DEPLETION PREMIUM APPLICATION

ON OIL CONTRACTUAL AGREEMENT IN INDONESIA

Dr. Arsegianto – PE ITB, Munadi ST. – PE ITB, Ahmad Faisal ST. – PE ITB

ABSTRACT
Petroleum is an un-renewable resource, means that after been used it will be over
and will needs billion years to get similar kind of this resources. At the surface,
petroleum, consist of oil and gas, than changed to fractions and burned to produce
energy needed by human and other creature in this planet.
Nowadays, this energy is used excessively, that’s why a large amount of investment is
required to keep the existence of this energy in the future. This investment may come from
government itself or from outside.
Depletion premium is a part of resource that will be consumed today, to be invested
for the future use as such that it replaces equal amount. With depletion premium
government will have enough funds to make investment related to oil exploration and
exploitation without depending to another country. In this paper a common contractual
agreement calculation and concept will be modified to include depletion premium in it,
thus the economic indicators from both contractual agreements could be compared and
analyzed, to investigate the attractiveness of the project and effects to Indonesia if it’s
been applied.

INTRODUCTION
Energy plays an important role in creature’s life. There are a lot of energy sources,
such as oil, gas, coal, nuclear, geothermal, etc. Oil is the most favorite energy source,
because it is the most effective, efficient, easy and relatively save to use.
The oil and gas exploration and exploitation operational right in Indonesia is held by
the government where the government may supervise all of the activities, include pre,
current, and post audit. While the technical operation may represented by national and
international company, using special cooperation agreement contract, known by
Production Sharing Contract (PSC).
Nowadays, oil is used excessively, that’s why a large amount of investment is
required to keep and fulfill the existence and supply of this energy in the future. This
investment may come from government itself (domestic) or from outside. From domestic,
this budget may come from a special cost taken from soling oil, usually called depletion
premium, royalty, rent, or marginal user cost.
Depletion premium is a part of resource that will be consumed today, to be invested
for the future use as such that it replaces equal amount1).
In Indonesia’s contractual agreement, depletion premium is not included. The absence
of depletion premium in the contractual agreement means that the government can’t
guarantee the energy supply and existence in this country in the future. It should be
created in a special post as immediate as we can to make clear the amount and the use of
it and applied it as soon as possible. We can make a total new contractual agreement or
just modified the existed one. The amount is decided by the government, but must still
consider the economic analysis so that investors feel it attractive.

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 The existence of depletion premium makes us independent from foreign company in
exploration and exploitation while in the mean time we may develop national company in
international scale. We may also do search and research on another source of alternative
energy using local expert. This can make our country more autonomous, develop, and
independent on other country.

OBJECTIVES
The objectives of this paper are:
1. To modify a model of oil and gas contractual agreement which include depletion
premium factor.
2. To make a calculation concept of oil and gas contractual agreement which is using
depletion premium.
3. To analyze a modified contractual agreement system which is using depletion
premium.

METHODOLOGY
Methodology used in this study is by calculating the project economic from a field in
South Sumatra which hasn’t included depletion premium. Then we modifiy the
contractual agreement to include depletion premium in it by Try and Error shares
(contractor and government) so the NPV or IRR of modified PSC will similar to
conventional PSC.
After that we do sensitivity analysis on oil price and percentage of depletion premium
to see its effect on NPV or IRR

Data Used In Study

Data used in this paper can be seen in Table 12) taken from a field in Block X South
Sumatra, with the following assumptions:
1. Project duration: 30 years
2. Oil price: 65 US$
3. Tax: 44%
4. Production Cost: 5 US$
5. MARR: 25%
6. Discount Rate: 10%
7. Double Declining Balance Depreciation Method
8. Depreciation Time: 5 years
9. Contractor Share: 15 years
10. DMO doesn’t exist.

