The Principle of Proportionality in Production Sharing Contracts in Indonesia

Under Indonesian Contract Law, upstream oil and gas activities are governed through Production Sharing Contracts that establish the contractual relationship between the State and business actors. The shift toward Gross Split Contracts highlights the growing importance of the principle of proportionality in balancing risks, operational burdens, and financial returns between the government and contractors.

Production Sharing Contract in Indonesia

The existence of oil and gas resources in Indonesia provides an opportunity for the State and business actors to optimize the management and utilization of such resources through business activities in the oil and gas sector. In this regard, Law Number 22 of 2001 concerning Oil and Gas as lastly amended by Law Number 6 of 2023 on the Stipulation of Government Regulation in Lieu of Law Number 2 of 2022 on Job Creation into Law (“Oil and Gas Law”), affirms that oil and gas are strategic, non-renewable natural resources under the control of the State and constitute vital commodities that affect the livelihood of the people at large and play an important role in the national economy, therefore, their management must be carried out in a manner that maximizes the prosperity and welfare of the people.

For the purpose of managing such oil and gas resources, oil and gas business activities principally consist of upstream and downstream business activities. Upstream business activities include exploration and exploitation activities, which are carried out and controlled through cooperation contracts as provided under Article 6 paragraph (1) of the Oil and Gas Law. Such cooperation contracts essentially establish a contractual relationship between the state and contractors in the conduct of upstream business activities, whereby the state retains control over oil and gas resources, while contractors are granted the right to conduct exploration and exploitation activities based on the provisions of the relevant contracts and applicable laws and regulations.

Read More: Contractual Risk in Construction Contracts: Practical Legal Guide

One form of cooperation contract used in upstream business activities is a production sharing contract. In its implementation in Indonesia, production sharing contracts in the oil and gas sector have generally been implemented under the gross split production sharing contract and the cost recovery production sharing contract. The fundamental difference between the cost recovery and gross split production sharing contract schemes lies in the treatment of operating costs and the basis for the allocation of production. Under the cost recovery scheme, contractors are principally required to initially bear the operating costs necessary to conduct upstream oil and gas business activities, including exploration, development, and exploitation activities. Operating costs that meet certain requirements may subsequently be accounted for as recoverable costs in accordance with the provisions of the relevant contract and applicable laws and regulations.

Accordingly, the implementation of the cost recovery mechanism requires a process to determine whether operating costs qualify as recoverable costs. The verification and supervision of operating costs may also have implications for the timing of exploration and exploitation activities. As a result, there is a potential where differences may arise between contractors and the government as to whether certain costs satisfy the requirements to be recoverable under the provisions of the relevant contract and applicable laws and regulations.

To address the issues arising under cost recovery production sharing contracts, the government began introducing the gross split production sharing contract scheme in 2017 through Minister of Energy and Mineral Resources Regulation Number 8 of 2017 on Gross Split Production Sharing Contracts, as amended by Minister of Energy and Mineral Resources Regulation Number 12 of 2020 (“MEMR Reg. No. 8/2017”), with the objective of promoting upstream oil and gas business activities that are more effective, efficient, and equitable. As the gross split scheme does not provide for the recovery of operating costs by the government, the scheme is expected to simplify the administrative and oversight processes that were previously required under the cost recovery mechanism.

Nevertheless, it should be noted that under a gross split production sharing contract, contractors bear the risks and operating costs without obtaining a cost recovery mechanism. Consequently, the economic viability for contractors will principally depend on the share of production obtained under the gross split mechanism and other factors taken into account under the contract. This is why, during its initial implementation, the gross split production sharing contract scheme was considered not to have consistently provided sufficient economic viability for contractors. In order to achieve adequate economic viability, a substantial number of contractors were required to request an additional production split from the government. This was considered to create uncertainty for contractors as to whether they would obtain adequate economic viability from the upstream oil and gas business activities they intended to undertake.

