[Australia and East Timor are squaring off for their first serious disagreement, government-to-government. Over the next 30 years Australia stands to earn billions of dollars in royalties from oil and gas reserves in the Timor Sea. East Timor is getting some of the royalties, but believes it should be getting more. Tonight, we look at a relationship where the warmth of friendship and benevolence is being replaced by a tussle for cold, hard cash. This report from Lisa Upton.]

Reporter: Lisa Upton

It's a regular morning in the life of Eusebio and Tina Guetteres. 28-year-old Eusebio is a lawyer and a member of East Timor's Parliament.

He's from the opposition Democrats. A great deal of Eusebio's time is devoted to studying complex maritime boundary issues.

Reporter: If Australia is rich, why must they steal more?

Eusebio Guetteres, opposition MP, East Timor (Translation): That is what confuses me so I cannot rest. I have to keep thinking about it. But I continue to campaign throughout East Timor so the people can realise they themselves have to stop these unfair negotiations. The world's newest country is also one of the world's poorest. More than 60% of the population lives on less than $4 a day. East Timor's only real hope of economic independence is oil and gas from the Timor Sea, and like a growing number of Timorese, Eusebio believes that his country is legally entitled to a lot more than Australia is willing to concede.

Eusebio Guetteres (Translation): Australians must be made aware of these issues. Once again, I apologise, as Australians need jobs, but not jobs gained from the resources of East Timor. That is plundering our resources and our rights, plundering the rights of our people. Plundering the resources and the independence of the East Timorese.

In 1999, Australia won international recognition for leading the military intervention in East Timor. Australia also won the heartfelt gratitude of the East Timorese people. Almost three years on, a new nation was officially born.

John Howard, PM (greeting Xanana Gusmao): Hello there, how are you? Good to see you.

President Xanana Gusmao made his first official visit to Australia just six weeks ago. He was accompanied by the Foreign Minister, Jose Ramos Horta. But beneath the smiles and the awkward embrace, a significant problem had begun to emerge.

John Howard, PM: Great to have you here.

At issue, enormously valuable reserves of oil and gas in the Timor Sea.

Canberra, Dili, the Northern Territory and a host of oil companies all want a slice of the multibillion-dollar action. On the face of it, there doesn't seem to be anything to fight about. Just a few months ago, the two countries signed a treaty to develop a joint area in the Timor Sea. The major gas field in that area is called Bayu-Undan. East Timor gets 90% of the royalties. Australia gets the remaining 10%.

John Howard (20 May, 2002): Well, we believe that the approach we have taken to date has been very fair, it's been generous. We must serve our own interests, but also ensure that we are fair and generous to the people of East Timor.

Phillips Petroleum is developing the Bayu-Undan field. It contains $15 billion worth of oil and gas. East Timor is expected to receive $6 billion over the 20-year life of the project. The Northern Territory will also receive substantial benefits because a gas pipeline is being built to Darwin.

Clare Martin, NT Chief Minister: Tangible benefits are certainly something like 1,500 jobs in the construction phase. There'll be something like 100 ongoing jobs once the LNG plant is up and running and of course associated industries and supplies with that, so it's a very large project but more importantly, once we have a pipeline coming in from the Timor Sea, we believe that it's got the capacity to provide leverage for other fields to be joined up.

But Bayu-Undan is not the problem. Overlapping the joint area is a much richer field – Greater Sunrise. It contains oil and gas reserves worth an estimated $30 billion. Under the terms of the treaty, Australia will get 82% of the revenue from Greater Sunrise, East Timor the remaining 18%.

Australia justifies that split on the basis that most of Greater Sunrise lies within its maritime boundaries, but East Timor disputes those boundaries.

Jose Ramos Horta, Foreign Minister, East Timor: Australia is getting the lion's share of the revenue without really being entitled to it, and Australia knows very well that it is not entitled to it.

The competing claims to Greater Sunrise are based on complex legal arguments. The Australian view is that its boundary extends all the way to the Timor Trough. East Timor claims its boundary extends 200 nautical miles from its coast. Current international thinking about maritime boundaries favours drawing a median line between two countries. It means East Timor has a very good legal claim to more of Greater Sunrise than Australia is willing to concede.

Reporter: You say that Greater Sunrise should be owned by East Timor. Why did your government then sign a treaty that gives away 80% of Greater Sunrise to Australia?

Jose Ramos Horta: No, we did not give away 80% of Greater Sunrise. There is a clause that says, you know, either side can review the basic position, particularly the treaty says without prejudice to either side's claims on the basis of international law, and our position is very clear. We do not have yet a defined maritime boundary with Australia. We never negotiated with Australia a maritime boundary. We have not signed a treaty, unlike Indonesia and Australia in 1972.

