Costly lesson for energy groups in Australia LNG projects

June 19, 2013 5:04 pm

Costly lesson for energy groups in Australia LNG projects

By Neil Hume in Sydney

The most surprising thing about the liquefied natural gas projects under construction on the central coast of Queensland is not their size, complexity or cost.

The UK’s BG Group and Australian groups Origin Energy and Santos are spending A$60bn (US$57bn) on three separate ventures near the port town of Gladstone to convert coal seam gas into LNG for export to high-paying customers in Japan and South Korea.Each project involves drilling thousands of wells, laying hundreds of kilometres of underground pipelines and constructing massive storage tanks that stand almost 40m tall. Added to growing supplies from Western Australia, the Gladstone projects will help Australia overtake Qatar as the world’s biggest LNG exporter by the end of this decade.

But what stands out is the lack of co-operation between the three ventures, which sit next to one another on Curtis Island in Gladstone harbour. Until recently, there has been no collaboration – even though the projects use the same liquefaction technology and the same contractor, US engineering group Bechtel.

The result has been costly duplication of facilities and services. Each project, for example, has its own ferry service to shuttle workers to and from Curtis Island, and workers’ housing (“dongas”, in mining parlance).

Analysts estimate BG, Origin and Santos could have saved billions of dollars by merging two of the three ventures, all of which have experienced cost overruns and are forecast to deliver meagre returns for shareholders.

However, Rod Duke, a senior Santos executive with the company’s GLNG project, says that was never an option.

“With 20/20 hindsight, it looks a missed opportunity. But at the time these projects were commissioned we were all competing for export contracts,” he told the Financial Times on a recent site visit. “Ours is a very competitive business and there is nothing wrong with being competitive.”

He says GLNG is within 1 per cent of its construction schedule and on course to produce its first cargo in 2015. This is slightly behind BG’s QCLNG project, which is due to make its maiden shipment next year, but ahead of Origin’s APLNG venture, which is planned for 2016. A fourth venture, jointly owned by Royal Dutch Shell andPetroChina, is yet to take a final investment decision but could feed its gas into one of the existing projects.

Even though Curtis Island is still a huge construction site, with almost 150 cranes scattered across the three projects, the impact of what is happening in Queensland is already being felt across Australia.

By connecting the state’s vast coal seam gas reserves to international markets, analysts say the Gladstone projects are set to transform the east coast gas market and, critically, push up prices.

“It was an intended consequence of these projects that domestic users would be paying international netback prices for gas,” Goldman Sachs commented in a recent report.

With 20/20 hindsight, it looks a missed opportunity. But at the time these projects were commissioned we were all competing for export contracts

– Rod Duke, Santos executive

Mark Greenwood, head of energy research at Citigroup in Sydney, says: “A lot of people, for example, focus on the expected low returns from the GLNG project in isolation but that overlooks two very important facts. First, the proceeds received from farm downs [the sale of equity stakes in the projects] and second, wholesale gas prices have increased because of a tighter market.”

That has given a new lease of life to assets in areas such as the Cooper Basin, one of Australia’s biggest sources of conventional gas.

“The economics in the Cooper have changed because gas prices have increased and legacy gas contracts, which were all done at very low prices, are starting to roll off,” adds Mr Greenwood.

Santos recently announced plans to increase production from Cooper by more than 30 per cent over the next three years.

Long-term wholesale contract prices, which have ranged between A$3 and A$4 a gigajoule on the east coast of Australia, are forecast to more than double by the time the Gladstone projects are fully operational in 2016-17. Members of the Australian Industry Group are already being quoted an average A$8.70 for long-term contracts.

This is both a consequence of the new link to international markets and demand from the new plants, which at full capacity will be able to produce more than 25m tonnes of LNG a year. Credit Suisse estimates east coast gas demand will treble because of the Gladstone plants.

“For years local prices have been low by world standards, but when suppliers can get a higher price exporting than on the domestic market, the domestic price has to rise,” says Tony Wood, director of the Melbourne-based Grattan Institute and co-author of a new report on the Australian gas market.

Grattan says Japanese customers currently pay about A$15 a gigajoule for Australian LNG, which includes a A$6 fee for transport and liquefaction.

As export and domestic and international prices converge, Grattan sees household gas prices on the east coast, particularly in Victoria state, rising by as much as A$170 a year. Large industrial users will also be hit with significant increases.

“Not everyone likes it, especially when electricity prices have also been rising, but it’s a natural consequence of an evolving market,” adds Mr Wood.