Throughout 2012 the international press has been awash with reports of changes to Indonesian mining laws and regulatory action in Indonesia with potentially far reaching consequences for foreign investors in the mining and energy sectors in the country. Recent months have seen the introduction of national content requirements, exports bans on unprocessed materials, imposition of high export taxes and high profile licence revocations.

However, the high water mark is undoubtedly the 13 November 2012 decision of Indonesia's Constitutional Court in case number 36/PUU-X/2012 dissolving the country's upstream oil and gas regulator BPMigas on constitutional grounds. This has created additional uncertainty for foreign investors in the oil and gas industry and is reportedly adding to mounting concerns among the wider investor community1. This alert considers the immediate impact of the decision and steps that foreign investors might consider in light of recent developments.

The Constitutional Court's decision in 36/PUU-X/2012

In summary, the Constitutional Court held that the structure and responsibilities of BPMigas, which included the power to licence and regulate the exploration and production of oil and gas in Indonesia as well as serving the state owned entity party to production sharing contracts with commercial oil and gas companies were unconstitutional. Some of the most striking aspects of the decision are set out below:

  • The existing separation between (i) the body which carried out the regulatory and policy making functions of the State (i.e., Ministry of Energy & Mineral Resources (“MoEMR”)) and (ii) the body which carries out the actual management of exploitation in respect of the upstream oil and gas sector (i.e., BPMigas) undermined the State’s effective control of Indonesia’s oil and gas resources for the greatest benefit of the people as mandated by Article 33(3) of the Constitution.
  • The fact priority was given to State owned enterprises in the management of exploitation of upstream oil and gas resources did not overcome the problem created by the separation of the roles of MoEMR and BPMigas.
  • The State’s effective control of Indonesia’s oil and gas resources for the greatest benefit of the people, as mandated by Article 33(3) of the Constitution, could only be realized by doing away with the bureaucracy associated with BPMigas.

As BPMigas is party to all of Indonesia’s production sharing contracts and other forms of co-operation agreements with private domestic and foreign developers of upstream oil and gas resources, the Constitutional Court’s decision immediately cast doubt on the future of these arrangements. Moving with uncommon speed, however, the Government took immediate steps to address the concerns of oil and gas companies by (i) promptly establishing a new unit, within MoEMR, to take over the former BPMigas staff for the purpose of ensuring the continuation of the role of the former BPMigas to the extent consistent with the Constitutional Court’s decision and (ii) assuring oil and gas companies that all existing production sharing contracts and other forms of co-operation agreements with private domestic and foreign developers of upstream oil and gas resources would be respected.

The Government’s “damage control” efforts seem to have been largely successful and, as a minimum, have bought the Government some much needed time to further study the implication of the Constitutional Court’s decision and find a long term solution to balancing the separate roles of the Government in regulating the upstream oil and gas sector and in controlling and exploiting Indonesia’s oil and gas resources for the greatest benefit of the people.

Wider implications?

The full effect and implications of the Constitutional Court's decision ruling and the new regulatory structures to be introduced as a result are yet unknown. Some fear that the change could result in increased political intervention in the management of the Oil and Gas Sector and the adoption of increasing chauvinistic policies.

The decision in Case 36/PUU-X/2012 is also likely to have wider implications, since Article 33(3) of the Constitution applies to all natural resources, the entire sector will likely be impacted by the decision.

What should foreign investors do?

There are a number of steps that companies considering new investments in the natural resources sector in Indonesia might consider to take account of these developments and increase stability going forward. For example:

  • Negotiating tax or legal stabilization clauses in concession licences;
  • Negotiating neutral governing law and arbitration clauses; and
  • Seek political risk insurance cover.

The position could be more challenging for companies that have already sunk significant investments in the host country's economy, and who see the expected returns diminishing as a result of changes in legal, regulatory or tax regimes. In extreme cases, such chances could lead to the loss of control over the business or the expropriation by the State of the entire investments. Companies facing possible drastic state action should consider the following steps:  

  1. Direct communications

Companies faced with the prospect of significant disruption to their business as a result of government action, in Indonesia or indeed elsewhere, should in the first instance consider making direct representations to the relevant ministerial departments. A carefully considered and drafted communication followed up by oral submissions and discussion have in many cases resulted in a satisfactory resolution of all concerns without the need for a formal action.

  1. International arbitration

If direct communications fail to produce a suitable accommodation parties should consider the terms and any remedies available under any applicable PSC's licences or contracts, including any applicable dispute resolution procedures.

Some companies will be in a position to avail themselves of the protections under the relevant contracts or pursuant to international investment protection treaties and conventions between states, commonly known as Bilateral Investment Treaties (BITs) or Multilateral Investment Treaties (MITs). States that are party to such treaties typically seek to encourage direct investment into their territories by guaranteeing certain standards of treatment including protection from expropriation (including indirect expropriation – through the imposition of taxes, for example), discrimination, and other unfair or inequitable treatment. The unique characteristic of such treaties is that they afford foreign investors the right to claim compensation directly from the state in question if the guarantees offered are broken.

Indonesia has, over the years contended with a number of Investment Treaty cases against it, including most recently the claim filed by Churchill Mining Plc before the International Centre for the Settlement of Investment Disputes (ICSID) in May 2012, in respect of the revocation of its Mining Licence.

International Arbitration tribunals appointed pursuant to such treaties are not bound to apply the laws of the host state, but may have regard to relevant principals of international law and to the terms of any relevant licences and contracts and any award rendered should be directly enforceable under applicable conventions.  

  1. WTO

States that are members of the World Trade Organisation must also refrain from adopting measures such as export bans or export taxes designed to afford protection to domestic producers. Companies that are affected by such measures might consider petitioning their home governments to file a complaint with the WTO Dispute Settlement procedure.