Nearly half a century after it was founded, state-owned petroleum company Pertamina will soon face its biggest ever challenge when it takes sole operational control of the Mahakham, Indonesia’s biggest producing natural gas block situated off the east coast of Borneo.

French oil giant Total E&P, which has run the East Kalimantan concession since 1974, will pull out on December 31 after failing to come to terms with the government on a five-year transitional period under which it and Japanese partner Inpex would have retained a 30% participating interest.

Indonesia’s Mines and Energy Ministry rejected the consortium’s additional demands for an investment credit arrangement for every US$100 million it invests, an accelerated rate of depreciation and international prices for gas reserved for domestic market obligation.

The fate of the Mahakam has been at the center of a politically-driven wave of economic nationalism which should eventually see Pertamina and other local companies take over half of the country’s expiring production sharing contracts (PSCs) for oil and gas by 2025.

But the pressure will now be on Pertamina to prove it can manage a large block — particularly one in decline — and whether, as one senior Indonesian oil executive put it, politics has become more important than commercial common sense.

Indonesia's Energy and Mineral Resources Minister Ignasius Jonan smiles during an interview with Reuters at his office in Jakarta, Indonesia August 22, 2017.   REUTERS/Darren Whiteside
Indonesia’s Energy and Mineral Resources Minister Ignasius Jonan at his office in Jakarta, August 22, 2017. Photo: Reuters/Darren Whiteside

Industry sources say Pertamina has a core of highly competent staffers in its 27,000-strong work force, but it is burdened down by the same management frailties that afflict most of Indonesia’s state-owned enterprises.

“Drill, baby, drill, that’s the key to Mahakham,” says one Western consultant who has studied the field and understands what is required. “Otherwise the decline becomes terminal and salt water intrusion leads to a permanent reduction in output.”

The government can ill-afford a further decline in revenues, with economists warning it may be forced to remove some of its energy subsidies, which account for 12% of the national budget, and risk rising inflation in the approach to an election year.

Indonesia’s oil and gas receipts plummeted from US$26.7 billion in 2014 to US$9.2 billion in 2016, with a corresponding plunge in the sector’s share of national revenues from 14% to below 4% over the same period, driven by low oil prices and falling production.

Discovered in the late 1960s, the 200-kilometer-long Mahakham block has more than 400 wells in 65 different clusters, all linked by pipeline to a central production area and from there to East Kalimantan’s Bontang liquified natural gas (LNG) facility.

Mahakam supplies 80% of Bontang’s natural gas, but with Total’s final two North Asia contracts running out in December, Pertamina will have to decide whether to look for new short-term foreign exchange-earning deals overseas or focus entirely on the domestic market.

Workers upload LPG (liquid petroleum gas) canisters before sending to customers in PT Pertamina LPG filling station in Jakarta January 27, 2011. PT Perusahaan Gas Negara (PGN), Indonesia's biggest gas distributor, said on Thursday a planned floating LNG regasification terminal in northern Sumatra will have a capacity of 1.5 to 2 million tonnes a year. REUTERS/Crack Palinggi (INDONESIA - Tags: BUSINESS) - RTXX55J
Workers upload LPG canisters before sending to customers in a file photo: Photo: Reuters/Crack Palinggi

Under the prevailing PSC regime, the government reimbursed contractors such as Total, Chevron and ExxonMobil for all exploration and production costs, often a contentious and time-consuming process, while receiving as much as 85% of the actual revenue.

Instead of a PSC with a built-in cost-recovery scheme, Pertamina will once it takes over operations submit to a rough 60%-40% revenue split with the government, depending on the depth of a field and the prevailing global oil price.

Mines and Energy Minister Ignasius Jonan has handed Pertamina what amounts to a poison chalice by saying he wants to see lower costs and higher production – an almost impossible task when Mahakham’s annual revenues are expected to be no more than US$2.2 billion.

