A 'MIDDLE ROAD' IN TIMOR'S OIL AND GAS OPTIONS By Andrew McNaughtan

The following piece is written in the hope of promoting useful discussion and debate about options that may exist for the East Timorese parliament and others in their approach to the oil and gas issue.

SYNOPSIS - LOOKING FOR A 'MIDDLE ROAD' IN THE OIL AND GAS OPTIONS

Currently there is some discussion about two broad approaches that East Timor might take towards its oil and gas resources. This piece suggests another possibility, a 'middle road' that could be adopted relatively

simply without too much disruption - but with some potential benefits to East Timor.

The two options that have been mainly aired so far are:

1. to ratify the currently proposed 'Timor Sea Arrangement' in which Australia and East Timor would share the revenues from the exploitation of the resources in a shared economic zone ('Zone A'), whilst leaving the sea bed boundaries between the two countries unresolved or 2. to determine East Timor's full maritime entitlements by setting the boundaries between Australia and East Timor in accordance with the United Nations Convention on the Law of the Sea (UNCLOS) and thus avoid the concept of a 'shared economic zone'.

Both options have significant benefits but also significant drawbacks for East Timor. Until the end of March, 2002 - with the publication of authoritative legal opinion on East Timor's maritime boundary entitlements - it seemed the only likely outcome would be the ratification of the 'Timor Sea Arrangement' in its current form. However the recent legal opinion confirms that East Timor's actual entitlements are significantly greater than was previously recognised. It is now understood that East Timor's potential eastern boundary - were it to choose to properly determine its boundaries with Australia - would include a major part (if not all) of the economically crucial Greater Sunrise fields. This would surely make the option of claiming its full sea-bed entitlements more attractive to East Timor. However Australia has recently taken steps to remove itself from the jurisdiction of the International Court, in an apparent pre-emptive move to thwart just such a boundary determination. East Timor fighting Australia for its rightful maritime entitlements could be messy and unpleasant. Both the options mentioned have drawbacks.

But are there any other options?

Timor could work within the framework of the currently proposed Timor Sea Arrangement (TSA) to receive a more equitable share of its own resources. Crucial to an equitable outcome for East Timor is the gaining of a fair share of this biggest resource in the 'Timor Gap' area - the 'Greater Sunrise' gas field.

Under the proposed Timor Sea Arrangement, 20% of the Greater Sunrise field is currently 'deemed' to lie within the shared economic zone (between Australia and East Timor). However the percentage of a resource 'deemed' to lie in an economic zone is simply the result of an agreement between the parties, which may be somewhat arbitrary. As the figure is arbitrary it could just as easily be replaced with another figure - for instance 80%. 80% happens to be the minimum percentage of Greater Sunrise that East Timor is estimated to be entitled to in reality, were it to pursue its actual entitlements in the International Court.

Altering the percentage of Greater Sunrise 'deemed' to be in the shared zone ('Zone A') from 20% to 80% has a significant effect on the overall economic outcome - Timor's overall share of its potential entitlements would rise from about 40% to about 70% - which most people would see as a more reasonable outcome, considering that as much as 100% of the resources under discussion would probably be East Timorese if the relevant international norms were applied.

The following piece outlines this argument in greater detail.

AN OUTLINE OF THE CURRENT 'TIMOR GAP' ISSUES.

A major controversy is brewing as East Timor approaches formal independence on May 20th. Behind the scenes there is massive pressure being brought to bear on the Timorese political leadership to ratify the Timor Sea Arrangement (TSA) that was negotiated between UNTAET and Australia and signed on 5th July 2001. This 'Agreement' is not legally binding but is "deemed" to be suitable for signing after East Timor becomes independent. To come into force the TSA will need to be ratified by the new East Timorese parliament.

