WHAT LIES IN STORE FOR TIMOR LESTE? MAY 2018

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1 N E W S ASIA PACIFIC SPOTLIGHT WHAT LIES IN STORE FOR TIMOR LESTE? MAY 2018 By 2010 Timor Leste was a country on the rise. After a tumultuous and violent independence process, continued civil unrest was finally on the wane. The country had accumulated around US$8 billion in its Timor Leste Petroleum Fund. The main contributor to the fund, the Bayu Undan field, was still producing large volumes of condensate and sending gas to the Darwin LNG plant to be exported as LNG. The Kitan oil field was about to start producing. Development of the Greater Sunrise gas-condensate fields was on the agenda, promising further filling of the country s coffers with petro-dollars. Fast forward 8 years to 2018 and Bayu Undan production is rapidly declining with expected shut-in by 2022 or Kitan ceased production in No progress has been made on the Greater Sunrise development after disagreement with project operator, Woodside. Scant exploration has been undertaken in the country, highlighted by no exploration wells drilled since So where has it all gone wrong? Timor Leste is an independent democratic nation located to the north of the Timor Sea. The country covers approximately half of the Timor island at the southern side of the Indonesian archipelago. Timor Leste differs from surrounding Indonesia in that it was a Portuguese colony, and the language is still widely spoken within the nation. Indonesia invaded Timor Leste in 1975 after Portugal exited and remained in control for 30 years. After a UN-backed independence vote in 1999, Timor Leste achieved independence in 2002 despite widespread strife from Indonesian-backed militias. The country with a population of 1.3 million has shown consistent economic growth since independence, but is still one of the world s poorest nations with a GDP per capita of only US$1,405 in

2 Timor Leste The national oil and gas regulator is the Autoridade Nacional do Petroloeo e Minerais (ANPM), which lies under the Ministry of Petroleum and Minerals. The country manages oil and gas resources under a Production Sharing Contract (PSC) fiscal regime, a common framework similar to that of neighbour Indonesia. Under the Timor Leste PSC scheme, the initial 10% of production is termed First Tranche Petroleum and is shared between the contractor and the government. Subsequently a cost recovery mechanism allows for exploration, capital and operating costs to be claimed as revenues by the contractor. Any profit petroleum beyond cost recovery is shared between the contractor and government. Finally, income tax is paid by the contractor on income earnt from the PSC. In 2003, Timor Leste signed the Timor Sea Treaty with Australia, which designated a Joint Petroleum Development Area (JPDA). The JPDA began at the median line between Timor Leste and Australia, but shared production revenues between the two countries. Timor Leste and Australia were granted 90% and 10% of the revenue from the JPDA, respectively. This is incorporated into the Timor Leste PSC scheme by assigning Australia a 10% revenue share of the First Tranche Petroleum and the Profit Petroleum. 2

3 JPDA between Timor Leste and Australia The Bayu Undan gas-condensate field operated by ConocoPhillips has long been Timor Leste s key production asset. The other joint venture partners in the project include Santos, Inpex, ENI and Tokyo Timor Sea Resources. Located in the JPDA, the field was initially came online as a gas recycling project to maximise condensate recovery whilst the export pipeline and Darwin LNG plant were built. Two production platforms over the field in 80m of water export natural gas via a 500 km pipeline to the Darwin LNG plant, where it is liquefied and transported to Asian markets. Condensate is separated on the platforms and pumped to a Floating, Storage and Offloading vessel moored nearby. Bayu Undan has produced over 750 million barrels of oil equivalent. Timor Leste started scrutinizing tax paid by ConocoPhillips in relation to Bayu Undan in Subsequent tax assessments were challenged by the company between 2010 and In 2014, several foreign judges and prosecutors hired by Timor Leste to support the country s legal system were expelled when a local court ruled in favour of ConocoPhillips in 7 tax cases. Timor Leste and ConocoPhillips subsequently settled the long-running tax disputes concerning Bayu Undan in As a young country so reliant on a single asset, Timor Leste is obviously determined to not be exploited by a large, foreign firm. Given that oil and gas production makes accounts for 95% of government revenue, it is unsurprising it has wanted to maximise the proceeds from its natural resources. However, since 2004, ConocoPhillips has contributed over US$19 billion in taxes and other payments, leading industry participants to question if this strict approach over a number of years has given Timor Leste a reputation as a difficult country to operate in. 3

