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Bayu-Undan: Catalyst for a New Energy Province

James J. Mulva
Chairman and Chief Executive Officer

Phillips Petroleum Company
South East Asia Australia Offshore Conference 2000
Darwin, Australia
June 26, 2000

I appreciate this opportunity to join you for SEAAOC 2000.

It is good to be back at the top end of Australia. Darwin is an extraordinary city, with a colorful history, a rich culture and a promising future as the onshore hub for Timor Sea gas.

For more than 30 years, the petroleum industry has been looking for ways to tap the Timor Sea's vast natural gas resources. Today, we are close to achieving that goal. By the end of the decade, the Timor Sea will be an important, new regional energy province, providing benefits to both Australia and East Timor.

Within the next few years, Phillips and its co-venturers will build infrastructure that will carry abundant, clean-burning Timor Sea gas to the Northern Territory and to major population centers throughout Australia. The gas will not only help meet domestic energy needs, but will also provide feedstock for products that can be marketed throughout all of Australia and Asia.

The deep Timor Trench makes it impossible to transport gas to East Timor; but even so, this newly independent nation will prosper greatly as the Timor Sea is developed. The revenue that will flow into the country will enable its citizens to build a strong, sustainable economy; develop new employment opportunities, and improve their overall quality of life.

The Timor Sea holds great promise for the region; and for companies like Phillips, which are pioneering the development of its natural gas resources. We have a long history as a major producer, processor and supplier of natural gas; and we hold patents for some of the most advanced gas processing technologies in the world.

Working with our partners, we are making investments that will unlock the potential of the Timor Sea. Bayu-Undan is the cornerstone of our effort.

Bayu-Undan is the world-class gas and gas condensate field that Phillips and its

co-venturers discovered some five years ago. It lies 500 kilometers northwest of Darwin and about 250 kilometers south of East Timor. It is located in the Timor Gap Zone of Cooperation and straddles two production-sharing contract areas. The field is estimated to hold almost three and a half trillion cubic feet of natural gas and 400 million barrels of condensate and liquefied petroleum gas.

Creating the Catalyst for Future Development

Bayu-Undan will be the region’s first major gas development. It will be as significant to the future of the Timor Sea as Phillips’ Ekofisk field was to the North Sea.

We discovered Ekofisk in 1969. Like Bayu-Undan, it was the first major discovery in a high-potential, centrally located region. The Ekofisk discovery was the catalyst for Phillips to invest in a pioneering development program more than 200 miles off the coast of Norway. For other companies, it was the catalyst to step up exploration in the North Sea, using our infrastructure to develop new discoveries.

The Ekofisk field established the North Sea as a major energy province and helped build a world-class service and supply industry. If we move together cooperatively – as developers, governments, suppliers and customers – Bayu-Undan will do the same for the Timor Sea.

Today, I have been asked to talk about Bayu-Undan and Phillips’ plans for developing it. I welcome your invitation; because just as Bayu-Undan is important to the future of the Timor Sea, so is it important to the future of Phillips Petroleum Company.

Bayu-Undan not only gives Phillips a strategic position in a major new energy province, but it also plays a key role in an overall strategy we have put in place to grow our company and make it more competitive.

Nine months ago, we told the financial community that we were taking Phillips in a new direction, one far different from that of our peers. What we outlined was a strategy to grow all four of our business lines, up and down the integration chain.

Over the past few years, we had seen several companies give up the benefits of integration to focus on one or two businesses. At the same time, we had seen others merge to form mega-companies, or be absorbed into these super-large enterprises.

Given our size and position in the industry, we believed there was another way to grow and remain competitive. Our approach was to put our midstream and downstream businesses into larger, stronger, self-funding joint ventures and invest more heavily upstream -- in projects like Bayu-Undan, where we could use our technical and project-execution skills to achieve higher financial returns and deliver greater shareholder value.