Current PSC
The diagram of common PSC Contractual Agreement without depletion premium can
be seen in Figure 13) and below is the calculation procedure4):
1. Revenue (R) = Production × Oil Price
2. FTP = R × %FTP
3. Operational Cost (OC) = Production Cost × Production

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4. Unrecoverable Cost (UR) = CR n-1 – Rec n-1
5. Recoverable Cost (Rec) = if CR > R – DP then Rec = R – DP
if CR < R – DP then Rec = CR
6. Equity To Be Split (ES) = R – FTP – Rec
7. Contractor Share (CS) = ES × %CS
8. Government Share (GS) = ES × %GS
9. Contractor Taxable Income (CTI) = CS + (FTP × %CS)
10. Net Contractor Share (NCS) = CTI + (44% × CTI)
11. Net Government Share (NGS) = GS + (FTP × %GS) + (44% × CTI)
12. Expenditure = C + NC + OC
13. Contractor Cash Flow (CCF) = NCS + Rec – Expenditure
14. Project Cash Flow = NGS + NCS + Rec – Exp

PSC with Depletion Premium

Afterward we will try to develop this PSC Contractual Agreement so that it will
include depletion premium in it. Figure 2 show the modification of it and below is the
calculation procedure:
1. Revenue (R) = Production × oil price
2. Depletion Premium (DP) = %DP × R
Depletion premium percentage (%DP) is calculated using equation5):
DP(1 + i)n – 1 = (1 + inf)n
3. Operational Cost (OC) = Production Cost × Production
4. Unrecoverable Cost Recovery (UR) = CR n-1 – Rec n-1
5. Cost Recovery (CR) = Non Capital + Depreciation + OC + UR
6. Recoverable Cost (Rec), if CR > R – DP then Rec = R – DP
if CR < R – DP then Rec = CR
7. Net Profit = R – DP – Rec
8. Contractor Share = x% × Net Profit
9. Government Share = (1-x)% × Net Profit
10. Government Tax = 44% × Contractor Share
11. Net Contractor Share = Contractor Share – Government Tax
12. Expenditure (Exp) = C + NC + OC
13. Contractor Cash Flow = Net Contractor Share + Rec – Exp
14. Project Cash Flow = Net Profit + Rec + DP – Exp

Calculation
If discount rate is 10% and inflation rate assumed to be 5%, then:
(1  0.05) 30  1
DP  And DP = 30.5%.
(1  0.1) 30
Calculation related to cost recovery is similar with conventional PSC. To make the
project still attractive, NPV or IRR with depletion premium must be equal with NPV or
IRR without depletion premium (conventional PSC).
x (profit share to contractor and government) is the independent variable which is
changed to fulfill this condition. With trials and errors (not listed), it is found that if x is
41.07% then contractors NPV and IRR has the closest value with contractor’s NPV and

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IRR calculated with conventional PSC, that is US$ 718,000,000 and 70%, shown in
Table 2. The rest of calculation is similar to Conventional PSC.
This x value, if agreed by both parties, will be fix along the project time and won’t
change the net percentage share received by contractor and government, still 15% : 85%,
because depletion premium is added to government share.