Most of those in the parliament apparently don't yet understand the issues on which they will be required to vote, yet Australia is exerting pressure to require that this provisional Timor Sea Arrangement is 'rubber stamped' by the East Timorese parliament as matter of urgency - Australia wants it signed as soon as possible after May 20. This is the most crucial economic issue for Timor's future, yet dealings over the oilfields have been conducted by a handful of officials in an atmosphere of secrecy.

Recently a public forum was held in Dili at which some options for East Timorese petroleum resources were discussed. These matters have been aired by Rob Wesley Smith of Australians For a Free East Timor (AFFET) in Darwin who attended this seminar and who has recently posted much useful

information relevant to this issue.

The ramifications of the handling of this issue will stay with East Timor for many years to come and the suppression of information and debate may turn out to be counterproductive.

At heart is a difficult dilemma. East Timor's full maritime entitlements

are potentially much bigger than those provided within the provisional

Timor Sea Arrangement negotiated by the UN. In fact under the provisional Timor Sea Arrangement, East Timor will receive revenues from less than 40% of the resources to which it is theoretically entitled.

There are currently two broad options - one is to properly determine formal maritime boundaries between East Timor and Australia (which will be referred to later in this piece as 'Scenario 2') whilst the other is to work within the concept of a "joint development zone" similar to that created by the Timor Gap Treaty (which was signed between Australia and Indonesia in 1989). The latter option (which will be referred to later as 'Scenario 1') avoids the issue of where the actual boundaries lie and focuses simply on creating a treaty for economic exploitation - leaving the actual sea-bed boundaries undetermined.

An internationally accepted sea-bed boundary (which relates to the oil and gas resources under the ocean floor) would be determined by the application of the United Nations Convention on the Law of the Sea (UNCLOS). UNCLOS has been accepted for some time as the guideline for determination of the maritime entitlements of nations. Advice from experts confirms that East Timor's potential sea-bed boundaries would extend south to the mid-line between East Timor and Australia (which is also the southern boundary of 'Zone A') but significantly further east and west than the lateral borders of 'Zone A' (which is currently considered to provide the lateral

boundaries to the Timor Gap). 'Zone A' has been officially renamed the 'Joint Petroleum Development Area' (JPDA), though the term 'Zone A' is still used for convenience. Australia has indirectly acknowledged the strength of the East Timorese case for widened lateral boundaries by recently attempting to withdraw from the jurisdiction of the International Court in these matters. The timing of Australia's withdrawal (about the time the seminar on this matter was held in Dili) cannot be a coincidence.

The significance of the debate over where the lines are drawn is that the most crucial reserves in the region will change hands (with major financial ramifications), depending upon which model is applied. The single most crucial resource in the 'Gap' is the Greater Sunrise field. This straddles the eastern border of 'Zone A' (favoring Australia if the 'Zone A', Timor Sea Arrangement is adopted) but would be mostly (or all) East Timorese if formal seabed boundaries were determined. As Greater Sunrise is a much bigger resource than any other in the 'Gap', determining which party has the major claim to it is a fundamental issue.

In negotiating with Australia on East Timor's behalf, the UN decided not to push for actual boundary determination but instead to settle (in their proposed Timor Sea Arrangement) for an altered revenue share within the central 'Zone A'. Under this proposed TSA the boundaries of 'Zone A' (now called the JPDA) remain identical to those that were determined in the 1989 Timor Gap Treaty signed between Indonesia and Australia.

Under the proposed Timor Sea Arrangement, the revenue share for 'Zone A' has been altered from 50/50 (between Indonesia and Australia) to 90/10 (between East Timor and Australia). Whilst this initially appeared a reasonable deal for East Timor, it may not have been initially recognised how much wider East Timor's boundaries should be (if determined under UNCLOS) and how potentially significant these changes could be given what large oil and gas reserves lie just outside the lateral borders of 'Zone A'. If East Timor ratifies the provisional Timor Sea Arrangement negotiated between the UN and Australia in its present form, it will forego its rights to these very significant fields. As mentioned above, that means East Timor will receive only about 40% of the reserves (and thus revenues) to which it would be entitled, if it were to pursue its full boundary entitlements.

