The spat over the split
Monday, October 30th, 2006

Neither the Indonesian government nor ExxonMobil will gain from a protracted spat over the status of the production-sharing contract for the development of the Natuna D-Alpha natural gas block in the East Natuna Sea.

Instead, both parties will lose if this feud escalates into a legal battle or arbitration process, which could drag on for years.

Another bout of dispute between the government and ExxonMobil, only a few months after the resolution of the five-year ExxonMobil-Pertamina quarrel over the Cepu oil block in East Java, would only hurt both sides.

The American oil giant, which claims to have spent US$350 million on exploring the D-Alpha block, would not only lose its investment but could also encounter a stronger wave of nationalistic sentiment against its operations in Indonesia.

On the other hand, new oil and gas investors could be scared off by what they might consider to be the heavy-handed manner and capricious attitude the government has toward its contracts.

One might initially be confused as to how BP Migas — representing the government — and ExxonMobil could have come up with so widely different interpretations of such an important contract involving up to $45 billion in investment commitment.

ExxonMobil owns 76 percent of the gas concession with state oil and gas company Pertamina holding the remaining 24 percent.
BP Migas chairman Kardaya Warnika and Energy and Mineral Resources Minister Purnomo Yusgiantoro confirmed on Oct. 11 the government had terminated the ExxonMobil-Pertamina contract and would later decide whether to retender the concession for fresh bids because the contractor failed to fulfill the requirements for the contract’s extension.

But ExxonMobil immediately denied the government statement, asserting that legally, the firm could continue development preparation until January 2009. The giant oil company claims the contract, which was revised in 1995, is extendible twice, each time for two years, after its maturity in 2005. ExxonMobil’s general manager for Indonesia Peter Coleman even convincingly said on Oct.12 that he had just met with Warnika and the BP Migas chief did not mention anything about contract renegotiations.

But setting this spat against the demand for contract revision Vice President Jusuf Kalla made earlier at his meeting with ExxonMobil senior executives in Washington late last September, one could easily get the impression the government was bent on
having the contract amended because it gives the contractor a 100 percent output split, instead of the 35 to 40 percent other gas concessionaires in the country usually get.

When the contract was revised in 1995 neither the Soeharto administration nor ExxonMobil had anticipated that natural gas prices would skyrocket to record highs, along with oil prices, which rose from $15 in 1995 to about $65/barrel now. Hence, no one at the mineral resources ministry then thought about the need to attach a price-escalation clause to the production split as the government and ExxonMobil did early this year for the production-sharing contract for the Cepu oil block in East Java.

The 100 percent production split for the ExxonMobil-Pertamina contract was then considered fair and necessary to encourage the contractor to invest huge sums in developing the gas field. Unlike other gas blocks, the development of the Natuna D-Alpha field is seen as much more difficult, extremely costly and complex due to the low quality and high carbon-dioxide content of its gas.

ExxonMobil has estimated the Natuna D-Alpha block contains around 46 trillion cubic feet of commercially recoverable gas, but due to the 70 percent carbon dioxide content of its gas the Natuna D-Alpha development could cost between $35-40 billion. The American oil giant claims that even under the current production split, the Indonesian government would earn minimally $13 billion in taxes, net-gas revenues and production bonus for each billion cubic feet of gas sold from the block.

Since both parties have big stakes in the contract, it is clear they are doing their best to resolve their differences.
ExxonMobil, which has big operations and will stay in the country for a long time, would be well-advised to review its 100 percent production split against the current natural gas market conditions. Stubbornly holding to the 1995 contractual terms will only heighten narrow-minded nationalistic sentiment against its presence in the country.

But the government should be reasonable in its demand for the contract’s revision, otherwise it will damage its credibility and earn itself a bad reputation for not honoring the sanctity
of contract.

The government also should draw whatever lessons it can from this spat by wising up to the importance of going through contracts with a fine-tooth comb and marking any articles, paragraphs or words that do not fit.
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