Industry Trend Analysis - Further Contract Reforms Needed To Boost Investment Appeal - MAR 2018

BMI View: Faced with depleting oil and gas reserves and declining production, Vietnam, Indonesia and Thailand will need to make further improvements to their respective licensing regimes and overall risk profile s to retain and attract much-needed private and foreign investment into the upstream.

We expect oil and gas reserves and production in Vietnam, Indonesia and Thailand to decline steadily over the coming years, as low oil prices and industry-wide spending cuts and greater capital discipline curtail much-needed investment in upstream projects. Despite considerable underground potential and access to large and growing consumer markets, we expect these countries to struggle to attract sufficient private and foreign investment into their respective upstream sectors. This is largely due to significant above-ground risks, including the dominance of state-owned enterprises, a growing sense of resource nationalism, regulatory uncertainties and unfavourable licensing terms, which will drag on investor sentiment.

In response, all three countries have undertaken various measures to improve their respective business environments. In particular, notable changes have been made in the petroleum licensing space, where all three countries have either transitioned or are in the middle of transitioning from dated oil and gas contracts based on concession regimes skewed in favour of the state, to production sharing contracts (PSC).

Oil, Gas Output To Decline Amid Low Prices, Investment
Selected Countries - Crude Oil, NGL & Other Liquids Production ('000b/d - LHS) & Natural Gas Production (bcm - RHS)
e/f = BMI estimate/forecast. Source: EIA, BMI

However, these countries continue to rank among the region's worst in view of their licensing terms with new contracts still generally skewed in favour of the SOEs and ladened with significant uncertainties, while offering insufficient incentives. An expected rebound in oil prices over the coming years should also support a comparable rebound in upstream risk appetite globally. However, without further improvements to their licensing regimes and overall risk profiles, Vietnam, Indonesia and Thailand will struggle to compete with lower-risk markets in Europe and North America, as well as with some of the higher-risk and more frontier plays, such as those opening up in Africa and Latin America.

High Risk Factors Drag On Region's Upstream Potential
Vietnam, Indonesia & Thailand vs Asia Average
Source: BMI

Thailand : Signs Of Growing Resource Nationalism A Concern

Following the government's amendment of the Petroleum Act in June 2017, oil and gas blocks in Thailand can now be exploited by a production sharing contract (PSC) or a service contract (SC), in addition to the previous concession based regime. However, this does not imply greater flexibility for E&P firms, given that the government will unilaterally determine which contract is used.

Moreover, the new contracts will limit the amount of petroleum that can be allocated for cost-recovery purposes to 50.0% of total annual oil production. This will likely result in prolonged cost-recovery periods for higher-cost offshore, deepwater developments, such as those in the Gulf of Thailand, and conflict with growing industry preference for lower-cost, shorter-cycle projects.

Further details of these contracts are yet to be made public. However, we believe Thailand's ability to significantly improve upon current fiscal terms will be severely curtailed, particularly amid growing public pressure on the government to establish greater control over domestic oil and gas resources. For instance, the existing concession-based regime under which the Thai government reportedly takes about 67.0% of pre-tax profits drew heavy criticism for granting overly favourable terms to E&P firms.

Vietnam : Increased Contractor Burden Dissuades Investment In New Projects

Vietnam has shifted to the current PSC regime back in June 2013, and the new model is applicable for all PSCs signed after this date. Moves have been made to introduce further reforms, though none have gained traction to date. The new PSC specifies the different royalty, corporate income tax and export tax rates for contractors, a significant improvement from the pre-2013 model which did not outline these. However, it offers little protection against changes in environment protection fees, profit surcharges and value-added tax, leaving contractors vulnerable to any new taxes or fees that may be introduced by Vietnam during the PSC's lifetime. This is a particularly negative prospect when viewed next to Vietnam's highly volatile regulatory environment.

Select Taxes & Fees Under Vietnam's New Model PSC
Source: National Sources, BMI
Oil < 20,000b/d > 150,000b/d
10% 29%
Gas < 0.05bcm > 0.1bcm
2% 10%
Encouraged Projects* < 20,000b/d > 150,000b/d
7% 23%
< 0.05bcm > 0.1bcm
1% 6%
Corporate Income Tax (CIT) 32% - 50% As determined by the Prime Minister.
Value-Added Tax (VAT) 10% Exemptions available for necessary imported goods that are not available domestically.

Moreover, under the new PSC, contractors are subject to three mandatory payments, namely a signing bonus, incremental production bonuses and contributions to the petroleum scientific research and technology development fund. All three of these are determined by the government and further drives up project cost in Vietnam. This has led upstream investment in Vietnam over the past few years to primarily favour farm-ins to existing blocks (that are operated under the old PSC scheme), though this will become increasingly difficult as existing projects mature.

Indonesia : Key Uncertainties Remain Unabated

Indonesia introduced a new gross-split PSC in January 2017, substantially raising baseline company-take from profits from petroleum sales from 15.0% for oil and 30.0% for gas to 43.0% and 48.0%, respectively. However, the new scheme's lack of any cost-recovery mechanism and insufficient incentives for marginal and mature projects drew muted response from industry participants, leading to further revisions in August based on inputs from key domestic and international stakeholders. Key changes included in Indonesia's revised PSC includes higher variable company-take for mature fields, frontier fields and high-sulphur gas developments, alongside higher progressive split for cumulative production.

Variable Company-Take Under Indonesia's New Gross-Split PSC
Previous Revised
Source: National Sources, BMI
Fields In Secondary, Tertiary Production 3% 6%
Frontier & Onshore Fields 2% 4%
High-Sulphur Gas Fields 1% 5%
Offshore Projects 2% 2%
Progressive Split For Cumulative Production 5% 10%
Subsequent PoD and Beyond 0% 3%

However, several key uncertainties remain. Crucially, the decision to remove a 5.0% cap on the minister's discretion to award an additional company-take split where a project does not meet a 'certain economic level' grants the minister significant discretion to adjust the overall split. Moreover, the lack of transparency over how the 'economic level' will be calculated, raises the risk of project delays due to drawn out negotiations between upstream regulator SKK Migas and E&P firms. Indonesia also did not increase company-take for offshore projects, keeping it unchanged at 2.0%, a rate that had previously been deemed insufficient. This is bearish for Indonesia given that most of the country's remaining oil and gas reserves lie offshore, where development costs are higher.