This issue is particularly relevant because, under the gross split scheme, contractors bear the risks and operating costs without obtaining a cost recovery mechanism as provided under the cost recovery scheme. At the same time, the amount of production allocated to contractors is determined based on the production sharing mechanism established under applicable laws and regulations. Given these characteristics, there is a need to ensure that the allocation of rights and obligations between the government and contractors remains proportionate. Accordingly, the principle of proportionality is important to be considered as one of the perspectives in analyzing the contractual relationship under gross split production sharing contracts.

To address this issue, the government revoked the previous regulation and introduced a new regulatory framework through Minister of Energy and Mineral Resources Regulation Number 13 of 2024 on Gross Split Production Sharing Contracts (“MEMR Reg. No. 13/2024”) and Minister of Energy and Mineral Resources Decree Number 230.K/MG.01/MEM.M/2024 on Guidelines for the Implementation and Components of Gross Split Production Sharing Contracts (the “MEMR Decree on Gross Split”). These refinements are intended, among other things, to increase the attractiveness of the gross split scheme to contractors and to establish a more proportionate balance between the interests of the government and contractors in the conduct of upstream oil and gas business activities.

Gross Split Production Sharing Contracts in the Contractual Relationship between the Government and Contractors

Before further examining the aspect of proportionality under MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split, it is first necessary to examine the contractual relationship between the government and contractors under production sharing contracts. A production sharing contract essentially constitutes a contractual instrument used to regulate the relationship between the government and contractors in the conduct of upstream oil and gas business activities.

Under a gross split production sharing contract, the contractual relationship has characteristics that differ from those under the cost recovery scheme. Contractors do not obtain recovery of the operating costs they have incurred. Accordingly, the economic risks borne by contractors are closely associated with the success of exploration and exploitation activities and the ability of the project to generate production capable of providing an adequate rate of return. In such circumstances, the production sharing percentage constitutes one of the important factors in determining the economic viability of an upstream business activity for contractors.

Read More: Understanding Indonesia Contract Law: Navigating the Essentials

These characteristics demonstrate that the allocation of production under a gross split production sharing contract cannot be separated from the allocation of risks and burdens between the government and contractors. The greater the risks and obligations assumed by contractors, the more important it becomes to ensure that the economic rights obtained by contractors bear a reasonable relationship to such risks and obligations.

The issue becomes more complex because production sharing contracts operate within a comprehensive regulatory framework. Unlike commercial contracts in general, which provide the parties with relatively greater scope to negotiate the terms of their contractual arrangements, oil and gas production sharing contracts must comply with various requirements established under applicable laws and regulations. In the context of gross split production sharing contracts, important aspects such as the terms of the contract, the production sharing mechanism, the components affecting the production sharing percentage, contractors’ obligations, and various other fundamental provisions have been prescribed under the regulatory framework.

Gross Split Production Sharing Contracts and the Principle of Freedom of Contract

As a contractual relationship, a production sharing contract remains, in principle, subject to the general provisions of contract law under the Indonesian Civil Code (“ICC”). A production sharing contract may be characterized as an innominate contract, namely, a contract that is not specifically regulated under the ICC and that has developed in response to the needs of practice. Nevertheless, the existence of specific regulations governing production sharing contracts does not preclude the application of the general principles of contract law insofar as they remain relevant to the characteristics of such contracts.

One relevant principle is the principle of freedom of contract, as reflected in Article 1338 paragraph (1) of the ICC, which provides that “all agreements lawfully entered into shall bind the parties thereto as law.” The concept of freedom of contract encompasses the following scope:

1. The freedom to enter into or refrain from entering into an agreement;
2. The freedom to select the party with whom one wishes to enter into an agreement;
3. The freedom to determine or select the cause of the agreement to be entered into;
4. The freedom to determine the object of the agreement;
5. The freedom to determine the form of an agreement; and
6. The freedom to accept or deviate from statutory provisions that are optional in nature.

Nevertheless, freedom of contract is not absolute. In its development, there have been limitations on the principle of freedom of contract. In practice, the principle of freedom of contract is based on the assumption that the parties have equal bargaining positions, but in reality, the parties do not always have equal bargaining positions, which may give rise to many one-sided relationships. This is one of the reasons why, in its development, the application of the principle of freedom of contract has increasingly been subject to limitations.