4 Bayu Undan Production Platforms The other producing field in the JPDA since Timor Leste s independence is the Eni-operated Kitan oil field. The field was a relatively small, offshore oil development that produced for only 4 years between 2011 to 2015 before being abandoned. Total field production was approximately 60 million barrels of oil. The Greater Sunrise area consists of the Sunrise and Troubadour gas-condensate fields. The fields were discovered in 1974 in 100 to 600m water depth. The Greater Sunrise fields hold Best Case Contingent Resources of approximately 5.1 trillion standard cubic feet (Tscf) and 226 million barrels (MMbbl) of condensate, which compares to expected recovery of 3.4 Tscf and 400 MMbbl from Bayu Undan. The operator of the Greater Sunrise area is Woodside, with other joint venture participants being Shell, ConocoPhillips and Osaka Gas. Woodside s preferred development concepts for Greater Sunrise have been a Floating LNG (FLNG) plant or tie-back via pipeline to Australia. To spur economic development, the Timor Leste government has repeatedly maintained that the fields be developed by a land-based LNG plant based in Timor Leste. Woodside disputed the practicality of a Timor Leste-based LNG plant, stating that the undersea Timor Trough made building a pipeline to such a plant unfeasible. However, the company may have overstated the technical complexity of building a pipeline across the trench. There is no disagreement that a greenfield, onshore LNG plant based in Timor Leste will significantly increase the capital costs for the project. Cost estimates for a FLNG development in the public domain are typically around US$15 billion, whilst a new onshore plant will likely be over US$20 billion. Onshore development costs could be benchmarked against similar frontier LNG developments such as those currently being undertaken in Mozambique and Tanzania. Development via an export pipeline to the Darwin LNG plant, which will have capacity available after Bayu Undan production ceases, 4

5 would be considerably less than the FLNG cost. Development of a greenfield large-scale LNG project will also take years. If planning and construction started immediately, earliest production would be in 2023, and more likely in 2024 or So each year development is delayed, the earliest date for Timor Leste to earn revenue from the project gets later and later. There is no disagreement that a greenfield, onshore LNG plant based in Timor Leste will significantly increase the capital costs for the project. Cost estimates for a FLNG development in the public domain are typically around US$15 billion, whilst a new onshore plant will likely be over US$20 billion. Onshore development costs could be benchmarked against similar frontier LNG developments such as those currently being undertaken in Mozambique and Tanzania. Development via an export pipeline to the Darwin LNG plant, which will have capacity available after Bayu Undan production ceases, would be considerably less than the FLNG cost. Development of a greenfield large-scale LNG project will also take years. If planning and construction started immediately, earliest production would be in 2023, and more likely in 2024 or So each year development is delayed, the earliest date for Timor Leste to earn revenue from the project gets later and later. Onshore LNG Plant under Construction in the United States Have the disagreements over the Greater Sunrise development and the tax disputes with ConocoPhillips have an impact on oil and gas investment into Timor Leste? Exploration may be an indicator of the industry s willingness to invest in the nation. After the 2014 oil price crash, global exploration has shrunk considerably, so it is unsurprising that during this time no exploration wells were drilled in Timor Leste and JPDA waters. However, since 2010 there have been only 7 offshore wells drilled, and none after Additionally, prior to the 2018, there were only 2 active offshore and 2 active onshore exploration blocks in Timor Leste and the JPDA. Exploration in Timor Leste and the JPDA isn t easy. There has been a lack of recent field discoveries with stand-alone potential such as the Kitan oil field. On the Australian continental shelf, the Elang Kakatua fields produced near Bayu Undan until 2007 and there have been a number of sub-commercial 5

