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Anthony – 291 17 005

PSC Financial Management and Leverage Buy Out

Kin Tjendrasa - PT Energi Mega Persada Tbk.

At first, we need to know about the industry or business before doing a valuation of the
company. This is different from the stock market, where the market is driven by the
technical analysis method that only focus on the candlestick. Technical analysis is
speculative. The price only moves by psychology factor which is when the demand
increase, traders will follow to buy, otherwise traders will sell when the market maker
sell their stocks. This is why stocks that listed in IHSG are volatile. Fundamental analysis
is another term for the company’s valuation analysis.
Production Sharing Contract (PSC) is one of the important part of oil and gas industry.
Long before Indonesia’s independent day, Netherland’s government is still using the
concession started from 1883. Shell Company granted a full access of the oil and gas
company at 1899 by the Netherland’s government. After a long journey, our government
make a new legal form for this PSC, which is PP No. 41 Tahun 1960. At that time,
Indonesia hasn’t had a legal administration yet, only a temporary position (MPRS).
That’s why there wasn’t any UU from the government.
The Organization of Petroleum Exporting Countries (OPEC) was established in 1960, and
Indonesia became the seventh country to join in 1962. However, Indonesia suspended
her membership for seven years from January 2009, and has just rejoined in January of
2016. During her initial 27-year tenure, Indonesia’s representatives held the position of
Secretary General four times, for a total of 10 years.
On 10 December 1957, PT Perusahaan Minyak Nasional, which is PERMINA is the first
company that hold the legal for the oil & gas in Indonesia. Until today, 10 December is
celebrated as the birthday of PERTAMINA. At 1960, PT Permina change its status as
Perusahaan Negara (PN) Permina. Then, PN Permina joint venture with PN Pertamin to
become PN Pertambangan Minyak dan Gas Bumi Negara (Pertamina) at 20 Agustus 1968.
Indonesia become the first who initiated the PSC amendment that followed by half of
total countries that produce oil. After 30 years from the first PSC established, Indonesia
still believe the PSC still can be used until today, that’s why Indonesia lack of
investment. Minister of energy and natural resources, Sudirman Said, launch a PERMEN
ESDM No. 8 Tahun 2017 (January), and revised by No. 52 Tahun 2017 (September).
Based on the oil and gas expert, Dr Ir Andang Bachtiar MSc, the total Basins in Indonesia
are 167, where there is a chance to get a Hydrocarbon. As the expert say, oil and gas
are made from Algae that can be detected from this hydrocarbon.
Oil and gas business industry is a high risk business, there’s only 3% chance that can be
drilling location will produce oil as the engineers have calculated and get the oil.
Nowadays, Indonesia’s gas production is still higher than oil production. The major
producer of gas is come from the Bontang L&G Plan, Mahakam Block. Besides that, at
Tampo, Sulawesi also produce a large amount of gas that processed by BIPI Energy. One
of the biggest oil production come from Tomori, Sulawesi Tenggara. This location
sometimes called by Senoro Toili by the local people which is operated by L&G
Mitsbushi, and the block are processed by Medco Energi Tbk.
Before starting any investment, risk management is a first thing to be analyzed. Risk is
important to become the standard or maximal estimated loss that needed to be
accepted. If the investment is without risk management, the investment is not much
differing from gamble game.
There are some risks in petroleum upstream industry:
1. Contry risks: This industry is a long-term Investment, at least 20-30 years’
investment. In Indonesia, after 2000 there are so many demonstrations that make
the foreign investors reluctant to invest in Indonesia.
2. Legal risks: How the legal of the country works. Sometimes after the contracts have
been approved, the government still change the contracts. This is the main reasons
why investors need to think carefully of the legal risks before they start investing.
3. Fiscal risks: The changing of tax policy in country can affect the company’s financial
4. Macro-economic risk: How is the economy of the country, and how will the inflation
affects the business’ industry
5. Business environment risk: Many new NGO established, and demonstrations become
the main factor of this business environment risk.
6. Technical risks: This is the most important part before the petroleum upstream
companies want to start their business in the country because technical risk is the
only risks that can be minimized and predicted.
a. Subsurface: Can be calculated from data and manage by the firm
b. Surfaces: Can be minimize and manage by the firm
7. Natural Risks
8. Project Risks
9. Operational Risks
10. Commercial Risks
11. Price Risks
12. People Risks
13. Regional Risks
From those risks, most of all can be diversified into some causes, which are
• Risk can be human-created, such as business cycles, inflation, changes government
policies and wars-conflict
• Risk also from unforeseen natural phenomena: weather and earthquakes
• Risks arises from primary source of long-term economic growth and technology
Before calculate the risk management, risk can be defined as volatility of unexpected
outcomes. Risk is the value of assets or liabilities of interest. Type of risks can be
broadly classified into business and non-business risks. The risk can be considered as a
return Measurement for a single asset
Oil Black Clop, use statistic to find the outcome because we don’t have grip about how
to determine the reservoir of deeper land of earth. This can be calculated based on
seismic but the calculation of the engineer may miss. Before find the oil, the company
need to do the project concept (source rock, reservoir, trap, timing & migration).
Below figure is a graphical representation of the SPE/WPC/AAPG/SPEE resources
classification system. The system defines the major recoverable resources classes:
Production, Reserves, Contingent Resources, and Prospective Resources, as well as
Unrecoverable petroleum. There are 3 possibilities when the company started to find
the oil blocks. Those are, proved, probable, and possible.