This figure is based on a report by leading Australian oil and gas engineer Geoffrey McKee presented at the seminar held in Dili on 23rd March, 2002. The presentations from the seminar (including information on the technical, financial and legal aspects of this issue with relevant maps, graphs etc.) can be viewed on the website at: www.gat.com/Timor_Site

However the ideal outcome - from East Timor's perspective - is complicated by the diplomatic, political and strategic concerns that underlie these matters. East Timor is a small country located between two huge and relatively powerful neighbors - Indonesia and Australia. Relations with Indonesia are still tense. Australia has belatedly emerged as a friend (of sorts) of the Timorese people - who will always be grateful for the arrival of INTERFET. Ideally East Timor would have good diplomatic relations with both countries. If Australia does not remain engaged East Timor could become vulnerable to those in the Indonesian armed forces who may not yet be fully reconciled to East Timor's departure from the Republic of Indonesia.

Thus Timor's insistence on receiving its full entitlements under

international law is constrained by the diplomatic and political realities it faces and the current Australian position may be seen as taking

advantage of this. A further complicating matter is that East Timor would clearly have the right - and probably the inclination - to develop its own resources on its own territory if it had full sovereignty over its own oil and gas. These oil and gas processing developments could be located in East Timor and create some thousands of jobs (with potentially huge multiplier effects on the East Timorese economy). Locating these developments within East Timor IS possible because (contrary to misleading reports circulated previously) it is possible to put a pipeline across the Timor Trough to the East Timorese mainland from the oil and gas fields, such as Bayu-Undan . The claim that it was not possible to do so was the basis for the assertion that oil and gas processing HAD to be done in Darwin. It is now clear that locating an Liquefied Natural Gas (LNG) export facility in East Timor is technically possible, although probably a more challenging prospect at this stage than locating such a facility in Darwin.

Yet no-one could doubt that East Timor desperately needs and deserves the revenues from all its resources to sustain it in the longer term and that Timor urgently needs projects that will create employment. Its notable that the political representatives of the Northern Territory of Australia (for example) have been lobbying energetically for the Northern Territory's

interests, whereas East Timor's interests have not been as actively pushed.

Currently there are strong pressures being exerted on the Timorese

leadership to have the Timor Sea Arrangement formally ratified and signed into legislation as soon as possible. This pressure is coming form the Australian Federal Government, oil companies such as Phillips, some within the East Timorese leadership and also from the Northern Territory

government (the part of Australia adjacent to East Timor). The Northern Territory (NT) is keen to secure the LNG export facility in Darwin and to potentially become a supplier of LNG to Japan and natural gas to the eastern states of Australia. The NT Govt. thus wants the Timor Sea Arrangement (which will facilitate the location of processing facilities in Darwin) ratified as soon as possible.

The FRETILIN party in East Timor is under the leadership of Mari Alkatiri who also has primary responsibility for East Timor's policy on petroleum resources. Alkatiri currently seems to endorse the UN's provisional Timor Sea Arrangement (though there are indications the issue may be under review). If the leadership decides to ratify the TSA in its current form, FRETILIN may have the numbers to push through the agreement in Timor's parliament without much debate. In this case East Timor will receive only about 40% of its estimated entitlements and ratification of the current agreement would also weaken the case for 'downstream' processing on East Timor's own territory. This would forfeit a potential huge boost to the Timorese economy. Under this scenario (of ratifying the current TSA as is), Timor would receive less than a third (and probably less than a quarter) of the overall potential benefits (from direct revenues as well as the potential benefits from 'downstream' processing within East Timor) from the exploitation of its resources. Australia would receive over two thirds of the benefits - from resources that do NOT lie within Australian territory (under the guidelines of UNCLOS).