Most of Total’s 3,500 Indonesian workers will stay on with Pertamina, a key factor in future efforts to maintain production. As one senior official put it recently: “Pertamina has decided that with or without Total we have to manage the Mahakham properly.”

It will be easier said than done. Total and Inpex have spent US$1 billion in their final year, drilling 30 wells of their own and another six at Pertamina’s expense to keep daily output at 1.4 million cubic feet of gas, in keeping with their contract obligations.

Pertamina hopes to maintain that level in 2018, but it will need to come up with a lot more than the US$187 million it paid for the six wells when it takes over management of the field on January 1.

FILE PHOTO: A Pertamina sign is seen at the Oil Centre Building in Jakarta, November 9, 2015.  REUTERS/Beawiharta
A Pertamina sign at the Oil Center Building in Jakarta. Photo: Reuters/Beawiharta

Industry experts say that with their contract nearing an end and oil prices on the decline, the two international oil giants spent the past few years cherry-picking the best prospective sites to drill.

Parts of the Mahakham already suffer from water intrusion. That ultimately reduces available reserves and needs to be minimized by improved well spacing, which can only be achieved through drilling. Other issues facing the company:

* Apart from regular reviews of gas gathering and processing systems, each of the fields must be individually analyzed and assessed given the different technologies that are required to optimize production.

* De-bottlenecking gas transmission and treatment facilities may be a more efficient than drilling in dealing with changing production volumes, but that is only a short-term solution.

* Well spacing often needs to change to pull together additional production from disconnected reservoirs within a field. Again, that requires more drilling.

Deputy Mines and Energy Minister Archandra Tahar, who spent 20 years working for a specialist offshore oil company in Houston, Texas, has said in the past that upstream technology remains the Indonesian industry’s biggest challenge.

Indonesia reoriented its natural gas to domestic needs in 2006, dropping from the world’s largest LNG exporter to fifth place in the space of a few years.

Its 16.6 million metric tons, down from a peak of 28 MMT in 1999, is now 6.4% of global supply behind Qatar (77.2MMT), Australia (44.3MMT), Malaysia (25MMT) and Nigeria (18.6MMT).  Pertamina recently said the country will be a net LNG importer by 2020.

State-owned oil giant Pertamina's refinery unit IV in Cilacap, Central Java. Photo: Reuters/Darren Whiteside
State-owned oil giant Pertamina’s refinery unit IV in Cilacap, Central Java. Photo: Reuters/Darren Whiteside

Investment in oil and gas dropped from US$19.3 billion in 2014 to US$11.1 billion in 2015 and US$13 billion last year, much of it eaten up maintaining production in mature wells and barely US$163 million going towards green field exploration.

That compares with the US$7.1 billion spent at the top of the 2010-2014 cost cycle, known by industry watchers as the ‘Great Eastern Indonesia Deepwater Adventure’, which produced only dry holes.

“That was the last roll of the dice for frontier exploration,” says one analyst, pointing to a fruitless search that covered the eastern side of the Makassar Strait, Papua and other remote reaches of the archipelago. “We probably won’t see that again.”

Pertamina’s budgeted oil and gas production in 2017 was 693,000 barrels of oil equivalent a day, comprising 334,000 barrels of oil and 2,080 million cubic feet of gas – slightly more than the 1,961 million cubic feet recorded in 2016.

Claiming new efficiencies, Pertamina’s net profits surged to US$3.1 billion last year, even though revenues slid by 12.6% to US$36.5 billion. Anticipated revenues in 2017 were put at US$42.6 billion, with a net income of US$3.04 billion.

More than US$6.6 billion in capital expenditure was allocated for the year, of which US$5 billion is earmarked for upgrades to the Cilacap and Balikpapan refineries to help boost capacity from 1.1 million to 2.6 million barrels a day by 2030.

But that doesn’t leave a lot left over for managing the Mahakham and other producing fields that Pertamina has taken over as a matter of nationalistic policy in the past few years as PSCs have lapsed.