What has happened?
Indonesia has recently released new regulations on the implementation of carbon capture and storage (CCS) and carbon capture, utilisation, and storage (CCUS), with the stated aims of accelerating project execution and reducing its CO2 emissions. Minister of Energy and Mineral Resources (MEMR) Regulation No. 2 of 2023 on the implementation of CCS and CCUS in Upstream Oil and Natural Gas Business Activities (MEMR 2/2023) aims to provide a regulatory framework for projects that will boost oil and gas production in the country while reducing greenhouse gas emissions. MEMR 2/2023 adds to Indonesia's existing legislation relating to carbon emissions and the potential implementation of carbon pricing, carbon trading, carbon taxes and carbon levies, and is another step in Indonesia's path to reach net zero.
In this blog post, we will take a high level tour of MEMR 2/2023 and some of its challenges. We’ll consider where clarifications and further regulatory developments would be helpful to the industry, and also place this legislation in a global context by comparing this new regulation with the current CCS and CCUS regimes in the United Kingdom, the European Union and Australia.
A number of CCS and CCUS regulatory regimes have now been established across the globe and, though most remain in their infancy, numerous projects are now being progressed. While Indonesia is at a more nascent stage of development than some other jurisdictions (e.g. Australia and the UK), there are also at least 16 CCS or CCUS projects which are targeted to be operational in the country before 2030, albeit that the vast majority are at the very early study and preparation stage. Given this, the release of MEMR 2/2023 is timely as it provides greater clarity around how a CCS or CCUS project could be implemented, and expressly contemplates certain other activities, as set out below.
In particular, MEMR 2/2023 covers:
- at the planning phase, the requirements for a Contractor to submit a comprehensive implementation plan (including feasibility studies and an estimation of carbon storage capacity) to the Special Task Force for Upstream Oil-and-Gas Business Activities (SKK Migas) or the Aceh Oil-and-Gas Management Agency (BPMA), as applicable, for approval by the relevant authority. For this purpose, a contractor refers to an Indonesian company or a foreign company with a permanent establishment in Indonesia which has been appointed to carry out exploration and exploitation in a designated contract area under a production sharing contract entered into with the Government of Indonesia;
- at the execution phase, requirements around:
- ongoing monitoring and measurement, reporting and verification of CCS and CCUS activities and periodic reporting to SKK Migas or BPMA, including in respect of any leakages, and other safety and environmental concerns;
- the build-up of a designated fund to cover expenses and costs that will be incurred during monitoring activities over a period of 10 years after the completion of the closure of the CCS or CCUS activity; and
- when a CCS or CCUS operation might be closed, and the transfer of such operation to the Director General of Oil and Gas;
- the possibility of a Contractor being able to inject and store carbon emissions produced by carbon emitting third parties outside the Contractor's designated area, potentially facilitating future "hub and spoke" models for carbon storage (including potential import of carbon dioxide from other jurisdictions). The expectation is that further regulations will be released in future to address this area; and
- support for the commercial viability of CCS and CCUS activities, including provision for third party funding (including project financing) of such projects, carbon trading arrangements, the availability of cost recovery under production sharing contracts (PSCs) which adopt a cost recovery model, and the extension of the application of certain tax incentives to upstream oil and gas projects.
Whilst MEMR 2/2023 is undoubtedly helpful in setting out the fundamental roles, responsibilities and steps required by a Contractor to implement a CCS or CCUS project together with other upstream oil and gas activities, there remain a few key gaps which stakeholders should be aware of and, where applicable, should seek to address when determining the feasibility of a CCS or CCUS project in Indonesia:
- Cost recovery: MEMR 2/2023 expressly permits the recovery of certain operating costs (including reserving of funds for the 10 year monitoring period) for the CCS or CCUS project through the relevant (cost recovery) PSC. It therefore provides some economic de-risking to the Contractor in respect of this reimbursement of costs – as with other costs recoverable under such PSCs, such costs can be deducted from the Government of Indonesia’s share of hydrocarbon production. However, cost recovery in upstream operations is governed by a number of other Indonesian laws and regulations (including Law No. 22 of 2001 regarding Oil and Natural Gas, and associated regulations), and consistency changes or clarifications across such laws are likely to be required to facilitate the implementation of cost recovery of CCS / CCUS costs as contemplated by MEMR 2/2023.
In addition, while the cost recovery principle might be clearly stated, there remain some questions around how this will be implemented. For traditional cost recovery PSCs, this would be most logically achieved by amending the typical definition of "operating costs" in the PSC to also cover the costs of the CCS or CCUS project from the Government’s share of production, as well as consequential amendments to ensure the understanding around the implementation of the CCS or CCUS project is accurately captured.