The course we are taking enables us to maintain the benefits of being a fully integrated petroleum company, yet grow large enough to compete with the very largest companies across all business lines.

This morning I want to talk briefly about the progress we've made in carrying out our strategy for growth, then focus on Bayu-Undan. I will tell you where it fits in our overall growth plans, and the vision we have for making it a long-term, legacy asset for Phillips and the people of this region.

Creating Significant Growth

We announced our strategy for growth last September. Since then, we have made three important transactions that have already increased our asset base by about 50 percent.

The first was the joint venture of our midstream company with Duke Energy. This created one of the largest gas gathering and processing companies in the United States.

Now, we are moving ahead with our second joint venture. We are working with Chevron to create a company that will be one of the largest and most competitive producers of chemicals and plastics in the world. We expect to complete this transaction within the next week or two.

Our third transaction is by far the largest and most significant in our company’s history. It is our $7 billion purchase of ARCO Alaska. We completed this acquisition in April. It immediately boosted our worldwide production by almost 75 percent; it more than doubled our reserves, bringing our reserve base close to the size of Texaco; and it added more than one million high-potential exploratory acres to our portfolio.

The deals we have done have enabled us to grow significantly in a very short time. At the end of 1999, we had an asset base of $15 billion. This year, our net asset base will be almost $23 billion.

Pursuing New Growth Opportunities

This is growth in the here and now. Mid-term and long-term, we are pursuing a number of other prospects that will sustain the momentum.

Downstream, we have a third joint venture planned for our refining, marketing and transportation operations. This will occur in a year or so, after we have completed two projects that will enhance the value of this business.

Upstream, we have an aggressive exploration and production (E&P) program under way, which will enable us to continue growing our production and reserves. Going forward, E&P is where we see the greatest opportunities to deliver shareholder value, and where we have the resources -- human, technological and financial -- to remain a strong competitor.

As we grow our E&P business, our strategy is to build legacy assets -- high-quality oil and gas developments that have a long producing life and provide strong financial returns. These are assets like Ekofisk, Alaska and Bayu-Undan.

On the exploration side, we are focusing our search on a few, select, high-potential areas. They include Alaska, the deep-water Gulf of Mexico, Canada, the North Sea, the Atlantic Margin and the Caspian Sea.

We are also drilling in less explored areas, such as Oman and South Africa; and we are looking at investment opportunities in the Middle East, primarily Saudi Arabia and Kuwait.

On the production side, we are developing three major projects, which combined will contribute more than a billion barrels of oil equivalent to our reserve base.

One is the Bohai Bay discovery offshore China, which we will bring into production late next year. Bohai Bay contains at least 500 million barrels of crude oil; we believe another 300 million barrels could potentially be recovered.

Next year, we also expect new production from the Hamaca heavy oil project in Venezuela. Hamaca is located in the Orinoco Oil Belt, an area that is believed to hold some 31 billion barrels of oil, of which about two billion barrels can be recovered with conventional technology.

Recovering Liquids from Bayu-Undan

And finally, there is Bayu-Undan, our world-class discovery in the Timor Sea. Bayu-Undan is a classic legacy asset, with a good mix of near-term and mid-term development opportunities for both liquids and natural gas.

In February, the Joint Authority for the Timor Gap Zone of Cooperation approved a development plan for a $1.4-billion gas recycle project. This is the largest approved investment to date in the Timor Sea.

The project is designed to recover liquids and recycle produced natural gas back into the reservoir. The development plan calls for building two bridge-linked gas production and processing facilities and a separate unmanned wellhead platform.

The liquids will be delivered to a floating storage and offloading vessel. Separate shuttle tankers will transport product to Asian markets.

To date, we have completed about one-third of the engineering design work for the offshore facilities. We recently awarded the contract for the storage and offloading vessel to Samsung Heavy Industries. In the next few months, we expect to award the other major fabrication and equipment contracts.

