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Interview

with Richard L. McAdoo, President & CEO, Continental Energy Corporation

14.03.2012 / Energyboardroom

Since the last time Focus Reports interviewed you back in 2007, what do you see as the main developments in Indonesia’s oil and gas industry?

Since 2007, there has been a sea change in the Indonesian economy with a transition towards rapid GDP growth. Indonesians refer to their current regional positioning as ICI or Indonesia-China-India which constitutes a regional triangle of fast development and high GDP. The western press talks about India and China all the time and mention Brazil and Russia as well as under the title “the BRIC countries”. It is highly surprising to me that the western press omits Indonesia, given that it has a population heading towards 300 million and is run by a very attentive and well educated executive government. Recently there have been major changes in the BKPN (the foreign investment board), who now have an aggressive executive who does an exemplary job in attracting investment in Indonesia. In my opinion, there has never been a more favorable time to invest in Indonesia.

Indonesia has woken up to the fact that it is in fierce competition for the investment dollar and Southeast Asian countries such as Thailand and Malaysia are by no means shy about advertising their opportunities whilst India and China already have an international reputation. I am pleased to see Indonesia becoming more vocal in demonstrating its attractiveness as a destination for investment and I agree with the ICI concept, that Indonesia forms a triangular base with India and China. I see Indonesia as even offering some advantages on the other points of this triangle. There was a rush to invest in China, which may not have been well thought out given the spate of recent fraud issues on mainland Chinese companies who went public in North America.

Specific to the oil business, 5 years ago I may have mentioned to you that the focus of the industry was shifting away from the international majors and towards independent producers. It is always the smaller companies in the industry who take the risks, who are creative and who carry out new ideas. The nature of the industry is that these smaller risk taking companies then get bought out by the major companies. Indonesia provides plenty of scope for other discoveries and one can see the activity of independents increasing in Indonesia.
Moreover there has been some new legislation in Indonesia to encourage investment in marginal, frontier exploration. At the same time the government is trying to promote indigenous activity in the oil and gas sector. The government is seeking a 50-50 share between international and local E&P companies by 2025. The climate is therefore conducive to more activity in the upstream sector and there are good opportunities for partnerships.

A number of IOCs seemed to demonstrate a new wave of interest in Indonesia last year. What is your view on how this changes the dynamic?

There has been a resurgence of interest by the big companies in Indonesia, however this is focused on offshore, deep-water and frontier areas of E&P. They are avoiding onshore production due to the problems of dealing with local populations and authorities on land use and surface damage claims issues. Their renewed interest is a good trend for Indonesia because these IOCs are the only companies who can afford to drill $100 million wells. Indonesia needs some new giant discoveries. The East of Indonesia is still relatively unexplored, especially in deep-water, so there is a good chance that some major discoveries can still be found.

Moving towards these frontiers is a necessity because there is not a great deal of potential left in the traditional onshore basins of Indonesia, with the exception of the Kutai Basin in Kalimantan. However the potential of this region is mainly because it also has deep-water access. The Tarakan Basin presents broadly the same picture.

I foresee onshore blocks ending up being run by local companies, who can deal with these issues on a local level. Parachuting specialists in from ExxonMobil, Houston and expecting that they can successfully negotiate with people versed in 3-4 centuries of Javanese culture is not the best way forward.

How important is gas within the future of Indonesia’s upstream industry?

Gas is at the center of Indonesia’s future upstream industry because the big game changer in Indonesia at the moment is the refocusing on the local markets. There is huge electricity demand and just a year ago there were rolling black outs in Jakarta. Despite huge coal fired power plants the demand is simply outpacing the supply and a new energy source needs to be introduced to meet demand. Furthermore the dispersed nature of the population means that the country does not lend itself to a few large energy producing regions and power plants. There needs to be many smaller scale power plants and these are currently diesel fired. By Indonesia’s own estimations around 31cents per kWh is being spent on diesel and yet the consumer is buying the power for 10 cents meaning that there is a huge loss for the government. There are many alternatives to meet this power demand from geothermal to hydropower, but the simplest solution by far is gas. You do not need much gas to generate electricity and most of these small island populations need 10-15 megawatts and one gas well can generate this for many years. The cost savings to the Indonesian government would be immense just by saving money on diesel. Even if the government offered the gas for free, they would reduce Indonesia’s fuel costs by 2/3rds.