On the other hand the Timorese could potentially reject the provisional

Timor Sea Arrangement and ask that the matter be arbitrated by procedures laid down under UNCLOS. Assuming that Australia is found to be obliged to be bound by relevant international legal procedures (which would be the first difficulty, given Australia's recent attempted withdrawal from the court's jurisdiction) Timor could still be faced with a long and acrimonious fight for its full entitlements. It is likely that, in this scenario, Timor would eventually win sovereignty over a much greater area with much greater revenues than those it will be able to claim under the UN's proposed Timor Sea Arrangement. Timor would then also be able to benefit from processing the resources on its own territory and gain huge 'downstream' benefits to its economy.

However Timor would not have the capacity to defend these resources from any enemies (such as some within the Indonesian army). This insecurity

might worry the oil companies and their financial backers. Timor might also face a period of uncertain (or absent) revenues whilst these issues were resolved. Perhaps one of the most concerning effects could be the straining of relations with Australia. The option of formally determining East Timor's maritime boundaries under UNCLOS has the possibility of delivering much greater rewards to the people of East Timor - but with significant

risks and costs.

However there ARE alternatives to these two opposing options which may have the capacity to deliver acceptable outcomes to all the interested parties, whilst significantly improving Timor's share of the resources which are, after all, really East Timor's entitlements.

The biggest sticking point is the amount of potential revenue from resources that East Timor will forfeit if it signs the current Timor Sea Arrangement (which will give Timor 90% of the returns from 'Zone A' only - but no returns from other resources in the 'Gap').

Outside 'Zone A' are 'Laminaria/Corallina' and most of 'Greater Sunrise' fields. Greater Sunrise is the most significant field in the 'Gap' with resources estimated at about 2 billion barrels of oil equivalent (an energy unit that covers both oil and gas deposits). Under the proposed Timor Sea Arrangement, 20% of this crucial Greater Sunrise field would be 'deemed' to lie within 'Zone A'. Thus East Timor would receive 90% of this 20% of Greater Sunrise within 'Zone A' - which means East Timor would get 18% of the overall revenue from Greater Sunrise.

However East Timor's actual maritime boundary entitlements, as recently determined by world authorities on the subject ( Vaughan Lowe of Oxford University and Chris Carleton of the UK Hydrographic Office - see report on website: www.gat.com/Timor_Site ) would entitle East Timor to between 80% and 100% of the resources of the Greater Sunrise field. Thus if East Timor ratifies the TSA in its current form, it would be sacrificing its right to the majority (or all) of the most significant resource in the area - a resource that lies within its potential boundaries.

Equally if East Timor ratifies the proposed Timor Sea Arrangement, it would forego claims to Laminaria/Corallina to the west of 'Zone A'. This is a field which is estimated to contain 200 million barrels of oil and is currently paying about US $ 300 million per annum in revenue into the Australian treasury. By Lowe and Carleton's determinations, this field would also be fully within East Timor's maritime boundaries and should thus theoretically be paying revenues to East Timor, not Australia.

If East Timor ratifies the current provisional TSA, it will forego claims to these resources which appear to be rightly Timorese.

Either option appears somewhat fraught - to be bullied by Australia into accepting an unfair agreement could lead to resentment and increased

political instability within East Timor. To try to fight Australia for East Timor's full share of its resources may prove difficult and could lead to diplomatic and political strains that would best be avoided. Are there any intermediate options? It seems that there may be.

Timor could work within the framework of the current proposed TSA to demand a more equitable share of its own resources. For instance 20% of the resources of Greater Sunrise field are currently 'deemed' to lie within 'Zone A' (from which East Timor would receive 90% of the revenues). This percentage of Greater Sunrise field that is 'deemed' to lie within Zone A is simply a legal tool - an agreement between the parties that is somewhat arbitrary and is not rigidly based on the underlying geomorphology. As the figure is arbitrary it could just as easily be replaced with another figure - for instance 80%. 80% happens to be the minimum percentage of Greater Sunrise that East Timor is estimated to be entitled to in reality, were it to pursue its actual entitlements in the International Court (in fact East Timor may be entitled to 100% of this field).

