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22 Aug Parting Thoughts for Australia’s #LNG Sector

As I am  moving permanently to the cold embrace of a Canadian winter in September, I feel a strong need to provide some closing advice to the Australian LNG sector.

 

 

Lest you think my move is because I’ve lost hope in the Australian LNG story, think again. The underlying fundamentals of the industry (demographics, climate pressures, energy security, globalization), are profound, unrelenting, and irreversible. They translate into steady demand growth. The low prices (a temporary phenomenon) will quell the enthusiasm for others to follow, positioning Australia solidly for the future.

 

 

To make the most of this opportunity, I believe the industry (which in my definition includes the LNG projects, its investors, suppliers, regulators and employees) need to make some changes.

 

 

On costs

 

 

Costs are coming in line. The operators and their suppliers have taken the pruning shears out, and have done well to move cost structures more in line with economic reality. But I fear that some of the cuts may have been too deep and may have removed institutional memory, throttled capacity for growth, and frightened the talent pool. Contracting and Procurement have been the heroes for the past 24 months, and good on them, but it’s time to move on.

 

 

What the industry now needs to do is make the cost structure sustainable. That means transforming how it does its work by streamlining its processes, simplifying as it goes, and automating via digital technologies and information tools to replace the lost person-power with bits and bytes. Many industries have trod this same path and it’s time for oil and gas to follow.

 

 

On productivity

 

 

I see three issues related to productivity.

 

 

First, in Queensland, which is now 75% of the East Coast gas market, business volumes have shifted downwards and have stranded valuable supplier assets(drill rigs, camps, frack spreads, haulage, construction, water handling). There needs to be some consolidation, particularly in the supply base, to take that capacity permanently out of the market to improve the productivity of what remains. Either suppliers should merge to take out assets, or the operators should move to consolidate their spend. Banks won’t like this, but it has to happen.

 

 

Second, the emphasis on cost reduction has also stifled innovation. Contracting and Procurement is generally not rewarded for speculative innovation and are more rewarded for measurable rate reductions, so innovation suggestions fall on deaf ears. Many contractors are now so cash famished that they cannot invest in innovative improvements to their businesses, and the gas industry as a whole will suffer. The operators need to lighten up on C&P, and start to reward investment in innovation.

 

 

Third, there are many assets held in captive value chains that are unlikely to reach their full productive potential given current ownership. The owners lack incentives or adequate capital to unlock that productivity, or have incentives that keep those unproductive assets on the balance sheet. Examples include pipelines, gathering systems, compression facilities, gas plants and water treatment.

 

 

Governments should revisit their tax rules that make it devilishly difficult to sell assets and find ways to make those transactions less painful. Boards should challenge management, given the current robust market for quality infrastructure, why assets need to be closely held.

 

 

On gas supply

 

 

Related to the question of productivity is the question of gas resource development. In this environment, gas companies lack the capital (and the price signal) to convert the incredibly rich and valuable gas resources on their balance sheets into gas reserves. While there are many sources of capital available to support this endeavour, the most obvious one is already on the balance sheet, in the form of infrastructure assets that could be sold.

 

 

Boards of gas companies need to ask why they should toleratebalance sheetloaded with gas infrastructure assets and suppressing the productivity of gas resources. Surely shareholders should be asking the same question.

 

 

By the way, I think it’s time to simply abandon NSW and VIC as gas precincts. The anti-development sentiment is too far entrenched. Those gas reserves should be sold off or turned back to the government, in favour of creative alternatives. In my view, it’s better for Queensland to simply own the entire east coast gas market and produce like mad, rather than trying to finesse a terra joule of gas here and there from piddly coal measures in NSW.

 

 

I also think the sentimentalism over the loss of Australian heavy manufacturing is unbecoming of a staunch free market economy. Why not embrace what Australia wants to be, a tourism-agri-health country and use its gas assets for those purposes?

 

 

On regulation

 

 

It’s no secret that Australia likes to bind itself up in its own red tape. My back of envelop calculation is that the Queensland gas industry alone suffers from some $1b in excess costs just because of its regulatory burden (actually, $250m is imposed by regulators, and $750m is self imposed trying to comply). That $1b gets deducted from revenues before royalty are tallied. Surely there must be some kind of compromise that allows the state to regulate and the gas industry to comply without this exorbitant cost burden.

 

 

The gas industry, a fragmented and weakened animal, is in no condition, financially or structurally, to confront the regulatory burden. At best it can only cope.

 

 

The government should therefore strike its own task force to work with the industry to transform the regulatory environment. Its goal should be to regulate at the least possible cost, all things equal (i.e., no relaxation of regulatory intent).

 

 

On future developments

 

 

We’ve had a great run for the past 8 years, but I am concerned that the Australian LNG business model (big banks funding big LNG projects to supply big markets with big volumes) is not well positioned for the future. The combination of US LNG projects with their different pricing model, the new small scale and floating LNG technology, and the changing requirements of the markets that want more flexibility, are tearing great chunks of flesh from this highly successful but threatened business model. The future of LNG will consist of many smaller markets, more modular gas developments, shorter contracts, greater flexibility and many more players. The die is cast for the existing projects but what about the future? Is Australia condemned to play the legacy model forever?

 

 

I don’t think so, but to hope to add 10 brownfield LNG trains to the 21 in the fleet in the same model is a fool’s errand. There aren’t 10 big Japanese gas utilities out there, dying for Aunt Matilda’s methane in the old model.