There are a growing number of people in Indonesia who understand this dynamic and are starting to recognize that the old PSC model of allocating large blocks is no longer the most applicable to Indonesian production. The old model is a “shotgun approach” with companies searching for reserves over a large area, where what is really needed is a “rifle shot approach” whereby the government identifies a small gas discovery that a company may have made 20 years ago and is “stranded” far from a pipeline to market. , Stranded gas offers an ideal opportunity to install small scale, distributed power generation at the wellhead. There should be a an alternative to the PSC to a more specialized contract to achieve the acceleration of production from smaller gas fields and simultaneously meet the electricity demand of the local population. Ultimately, the trend should be about producing electricity not gas.

How does Continental Energy fit into the Indonesian upstream dynamic?

Continental Energy is a niche player, engaged in exploration in areas which we feel are underexplored. Our strategy has remained consistent for many years in Indonesia and we have strong relationships with many local companies. In fact, Continental Energy partners with the local industry as a matter of course. There are many small Indonesian companies who receive blocks and are looking to farm out production to companies with technological expertise, experience and investment capital like Continental Energy.

What is the current situation on Continental Energy’s own Bengara II block?/i>

Continental Energy has invested a lot of time in a very expensive 2D and 3D seismic program which has recently been completed – shooting finished in November. Unfortunately, this process had been delayed for almost 18 months and our Chinese partners had great difficulties with this. We were shooting in a coastal area and there were many prawn farms in the area. Continental Energy was drilling 40m deep holes and setting off 5kg of high explosive in each of these holes so naturally the reaction of the prawn farmers was not positive.

In normal circumstances, to conduct a staged seismic shoot properly requires a lot of time and precise timing. Firstly you need a survey crew to lay out the lines topographically, then you need to cut and prepare a walkway, then drill shot holes down 40m, then lay cable on top of this and then place the explosive and shoot. This is a very precise system of operations taking place over a long time. Continental Energy was negotiating with over 3,000 individual prawn farmers making this a very complex process. The shoot was budgeted at $32 million and we ended up having to spend $44 million with some portions of the shoot simply abandoned.

However, we have finally collected our data and are at the interpretation stage with plans to drill 3 appraisal wells as soon as the results of the analysis are back.

How do manage this risk?

Many of these issues must be resolved in advance of mobilizing equipment and people. Spending money on an operation and simultaneously waiting for approval is asking for trouble.
Ultimately the costs are already dealt with in Indonesian regulation. The destruction of a banana tree will cost X amount of money, the destruction of a square meter of rice paddy will cost a different amount. The problem in our case was the sheer number of prawn farmers and whether they would agree to accept this compensation. Just because the government has published prices, it does not mean the end of the problem.

These are challenges which do not just affect the independents but the large players as well. Indonesia needs to confront this challenge to the industry because it is the single largest obstacle to onshore production in Indonesia today.

Despite these challenges what is your level of optimism for Continental Energy’s future in Indonesia?

Continental Energy continues to believe strongly in the Bengara II block and if we make large discoveries then the challenges I was mentioning will be ones we are happy to deal with. However, we are revising our estimates for dealing with land issues in the case of a major discovery. The costs will vary a great deal depending on where the discovery happens to occur. In the example I mentioned this was a 900 Km2 seismic shoot covering a vast area, however if you are drilling a well then you are using only 100m2 space so the issues could be resolved with time. The Bengara II block still has plenty of potential for some elephants.

Where will we see Continental Energy in 5 years?

Continental Energy will still be based in Indonesia because there is so much opportunity remaining here. However, I do foresee expansion into other areas of Southeast Asia and possibly India. Continental Energy can be more proactive and confidently engage with Petronas or PTT due to our familiarity with the geology of Indonesia and its neighbors in the SE Asia region.

What would be your word of advice on operating successfully in Indonesia?

Persistence wins the day. There are countless examples of numerous companies launching E&P operations on a particular site, they all leave and then a final company enters the site and makes a huge discovery. You also have to bring new ideas to the operation and not simply repeat what has gone before.

What would you like to say to the readers of OGFJ on behalf of Continental Energy as a final message?

Continental Energy is always looking for partners and any company who is looking at launching E&P in Indonesia is more than welcome to get in touch with us.

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