Production is the cumulative quantity of petroleum that has been recovered at a given
date. While all recoverable resources are estimated and production is measured in
terms of the sales product specifications, raw production (sales plus non-sales)
quantities are also measured and required to support engineering analyses based on
reservoir void-age. Reserves are those quantities of petroleum anticipated to be
commercially recoverable by application of development projects to known
accumulations from a given date forward under defined conditions. Reserves must
further satisfy four criteria: they must be discovered, recoverable, commercial, and
remaining (as of the evaluation date) based on the development project(s) applied.
Reserves are further categorized in accordance with the level of certainty associated
with the estimates and may be sub-classified based on project maturity and/or
characterized by development and production status. This also known as P-90, where
there is 90% chance to get the results that has been predicted/calculated.
Contingent resources are those quantities of petroleum estimated, as of a given date,
to be potentially recoverable from known accumulations, but the applied project(s) are
not yet considered mature enough for commercial development due to one or more
contingencies. Contingent Resources may include, for example, projects for which
there are currently no viable markets, or where commercial recovery is dependent on
technology under development, or where evaluation of the accumulation is insufficient
to clearly assess commerciality. Contingent Resources are further categorized in
accordance with the level of certainty associated with the estimates and may be sub-
classified based on project maturity and/or characterized by their economic status.
This also known as P-50, where there is 50% chance to get the results that has been
Undiscovered Petroleum Initially-In-Place is that quantity of petroleum estimated, as
of a given date, to be contained within accumulations yet to be discovered.
Prospective resources are those quantities of petroleum estimated, as of a given date,
to be potentially recoverable from undiscovered accumulations by application of future
development projects. Prospective Resources have both an associated chance of
discovery and a chance of development. Prospective Resources are further subdivided
in accordance with the level of certainty associated with recoverable estimates
assuming their discovery and development and may be sub-classified based on project
maturity. This also known as P-10, where there is 10% chance to get the results that
has been predicted/calculated.

From the above graph, the average time needed to find the oil after drilling takes 5 to
7 years in the developed countries. As an example, in Indonesia, there’s already an oil
refinery on 2004. The oil refinery is built at Sumur Masala (Lapangan Abadi), with a
range of 23TCM. After 13 years, there still any final investment decision (FID) made by
the minister yet. This is why the company need to calculate the risk management very
well as the upstream oil exploration can’t get loans from banker because of the low
probability (3%) of the success rate. This cycle is important to find the time when the
company can do the LBO (Leverage buy out) to the banker. Until today, there isn’t any
company in Indonesia that become the oil exploration company.
Project Life Cycle of upstream oil business industry can be classified into 5 sub-part as
shown on below figure, which are Identification – Initiation – Delivery – Closure – Benefit

Based on E&Y professional service company, here are the top ten of oil and gas risks:
Access to reserves: political constraints and competition for proven reserves; Uncertain
energy policy; Cost containment; Worsening fiscal terms; Health, safety and
environmental risks; Human capital deficit; New operational challenges, including
unfamiliar environments; Climate change concerns; Price volatility; and Competition
from new technologies
Beside the risk that mentioned above, there are also some opportunities that predicted
by the E&Y company: Frontier acreage; Unconventional sources; Conventional reserves
in challenging areas; Rising emerging market demand; NOC-OC partnerships; Investing
in innovation and R&D; Alternative fuels, including second generation biofuels; Cross-
sector strategic partnerships; Building regulatory confidence; Acquisitions or alliances
to gain new capabilities
As the expert of this industry, Mr. Kin Tjendrasa said, the biggest risk from the oil
industry is to predict the oil price. Oil prices is unique and unusual from any market
prices. This is because the oil prices are not determined from demand and supply, but
based on human’s actions. As the figure below shown that, it’s extremely hard to
predict the oil prices movements that come from human’s actions.

