"There were 3 elephants in the room at the APPEA Conference but were there really four?"
1. Observations from the APPEA Conference
a.3 Elephants in the room- Super Profits Resource Tax (SPRT), Safety and LNG.
i. SPRT and Safety. At the start of the Conference, "2 elephants in the room" were bluntly established by the Federal Minister Hon. Martin Ferguson- super profits tax and safety. The Government saw them as critical to its performance credentials;
SPRT: From the Government's perspective the profits tax is going to happen so the industry had better get involved and talk with the Government about its implementation. Matters surrounding the insidious nature of this tax, including its retrospectivity and the failure of government to understand risk-reward issues in resources exploitation as well as a need to address the question "why not use the existing PRRT as a basis for discussion?" are likely to be canvassed in the media by all stakeholders.
Safety: from Government's perspective, this referred to the Montara oil spill and the industry needs to take note that following the tabling of the Montara report, there will be legislated change in offshore operations based on its recommendations. This will include the formation of a Federal National Regulator, already foreshadowed by the Minster, covering offshore petroleum activities and navigation.
Did the industry hear this commentary above the consternation of the SPRT? At the Darwin APPEA (as reported in the APPEA Darwin Palliser Report) Minister Ferguson gave a clear signal that retention leases must be worked for hydrocarbon development or run the risk of losing them. This message was largely glossed over, although the Browse Basin LNG participants did see the strength of his resolve. Safety, including the environment, is very much a Federal Government focus especially with the BP disaster in the Gulf of Mexico swaying public opinion. The industry will need to be on the "front foot" as the recommendations and legislation are rolled out.
ii. LNG: As the conference themes developed, a "3rd elephant in the room" emerged around gas and its importance to the Australia economy - the dominance of LNG to Australia. It became apparent that collectively (offshore WA and CSG in Queensland) potentially there will be 15 LNG projects by 2018, costing some A$220 billion involving 55,000 construction jobs and around 22,000 permanent jobs utilising about 460 TCF over 20+ years. The financial flow-through to the economy for the A$40 billion Gorgon/Jansz/Io project alone over its 20 year field life is estimated at A$50 Billion in local goods and services and A$60.0 billion tax receipts.
This massive development schedule to 2018 followed by operations for a further 30 years beyond the construction phase is a long-term commitment beyond the normal government election cycles of 2 to 4 years.
These LNG developments cover projects with a variety of risks and challenges, including production of conventional gas with high CO2 content and its disposal by re-injection, developments in fragile environments, unproven technologies for floating LNG facilities in cyclone zones, CSG to LNG with water disposal challenges to meet regulations as well as community expectations for a share in the generated wealth from these developments. The projects will have access to local infrastructure (roads, schools, hospitals and housing) requiring unparalleled community consultation, agreement and a focus on local safety.
In addition, industry expects Governments to streamline approval processes to avoid duplication and inefficient use of scarce resources. Aboveall there is a need for a rational and stable fiscal system that evolves with all stakeholders involved.
These massive resource projects demand solid partnerships between all participants- Governments at all levels, resource owners and developers, banks, regulators, customers and community. Everything is interconnected and disruptions from short-term political expediency (governments and labour) will have profound impacts on the supply chain of the economy; in essence, it will go to the sovereign risk of the country. At less than 2% of the global economy GDP, Australia has limited capability to arrest capital flight from sovereign risk issues when caused by short-term political expediency.
I am not sure the industry in general realises the magnitude and consequences of this massive capital expenditure of up to A$ 220 billion. The community certainly does not. Development of partnerships with all stakeholders to realise the full potential for Australia will require a seismic shift in attitude and co-operation and communication. The industry has started this process but will have to be the leader to ensure it happens.
The market risks of these projects cannot be under estimated. During the last five years petroleum engineering technology has provided a significant competitive edge for the alternate gas fuel source - shale gas- to be a viable option for satisfying energy demand in the USA and elsewhere. This has fundamentally changed the Atlantic Basin energy market for LNG demand, as it is projected that LNG annual tonnage will fall from a 2020 forecast volume of 90 mmtpa to 10-15 mmtpa. In other words, the Atlantic Basin will change from being the largest global LNG importer to 10th largest global importer by 2020. This dramatic change is a result of competitively priced shale gas in the fuel mix referenced to Henry Hub pricing that meets the local gas market demand and wins market share at the expense of imported LNG. This change has occurred during the last 5 years within the planning and construction phases for new global LNG supplies mainly destined for the USA energy market. It is a long-term phenomenon in the USA as the IGU estimates there are at least 90 years of proven and potential gas reserves in the country which will augmented by further shale gas discoveries i.e. by 2020, 73% of the USA gas reserves will be unconventional gas with shale gas being a dominant player in the market.