Such limitations are important in gross split production sharing contracts. Gross split production sharing contracts do not arise solely from the negotiation process between the government and contractors, but also operate within the framework of state policies and regulations in the oil and gas sector. This is reflected in Article 3 of MEMR Reg. No. 13/2024, which provides that a gross split production sharing contract must at least contain provisions concerning:

1. State revenues;
2. The contract area and its relinquishment;
3. Funding obligations;
4. The transfer of ownership of oil and gas production;
5. The term and conditions for extension of the contract;
6. Dispute resolution;
7. The obligation to supply crude oil and/or natural gas for domestic needs;
8. Termination of the contract;
9. Post-mining operational obligations;
10. Occupational safety and health;
11. Environmental management;
12. The transfer of rights and obligations;
13. Required reporting;
14. Field development plans;
15. Prioritization of the use of Indonesian workers;
16. Prioritization of the utilization of domestic goods and services; and
17. Development of surrounding communities and guarantees of the rights of indigenous peoples.

Furthermore, the applicable laws and regulations have also regulated limitations on the production sharing percentages to be obtained by contractors. This condition demonstrates that the scope of freedom of contract in gross split production sharing contracts has certain limitations when compared with commercial contracts that are entirely formed through negotiations between the parties. In this regard, the existence of such limitations at the same time raises the issue of how to ensure that limitations on freedom of contract do not result in an exchange of rights and obligations that is disproportionate.

The Principle of Proportionality in Gross Split Production Sharing Contract

The principle of proportionality is one of the important principles in contract law, particularly in contractual relationships that are commercial in nature. Commercial contracts in general are characterized by placing the parties in an equal position, so that the purpose of establishing such relationships is in principle oriented towards business benefits. This can be achieved where there is a proportionate exchange of rights and obligations. Therefore, proportionality is not merely viewed in the context of balance, but also in the process and mechanism of the exchange of rights and obligations that takes place fairly (proportionately) between the parties involved.

This means that proportionality cannot be measured solely based on whether each party obtains an equal share. A contractual relationship may remain proportionate even though the performance received by each party is different, as long as such difference has a reasonable basis when associated with the respective risks, responsibilities, contributions, and interests of the parties. One of the functions of the principle of proportionality in the implementation of commercial contracts is to ensure equality of rights and freedom in determining and/or regulating the respective proportions of the rights and obligations of the parties fairly.

Read More: Court provides guidance on impact of principle of balance in contractual agreements

Although the principle of proportionality is not expressly formulated in the ICC, its existence is closely related to the principle of freedom of contract. Freedom of contract basically assumes that the parties have the ability to determine the contents of their contractual relationship. However, in practice, the parties do not always have the same bargaining position. Differences in position, economic capacity, control of information, and ability to determine the contents of the contract may affect the process of forming and implementing a contractual relationship. Therefore, freedom of contract cannot be understood merely as the formal freedom to agree to a contract, but needs to be viewed in relation to the fairness of the exchange resulting from such contract.

In this regard, the application of the principle of proportionality may be considered in relation to the provisions contained in gross split production sharing contracts. On the one hand, the government has the authority to determine the framework for the management of oil and gas resources based on its position as the party that controls strategic natural resources. On the other hand, contractors are the parties that carry out exploration and exploitation activities and bear the risks and operating costs in accordance with the characteristics of the gross split scheme. These differences in the positions of the parties and the allocation of risks make proportionality an important aspect to be considered in determining the production sharing mechanism.

Adjusting Proportionality in the Gross Split Scheme under MEMR Reg. No. 13/2024

In the context of gross split production sharing contracts, as stated previously, contractors often face difficulties in obtaining an adequate economic value from the production sharing percentage determined after assessing the existing components. As a result, the contractor’s production share may be very low, uncompetitive, and fail to provide a proportionate value commensurate with the activities it has undertaken. Consequently, in order to obtain adequate economic viability, most contractors are required to apply to the government for an additional production share.

In response to this issue, the government has refined the gross split mechanism through MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split. Such refinement is intended, among others, to increase the attractiveness of the gross split scheme for contractors and to establish a more proportionate balance between the interests of the government and contractors in the conduct of upstream oil and gas business activities. One of the important changes introduced under the new regulations is the adjustment of the base split as well as the adjustment of the overall production sharing percentage.

