Brian Robins – From being only rank hopefuls among offshore gasfields, Timor Sea projects backed by Phillips Petroleum and Woodside are racing off the starting blocks. Both are pushing into the east coast gas market, to emerge as replacements for the Cooper Basin as its reserves decline this decade.

In the process the long mooted $6 billion PNG-Queensland project backed by Exxon Mobil, Chevron, Oil Search and others may be delayed even longer, if not derailed altogether.

Delivering East Timor gas into the domestic market will involve investing $1.5 to $2.4 billion on new pipelines on top of the likely $2.5 billion cost of developing the offshore component – an all-up cost of as much as $5 billion.

Linking Timor Sea gas to the east coast grid would go some way towards former Federal Minerals and Energy Minister R.F.X. (the "Strangler") Connor's dream of a trans-Australia gas pipeline linking gas reserves in Western Australia with the east.

That ambitious plan, outlined in the mid-1970s, may yet come to pass, although it will take a little longer until the economics of linking gas in the North-West Shelf to the east coast stack up.

And as the dominant marketeer of gas in NSW, AGL is expected to be central to the ambitions of the Timor Sea project promoters, especially as its long term contracts with Santos start to expire over the next few years.

The kick-off for developing Timor Sea gas is the so-called "framework agreement" between Australia and East Timor, which is due to be in place by early next month, opening the way to develop both the Bayu Undan and the Sunrise gasfields.

Bayu Undan lies fully within the zone of co-operation between Australia and East Timor, as does 20 per cent of Sunrise.

Bayu Undan has estimated gas reserves of 3.4 trillion cubic feet. Phillips Petroleum is the operator. Sunrise, operated by Woodside Petroleum, has 9.16 trillion cubic feet. In round terms, if the two gasfields are pooled, East Timor is entitled to royalties covering half the total.

The final framework agreement will involve either an 85:15 revenue split (favoured by Australia) or a 90:10 split (favoured by East Timor) between the two countries. A 50:50 split had earlier been agreed with Indonesia.

The revenue split in favour of East Timor will take pressure off future aid donors, giving the former Indonesian colony a prime source of income to fund its reconstruction.

Backers of the PNG-Queensland project may argue Australian foreign policy interests are at work in seeking to develop Timor Sea gas projects over PNG, but there are fundamental differences.

For a start, the PNG proposal is plagued by civil unrest, with 25 killed in a dispute along the proposed pipeline route earlier this month. As well, the PNG Government needs a soft loan to cover its part of the project financing, which it is having trouble finalising. Exxon Mobil, operator of the PNG project, denies the recent civil unrest has had anything to do with the project, although few take its comments at face value.

As Oil Search chairman Trevor Kennedy told shareholders earlier this month: "Continued mismanagement and waste at provincial and local levels are significant influences on instability in project areas ... We now see regular evidence of corrupt practices in various areas of our business."

With the Timor Sea projects, East Timor's leaders, such as Jose Ramos Horta, have consistently said the new Timorese administration would not impose conditions more onerous than those put in place during the Indonesian regime, providing comfort to the projects' backers.

But East Timor is anxious to secure some of the spin-off investment, while ensuring that Timorese are employed in the project. Supply bases could be located in East Timor, which lies much closer to the gasfields.

Phillips Petroleum and Woodside are co-operating with the offshore component of the Timor Sea project, but are competing to find domestic buyers to get sufficient tonnage to make it viable to push gas onshore.

There is sufficient demand in export markets and also from groups planning processing plants in Darwin for the project to be up and running by 2004. The difficulty remains the extent of domestic demand for Timor Sea gas.

The PNG-Queensland gas project involved selling a hefty 200 petajoules of gas into the Queensland market alone, mostly in Townsville and Gladstone, although the lack of firm demand has sent it back to the drawing boards.

The rival Timor Sea groups are hoping to put less than half that volume into the domestic market, which would be easier to absorb, but still significant.

AGL, for example, sells about 95 petajoules of gas in NSW and the ACT, so that any sizeable new gas demand would have to be unlocked in Queensland either in new markets, or by targeting big new projects such as Comalco's long-awaited new alumina refinery planned for Gladstone. It had signed up to take PNG gas, but delays in delivery have seen it turn to coal, at least for now.

Woodside scored a minor coup by signing a letter of intent to supply up to 19 petajoules a year of gas to the Yabulu nickel refinery in Townsville, which is owned by BHP-Billiton.

Woodside officials concede it would not be economic to build a pipeline from Mount Isa to Townsville just to supply Yabulu and want to win other large customers. A minimum of 30 to 35 petajoules of demand would be needed to justify a pipeline.

The Queensland Government is committed to generating 13 per cent of the State's electricity from gas – a policy inducement initially aimed at finding enough gas to get the PNG pipeline project off the ground, but which will probably aid the Timor Sea plans. A gas-fired power station, for example, is planned for Townsville.

But pricing is uppermost. "Studies I've seen show that gas could be landed at 40c/gigajoule in Darwin," says JP Morgan analyst David Leitch. "If it can put 100 petajoules of gas into Moomba at $2.60 a gigajoule, it could compete with Cooper Basin. Cooper Basin is running out, and while there is a lot left, it will take a lot of capital to get it out." AGL's original take-or-pay contracts for gas from Moomba start to run out from 2002, and expire fully in 2006.

A new source offering gas competitive with Cooper Basin gas, and also with new gas supplies now emerging in the Otway Basin, would be of clear interest.

Pivotal to selling Timor Sea gas into the eastern states is the stance of AGL, whose pipeline affiliate, Australian Pipeline Trust, has proposed a $2.4 billion pipeline linking Timor Sea gas to Townsville and the Moomba grid. The idea is staged and partners would be sought.

Epic Energy has outlined an alternative involving a pipeline of around 100 petajoules, primarily linking Darwin with Moomba. But how AGL in particular would react to that volume hitting the market in one move is the key.

"Its purchasing power has the ability to make or break potential gas supply deals," argues JP Morgan's Leitch. "AGL faces risks, however, if competing gas supplies are looking for markets. Notwithstanding that the Duke Victoria to NSW pipeline has not greatly changed the NSW market, it has created new potential for price pressure."

Already Phillips has a letter of intent with El Paso – which has a one third of Epic Energy – to supply 4.8 million tonnes annually of liquified natural gas from 2005. The North-West Shelf exports 7.5 million tonnes annually. Phillips is also negotiating with GTL Resources for a gas to liquids project to be sited near Darwin.

Similarly, Woodside has a letter of intent to supply Methanex Corp with 100 petajoules annually. Methanex is soon to launch an environmental impact statement into its venture, a $1.5 billion synthetic gas project.