6 oil and gas discoveries. But offshore wells in this region are expensive, up to US$30 million depending on water and target formation depth. Closer to Timor Leste, the geology around the Timor Trench is highly faulted. Any hydrocarbon discoveries in this area would likely be small and not continuous. Hence there has been a lack of wells drilled in this area. Furthermore, on the Timor island, there are multiple oil seeps, but there has been no successful exploration drilling. Change came in March 2018, when Timor Leste and Australia signed a new treaty establishing revised maritime boundaries between the countries in the Timor Sea. This came after years of negotiation and some questionable surveillance tactics on the Australian side. The new boundaries were based on the median line, effectively delivering the JPDA as Timor Leste territory. The treaty also had the effect of increasing Timor Leste s maritime territory over more of the Greater Sunrise fields. Under the treaty, the two countries agreed the division of upstream revenue from Greater Sunrise development. If developed by an onshore plant to Timor Leste, the share will be 70% and 30% to Timor Leste and Australia, respectively. Alternatively, if the fields are developed by FLNG or a pipeline to Australia, then the share will be 80% and 20% to Timor Leste and Australia, respectively. Revised Maritime Boundaries between Timor Leste and Australia Following the signing of the treaty, Woodside has issued releases in the media stating that it now has regulatory certainty regarding the Greater Sunrise fields and will look to progress development. However, with possible Pluto LNG expansion, Browse LNG development, an increased share in the large offshore Scarborough gas field, and a non-operated interest in the British Columbia-based Kitimat LNG project, their LNG portfolio is filling fast. Non-operated Sunrise partner Shell also has a strong global LNG portfolio, so these partners may not be as aggressive while they weigh up which are the 6

7 lowest cost LNG developments on their books. Internal company views on whether the global LNG market will be in surplus or shortage in the 2020 s may determine how forceful Woodside and Shell are in pursuing development of Greater Sunrise. More news came earlier this year when Carnarvon Petroleum signalled its intent to re-develop the Buffalo oil field in the Timor Sea. This shallow-water field produced 20.5 MMstb under operatorship by BHP from 1999 to 2004, and was shut-in whilst producing 4,000 bopd. With the redistribution of the maritime boundaries the Buffalo field now lies entirely in Timor Leste waters. Carnarvon has estimated 2C contingent resources of 31 MMstb, though project progression will likely be highly dependent on the success of the Buffalo-10 appraisal/production well. Revenue to Timor Leste from Buffalo will be on a smaller scale than Sunrise, but could contribute funds to the government earlier than Sunrise if production comes onstream in 2020 or It is key that Timor Leste understands what resources lie within their maritime boundaries, from both a technical and economic standpoint. Production from the Buffalo field will provide some revenue inflow, but not on the same scale as Sunrise. Therefore, how much gas and condensate can be produced from Sunrise, which development is optimal and how the production fits into the global LNG market is crucial to Timor Leste s future. Immediately, Timor Leste needs a strategic plan to get Sunrise development up and running. Whether this plan includes ceding to Woodside s preferred development options of FLNG or Darwin LNG remains to be seen. However, when Bayu Undan ceases production in 2022 or 2023, the country will need to see Greater Sunrise at least under development. Each year beyond this date without revenue generation from Sunrise will require considerable funds to come out of its Petroleum Fund to support the country s budget. Beyond Sunrise and Buffalo, since there are no other discovered fields to develop, Timor Leste also needs a plan to promote its exploration potential to attract future seismic and drilling. This may include offering significant incentives to change the confrontational perception some industry observers have of the country. The recent Timor Sea treaty with Australia offers hope that the Greater Sunrise project may proceed in a reasonable timeframe, and Carnarvon s Buffalo intentions show that there still is interest in the country s upstream. However, difficulties still remain for the young nation in the Sunrise development negotiations and kick-starting exploration. Ultimately, given the importance of the oil and gas industry to Timor Leste, what happens with Sunrise will have a significant impact on the future of the country. 7