Cepu block settlement looks good, for the time being

Dadan Wijaksana, The Jakarta Post, Jakarta

Fresh investment. That is what comes to mind when a government- sanctioned negotiating team on the Cepu block revealed last week a deal had been reached with the U.S. energy giant ExxonMobile, ending a nagging dispute that had stalled the development of the oil-rich block since 2001.

While a production sharing contract (PSC) -- the legal basis for the block's operators to start all the work -- would only be signed within the next 90 days, the in-principle agreement is still, by far, the most substantial results produced in the high- profile case.

Above all, the deal, despite it being a preliminary one, will be seen as a stronger initiative to address one prevailing Achilles heel that has for a very long time been a key concern of the business community -- uncertainty.

It is no coincidence that the stagnant investment climate in the energy sector, as it is in most other sectors, over the years has occurred at a time when the country is struggling to restore investor confidence.

Despite being in dire need of funding sources, so that it can generate more robust economic activities and push economic growth up, certainty -- a foremost prerequisite to luring fresh investment -- is not something this country has been very good at providing.

In addition to traditional problems of security, confusing regulations and labor issues, years of haggles and hassles in some key cases pitting the government against foreign companies have been largely to blame for the eroding confidence and poor performance in investment.

Against this backdrop, the settlement of the Cepu block -- which contains huge oil reserves and could boost, at peak capacity, the country's dwindling oil output by more than 15 percent -- is imperative indeed.

As not only does it highlight the government's commitment to resolving a high-profile case of dispute with a foreign investor, it also paves the way for the pumping of billions of dollars in fresh investment into the largely untapped block, located on either side of the border of Central Java and East Java provinces.

With preliminary estimates showing that the investment needed to develop the area may reach up to US$2 billion, before it starts producing in about three years, the deal should bode well for that objective.

However, the impact will prove to go beyond that, as other investors will see that the government is willing to go the extra mile to provide legal certainty, and a climate conducive to doing business here.

Meanwhile, as the big picture looks largely favorable, equally impressive is the deal itself with the government managing to secure quite a healthy production split scheme, even better than most of the existing oil contracts.

The deal, under which Exxon is allowed to manage the block until 2030, reveals that the production split would vary in accordance with the movement of global oil prices, although the government would get larger shares one way or the other.

State oil and gas company Pertamina will be awarded $400 million in compensation for extending the contract, which would otherwise expire in 2010.

Under the adjusted split scheme, the share of Exxon will be between 6.75 percent and 13.5 percent, while the government -- counting the state oil company Pertamina and the local administrations' cuts -- will rake in between 86.5 percent and 93.25 percent.

This allows the government to get the most benefit if the oil prices are high, while on the other hand, provides incentives also to the investing contractors should the prices go low, as their profit share will increase accordingly.

The block is estimated to hold two billion barrels of potential oil reserves and 11 trillion cubic feet of potential gas reserves. At its peak, the area may produce up to 170,000 barrels per day (bpd), or about 17 percent of the domestic oil output of slightly above 1 million bpd.

With the oil output has been declining by an annual average of 5 percent in the past six years, exacerbated by the steady increase in fuel consumption at home, the Cepu block simply offers great benefits that the government could not afford to miss out on.

Increased oil output means less oil imports, be it in crude or in processed fuel products, giving Pertamina an easier job in securing domestic fuel supplies. Equally important is that, less oil imports mean less demand for dollars, and thus eases pressure on the rupiah.

All seems to be working out fairly well.

The government now has to work to ensure that the ironing out of technical and procedural details for the final contract runs smoothly so that the official signing of the final deal takes place on schedule.

Potential obstacles could, however, come from some House of Representative legislators, and perhaps some of Pertamina's top brass, who have said they would reject any deal on Cepu, questioning the legal mandate and good intention of the negotiating team.