Sensitivities
We do sensitivity analysis on price to see its effect to contractor’s NPV and IRR. We
consider if oil price is down to level 55$/bbl and rise to level 75$/bbl. The result can be
seen in Table 3 and plotted in Figure 3 and 4 to compare with conventional PSC.
In Figure 3, we find that if oil price is raised to 75$/bbl then contractor’s NPV
856,000,000 US$ will be higher than if calculated with conventional PSC 848,000,000
US$. This is caused by a higher share taken by contractor 40.17% (after cut by cost
recovery and depletion premium) compared to conventional PSC 26.78%.
Still in Figure 3, we find that if oil price is down to 55$/bbl then contractor’s NPV
580,000,000 US$ will be lower than if calculated with conventional PSC 589,000,000
US$. This is caused by profit taken by contractor is low cut by high cost recovery
(always similar in any oil price) and depletion premium even though it’s percentage share
is high, while in conventional PSC the income is still added by FTP percentage.
In Figure 4, we find that if oil price is raised to 75$/bbl then contractor’s IRR 74%
will be lower than if calculated with conventional PSC 76% and when oil price is down
to 55$/bbl contractor’s IRR 60% will be lower than if calculated with conventional PSC
63%. This is caused by the calculation of IRR is mainly influenced by first years present
value. Present value of conventional PSC in early years is higher than present value of
depletion premium PSC, that’s why conventional PSC’s IRR is always higher than
depletion premium PSC’s.
Our second sensitivity analysis is on percentage of depletion premium itself to
contractor’s NPV and IRR. We changed it to 20% and 40% for oil price 65$/bbl and
further 55 and 75$/bbl. The result can be seen in Table 4, and plotted in Figure 5 and 6
along with the changes in oil price.
In Figure 5, we found that if depletion premium percentage is raised to 40% for oil
price 65$/bbl then contractor’s NPV will be reduced to $595,000,000 from initially
$718,000,000. And if depletion premium percentage is reduced to 20% for oil price
65$/bbl then contractor’s NPV will be increase to $854,000,000 from initially
$718,000,000. Similar trend will occurred for the other oil prices.
In Figure 6, we found that if depletion premium percentage is raised to 40% for oil
price 65$/bbl then contractor’s IRR will be reduced to 61% from initially 68%. And if
depletion premium percentage is reduced to 20% for oil price 65$/bbl then contractor’s
IRR will be increase to 74% from initially 68%. Similar trend will occurred for the other
oil prices. These cases occurred caused by the existence of depletion premium itself.
The existence of depletion premium will directly influence contractor’s profit because
it’s the first outflow from their revenue. So, higher depletion premium percentage then
lower contractor’s IRR and lower contractor’s income shown by its NPV. In contrary,
lower depletion premium percentage then higher contractor’s IRR and NPV.

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Depletion Premium Application In Indonesia
In depletion premium PSC, First Trench Petroleum (FTP) don’t need to be occurred,
because if revenue is lower than cost recovery then the government still have income
from depletion premium itself. The government still needs a share in case they wanted to
give incentives if this project is considered not attractive to be developed or marginal.
The main problem occurred is that this income (which is big) posted only for energy
conservation in the future, while as we know all of government income had to be used for
Indonesia development in all sectors, not energy only.
Applying depletion premium in our contractual agreement will enable government to
do investment and no need to wait from outside. By doing their own investment,
government income will automatically higher and has wider control on a block, so they
can make a policy which interest Indonesian people. Depletion premium can also be used
to develop, search, and invest to alternative energy by using domestic scientist.

CONCLUSIONS
1. Oil PSC Contractual Agreement which include depletion premium has been
developed.
2. Depletion Premium 30.5% is get from equation if we use discount rate 10% and
assumption of inflation rate 5%.
3. Contractor share in modified PSC is calculated by trial and error to get NPV which is
similar to conventional PSC so the project still considered attractive.
4. An increase in oil price will produce higher contractor NPV, which is higher than
conventional PSC and produce higher contractor IRR, which is lower than
conventional PSC.
5. A reduction in oil price will produce lower contractor NPV and IRR, which is lower
than conventional PSC that will make the project become unattractive to develop, and
required an incentive.
6. An increase in depletion premium percentage will reduce contractor’s NPV and IRR,
and vice versa.
7. Depletion premium application will reduce government expenses in development
beside energy sector, but will enable government to invest and develop energy used
for the future.

BIBLIOGRAPHY
1. Arsegianto: Ekonomi Minyak dan Gas Bumi, Diktat Kuliah Teknik Perminyakan ITB,
Bandung (2000).
2. Prabowo, Wahyu E.: Pengunaan Perangkat Lunak Untuk Analisis Keekonomian
Lapangan Minyak Dengan Studi Kasus Pada Lapangan Blok X, Tugas Akhir, Jurusan
Teknik Perminyakan ITB, Bandung (2000).
3. www.esdm.go.id
4. Partowidagdo, Widjajono: Manajemen dan Ekonomi Minyak dan Gas Bumi, Program
Studi Pembangunan Pasca Sarjana ITB, Bandung (2002).
5. Arsegianto, and Tambunan L.: Marginal Field; Concept and Application, IPA,
Jakarta (2001).