Alexander Downer, Foreign Minister: I thought it was a tough negotiation. We wanted to be fair to East Timor. We certainly want East Timor to have a satisfactory and generous revenue flow from the Timor Sea because it's very important to its development prospects. At the same time, we obviously have our own sovereignty and our own interests and we want to pursue those, and as the Foreign Minister of Australia I make no apology for promoting Australia's interests.

Bob Brown, Greens Senator: I find it incomprehensible that we've been such good neighbours to East Timor and now we're in their house robbing them of their resources. What a turnaround! Were we ... this brings up the question: Was the Howard Government's quick action to help East Timor really to help the people of East Timor, or was it with a view to securing the oil and gas, the billions of dollars off-shore? It's a terrible question, but the way this is going, it has to be asked.

Master of ceremonies at conference: Prime Minister, I invite you to address the conference.

This is the man arguing East Timor's case – Mari Alkatiri is the new Prime Minister. When Dr Alkatiri returned to East Timor from Mozambique in 1999, he was thrown almost immediately into oil and gas negotiations.

Mari Alkatiri, Prime Minister, East Timor: I tried to do my best. At that time I knew nothing on oil and gas. Now I know something. When the other side raises a problem that you don't know, it's better to postpone the discussions. This is what I did – why I did it, was postpone the discussion, when the question is not known ... very well known for me, and I tried to study it.

Dr Alkatiri is confident that East Timor will get a larger slice of Greater Sunrise.

Mari Alkatiri: I am here to defend the interests of my people. I am here to defend the interests of my Government.

Reporter: What sort of bargaining power do you have?

Mari Alkatiri: The same bargaining power – my people.

The arguments over who owns what in the Timor Sea are not new. Canberra and Jakarta could never reach agreement over a permanent maritime boundary near East Timor. What they agreed to instead was a joint development area where the resources were shared 50-50. When East Timor became independent three years ago, the new arrangement on the Timor Sea had to be worked out with Australia. Peter Galbraith, the former US ambassador to Croatia, and Mari Alkatiri, led the United Nations team into negotiations with Australia.

They were determined to win a greater share of the oil and gas revenue and to establish a permanent maritime boundary between the two countries. Australia wanted the same 50-50 deal it had with Indonesia.

Peter Galbraith, former UN negotiator: I think the Australians knew they had a weak case and sometimes when people have a weak case, they use other tactics. They try to threaten, they try to be tough, they try to be obstinate, and I think Australia tried all those tactics.

It was a relationship based on mutual loathing. The view inside the Foreign Affairs Department is that Peter Galbraith was as obstinate and threatening as he accuses the Australians of being.

Peter Galbraith: There was a certain amount of bullying that went on. There was an effort to pressure the United Nations simply – not to get involved, to leave this to an independent East Timor, because of course Australia knew that an independent East Timor would not have the same negotiating leverage as the combination of the East Timorese and the United Nations.

When that didn't work, there were many complaints that the East Timorese, that the UN, that I personally were demanding too much. There were efforts to go to other governments, including my own government – that is the American Government – to try to get those governments to pressure me personally, to pressure the UN, to pressure the East Timorese. None of those tactics worked. The East Timorese, I think, are incapable of being intimidated. After all, they stood up to the Indonesians alone for 24 years and prevailed.

The International Court of Justice in The Hague is the final arbiter in the event that countries can't resolve their maritime boundary problems.

Reporter: Did you ever threaten the Australian side? Did you ever say that East Timor would take Australia to the International Court of Justice?

Peter Galbraith: I did make the point that East Timor had an alternative of going to the International Court of Justice. And I don't think that saying you have a legal alternative is in any sense a threat. Courts exist so that people who cannot settle their disputes through negotiation can have them settled by an impartial, fair arbiter, who will apply international law. Australia and the UN Administration in East Timor eventually did a deal, but both sides have a very different view of what the treaty delivers. The Timorese position then and now is that it's a temporary arrangement until a permanent maritime boundary is established.

Jose Ramos Horta: The treaty is not a maritime boundary treaty. It's a treaty of cooperation and our position has been made very clear, time and again, that we do not have yet a maritime boundary with Australia. We wish to negotiate maritime boundaries. We do not recognise the boundaries that Australia is alleging, and which form the basis of its claims to the Greater Sunrise area.

It's clearly not in Australia's interest to agree to a maritime boundary that would deliver East Timor a greater share of the oil and gas reserves in the Timor Sea. Nevertheless, Australia says it is willing to sit down and talk to East Timor about a permanent boundary at some stage. But earlier this year, in a move that astonished the international community, Australia withdrew from the International Court of Justice's jurisdiction on maritime boundaries.