In terms of the base split, the percentage allocation of production between the government and the contractor has been revised. Previously, through Article 5 of MEMR Reg. No. 8/2017, the base split was regulated as follows:

1. For oil, 57% for the state and 43% for the contractor; and
2. for natural gas, 52% for the state and 48% for the contractor.

Whereas the percentages were subsequently adjusted through the MEMR Decree on Gross Split, which provides contractors with a larger percentage, as follows:

1. For oil, 53% for the state and 47% for the contractor; and
2. For natural gas, 51% for the state and 49% for the contractor.

When compared with the previous regulation, there is an increase in the portion of the base split for contractors, both for crude oil and natural gas. Nevertheless, the production sharing amount under the gross split scheme is not solely determined based on the base split. The final production sharing amount is also influenced by variable components and progressive components that function as factors increasing or decreasing the base split.

In addition, the regulation on gross split production sharing contracts previously provided under MEMR Reg. No. 8/2017 contained variable components and progressive components that were relatively complex. Accordingly, to realize the implementation of gross split production sharing contracts in a more practicable manner, MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split have simplified such variable and progressive components. Whereas under the previous regime, MEMR Reg. No. 8/2017 regulated a relatively greater number and variety of parameters, as follows:

1. Variable components:
   • Work area status;
   • Field location;
   • Reservoir depth;
   • Infrastructure availability;
   • Reservoir type;
   • Carbon dioxide (CO₂) content;
   • Hydrogen sulfide (H₂S) content;
   • Oil specific gravity;
   • Domestic component level during the field development stage; and
   • Production stage.
2. Progressive components:
   • Oil price;
   • Natural gas price; and
   • Cumulative oil and natural gas production.

The large number of such parameters in practice creates a need for verification and measurement processes concerning various field conditions. This became one of the aspects subsequently evaluated in improving the gross split scheme. In addition to the relatively large number of parameters, there were also parameters considered not to have a significant influence on the production sharing amount. Such conditions may ultimately increase the complexity of determining the extent of the adjustment to the production sharing percentage.

Under the MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split, such components are simplified as follows:

1. Variable components:
   • Amount of reserves;
   • Field location; and
   • Infrastructure availability.
2. Progressive components:
   • Oil price; and
   • Natural gas price.

Such simplification essentially reduces the number of parameters that must be taken into account in determining the adjustment to the production sharing percentage. With fewer parameters, the calculation is expected to be carried out in a simpler, more measurable, and easier-to-implement manner. At the same time, such simplification is also intended to provide a clearer picture of the factors that affect changes in the production sharing percentage received by contractors.

Such amendments become relevant when associated with one of the proportionality issues arising from the implementation of the gross split scheme under MEMR Reg. No. 8/2017, namely the need for an additional split to achieve a certain level of economic viability for the contractors and also to create proportionality between the parties. As previously described, Article 7 of MEMR Reg. No. 8/2017 granted the Minister the authority to provide an additional production sharing percentage to contractors if the calculation of the commercialization of a field or several fields did not achieve a certain level of economic viability. In practice, although the base split had been determined from the outset, the actual production sharing percentage required to achieve the economic viability could still require adjustment through the additional split mechanism.

Under the new regulation on gross split production sharing contracts, the government states that, through the adjustments to the updated variable and progressive components, the contractor’s production share may reach 75–95%. Such percentage does not constitute the generally applicable base split, but rather results from the application of the overall production sharing adjustment mechanism based on the specified variable and progressive components. As provided under the MEMR Decree on Gross Split, the production sharing adjustment for the contractor’s share may reach 10% to 13% for each variable component, which will subsequently be determined based on the classifications and characteristics established for each variable.

Accordingly, the refinements introduced through MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split do not merely concern changes to the base split percentage, but also encompass changes to the manner in which the overall production sharing percentage is determined and adjusted. The simplification of parameters, the increase in the portion of the base split allocated to contractors, and the provision for adjustments based on variable and progressive components constitute measures intended to make the gross split scheme simpler and to provide greater proportionality for contractors.