The short to medium term-market consequence is that these supplies, mainly from Qatar, deflected from the US market, will be sold principally into the Asia market where there will be price competition just at the time CSG LNG from Queensland and WA LNG are fighting for market share in Asia. When coupled with the uncertainty of a RSPT, it will bring the economics and profitability into sharp focus and potentially delay FID and production start-up. These market matters were not considered in 2008 and 2009 when corporate decisions to pay high transaction prices for the significant CSG resources were made to buy 2P reserves from 2007 to 2010 at a median price of A$1.98/GJ in Queensland. If the projects cannot reach FID in the next few years there are likely to be some balance sheet write-downs for those companies with no or deferred projects as these commercial matters become better understood in the coming years by investors and regulators.
b. Asian Gas market - The prevailing forecasts are that Asia will be the engine for energy growth to 2030 with an annual increase of 1.3% p.a., where it will account for about 60% of the global energy growth. The Asian countries are short of domestic oil and gas production and hence gas sold as LNG, through an increasing interconnected logistics system, is a key substitute product for the market in general.
c. Balance of Payments implications - Liquids deficit. Minister Ferguson's presentation provided a stark reality check on the dramatic impact on the nation's balance of payments outlook of rapidly declining domestic oil production. The Palliser Report from previous APPEA Conferences has highlighted this impact as critical to future standards of living with significant downside to the Australian dollar as the currency adjusts to increasing energy imports and the general demand for overseas goods and services. The Government's own figures forecast that the deficit, from increased purchases of imported petroleum, will increase from A$16 billion in 2010 to A$30 billion in 2015 at current prices. Tightening oil supply over this period due to increased Chinese and Indian demand will likely increase prices and hence the deficit. Payment has to come from somewhere - increased exports of LNG would be critical, but commercial uncertainties as noted above may defer the timing and magnitude of additional export receipts. This potentially would put the Australian dollar at increased risk.
d. Workforce - Key issues again were raised noting the Herculean task of attracting about 20,000 new employees into the industry, with training and safety as a priority. This has far-reaching implications for government education and immigration policies. The industry has a particular problem in that it retains only about 18% of its female employees compared to other industries nationally at about 45%. The industry needs to develop HR policies that provide incentives for women to stay in the industry.
e. Greenhouse Emission. This was not a 'hot' topic for discussion although the need to provide a carbon pricing of A$20-A$40 per tonne was noted to give the right pricing signals for electricity investment decisions- coal vs. gas. Base-load generation is unlikely to be built until this carbon pricing question is sorted out. There are also difficulties in using renewable energy as base-load capacity to meet RET targets as this is likely to result in much higher electricity prices due to online performance. There are opportunities for gas penetration into electricity generation if the carbon pricing signals are developed. These issues have slipped under the Federal Governmentâ€™s radar, but they demonstrate the need for stable long-term policies for major investment decisions.
2. Global - Supply and Demand - Pricing
a. Energy demand is estimated to grow by 1.5% p.a. from 2005 to 2030 for a cumulative growth of about 35% to 40% fuelled by a global population increase from 6.7 billion to 8 billion. About 80% of the 2030 demand will be sourced from fossil fuels with gas the best credentialed to help in the reduction of CO2 emissions. Asia will account for 60% of this energy demand growth with liquids demand rising by 1.0%- 1.5% p.a. and gas demand accounting for 6% growth p.a. By 2030 power generation will account for 40% of total energy demand fuelled by the China and India as they source energy for their burgeoning economies. China is targeting gas/LNG to change its fuel mix so that 35% of energy needs are sourced from gas as the country pushes to reduce environmental impacts of the GDP growth of 10-12% p.a.
The main sources of this gas will be from Russia (1500 TCF, reserve index 180 years), Iran (1000 TCF, reserve index 80 years) and Qatar (930 TCF, reserve index 80 years). These reserve life indices show overall capacity to meet global demand in excess of 60 yearsâ€™ production at 2010 demand. It does beg the question of why Iran needs a nuclear capability with its high reserve life index!
