Cepu Deadlock

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.