Peter Galbraith: I was shocked by it for several reasons. First, Australia has been one of those countries that has stood up for international law. It has been a very solid global citizen, so I never thought that they would withdraw, even though they threatened to do so during the negotiations of the Timor Sea treaty.

Alexander Downer: We don't want to get into litigation to try to resolve any questions that arise in terms of our maritime boundaries. We want to negotiate those with countries which are our neighbours as partners and friends.

Reporter: Did the withdrawal from the jurisdiction of the court have anything to do with East Timor?

Alexander Downer: Well, it's to do with all of our maritime boundaries and we have...

Reporter: But specifically East Timor?

Alexander Downer: We weren't just focusing as I've explained to the East Timorese, we weren't just focusing on East Timor. We have negotiations at the moment with New Zealand and we have of course, I've explained other maritime boundaries and we just wanted to do those negotiations as friends, not start litigating against each other.

Peter Galbraith: All East Timor wanted was a settlement based on international law, and international law is very clear that in these circumstances – that maritime boundary should be at the midpoint between the two countries.

Jose Ramos Horta: Are we going to treat international law, the UN, international mechanisms as a sort of restaurant menu? You know, you look at it, the list of international treaties, and you decide which ones you like, which ones you don't like? Like, you know, if you go to a Chinese restaurant and you order, you know, the meals according to your taste. Well, you cannot deal with international law like that, and Australia is doing this.

The strategic view from Canberra is a mixed one.

Reporter: What does this say about us as a country?

Alan Dupont, Defence & Strategic Studies Centre: Well, it says that we're just as hard-headed as any other country in seeking to protect its national interest and there's a lot of money involved here – jobs, royalties of course. These are very big, potentially, oil and gas fields, a lot of revenue from them. It will have implications broadly for the Australian economy and particularly for the Northern Territory, depending on how all these things develop, so there are some important economic issues at stake. Alan Dupont says East Timor is in danger of overplaying its hand.

Alan Dupont: There's a line beyond which no government can go and I think the East Timorese are in danger of actually now crossing over that line, if they pursue too aggressively the claim to renegotiate the maritime border and get a greater share of the resources cake.

Allan Behm takes a different view. He headed the international policy division of the Defence Department until last year.

Allan Behm, former Defence Department: If our position is either not capable of being substantiated at law, or, at best, doubtful or marginal, then we may well be in the position of creating that kind of resentment in East Timor that could last a very long time, and lead it to do things further down the track which are markedly against our own interests. Most people in East Timor remain unaware of the tussle between Dili and Canberra over oil and gas. Even at the country's one TV station, the story is only covered occasionally. Titi Ribeira is a journalist and newsreader.

Reporter: Do you often cover the Timor Gap?

Titi Ribeira, newsreader: Not often. Sometimes when, like, we have a press conference from Government, it's usually ... so we just go in the press conference to get information.

Do you think it's an important story?

Titi Ribeira: Yes, it's a very important story, because all people should know about the development – about the Timor Gap, you know?

Reporter: Do you know about it?

Just a little bit.

Reporter: Do other journalists know about it, do you think?

Titi Ribeira: Not really, no. Just a little bit of information.

Since the UN started its withdrawal from East Timor, these journalists haven't had Internet access, and there are no longer any phones. Despite the challenges most evenings, the news goes to air. How many people watch depends on how many parts of Dili are receiving electricity. Eusebio Guetteres is among the tiny percentage of people in East Timor who owns a television. It makes him popular with the kids in his neighbourhood.

Eusebio is frustrated that the oil and gas story isn't receiving more coverage. He also accuses the Alkatiri Government of not doing enough to explain the issue to ordinary people, and he's determined to do something about it. It's now Sunday morning and Eusebio's heading for the town of Balibo as part of his campaign to inform people about the Timor Sea issue.

Eusebio Guetteres (Translation): Only Dili has television, and not everyone has a TV set. Only a few people have radios. Many people are illiterate and can't read the paper. It's not always affordable.

Eusebio's first visit is to the local priest, Father John Suban. Eusebio explains to Father John what various international lawyers have told him – that the oil and gas claimed by Australia should be Timorese. Father John promises to distribute the maps and information to others in the town. It's a very difficult campaign, but support for Eusebio's stand is growing. Back in May, Eusebio succeeded in organising East Timor's first political demonstration as an independent country. The protest did not pass unnoticed by the Australian Prime Minister. Mr Howard made it clear while he was in Dili that the relationship would now be more business-like.

John Howard (May 20, 2002): Because we are now in a different relationship.