BP has projected the oil prices from 1861. After the BP predict the oil prices to today’s
price after inflation and deflation. The using of oil 100 years ago, is same as today oil
price if the inflation or deflation effects have been measured.
FDO&A: Finding, Development, Operation, and Acquisition Cost of oil have been
measured by SPE. This is a limited resource that can’t be continuous, expert predict
that the business only stands for 50-100 years, while the concept of company is always
continuous. This FDO&A will help a lot on determining the return on investment from
the investment.
Indonesian PSC Management
Production Sharing Contract is a contract between Government and a company
(Contractor). Length of contract is normally 30 years; 1st 6-10 years is categorized as
exploration period.

- If PSC can’t be commercialized before the expiry of the exploration period, the
block must be returned to the government
- Contract may be extended for up to 20 years.
Contractor can be one company or joint venture of several companies. Operator
normally company with the biggest share, will act on behalf of ‘Contractor’.
Government of Indonesia (GoI):

- Regulatory: MIGAS
- Implementation: BPMIGAS/SKK Migas, from UU No 22 Tahun 2001.
If PSC success after 30 years, it can be extended for 20 years. The contractor can be
more than 1 company. About the new PSC’s concept, the cost will be 100% responsibility
to the contractor. If the oil production is successful, Indonesia government will give a
permission to expand its exploration areas. This will give the company recover the cost
through the oil production costs. The net profit come from 80% from the revenue. The
government need 20% First Tranche Petroleum. FTP is a certain amount of crude oil or
natural gas produced from the working area within the contract years, which can be
taken or received by the contractor before deducting refund of operating and handling
of the production. POD (Plan of Development) must be approved by minister, if the
exploration unsuccessful, the block must be returned to the government.
Gas and Oil has different profit split and cost recovery rules
Gas: normally 30% after tax profit split (ATPS) to contractor
Oil: normally 15% after tax profit split (ATPS) to contractor
Split from equity. Revenue – FTP can be split, cut cost, and the remaining will become
the ATPS. PSC terms (profit split, tax, and incentives) may vary from one contract to
another or from one field to another based on: Contract signing year, Location, Water
depth, Applicable tax regulation, and Type of HC recovery (Primary, secondary or
This is happened because of the incentive rule from 1994. The extension contract may
be varying from the first contract. The summary of this regulation can be find on PP
No. 22, Tahun 2001
“Oil company is a contractor to BP Migas (BP-M) as regulatory body carrying out
operations for BP-M (as implementation body) at his expense and risk.”

- explore for and produce discoveries for 30 years

- recover costs out of production
- share in production (equity) remaining after cost recovery
- hold no mineral rights, owns no assets/=.
- Upon expiration, contract may be negotiated to be extended another 20 years

- fund all operations:

- conduct operations under BP-M management
- If PSC does not meet commercialization term before the expiry of the exploration
period, the block must be returned to the government
- execute in accordance with BP-M approved
o work program budget and projects AFEs & /POD
o procurement of goods and services
o manpower, domestic and foreign
o domestic market delivery at reduced price
o transfer 10% W.I. to Indonesian entity upon first commercial discovery
Before doing the leverage buy out, banker will focus on 3 points:

- Reputation; Is the company have the reputation to established the debt from the bank. Can
the company manage the business that proposed by the company.
- Value; The value of the business proposed need to have a minimum IRR of 30%. This is the
standard minimum of the IRR requirements by most banker; Re-calculate the value of the
business/project by asking expert/consultant.
- Oil prices; How the company predict the oil prices that proposed of the project.

The company need to focus on other aspect rather than LBO Concepts. This is the key
success factor for the company to get the leverage buy successfully. Those LBO
Concepts are:
1. Oil Price: The margin of projection
2. Reputation Risk: Reputation of the company
3. Location Risk: The location of the project
The criteria the lenders will impose:

- Economic Evaluation of the Project

- Valuation of the business
- Recourse Financing
- Non-Recourse Financing
- Cash Flow Management
- Loan Seniority
- Escrow; Water Fall
- Default