The Principle of Proportionality in Production Sharing Contracts

Although production sharing contracts have specific characteristics and regulations and are rigidly regulated under applicable laws and regulations, in essence, production sharing contracts remain a contractual relationship between the government and contractors. Therefore, such specific regulations do not override the applicability of the provisions and principles of contract law as recognized under the ICC, including the principle of freedom of contract and the principle of proportionality. In this context, proportionality is not interpreted as an equal allocation between the government and contractors, but rather as reasonableness in the exchange of rights, obligations, risks, and benefits, taking into account the respective positions and interests of the parties.

The development from the cost recovery scheme to the gross split scheme was essentially intended to establish a simpler mechanism for the management of upstream oil and gas business activities, particularly by reducing the need for complex processes for the verification and oversight of operating costs. However, the initial implementation of gross split production sharing contracts also gave rise to issues concerning the level of economic viability and the proportionality of the share received by contractors in comparison with the risks and costs they are required to bear. MEMR Reg. No. 13/2024 and the MEMR Decree on Gross Split subsequently emerged as efforts to refine such mechanism through changes to the base split, an increase in the potential share allocated to contractors, and the simplification of the variable and progressive components. These changes demonstrate an effort to establish a more proportionate allocation between the burdens and risks borne by contractors and the economic benefits obtained by them.

---

Author

---

Editor

---

---

Reference:

• Law Number 22 of 2001 on Oil and Natural Gas as lastly amended by Law Number 6 of 2024 on Stipulation of the Government Regulation in Lieu of Law Number 2 of 2022 on Job Creation in Law.
• Mineral Resources Regulation Number 8 of 2017 on Gross Split Production Sharing Contracts as amended by Minister of Energy and Mineral Resources Regulation Number 12 of 2020.
• Minister of Energy and Mineral Resources Regulation Number 13 of 2024 on Gross Split Production Sharing Contracts.
• Minister of Energy and Mineral Resources Decree Number 230.K/MG.01/MEM.M/2024 on the Guidelines for the Implementation and Components of Gross Split Production Sharing Contracts.
• Hernoko, Agus Yudha. Hukum Perjanjian Asas Proporsionalitas dalam Kontrak Komersial. Jakarta: Kencana. 2010. Ed. 1 Cet. 1.
• Perdana, Aditya. “Pemerintah mengusulkan kenaikan “cost recovery”, sedangkan target “lifting” minyak bumi turun. Apakah linier?” perpustakan.dpr.go.id. Available at https://perpustakaan.dpr.go.id/epaper/index/popup/id/19148.
• Ministry of Energy and Mineral Resources. “3 Tahun Kinerja Sektor ESDM: Menerapkan Kontrak Gross Split untuk Mendorong Efisiensi Hulu Migas.” esdm.go.id. 20 October 2017. Available at https://www.esdm.go.id/id/media-center/arsip-berita/3-tahun-kinerja-sektor-esdm-menerapkan-kontrak-gross-split-untuk-mendorong-efisiensi-hulu-migas.
• Ministry of Energy and Mineral Resources. “Babak Baru Kontrak Gross Split, Kini Makin Menarik.” migas.esdm.go.id. 1 October 2024. Available at https://migas.esdm.go.id/post/babak-baru-kontrak-gross-split-kini-makin-menarik.
• Bloomberg Technoz. “Rezim Gross Split RI Dinilai Bikin Investor Migas Ogah Eksplorasi.” www.bloombergtechnoz.com. 27 August 2024. Available at https://www.bloombergtechnoz.com/detail-news/47484/rezim-gross-split-ri-dinilai-bikin-investor-migas-ogah-eksplorasi/2.
• Tempo. “ESDM Terbitkan Aturan Terbaru untuk Tarik Investasi Hulu Migas, Ada Soal Bagi Hasil?” www.tempo.co. 2 October 2025. Available at https://www.tempo.co/arsip/esdm-terbitkan-aturan-terbaru-untuk-tarik-investasi-hulu-migas-ada-soal-bagi-hasil–3632.