Altering the percentage of Greater Sunrise 'deemed' to be in 'Zone A' from 20% to 80% has a significant effect on the outcome - Timor's overall share of its potential entitlements rises from about 40% to about 70% - which most people would see as more realistic under the circumstances. This option is referred to below as 'Scenario 3'.

If East Timor forfeits the right to full sovereignty over its resources by signing the TSA it loses the ability to insist that the 'downstream'

developments be based within its own territory. Thus it becomes almost predetermined that these developments will occur in Darwin. Phillips

Petroleum and the NT government are determinedly touting this option (downstream processing in Darwin) for obvious reasons. If East Timor is to surrender its rights (to develop its own resources on its own territory), it should insist on adequate compensation. It could demand that a significant percentage (such as a third, for example) of the jobs in the 'downstream' processing be for East Timorese. This will mean that skills and at least some of the financial benefits from this employment will flow back into East Timor.

There are other 'intermediate' options available - such as:

The retention of the current 'Zone A' shared economic zone concept but with widening of Zone A's eastern and western boundaries to accord with the maritime boundary guidelines of UNCLOS (the northern and southern boundaries would be left intact). This would allow the basic provisional Timor Sea Arrangement to remain intact whilst resulting in much greater returns for East Timor.

Another possibility is that East Timor seek its full maritime entitlements but contract that its oil and gas be piped to Darwin for processing, resulting in Australia and the Northern territory obtaining all 'downstream' benefits.

PROS AND CONS OF THESE 'SCENARIOS' FOR ALL PARTIES:

From the perspective of the Australian Federal Government:

Scenario 1: (ratifying the current Timor Sea Arrangement unchanged) - this is the best deal for Australia. The Australian Federal Government would receive royalties from 60% of the resources in the 'Gap' that would probably belong to East Timor if the matter was settled in accordance with international principles. In addition Australian would receive the huge 'downstream' benefits of LNG processing on Australian soil. There are no drawbacks to this scenario from Australia's perspective. In spite of Alexander Downer's misleading claim that Australia was 'generous' (with the deal that would provide 90% of the revenue form 'Zone A' to East Timor), the actual effect of this deal would be to turn East Timor into a de-facto major donor of foreign aid (to the tune of many billions of dollars) to Australia. In summary - this is a perfect deal for Australia and it is no surprise that Australia is pressing Timor to accept it.

Scenario 2: (East Timor fights Australia for its full maritime entitlements and thus access to it's full rights to oil and gas resources and revenues) - this would be the worst case outcome for Australia. The whole issue could be frozen pending legal developments, Phillips' proposed development near Darwin might be stalled. Tensions could increase between the Australian and East Timorese governments. The issue would get more media attention in Australia, resulting in the public waking up to the fact that their government has shown bad faith by resisting having this matter dealt with in the International Court. This would result in increased debate and discussion about the matter in Australia - resulting in unwanted controversy and criticism of the government.

Scenario 3: (a simple technical alteration to the proposed Timor Sea Arrangement such that 80% of Greater Sunrise is 'deemed' to lie within 'Zone A' rather than the current 20%) - the Australian Federal Government can live with this arrangement. Australia gets less revenue than under Scenario 1, but a great deal more than in Scenario 2 (in which Australia gets nothing). The resources in question would appear to be East Timorese anyway, so in this scenario Australia would be receiving about 30% of the 'Gap' revenues as an effective 'gift' from East Timor. Australia (through the Northern Territory) may also stand to gain nearly ALL downstream development benefits which are likely to be huge (unless changed conditions make it more profitable to process gas within East Timor). Therefore

Australia comes out extremely well overall under this scenario. Australia would have the overwhelming bulk of responsibility for defense of the oil and gas resources using its navy, air force and signals intercept capability. As these services are all in place and already functional this cost would not be a prohibitive burden on Australia.