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APPENDIX

Revenue

FTP
Cost Recovery

Equity To Be Split

Government Share Contractor Share

Government Tax

Net Government Share Net Contractor Share

Figure 1. Conventional PSC Diagram

Revenue

Depletion Premium
Cost Recovery

Net Profit

Government Share Contractor Share

Government Tax

Net Government Share Net Contractor Share

Figure 2. PSC Diagram With Depletion Premium

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 Oil Price vs NPV

$900

$800
NPV (in million US$)

Conventional PSC
$700
Depletion Premium

$600

$500
50 55 60 65 70 75 80
Oil Price (US$)

Figure 3. NPV Changes to Oil Price With Different PSC

Oil Price vs IRR

80%

70%
IRR (%)

Conventional PSC
Depletion Premium

60%

50%
50 55 60 65 70 75 80
Oil Price (US$)

Figure 4. IRR Changes to Oil Price With Different PSC

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 Depletion Premium vs NPV

$1,100

$1,000

$900
NPV (in Million US$)

$800
55$
65$
75$
$700

$600

$500

$400
15% 20% 25% 30% 35% 40% 45%
Depletion Premium (%)

Figure 5. NPV Changes to Depletion Premium With Different Oil Price

Depletion Premium vs IRR

90%

80%

50$
IRR

70% 60$
70$

60%

50%
15% 20% 25% 30% 35% 40% 45%
Depletion Premium (%)

Figure 6. IRR Changes to Depletion Premium With Different Oil Price

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 Table 1. Data Used In Cash Flow Calculation
Year Production (bbl) Capital (US$) Non Capital (US$) Opex (US$)
0 0 0 4,550,000 0
1 0 0 6,519,622 0
2 0 6,855,920 33,100,680 0
3 0 30,926,780 80,002,920 0
4 8,191,900 30,926,780 80,002,920 33,267,600
5 13,729,000 30,926,780 80,002,920 55,416,000
6 18,375,600 31,365,060 61,115,040 74,002,400
7 22,609,300 32,823,900 63,957,600 90,937,200
8 26,496,600 17,506,080 34,110,720 106,486,400
9 26,247,800 0 0 105,491,200
10 22,027,600 0 0 88,610,400
11 18,484,400 0 0 74,437,600
12 15,511,800 0 0 62,547,200
13 13,017,200 0 0 52,568,800
14 10,923,800 0 0 44,195,200
15 9,167,000 0 0 37,168,000
16 7,892,800 0 0 32,071,200
17 6,455,700 0 0 26,322,800
18 5,417,500 0 0 22,170,000
19 4,546,300 0 0 18,685,200
20 3,815,100 0 0 15,760,400
21 3,201,600 0 0 13,306,400
22 2,686,700 0 0 11,246,800
23 2,254,600 0 0 9,518,400
24 1,646,300 0 0 7,085,200
25 1,175,900 0 0 5,203,600
26 781,200 0 0 3,624,800
27 439,900 0 0 2,259,600
28 143,400 0 0 1,073,600

Table 2. NPV and IRR Calculated With Share = 41.07%

Conventional Depletion
Indicators
PSC Premium PSC
NPV $718,530,603 $718,637,404
IRR 70% 68%

Table 3. NPV and IRR With Different Oil Prices

Oil Conventional PSC Depletion Premium PSC
Price NPV IRR NPV IRR
55 $588,955,974 63% $580,558,770 60%
65 $718,530,603 70% $718,637,404 68%
75 $848,105,232 76% $856,716,038 74%

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 Table 4. NPV and IRR With Different %Depletion Premium
Depletion Oil Price = $55 Oil Price = $65 Oil Price = $75
Premium NPV IRR NPV IRR NPV IRR
20% $695,293,175 66% $854,232,610 74% $1,013,172,044 82%
30.5% $580,558,770 60% $718,637,404 68% $856,716,038 74%
40% $476,751,452 54% $595,956,028 61% $715,160,604 67%

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