Matthew Stevens   The Australian    February 05, 2011

THE miserable and diplomatically fraught confrontation between Woodside Petroleum and East Timor over a proposed $14 billion liquid natural gas project called Sunrise has reached a bizarre new low, with one of the world's poorest nations suspending negotiations on the company's proposed development plans.

Greater Sunrise is a pair of good-sized gas and condensate fields discovered way back in 1974 and a combination of buoyant energy pricing and new production technologies means their time for successful commercialisation should be dawning.

Global petroleum certainly thinks so.

The Sunrise partners, led by operator Woodside (which owns 33.4 per cent of the project), along with ConocoPhillips (30 per cent), Shell (26.6 per cent) and Osaka Gas (10 per cent), are ready to spend the billions necessary to extract and process the gas wealth, and have targeted late 2016 for production.

But Sunrise has become mired in a sink of misplaced aspirations and misunderstanding born of good intentions and an understandable national guilt.

The Sunrise and Troubadour discoveries sit at the northern edge of Australia's continental shelf, some 450km northwest of Darwin but about 150km southeast of the fledgling nation of East Timor.

The result is that, while all the permitting that delivers Woodside et al ownership of the gas they found in 1974 is Australian, some 30 years of exhaustive and thoroughly necessary negotiation that started with Indonesia and was continued by East Timor has resulted in the commonwealth agreeing to divide ownership of the fields with its new and junior neighbour.

Two iterations of international agreements (the second fuelled to considerable degree by a public campaign by Australians concerned we were somehow ripping off the tiny East Timor by claiming resources that sit on our continental shelf) have apportioned 18 per cent of the Greater Sunrise gas to East Timor but a substantially greater share of any "upstream" revenues generated by the development.

The effect of the overlapping arrangements is that, according to Woodside's most recent estimates, East Timor's national coffers would be enriched by $US13bn ($12.9bn) over the life of the Sunrise project while it would generate $US19bn for the commonwealth.

Now, however you cut it, that disproportionate share of the revenue pie reflects well on Australia's determination to actively assist East Timor in its quest for financial sustainability.

But cash-strapped East Timor wants a whole lot more from the Sunrise joint venture than simply revenue. It views the project as the potential cornerstone of a new generation of industry and so is insisting that the joint venture lands and processes the gas in East Timor.

That is a nice idea and if Woodside's mission statement listed the fostering of nascent democracies as its fundamental requirement, then it would make sense. But, for good or ill, that is not how things are.

Woodside does not want to pipe the gas anywhere -- not to the other onshore option, Darwin, and certainly not down and then up the 2950 metre cliff faces of the Timor Trench.

Woodside's board is required to act in the interests of its shareholders. It would cost Woodside $US5bn more to build an LNG plant in East Timor than to exercise commercial good sense and build a floating processing plant above the fields.

And, even though the 278km of 26-inch pipeline needed would sit at the very edge of the technological challenges known to the gas industry, the link represents a relatively small portion of that increased cost.

The greater part of the additional cost is the construction of a greenfields LNG plant on the south coast of East Timor, a challenge that carries with it a steep increase in project and sovereign risk.

These points and many more are made in the three separate concept studies the JV delivered to the Sixth Sunrise Commission on September 29 last year.

In response, on December 16, East Timor requested that the two regulators of the Greater Sunrise agreements stop evaluation of Woodside's concept studies. The government claimed then (and is still claiming) that Woodside has, in part, studied the wrong thing.

The idea, apparently, is that Woodside is entitled to assess only the production of the gas, and not its processing.

Essentially, the Gusmao government seems to be claiming Woodside owns the gas only until it hits the surface.

After that, its fate lies in the hands of the Australian and East Timor governments.

In a statement confirming suspension on Sunrise, released on January 24, the East Timor government asked the twin regulators of the gasfields to "cease their evaluation of Woodside's development concepts". According to government spokesman Agio Pereira, this was because Woodside has "included not only upstream but also downstream activities" in its proposals.

"Woodside has no licence or permit to carry out downstream activities nor have the States given the right to the National Petroleum Authority to assess downstream activities which are not covered in the Timor Sea Treaty.

"Therefore, neither Woodside nor regulators will proceed with the proposals until the downstream title issue is resolved."

Clearly, East Timor is saying the "States" have the power under the treaties to dictate how Greater Sunrise is developed.

It may indicate, too, a belief that the government can award processing rights to a party other than the joint venture.

Woodside rejects both these propositions as inconsistent with the requirements of the international treaty and Australian law.

Woodside's view is that Pereira's attempt to draw legal distinction between the "upstream" and "downstream" components of an LNG development reflects the different tax regimes that apply to different parts of an LNG project.

In Australia, a Petroleum Resource Rent Tax applies to "upstream" (prior to entry into the liquefaction train) and income tax applies to the "downstream" (the value adding resulting from liquefaction).

But that holds no relevance in the context apparently being used by East Timor.

The more fundamental question is who has the legal right

to extract and market the gas molecules.

The International Unitisation Agreement between Australia and East Timor sets out a framework for the development of Greater Sunrise that includes a requirement that "the exploitation of the Unit Reservoirs shall be undertaken in an integrated manner in accordance with the terms of this agreement".

It is the terms of the IUA that apportions 79.9 per cent of the Greater Sunrise gas to Australia and specifies that that portion is exclusively regulated by Australian law.

That, in turn, would suggest that, even under a worst-case scenario for Woodside, the East Timor government would have no call over that greater slice of the production.

Now, from the JV's perspective, the other key part of the IUA is contained in article 12. It effectively prescribes the process for approval of the Greater Sunrise development plan.

Article 12 says the regulator "shall" sign off on a project where:

l The project is commercially viable;

l The contractor or licensee possesses the competence and resources needed to exploit the reservoir to the best commercial advantage;

l The contractor or licensee is seeking to exploit the reservoir to the best commercial advantage consistent with good oilfield practice;

lThe contractor of licensee could reasonably be expected to carry out the exploitation of the reservoir during the specified period;

lThe contractor or licensee has entered into contracts for the sale of gas from the project which are consistent with arms length transactions.

Nonetheless, nothing can happen without East Timor's sign-off and that does not look likely anytime soon.

So what happens now?

There are arbitration mechanisms to break treaty deadlocks, but a successful arbitration requires the active participation of both governments and, what's more, undertakings by both to recognise and act on the recommendations that emerge from that process.

Which all leaves Sunrise exactly where?

In the wake of spokesman Pereira's feisty rant, key powers in Timorese politics (including President Ramos Horta and Fretlin leader Mari Alkatiri) have called for a return to discussion on Woodside's proposals.

Mind you, each reinforced that TLNG, not FLNG (as in Timor, not Floating), remains the right national ambition.

Which pretty much means that the gas at Greater Sunrise will remain right where it is for sometime yet given that there is no way any sane board can sign off on a project that will cost $US5bn more than it should.