>From East Timor's perspective:

Scenario 1: (ratifying the current Timor Sea Arrangement unchanged) - Timor may feel 'ripped off', receiving only 40 % of its potential entitlements, as well as forfeiting most, if not all, of its potential 'downstream' benefits. The Timorese parliament and people may feel frustrated that they have been coerced into 'rubber stamping' an agreement that they haven't had time to properly understand (if the process is pushed through with inadequate debate). This could lead to 'bad blood' within Timorese society as well as resentment towards Australia for its handling of the issue.

Scenario 2: (East Timor fights Australia for its full maritime entitlements and thus access to it's full rights to oil and gas resources and revenues) - Timor gets the best and fairest outcome economically. It may get 100% of it's maritime entitlements and all downstream benefits. This is potentially an economic bonanza for Timor. If East Timor chooses it could make an LNG export facility based in East Timor more profitable for the oil companies through appropriate tax incentives and risk reduction measures and thus encourage that investment in East Timor, with extensive benefits to the Timorese economy.

However there might be a risk to East Timor's diplomatic and strategic objectives. This approach could have a negative effect on relations with Australia. There may be long delays in commencement of projects due to legal wrangling. The Northern Territory government (close to Timor) might be upset by loss of their expected processing facilities and the oil companies involved might be unhappy because the security of their operations could be compromised, with attendant complications.

Scenario 3: (a simple technical alteration to the proposed Timor Sea Arrangement such that 80% of Greater Sunrise is 'deemed' to lie within 'Zone A' rather than the current 20%) - Timor gets a much better outcome financially than Scenario 1 (but significantly less than in Scenario 2). Timor does not alienate the Australian Federal Govt. or the NT Govt. Timor could insist on jobs and training for downstream developments that would be located in Australia. The long-term diplomatic and strategic interests of East Timor should not be compromised and the oil companies should not be concerned as there should be little or no impact on their activities (provided there is a small adjustment by East Timor to their tax regime in the case of Greater Sunrise so that Timor's increased share does not jeopardize project economics).

>From The Northern Territory Government's perspective:

Scenarios 1 and 3: (from this perspective) are about the same as the NT's interest is in obtaining the Phillips processing plant in Darwin and gaining revenue and jobs for their region.

Scenario 2: (East Timor fights Australia for its full maritime entitlements and thus access to it's full rights to oil and gas resources and revenues) - the NT Govt. would be totally opposed to this option, because of the likely loss of what it sees as an important development for Darwin.

>From the perspective of Phillips Petroleum and co:

Scenarios 1 and 3: are the same as far as they are concerned (although some adjustment might be needed in East Timor's tax regime, so that the costs to the oil companies from taxation are not increased by adopting scenario 3). If overall costs to the companies were kept the same, the oil companies would experience no difference between these two options. Security and other factors should also be the same in either case.

Scenario 2: (East Timor fights Australia for its full maritime entitlements and thus access to it's full rights to oil and gas resources and revenues) - would also be unpopular with Phillips who have expressed a clear preference for processing developments to be located in Darwin. If East Timor had sovereignty over all it's resources, it would probably want to develop them in its own territory - East Timor. From the oil company's perspective Darwin is probably more secure and politically stable with more existing infrastructure and thus seen as more suited to such an major investment. Thus Phillips would likely oppose Scenario 2, unless they were convinced that the East Timor option (referred to above, of development of 'downstream' facilities in East Timor via a pipeline) would be significantly more profitable for their shareholders.

(Dr.) Andrew McNaughtan, Convenor of the Australia East Timor Association, Sydney, NSW, Australia. Contact via email <amcn@ozemail.com.au> Mobile phone (from within Austrlia or East Timor) 0419 733707 (from overseas + 61 419 733707).

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