To bring Bayu-Undan into full production, we will initially need to drill 16 wells, 10 producing wells and six injection wells. We will begin drilling them in 2002 and add wells as the field matures.

We expect Bayu-Undan to be in full production in early 2004 and to peak the following year at around 100,000 barrels of liquids a day.

Monetizing the Gas

The first phase of the Bayu-Undan development is to produce the field’s petroleum liquids. The second phase of the project will deliver gas to onshore markets and possibly to a liquefied natural gas (LNG) processing facility in Darwin.

Phillips developed the world’s most advanced LNG technology, and we have been supplying product to Japan for more than 30 years from our facility in Kenai, Alaska. We would like to do a similar LNG project here if Asian markets can be developed.

As we look at the overall development of Bayu-Undan, the gas-recycle project is possible on a standalone basis. However, natural gas represents 60 percent of the resource base and is valuable in its own right. Phillips and the Joint Authority want to develop the liquids and gas simultaneously, and we are moving closer to that goal.

Producing the gas and liquids together not only would greatly enhance the value of our project, but it would also put the infrastructure in place to economically develop other Timor Sea gas reserves.

There is sufficient demand in Australia to justify a gas-development project. By the end of the decade, the country’s traditional onshore gas supplies -- those that can compete with offshore sources -- will be rapidly depleting. Bayu-Undan and other parts of the central Timor Sea will provide a new supply source and keep gas prices competitive.

We have looked at a number of options for monetizing Bayu-Undan gas -- options that have low technical risk and provide maximum flexibility as new gas markets evolve. All require constructing a 500-kilometer subsea pipeline to Darwin.

With an offshore pipeline in place, we could then facilitate the development of a national onshore pipeline system -- one that would transport gas to customers here in the Northern Territory, as well as other parts of Australia.

We are now working with two large companies to develop the pipeline infrastructure. For the subsea portion, I can confirm that we are in the final stage of exclusive negotiations with Multiplex Construction to build a primary trunk line from Bayu-Undan to Darwin.

Multiplex has the demonstrated capability to manage large projects and has aligned itself with an experienced, well-known group of sub-contractors who can assure the successful completion of a turnkey pipeline project. We believe our negotiations with Multiplex will lead to an agreement and expect to announce a project soon.  

Onshore, we have formed an alliance with Epic Energy to identify potential markets outside the Northern Territory. To date, Epic has identified some 2,800 kilometers of new pipeline infrastructure in the eastern half of the country. This new system will connect to the company’s existing assets in Queensland and South Australia. This will help establish a national distribution network that can economically supply gas to the population centers of south and eastern Australia.

We are also pursuing markets in other parts of Australia where Timor Sea gas can effectively compete. We will announce these projects as they are approved. Because of confidentiality agreements, it is our policy to issue joint announcements only after all parties have agreed to a project.

Given the advanced status of our Bayu-Undan liquids project, as well as our work with Multiplex and Epic, customers can be assured that Phillips and its co-venturers will supply gas on schedule and at a competitive price.

The infrastructure we will build -- both offshore and onshore -- will ensure the timely development of Bayu-Undan; but just as importantly, it will be the catalyst for other companies to increase their investments in the region and develop additional markets for Timor Sea gas. Looking ahead, it is conceivable that our subsea pipeline could be expanded to include other fields, such as Greater Sunrise, Evans Shoal and Petrel-Tern, as well as new discoveries east and west of the Zone of Cooperation. This would increase the value of Timor Sea gas to all stakeholders.

Overcoming the Challenges

The Timor Sea offers enormous opportunities to contracting nations and producers alike, but it also presents some challenges. As we go forward, there are several issues of particular significance that must be addressed.

One is the intense competition for long-term gas markets. For the Timor Sea to be a successful, commercial development, all of us must work cooperatively to deliver low-cost gas supplies. The global competition for gas markets is intense. Unless Timor Sea gas can be delivered at a competitive price, other projects will capture these markets.

