Cepu Deadlock

The devil is in the detail. This old adage warns of the pitfalls in agreements, especially when they involve big, complex deals. Nonetheless, it is flabbergasting that five months after the conclusion of an agreement-in-principle between state oil company Pertamina and ExxonMobil Corp. in June for the development of the oil-rich Cepu block in Central Java, the final deal has yet to be wrapped up.

When ExxonMobil and a special government negotiating team announced a preliminary agreement in late June, it was hailed as a model for new production sharing contracts (PSCs) in the hydrocarbon sector. So optimistic were the parties about the deal that both expected to work out the technical details for a final agreement by September at the latest.

But is now already December, and Pertamina and ExxonMobil are still deadlocked over the details of their joint operation agreement. Pertamina even threatened last week to develop the Cepu block by itself, even at the risk of facing a messy arbitration lawsuit against the giant American oil company.

No further details were immediately available as to the bones of contention causing the stalemate, but we do know that the country, already a net oil importer, desperately needs to develop the Cepu block as soon as possible as it is estimated to be capable of pumping 170,000 barrels of oil a day.

It was the urgent need for additional oil reserves that prompted the government to intervene early this year and set up a special inter-ministerial team to accelerate negotiations after Pertamina and ExxonMobil became deadlocked after more than three years of negotiations.

The agreement-in-principle that was achieved in late June was considered the best for all parties. Under the contract, Pertamina and ExxonMobil will each have a 45 percent equity holding in the block with the remaining 10 percent being held by the East and Central Java administrations. The production split would be based on a new, innovative arrangement whereby the government will take 85 percent of the output, and the contractor 15 percent if the international prices average over $45/barrel, and 70:30 if the oil prices average below $35/barrel. Based on this sharing agreement, ExxonMobil's take will range from 6.75 to 13.50 percent, depending on oil prices.

ExxonMobil has also agreed to pay Pertamina around $400 million in compensation for giving up its right to reclaim the Cepu oil field from ExxonMobil when its current contract expires in 2010. About $2 billion in new investment will be needed to bring Cepu -- estimated to hold about 500 million barrels of oil -- to full-capacity production.

Technical details and terms for the joint operation of the Cepu block should understandably be clear-cut so as to prevent misinterpretations. But failure to wrap up a final agreement after five months of negotiations is simply mind-boggling. Most had thought that the most complex elements of the deal were settled in June.

Given the urgency of the government to conclude the deal, Pertamina's outburst last week that it might go alone in operating the field was rather confusing. This emotional expression demonstrated that Pertamina and the government are like different entities with different interests.

We understand that the terms of the joint operation agreement should be formulated in such a way to give autonomy to both Pertamina and ExxonMobil to manage their operating or production costs with a minimum of bureaucracy. On the other hand, the government, which in this case is represented by BP Migas (upstream oil regulatory agency), is tasked with controlling production costs because the government's take (share) from the production-sharing contract (PSC) is based on output after production costs are recovered.

Hence, the provisions should be clear that costs claimed by the contractor are truly expenses needed for production operations. It is also in light of controlling production costs that the government hired an independent surveyor company to check equipment and machinery procured by oil contractors/operators to ensure that their procurement costs reflect normal market prices.

But this issue is not entirely new to the government. Since the late 1960s, it has built up considerable experience in supervising oil contractors' operations, first through BKKA, and now through BP Migas. Moreover, as a 45 percent shareholder in the Cepu block, Pertamina itself will be very active, together with ExxonMobil, in the day-to-day management of the PSC for the block.

It is imperative that the government, Pertamina and ExxonMobil iron out the joint operation agreement so that the hydrocarbon resources at Cepu can be tapped as soon as possible for the benefit of the nation.