Publications

The gas price in an upstream gas sales agreement (GSA) in Indonesia is generally determined by: (i) indexing it to other products or (ii) using a fixed price, each with or without an annual escalation. The price formula intends to protect both the seller, including the Government’s share, and the buyer in implementing the GSA taking into account the economics of both parties. Historically, the gas price for export sales has been indexed to an oil price while the gas price for domestic sales has been based on a fixed price. The index formula may also have variations such as a floor and/or a ceiling and/or some escalation, which worked well until mid-2000 when oil prices were relatively stable. However, the unanticipated sharp increase in the price of oil from 2004 until its peak in 2008, accompanied by equally sharp increases in upstream materials and services costs, significantly impacted the economics of the sellers and buyers. Gas prices determined using formulas without ceilings have quadrupled while those with caps no longer sustain the economics of the seller, which ultimately affects the sustainability of the supply. Additionally, caps can result in gas prices that are below the seller’s economic threshold, which can lead a seller to trigger GSA termination and further strand reserves. Amending the GSA gas price formula to introduce “tiered pricing” is one possible approach for dealing with the impact of gas price formulas that no longer protect the economics of both the seller and the buyer. Under this approach, existing production from facilities that have been fully developed and do not need further capital investment can be sold at a slightly revised version of the existing gas price (“Tier-1 price”). A gas price that is indexed to the price of oil or other product without a ceiling (“Tier-2 price”), is applied to the new or remaining production that still requires major capital investments. The Tier-2 price will enable the seller to economically develop new production while a blend of Tier-1 and Tier-2 priced gas may improve the buyer’s economics when compared to purchasing gas from alternative sources if the GSA is terminated by the seller due to the seller’s low economics. Managing Tier-1 and Tier-2 flow streams that may be commingled and share common facilities and the related implications to the volume allocation, billing, shortfall, take-or-pay, etc. is more challenging and requires closer cooperation and trust between the seller and the buyer. Including a more detailed procedure as part of the GSA amendment is the key to reaching a fair allocation of Tier-1 and Tier-2 priced gas delivered and billed to the buyer. This paper discusses a tiered pricing solution to sustain the economic life of a GSA and illustrates a fair allocation arrangement to implement such tiered pricing. The tiered pricing discussed in this paper is modeled on an actual GSA signed before 2004 that required amendment to add a Tier-2 price. Certainly this tiered pricing may also be applicable to any new GSA.