We are still two countries that have gone through a lot together, and there's obviously an enormous difference in size and wealth between the two communities, and that's one of the reasons why we've made a number of concessions in relation to the royalty negotiations and the split, the 90/10 that we think is very reasonable and fair, it represented a shift from our original position, and that's why we are carefully pointing that out.

Bob Brown, Greens senator: That's all a very insidious deception. We're giving the East Timorese nothing. It is theirs. We are taking from them. I met the Prime Minister in Dili at the independence celebrations. He said, "We're giving them 90%, what more can we do?" Well, I said, "We're not giving them anything. You are taking 10% of a small part of the resource, but when it gets to the big, rich, richest part of that resource, you're taking 82%, and it's an illegal act." It is illegal, and the Prime Minister knows it's illegal. That's why he's withdrawn Australia from the International Court of Justice's jurisdiction. So "giving them" – my foot!

Reporter: How hard can the East Timorese leaders push this issue with Australia, given the fact that the Timorese are dependent on Australia to a large degree for security and for aid?

Alan Dupont: Well, that's a good question, and that's certainly one the East Timorese will have to ask themselves fairly soon. It's perfectly reasonable for them to push this as far as they think they can if there's a possibility of them getting some additional revenue. But I think the reality is, the Australian Government's not going to give way on this issue, and therefore, the East Timorese have to be careful they don't alienate the Australian Government, and even Australian popular opinion.

But the Timorese leaders aren't backing down, and their rhetoric has become much stronger since independence. Just last week, the parliament passed legislation relating to the nation's borders, claiming a 200 nautical mile exclusive economic zone. It takes in all of the lucrative Greater Sunrise field.

Mari Alkatiri (Translation): We're informed that under international law our maritime boundaries in the Timor Sea would be much wider than those formally defined for exploration in the joint development area.

Mari Alkatiri: Peter Galbraith was very important for the whole agreement, but now I think that they realise already that the tougher position comes from a different person.

Reporter: And that person is you?

Mari Alkatiri: I hope so. I would prefer not to be.

Reporter: Is that how you see yourself, as a pretty tough man?

Mari Alkatiri: No, I am trying to do my best. I am trying to serve my people and this question of serving the people – I will do everything possible to defend their interests.

Reporter: Does East Timor have the power to stop the development of Greater Sunrise?

Mari Alkatiri: Of course that we have. We have technical instruments, we have mechanisms to do it, and we are not going to do it if Australia is willing to negotiate the maritime boundaries.

Will you negotiate a permanent maritime boundary with East Timor?

Alexander Downer: No doubt that will be negotiated in time, yeah.

Reporter: Can you give me any time frame?

Alexander Downer: We haven't even considered a time frame.

The oil companies have stood to one side during the debate, but they're making it clear their patience isn't inexhaustible. Blair Murphy is Phillips' representative in Darwin.

Blair Murphy, Phillips representative: I think for anybody to develop these fields, whether it be Bayu-Undan or Sunrise, the developers or the oil companies want certainty in terms of the fiscal and regulatory regimes and so we would want certainty what the deal, what the project is.

The response from Dili:

Jose Ramos Horta: Well, I think the recent history would counsel the oil companies to be very careful that if there is no agreement on Greater Sunrise, that they are liable to be sued by the East Timorese Government in case there is no agreement.

In the end, though, it's not an equal relationship. East Timor will depend on Australian aid and security for the foreseeable future. The Timorese argue that if they could receive their legal entitlements, they wouldn't need Australian handouts. But any recourse East Timor had to legal action has been severely curtailed now that Australia has withdrawn from the International Court's jurisdiction.

Jose Ramos Horta: We are not easily amenable to pressure. We have our interests, our dignity, our pride, our sovereignty, but we are also pragmatic enough to know that when you negotiate, it is never going to be a 100% win to one side or the other.

Reporter: What sort of bargaining power do you have when you're dependent on Australia for security and for aid?

Jose Ramos Horta: Well, it's not so simple, it is not so black and white, just like that, you know. Isn't Australia interested in preserving in the eyes of its own people, in the eyes of the world, an image of a caring country, or does it want to be perceived as bullying a small country?

It's a Monday evening in Dili. The restaurants once populated by United Nations workers are much quieter now. Six months ago, it was often difficult to get a seat here. At Metro Cafe, the Prime Minister Mari Alkatiri is having drinks with friends and family. It's quiet here too. The owners say business is down 50% to 70% since independence. Money is still flowing into Dili through the international donor community, but in a few years' time, East Timor will be expected to stand alone. Just how effectively it makes the transition from one of the world's poorest countries to a viable state depends largely on who wins the battle over the vast riches in the Timor Sea.

Jenny Brockie: I should point out that Insight called the Opposition Foreign Affairs spokesman, Kevin Rudd, several times for comment for that story. He did not return our calls.