A second issue is the need for a secure and stable legal, fiscal and administrative regime. Phillips and its co-venturers will invest almost one and a half billion dollars for the gas recycle project alone. The gas development will require an even greater investment. Projects of this magnitude can only go forward in a business environment that’s fair, transparent and bound to contractual commitments.

These issues are not unique to Bayu-Undan; they affect other developments in the Zone of Cooperation. How they are resolved depends in large measure on the efforts of Australia, East Timor and the United Nations to negotiate the Timor Gap Treaty.

The current terms of the treaty provide a clear fiscal regime for oil development within the Zone of Cooperation, but not for gas development. To date, there has been no agreement on how or where gas will be valued. As a result, contracting states cannot calculate their share of revenue from gas sales. This is unsettling to producers and potential customers, and could delay gas development.

Earlier this year, the parties agreed to continue the terms of the treaty during East Timor's transition to an independent nation. Phillips applauds this decision.

Now, there are indications that East Timor and the United Nations are in negotiations with Australia on a new treaty, one that may not be ratified until East Timor's government is in place sometime between mid-year 2001 to late 2002. We would like to see the parties reach an agreement in principle on the gas issue well before then.

We are encouraged that Australia and East Timor have expressed a desire to see gas developed as quickly and efficiently as possible and equally encouraged by their assurances that a new treaty will not impair the investments of companies operating in the Zone of Cooperation.

Both countries have made it clear that they understand the economic benefits of simultaneously developing the region's liquids and gas resources and the importance of a gas fiscals agreement in reaching that goal.

They have also indicated a desire to provide a stable business environment that will encourage additional investments in the Timor Sea.

All of this is cause for optimism.

For more than 30 years, producers and contracting nations alike have searched for ways to tap the rich potential of the Timor Sea. Today, we have that opportunity; but only if we maintain a spirit of mutual trust and cooperation and move quickly to address the issues that could impede our efforts.

Helping Build an Emerging Economy

For Phillips, one of the most gratifying aspects of Bayu-Undan is the opportunity to contribute to the economic development of a new nation. The people of East Timor have experienced great hardship and are now working to establish a stable, independent government.

Bayu-Undan will contribute significantly to the effort. Our gas-recycle project will likely be the country’s largest source of revenue for a number of years; our gas project will benefit them for decades. As we establish Phillips' presence in the region, we will make every effort to be a good citizen and contribute to the quality of life.

Already, we are working on several educational and training initiatives, which will prepare the people of East Timor for jobs in the petroleum industry. The long-term nature of most developments in the Zone of Cooperation means there will be significant employment opportunities.

We are also working with East Timor and the U.N. transitional team to develop a taxation system for the country, one that will encourage additional investments in the Zone of Cooperation.

And we are helping the country restore its agricultural and educational base. We recently donated 13 trucks -- one for each province -- to support agricultural efforts, and a four-wheel-drive vehicle that serves as a mobile medical clinic in the Suai area. With our co-venture companies, we have also provided school supplies to rebuild the educational system in Dili.

As we develop Bayu-Undan, we will continue to look for other opportunities to help the people of East Timor build their economy and raise their standard of living.

Building a New Legacy

Before I close, let me emphasize once again Phillips’ commitment to Bayu-Undan and the Timor Sea. We see Bayu-Undan as a long-term, legacy asset -- one that will help Phillips grow and compete against the largest companies in the industry, and one that will benefit the economies of both Australia and East Timor.

There are challenges ahead, both commercial and political; but we are optimistic they can be overcome, especially if we work cooperatively.

The Timor Sea is uniquely positioned to become a major, regional energy province. Bayu-Undan will be the catalyst that makes it happen.

Thirty years ago, Phillips and its co-venturers helped turn the North Sea into one of the world's premier energy-producing regions. We are now prepared to do the same in the Timor Sea.

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