INDONESIA - Indonesian-Malaysian Dispute Over Offshore Reserves.

Malaysia's state-owned oil firm Petronas last month awarded PSCs for two deep-water blocks, off the east coast of Sabah, in an area hotly disputed by Indonesia. Shell and Petronas are to operate the blocks on a 50:50 basis, but Shell says any overlapping claims are a matter for the respective governments to resolve. Indonesia awarded what it calls the East Ambalat block to Unocal last November.

Malaysia was given sovereignty over the nearby Sipadan and Ligitan islands by the International Court of Justice in 2002, but the ruling left maritime issues and border demarcation unresolved. Shell and Petronas have earmarked a combined minimum investment of $50m for exploration of the blocks, including seismic surveys and drilling of exploratory wells.

The two states by March 5, 2005, came close to military confrontation over the areas. But Malaysia on March 8 said it was taking control of the areas, while Indonesia said it was for a peaceful solution. On March 7, Malaysia's Prime Minister Abdullah Ahmad Badawi and Indonesian President Yudhoyono announced separately they had agreed in a telephone conversation that their foreign ministers will discuss the matter further and that the two states were seeking a diplomatic solution.

Both states have sent warships and planes to the disputed areas in recent days. The attempt to defuse the crisis came after Malaysia accused Indonesia of trespassing in its territory when a navy patrol ship crossed about eight nautical miles (9.2 miles; 15 kilometers) into Malaysian waters. Indonesia now has five warships, two nomad aircraft, four F-16 jets and one helicopter in the area. Indonesian Navy spokesman Lt. Col. Guntur Wahyudi on March 6 said two more warships could be deployed there if needed.

The Royal Malaysian Navy has sent two warships to patrol within Malaysian waters. Premier Badawi said: "To prevent any undesirable incidents which may create tension in the relationship between Indonesia and Malaysia, both of us agreed for the matter to be discussed at the diplomatic level. Hopefully, in this way, any problem faced will, God willing, be resolved in a cordial manner". His Foreign Minister Syed Hamid Albar was on March 9 to leave for a three-day visit to Jakarta for talks with his Indonesian counterpart, Hassan Wirajuda, on the overlapping claims. On March 7, President Yudhoyono visited an island near the disputed sites off Borneo Island and said: "Solving the problem should be done without any confrontation, especially armed confrontation".

Also on March 7, however, the Chairman of Indonesia's parliamentary Foreign Affairs Commission, Theo Sambugaga, demanded that Indonesia recall its ambassador to Malaysia to protest that country's claims in the areas, telling reporters: "We ask the government not to negotiate with Malaysia on this issue because it (Indonesia's ownership) is indisputable and not up for negotiation". Separately, about 100 Indonesians demonstrated outside the Malaysian Embassy in Jakarta, shouting "crush Malaysia".

Indonesia claims Malaysia's water territory extends only 19 km (12 miles) from the Sipadan and Ligitan Islands, in the South China Sea. Since the crisis began in mid-February, politicians and military officers on both sides have released increasingly aggressive statements about guarding territorial integrity.

The show of military strength around the islands is unusual between two fellow members of the Association of South East Asian Nations (ASEAN), underscoring the sensitivity of the territorial issue. Both are signatories to the ASEAN treaty of amity and co-operation, and both have Muslim and ethic Malay majorities. Finding a way through the territorial dispute might require more than goodwill and bilateral diplomacy. The two states may once again need an international opinion to resolve their differences, a step Indonesia is reluctant to take after losing the 2002 legal ruling. Neither country is likely to back down readily, considering the potentially large economic benefits at stake. The waters off the east coast of Borneo have been a major source of LNG for Indonesia, pumped from deep-water blocks managed by Unocal.

One solution might be the creation of a joint economic zone. In this way, the two states would share royalties while maintaining strong convictions over the validity of their competing claims. Although the military deployments are widely seen as no more than posturing, officials in Jakarta and Kuala Lumpur are concerned about the possibility that a miscalculation by commanders in the area could produce an incident which would make diplomacy much harder.

BPMigas estimates that nearly 10 bn barrels of proved and potential oil reserves remain, and nearly 180 TCF of proved and potential gas reserves. The challenge is extracting these reserves in a timely and commercially attractive fashion.