To 2020, LNG demand is expected to grow globally from around 200MTPA in 2010 to 350-400 MTPA by 2020, but will be influenced by the changing gas markets of the Americas as unconventional gas such shale gas wins market share at competitive prices. The new transportation and degassing facilities in Asia are making this market more integrated and competitive.
The clear picture is that China, with its massive foreign exchange reserves, is positioning itself for global reach and, as a consequence, exerts market power with producers for all forms of energy with its relentless investment in exploitation and supply chain assets. The Chinese Government is positioning itself to meet long-term supply needs. Currently, the country produces about 850,000 BOPD and sells about 60% on the international market. China is a portfolio manager of its energy assets, balancing energy needs with political hedging and reality.
In Australia, gas market share of energy demand is impacted by competition from an abundance of cheap coal which limits gas power generation to about 9%. This is especially acute with no carbon pricing policy or signals that will change the economic equation in favour of gas.
The success of the domestic gas industry depends on the export of gas to Asian markets. These markets are in a rapidly changing landscape as LNG destined for the Atlantic Basin will look to find other markets in Asia. In addition, there will be significant additional LNG gas supply as countries such Qatar and Australia bring new capacity of about 75 MTPA and 80 MTPA respectively on line towards the mid 2015 to 2016, of which 50% of the Australian capacity will be sourced from CSG projects. This additional capacity will cloud the pricing signals needed for long-term investment. Industry sources estimate that the supply/demand balance in the next 5 years will rapidly turn to a tight LNG market as global growth advances. The challenge for the industry is to be constantly adjusting to these market dynamics.
Pricing decisions for LNG contracts will start from an oil/gas differential of US$8-9/mmbtu from the per-barrel oil price. This differential has varied little recently and at current oil prices in the range of US$70-80/bbl, it would translate to an LNG price in the Atlantic Basin of US$6/mmbtu compared to Henry Hub prices below US$4-5/mmbtu. The economics don't compute on today's pricing! The betting is that the Asia market will see this differential significantly reduce from 2020. Investing in LNG is in essence a 'leap of faith' that long-term pricing will support the investment. This was noted at the APPRA Darwin 2009 Conference during the plenary sessions and the changes in market sentiment since then make this statement more understandable.
Interestingly, the industry seems to accept the oil price is 'what it will be' and there are few if any serious forecasts, although there is a recognition that as higher Asian demand kicks in (estimated 250 million cars in China in 2025) and supply tightens, the long-term oil price will rise steadily. However this will not be without some significant short-term gyrations caused by major supply interruptions.
3. Government Policy
In Norway there is a very interesting example of government intervention policy that may have merits upon further investigation when developing public policy for industrial development here in Australia. In the pre-oil production years of the 1970s, Norway was largely a fishing and shipping based economy. In the 1980s with the prospect of dwindling North Sea Oil, Norway developed a co-ordinated strategy to develop a global service industry that would sustain economic development into the future. In brief, this policy was to develop Norwegian capabilities in the long-term to compete globally in energy services. It gave Statoil a dominant position in all permits and influence, favoured Norwegian content via JVs, provided a focus on R&D to fund industry programs and Norwegian Universities which also developed educational programs tailored to industry programs. The consequence of this co-ordinated policy is that today Norway has a burgeoning export-oriented energy service industry that completes globally. It has 45 companies listed on the local securities exchange worth A$50 billion compared to Australia with a hand full of energy service companies listed on the ASX worth about A$8 billion. Australia does not have the local capacity to meet the challenge of developing the A$240 billion worth of proposed LNG projects to 2018. The expertise must be imported which means there will be limited skills transferred to the local economy. With Perth touted as a global energy centre, what is actually being serviced from within Australia?
It appears that Norway may have established the right policy settings to generate the 'golden egg' of sustainable economic performance! On reflection, maybe there was a fourth elephant in the room at APPEA - not spoken, but it should have been firmly placed at seat of Government in a loud and co-ordinated voice. There is no long-term, consistent, innovative and stable government policy created with considered stakeholder communication aimed at wealth creation, sustainability and development of employment skills. Instead we seem to have a scrambling of the golden egg for short-term political expediency!
Geoffrey R Widmer
30th June 2010
The preceding commentary is a compilation of views and data expressed at the 16th May to 19th June 2010 APPEA Conference expressed by the various participants. The Palliser Group has not verified these facts as presented to the conference and has not made independent enquiries as to the validity of the statements made or of the data presented. The Palliser Group recognises the authors of the various views as detailed in the APPEA Conference Program.