 

 

The Australian projects need to confront this change head on and adjust the business development model forever. The targets are many and varied, smaller Tier 2 and 3 cities in China and India, island economies like Hong Kong, and local market development. This means deeper trading abilities, smaller more frequent shipments, investments in consumption, different infrastructure and different pricing.

 

 

On jobs

 

 

My single most popular article ever was on jobs. It’s been looked at 7000 times or more, which isn’t surprising. What advice for someone in the industry?

 

 

  • Hang in there as the old guard is set to retire.

 

  • Move to ops and maintenance.

 

  • Consider the national oil companies instead.

 

  • Try the regulators.

 

  • Move to services.

 

  • Innovate outside the walls of the operator.

 

  • Look at trading.

 

 

On opportunity

 

 

Local business is at risk of sacrificing the upside from maintaining all the new gas and LNG kit by surrendering the market to the large players. This would be a mistake. The operators, if they behave like oil and gas everywhere else, will want to shift to local businesses as soon as practical – they will want the deeper expertise and the lower costs from dealing with small local firms rather than the usual global suspects.

 

 

So far, the response to the opportunity has been thoroughly underwhelming, based on my exposure to the sector in Gladstone and Darwin (admittedly not a scientific poll but these two locations account for about 50% of the new LNG additions to the Australian sector).

Local businesses should investigate the strong potential that comes from having to maintain some $200b in new infrastructure. Those who bank the industry should take a hard look at their portfolio and ask how exposed is it to the sustainable end of LNG, its ops and maintenance tail.

 

 

Final final thoughts

 

 

When I started this blog, I wasn’t sure it was having any impact, until the financial analysis team at an investment bank called, wanting to meet to “meet the guy yelling at the LNG industry”.

 

 

Thanks for listening.

 

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14 Comments
  • Richard Holliday
    Posted at 06:05h, 22 August Reply

    There are some great messages in this article for Australia’s natural gas sector.

    Sell bricks and mortar ( infrastructure), retain the knowledge base, it’s depleted, speak with a united and single voice, sit down with regulators and discuss reform that enhance the environmental and social outcome not merely ticks a box and finally give up on NSW and Victoria as natural gas exploration opportunities.

    Geoffrey Cann is an awesome LNG expert. and I wh him well in the next chapter of his life back in the cold of Canada.

    • Geoffrey Cann
      Posted at 15:45h, 22 August Reply

      Richard – much thanks for the kind words, and I’ll miss your sage advice and insight into the Australian public policy scene.

  • Ili Cava
    Posted at 08:57h, 22 August Reply

    Going to miss your blogs but will keep an ear out for the next episodes for sure. Safe travelling mate.

  • Adam Welch
    Posted at 17:14h, 22 August Reply

    Excellent summary Geoffrey and thank you for sharing your insights on the many years. Passing on your wisdom through your blog has done wonders for “knowledge retention”! Best wishes on the move back home and hope you continue to provide your insights from afar.

    • Geoffrey Cann
      Posted at 05:37h, 23 August Reply

      Adam – thanks for the feedback. It’s been a labour of love, taking up a chunk of every Saturday or Sunday for 3 straight years.

  • Paul Gregory Tompkins
    Posted at 08:35h, 23 August Reply

    Geoff – Have been reading from that same September winter country. It takes a lot of guts and humour and you have both in great quantities. You have done a yeoman’s service with this blog. It has always been, at the least, entertaining, and often times very insightful and offering critical analysis that is in short supply, no pun intended.

    Well done !

    Hope to see you back in YYC, if that’s where you are heading.

    Safe travels.

    • Geoffrey Cann
      Posted at 19:30h, 23 August Reply

      Paul – thanks for the feedback. I’m indeed returning to YYC. Catch you there.

  • Jeroen van der Heijden
    Posted at 13:44h, 26 August Reply

    Geoffrey, I would like to thank you for your entertaining and qualified views on the LNG / Gas industry.
    I have read your blog with interest and anticipation.
    I wish you good luck in your next endeavour.
    Regards Jeroen

    • Geoffrey Cann
      Posted at 16:27h, 27 August Reply

      Jeroen – thanks for the feedback. I hope to keep the blog going from Canada.

  • Anthony Mark Khan
    Posted at 22:29h, 26 August Reply

    I quite enjoyed your articles, Geoffrey. I hope that you have a good trip back to Canada.

    • Geoffrey Cann
      Posted at 16:28h, 27 August Reply

      Anthony – I’m delighted that you gained some value from the articles. It’s been a labour of love to write them each week. I did the best that I could.

  • Glenn Wright
    Posted at 18:46h, 01 September Reply

    Geoffrey, it has been a pleasure to have known you during your time here in Brisbane. We are indebted to you for not only your technical knowledge on oil and gas issues, the big picture and all that, but also for your good humour and camaraderie. You have been a wonderful contributor to the Resources Discussion Group lunches and we have been blessed with your insights. You are the quintessential gentleman and scholar, good sir. We all hope you and your good wife have a safe trip back to Canada and hope that you will come back to Australia to see us soon. The next red wine is on me, no Shiraz, just a fork and spoon 🙂 Cheers Glenn W

    • Geoffrey Cann
      Posted at 05:31h, 02 September Reply

      Glenn – I thank you most sincerely for your kind words. It’s been a terrific experience living and working in Australia these past 4 years, and I will miss the passion for life that all Australians bring to each and every day. And I’m sure you’ll find another Gashole or Motherfracker to grace the resource discussions. All the best to you and colleagues.

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