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C O N F I D E N T I A L SECTION 01 OF 02 BANDAR SERI BEGAWAN 000194 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 07/09/2027 
TAGS: EPET BX MY PREL
SUBJECT: BRUNEI-MALAYSIA OFFSHORE OIL DISPUTE -- RESOLUTION 
NEARING? 
 
REF: 06 BANDAR SERI BEGAWAN 195 
 
Classified By: Ambassador Emil Skodon for Reasons 1.4 (B, D) 
 
 ¶1.  (C)  In recent weeks we have picked up a number of hints 
that the long-running dispute between Brunei and Malaysia 
over delineation of offshore oil exploration zones may 
finally be nearing a compromise settlement.  There has been 
no exploration activity in the zones, designated as Blocks 
"J" and "K" by Brunei, since naval incidents that occurred in 
¶2003.  A senior oil industry executive told Ambassador that 
the head of Malaysian national oil company Petronas recently 
commented to the CEO of a major American firm that he 
expected the dispute to be solved this year.  Working level 
contacts at the Ministry of Foreign Affairs and Trade told us 
that, even though their government is confident it could win 
any international arbitration over the dispute with Malaysia, 
it might be willing to forego such arbitration and reach a 
compromise in order to avoid causing a fellow Islamic country 
to lose face.  In our view, these talking points have more to 
do with avoiding a loss of face by Brunei, which has long 
maintained that it will accept nothing less than total 
control over the offshore blocks and that the Malaysian claim 
has no merit. 
 
¶2.  (C) Local oil industry executives have outlined for us 
the shape that an eventual resolution could take, at a level 
of detail not heard previously.  They foresee a production 
sharing arrangement that allocates 65-75 percent of oil and 
gas output by volume (not revenues) from the disputed 
offshore blocks to Brunei and the rest to Malaysia. 
Companies that have signed competing contracts with Brunei 
and Malaysia would have their contracts honored based on a 
pro rata calculation of each country's share; for example, a 
company which had signed a contract with Brunei for 25 
percent of the production rights in the disputed zone might 
end up receiving 25 percent of 75 percent of total output, or 
18.75 percent.  Royalties, taxes, and the prices charged to 
third country customers would depend on the terms dictated by 
the country with which the original contract was signed, 
either Brunei or Malaysia.  One sticking point may be a 
decision on which firm will be named as overall perator for 
the production sharing area, and howmuch compensation it 
will receive.  French compan Total, which has a contract 
with Brunei for exploration in the disputed zones, is an 
obvious candidate because of its long presence in the region 
and experience in deep-water drilling, but others will also 
be interested. 
 
¶3. (C) The sudden flurry of activity on this long-standing 
dispute is probably attributable to the start of offshore 
production earlier this year by U.S. firm Murphy Oil under 
the terms of its contract with Malaysia.  Murphy's rig is in 
a Malaysian offshore zone undisputed by Brunei, but is 
located very near the disputed area and taps a reservoir that 
probably extends under the area claimed by Brunei.  The large 
amount of gas located below the oil in this area produces 
strong pressure that serves to push the reservoir's 
hydrocarbons towards Murphy's well.  Local oil industry 
executives who briefed Bruneian government officials on this 
situation told us that the information was a wake-up call on 
the need for a resolution sooner rather than later, 
especially in light of high world-wide demand for exploratory 
rigs and drilling equipment and resulting long wait times for 
putting such equipment to use in new locations.  The 
Bruneians have realized that the longer they wait to reach an 
agreement that allows them to begin drilling in Blocks J and 
K, the less oil and gas they may ultimately be able to 
extract.  This serves as powerful motivation to get serious 
in their negotiations with Malaysia and look for a 
compromise.  That motivation is enhanced by the need for 
Brunei to identify new gas reserves that will underpin the 
renegotiation of contracts for the supply of Liquefied 
Natural Gas to Japan, due to expire in 2013. 
 
¶4.  (C) Comment:  As we previously reported, the ultimate 
decision on whether and when Brunei should reach a compromise 
agreement with Malaysia over the offshore fields will be made 
personally by the Sultan, which is another way of saying the 
decision process will be deliberate and opaque.  It is 
entirely possible the hopeful signs mentioned above will 
amount to naught.  It is in the U.S. interest, however, for a 
resolution finally to be reached given the stakes involved 
with the potentially extensive reserves that could be opened 
for production.  We understand that the industry's upper 
 
BANDAR SER 00000194  002 OF 002 
 
 
estimates for potential reserves in the J and K Blocks reach 
up to 5 billion (sic) barrels.  If proved, these reserves 
could help ease the pressure on East Asian oil and gas 
markets significantly for a long period after production 
begins and so lessen the likelihood of potential conflict 
over access to energy resources.  End Comment. 
SKODON