indonesia, on the basis of Article III.8. This exempts the application of the national treatment principle for procurement by government agencies of products purchased for government purposes and not with a view to resale. However, even though Indonesia is not a party to the WTO Agreement on Government Procurement, any such argument put forward on behalf of the authorities in Indonesia would need to demonstrate that: in the context of Indonesian oil and gas, it is the government that is procuring the equipment. This seems debatable, at least, as the government is not paying for such equipment itself (at least, not until the equipment is cost recovered); oil and gas procurement is being carried out for government purposes (query whether producing and selling oil and gas is a "government purpose"); and such purpose is not with a view to the production of goods for commercial sale (again, this seems debatable).

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Similar provisions to Article III are set out in the General Agreement on Trade in Services (although there are more derogations from this). It should be noted that Indonesia is a member of the WTO, and has signed up to both the GATT and GATS. Accordingly, while the WTO panel decision in this case is not directly applicable to Indonesia, query to what extent the current oil and gas procurement regime is WTO-compliant.

For further information please contact Luke Devine Foreign Legal Consultant +62 21 515 4909 luke.devine@bakernet.com Norman Bissett Foreign Legal Consultant +62 21 515 5350 norman.bissett@bakernet.com Muhammad Karnova Partner +62 21 515 4869 muhammad.karnova@bakernet.com John Sitepu Associate +62 21 515 4868 john.p.sitepu@bakernet.com Alamanda Vania Associate +62 21 515 5090 Ext 6104 alamanda.vania@bakernet.com

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5 Oil and Gas New Rules on Domestic Content: Hard Headed Pragmatism or Impossible Dream? April 2013