The mechanism under gross split PSCs (which do not include a mechanism for cost recovery from the Government’s share of production) is more uncertain. Under such PSCs, parties directly split gross revenue (typically further divided into base split, variable split and progressive split components). The contractor parties then bear all costs of developing and operating the project; with the underlying rationale being that the contractor's share of gross revenue would be more than sufficient to cover costs, and still provide a return on investment. MEMR 2/2023 is silent as to how the economics of a CCS / CCUS project will translate into revisions to the terms of gross split PSCs. In lieu of a cost recovery mechanism, we would expect adjustments will be made to certain of the split percentages to accurately capture the cost of the CCS or CCUS project (which will in turn need to be modelled). At the very least, one would expect that through adjustments to the production splits (together with any other incentives), the contractor parties to a gross split PSC should be able to achieve a rate of return on their investment that is similar to that which they would have anticipated making had no CCS or CCUS project been implemented, but this is ultimately a process which will require discussion with SKK Migas or BPMA (as applicable).
- Trailing liability of the Contractor: MEMR 2/2023 includes an obligation on the Contractor to reserve for the cost and conduct of 10 years of monitoring activities after the completion of the closure of the CCS or CCUS project. Following this period and upon confirmation that the monitoring results show (among other matters) no detectable CO2 leakage, MEMR 2/2023 provides that all rights, obligations and responsibilities of the Contractor for the operation of the CCS or CCUS project are terminated. However, it remains unclear if such termination generally absolves the Contractor of all future liability in relation to the CCS or CCUS project (including under other applicable environmental and other legislation). This is of key importance given that such liability may be indeterminate in size and scope, and may not be capable of mitigation by other means (e.g. insurance). Given the commercial importance of this issue, and absent further clarifications from the Government of Indonesia or SKK Migas (or BPMA), Contractors should seek to address this issue prior to implementation of any CCS or CCUS project, potentially through an amendment to the relevant PSC or a separate supplemental agreement.
- Monetisation: While MEMR 2/2023 does make mention of monetisation opportunities, given the current lack of an established carbon price or a carbon trading regime in Indonesia and the clear signal that further regulation for providing carbon storage services to third parties (including from overseas) is forthcoming but not yet implemented, the current available avenues for monetising CCS or CCUS projects appear to be limited to: (i) enhanced oil recovery; and (ii) facilitating production from fields which currently have an unacceptably high CO2 content. One corollary of this is that project financing for a standalone CCS or CCUS project may be very challenging to obtain as banks continue to retreat from financing oil and gas project developments.
- Discretion of SKK Migas (and BPMA): Under MEMR 2/2023, SKK Migas and BPMA are the primary entities to whom authority to review and implement CCS or CCUS projects has been delegated. It is an issue which will be resolved with time, but we would expect that the first few CCS or CCUS projects will require significant engagement with SKK Migas or BPMA (as relevant) to assuage any concerns that the regulator may have in making the determinations required of it under MEMR 2/2023. Approvals processes could take a considerable period of time as a consequence. We would expect that, with the evolution of market practice and experience gained from previous projects, this position would improve and SKK Migas and BPMA’s requirements will become more specifically formalised through further administrative regulations and guidelines.
Comparison with other jurisdictions
Perhaps due to the differing stages of development of their respective markets, or there being greater focus on specific national development goals in such jurisdictions, there are a few direct comparisons that can be made between the CCS / CCUS regimes in the UK, the EU and Australia, and that contemplated by MEMR 2/2023.
Scope and objectives: The CCS / CCUS frameworks implemented to date in Australia, the UK and the EU are more independent in nature from the upstream oil and gas (or any other) industry. Each regime has a general focus on the identification and operation of storage sites, including a licensing framework for parties who might obtain a storage licence, as well as the further build out of related transport and storage infrastructure. This stands in contrast to MEMR 2/2023, which focuses primarily on integrating CCS or CCUS activities within existing designated areas for upstream oil and gas activities, including an implicit assumption that such CCS or CCUS projects would be carried out by the same parties that are conducting the exploration and production activities. The focus in MEMR 2/2023 seems to be to accelerate project investment and execution first into what may be its clearest and most commercially feasible use case in Indonesia, particularly where captured CO2 can be utilised to enhance recoveries of oil and gas. That said, MEMR 2/2023 does include a brief mention of the transportation of CO2 (and the potential development of a "hub" model mentioned above). It also touches on CCS’s potential application to other industries, as well as the potential for direct capture of CO2 from the atmosphere, although it is not yet clear how such initiatives would be implemented within the framework of MEMR 2/2023, and clarification through further legislation or guidelines would seem necessary.
The difference in focus also results in differences in implementation. Whereas Australia, the UK and certain jurisdictions in the EU have held bid rounds specifically designed to kickstart CCS or CCUS activity in their respective jurisdictions, we would currently expect the initial CCS or CCUS activity in Indonesia to be spearheaded by existing upstream concession holders.
