East Timor's Petro Trouble

Australia is claiming Timorese oil

When the U.N. sent peacekeepers to the former Indonesian territory of East Timor in September, 1999, Australian troops were at the vanguard. They helped restore a semblance of law and order to a U.N. protectorate that had been laid waste by the Indonesian military after the East Timorese had the temerity to vote for independence. The Australian government has since spent $500 million on peacekeeping, plus about $40 million on humanitarian aid, from medicine for sick kids to rebuilding schools. In the process, Australia earned the heartfelt gratitude of the East Timorese.

The peacekeeping mission was not entirely altruistic, of course. A regional military power in its own right, Australia hoped to win international credibility by wading into East Timor. And besides addressing its security concerns, Canberra had economic motives as well. That became clear in mid-October, during closed-door negotiations in East Timor's capital of Dili, when Australian diplomats told their hosts that Australia was not giving up its claim to half of East Timor's oil and gas reserves.

The Australian position has shocked the diplomatic community. East Timor badly needs the petroleum money to rebuild its economy. One oil field alone is expected to generate $6 billion in royalties and taxes over 20 years, once production begins in 2004. That's minute by Saudi Arabian standards, but it would be of major significance to a small, new nation of just 800,000 people. Moreover, the U.N. considers Australia's claim to half the oil illegitimate. Canberra cut the deal in 1989 with Indonesian President Suharto, whose soldiers had illegally occupied East Timor 14 years before.

WAIT AND SEE. Which brings us to the oil at the heart of the dispute. It lies beneath the Timor Sea, just on East Timor's side of the midpoint that divides the 711-kilometer-wide body of water between East Timor and Australia (map). Last November, Bartelsville (Okla.)-based Phillips Petroleum Co. and four partners agreed to spend $1.4 billion to exploit the Bayu-Undan oil field. Phillips already operates the smaller Elang oil field in the disputed area, and pays royalties and taxes on the oil to both East Timor and Australia. The company wants the same 50-50 arrangement to prevail in the new, more extensive oil venture.

It is not in Phillips' interest for East Timor to get all the oil money because the fledgling nation hasn't yet decided what its royalty and tax regime will be--and won't until its new government takes power at the end of August, 2001. Right now, Phillips pays East Timor the Indonesian rate for oil taken from the Elang field, which is higher than that levied by Australia. East Timorese officials have promised Phillips that it will not have to pay higher rates than it anticipated. But Phillips is taking a wait-and-see position. "If we can't have fiscal and legal certainty," says Jim Godlove, who runs Phillips' operation in northern Australia, "the investment will be jeopardized--and there will be nothing to share." The message is clear: If Phillips deems the investment uneconomic, it may not proceed.

That could seriously hurt East Timor's ambitious nation-building program. Its first election is only 10 months away, and already expectations are dangerously high among the largely illiterate population. With all the aid money sloshing around, many locals have become convinced that East Timor will become a developed nation practically overnight. Says Mari Alkatiri, East Timor's transitional economics minister and a former guerrilla leader: "It's not easy to reconstruct a country where the people are expecting to have a Singapore in three to five years." While that is clearly an impossible dream, Alkatiri and the World Bank contend that the royalties and taxes from the oil and gas could help quintuple annual per capita income, to $1,000, by 2009.

"CRUDE, EMPTY THREATS." Indeed, oil is East Timor's only economic hope. Phillips estimates that the Bayu-Undan oil field will produce 400 million barrels of crude and 3.4 trillion cubic feet of natural gas annually. The royalties and taxes are expected to reach $300 million a year. That's six times East Timor's current budget, and enough, says Sarah Cliffe, World Bank chief of mission in Dili, to fuel an annual economic growth rate of 15% for nine years. A $200 million investment by the U.N. and others in bare-bones infrastructure, health, and education already has given the economy a lift. But if East Timor is forced to split oil royalties and taxes with Australia, says Alkatiri, the territory would be able to meet only its immediate humanitarian needs.

That hasn't stopped Australia from playing hardball. A Western diplomat in Dili says Canberra is making "crude, empty threats" to cut its four-year, $75 million aid program for East Timor unless the treaty is honored. Asked to confirm whether Australia was linking possible aid cuts with the results of the oil negotiations, a Foreign Ministry spokesman told BUSINESS WEEK: "I couldn't say they're not linked." East Timorese leader Xanana Gusmau responded to the veiled threats emanating from Canberra by saying: "East Timor doesn't want to be dependent on Australia's generosity. It just wants to stand on its own two feet."

That won't be easy because East Timor isn't overrun with foreign investors. So chaotic is the business climate that Portugal's Banco Nacional Ultra- marino, returning to East Timor after 25 years, plans to use an armored personnel carrier as a mobile branch. And Dili's new hotels--air-conditioned trailers parked near the beach, and a Thai cruise ship anchored offshore--are designed to pull out at a moment's notice.

East Timor also has its work cut out putting in place a competent bureaucracy and drawing up regulations. It doesn't even have an investment code, and Alkatiri says the transitional administration can't write one until it decides how to resolve property disputes between returning exiles and people who bought their land during the Indonesian occupation. The legal system is barely functioning. Judges were only recently trained by the U.N., and shortly after completing their training went on strike for more pay.

BAD BEANS. Nor will coffee, a crucial export, be the hoped-for economic elixir. This year's crop will earn only $12 million because prices are at their lowest in a decade. Besides, the harvest is down 25% from last year due to drought, damaged storage facilities, and because Indonesian forces continue to prevent some 100,000 East Timorese from leaving so-called refugee camps across the border in West Timor. The U.S. Agency for International Development and the World Bank provide technical assistance to a growers' cooperative that sells to Starbucks Corp. But critics say the U.N. miscalculated by providing farmers with nonorganic fertilizer; Starbucks won't buy beans grown that way.

East Timor's Petro Trouble (int'l edition)

Only petroleum can quickly vault East Timor into the league of viable nations. And a stable neighbor presumably is in Australia's strategic interest. Hence, some analysts have dismissed Canberra's tough stand as a bargaining ploy. Besides, legal experts say East Timor's claim is justified. Under the 1982 U.N. Convention on the Law of the Sea, countries within 400 nautical miles of each other divide the seabed at the midpoint. Hence, East Timor would almost certainly win should it take the dispute to the International Court of Justice.

A compromise is more likely, and, indeed, both sides have agreed to meet before East Timor holds its election next August. "The East Timorese are in a very strong position, and they know it," says Geoffrey A. McKee, a senior petroleum industry consultant in Sydney. Alkatiri says that he would settle for 90% of the oil royalties and taxes. That may be enough for Canberra to save face--and recoup some of the money it has spent to stabilize East Timor.

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