Incentives: The UK, the EU, Australia and Indonesia have all taken somewhat different approaches to the creation of commercial incentives for CCS and CCUS projects.
The UK has been the most generous to operators of CCS and CCUS projects. It has taken a direct approach to make CCS and CCUS commercially viable, by not only having a hand in establishing potential business models for each portion of the carbon supply chain, but by also providing direct funding and subsidies to CCS and CCUS projects and linked emitters.
The EU has, however, approached this from almost the opposite direction. Instead of providing additive incentives to spur CCS and CCUS projects, project operators have been ‘incentivised’ to build such projects and reduce emissions to avoid the high carbon price.
Australia, in turn, has taken a more neutral approach to incentivising CCS and CCUS projects to come online. The primary thrust there has been to allow CCS and CCUS projects to earn carbon credits for each tonne of carbon stored, which can in turn be sold either directly to the government or the secondary market. The availability for sale and trading allows for direct monetisation, incentivising project operators to undertake such projects.
Indonesia has not (as yet) directly embraced any of these approaches, although the ultimate reliance on carbon trading is perhaps more akin to the Australian approach. While there are currently no direct funding incentives in place and there remain issues with direct monetisation (as noted above), the availability, in principle, of cost recovery or enhanced production splits (depending on the PSC) and tax incentives does mean that projects can be partially de-risked, providing greater assurance of the commercial viability of projects. It remains contemplated that, similar to Australia, UK and EU, further monetisation options in Indonesia will exist in due course through carbon trading schemes. However, the Indonesian framework for this remains at a very early stage, and so such options may be of limited attractiveness now, pending further establishment and usage of carbon credits and a developed carbon market.
Implementation: In relation to planning, implementation and the scope of the monitoring obligations (including post-closure requirements), the requirements of MEMR 2/2023 are in principle broadly similar to the requirements as set out in the Australian, UK and EU regimes. However, this is not to say that, in practice, approvals will be granted or administered in the same manner. MEMR 2/2023 grants broad review and approval powers to SKK Migas and BPMA, and it might take some capacity building within the regulators before such review and approval processes can be carried out without significant delays. This uncertainty should be mitigated over time as more projects are implemented and market participants gain a better understanding of the expectations involved, and/or as SKK Migas and BPMA issue administrative regulations and guidelines to participants.
Another difference in this respect is the position on trailing liability after the post-closure monitoring period. The Australian, UK and EU regulations all allow for some form of assumption of long-term risks, including leakage risk, by the government or relevant authority upon fulfilment of particular conditions. MEMR 2/2023 is silent in this regard and, as noted above, Contractors will need to address this given the material impact this could have on the feasibility of a CCS or CCUS project.
MEMR 2/2023 represents a clear step forward that will help progress the first wave of CCS and CCUS projects in Indonesia. The focus on attaching CCS and CCUS projects to upstream activities in Indonesia is likely to help Indonesia develop its gas reserves in a low carbon or carbon neutral manner, and further downstream, facilitate a quicker and greener transition away from coal in its baseload power supply mix. However, in comparison to the current Australian, UK and EU examples, it is clear that Indonesia has a long way to go to establish a comprehensive CCS and CCUS regime.
Two particular areas that we anticipate commercial parties will be particularly keen for future legislation to address include:
- providing a concrete end to liability of the Contractor after conclusion of the 10 year monitoring period (and termination of the PSC); and
- further clarity on monetisation avenues, including:
- the development of a "hub and spoke" model for project operators, which would in turn require further clarity on, among others, CCS activities not linked to existing oil and gas activities (e.g. for already depleted reservoirs not under a PSC), risk allocation of, and title to, comingled CO2, and the transportation and potential importation of CO2 into Indonesia (see Part 1: Dangerous or Precious Cargo? – Key Considerations for Cross-Border CCUS); and
- the development of a carbon credit scheme and establishment of a carbon trading market including, at the early stages, government schemes to support liquidity and price certainty in the market.
On a regional level, neighbours Malaysia and Thailand are currently developing their own CCS / CCUS regulatory regimes. It will be interesting to see if these follow the path taken by Indonesia and focus, initially at least, on potential projects linked to their own upstream oil and gas assets or, alternatively, take the broader-based regulatory approach pursued in jurisdictions such as Australia, the UK and the EU. The commercial incentives (if any) that Malaysia and Thailand will offer to spur the development of CCS or CCUS projects may also prove critical in determining where regional players are prepared to deploy capital to advance carbon capture projects. As carbon trading business models and markets develop and mature, it will be interesting to see if any ASEAN country seeks to use CO2 storage capacity as a resource (i.e. to store a neighbouring country's CO2 emissions) as a new revenue stream.