17 Oct Why Qatar beats Australia in the #LNG royalty olympics
Are the Australian people getting their fair share of the value of their LNG exports? From Down Under comes this latest fizzle, an argument that could pit the resource owner, whose coffers could well be empty relative to the next biggest national exporter, against the resource producers, who have run up huge costs to get into the LNG game by following the rules set by the owner.
Who’s right? Let’s let some high-price Canberra lawyers make the case, but as a public service to the Canadian and African projects, here’s my views on the matter.
The problem – Australia’s take from its LNG exports
Australia is about to become the world’s biggest exporter of LNG by volume, by overtaking the long running market gorilla, the Qataris. However, researchers in Australia claim that the Qatar government will take in $26.6 annually in taxes and royalties from its LNG export business, whereas Australia will take in less than 5% of that (a paltry $800m) via its national tax scheme, called the Petroleum Resource Rent Tax or PRRT. Something smells, and it’s not mercaptan.
The researchers haven’t posted their analysis on line (that I’ve been able to find), so I can’t vouch for the quality of the analysis. But trying to replicate it would be devilishly difficult and would need access to confidential government data from Qatar. Sure. Easy.
Sadly, in a blog post back in March of 2015, John Bland (a tax guru) and I warned that royalties would be lower than expected. And now they might well be.
Here’s some of the many reasons why Australia should expect to take in considerably less royalties and taxes.
Who set the rules?
I’m not that knowledgeable on who sets the rules in Qatar, but in Australia, it couldn’t be messier. There are no fewer than three tiers of government with rule making authority, and multiple departments at each tier making up the rules. Indeed the projects in Queensland were saddled in some instances with 2000+ specific compliance rules that they had to meet. Anti-combines laws then make it very difficult for the Australian LNG projects to work together to share insights, collaborate and challenge the rules.
The royalty and tax rules were also set by governments of the day based on the best available information and practices at the time. The royalty and tax rules rightfully permit the projects to recover their costs first (if they didn’t no investor would finance the projects), but all these enthusiastic rule makers helped inflate the costs, which then delays when the government gets its share, and makes its share smaller than it needs to be.
Not to mention the cost the resource producers then incur trying to comply.
What’s all the red tape worth? My back of envelop suggests a cool $4b.
Is Aussie gas identical to Qatari gas?
Royalties and taxes must take into account the market value of the commodity, and not all natural gas is identical. A “wet” or “rich” gas contains a higher portion of valuable gases like ethane, propane and butane (usually derived from oil, and highly sought after by the chemical industry who have no alternatives). These gases carry a higher price than dry methane. Many of Australia’s gas exports (indeed, all of the Queensland LNG exports), are exclusively methane and have the lowest market price (methane buyers, generally large power utilities, have alternatives, such as coal and renewables).
Globally, natural gas producers concentrate on producing wet gas, with the dry gas more of a side product, that may be sold at a loss, sustained only because of cross subsidies from the wet gas. How much of the Qatari gas production is actually wet and is included in their royalty calculation? I’m betting more than less.
When were the projects built?
The Qatari projects were built a decade ago, when oil prices were at $70/bbl, and the memory of $30 was still fresh. It’s highly likely the Qatari developments were more careful to manage construction costs, anticipating that the low end of the price of oil could dip to $30. And they recently did. Now that the Qatar plants are old, they likely have been fully paid off.
How about the Australian projects? Most were launched after the industry had grown accustomed to $100/bbl and when $70 was a distant memory. Therefore, it’s highly likely that the Australian LNG projects were approved with a most likely market price floor of $70. Certainly some risk modeling might have been done to test project viability at much lower prices than $70, but these low prices were probably discounted as too far fetched an outcome.
Today we’re at a ceiling of $50 and a floor of $30.
Currency played a part too. During part of the build boom, Australia’s dollar traded at par with the US dollar. Some of the costs of the project (borrowings, steel, fuel) would have risen by 30% as the Aussie dollar has eroded (and some, like wages, have fallen).
How were the projects built?
To keep the costs of their projects down, the Qataris built their projects in a paced and measured way. They too have a small country and limited expertise to go around. This allowed for maximum learning, idea sharing, infrastructure reuse, cost management, and optimization, and kept costs from inflatingtoo much. Indeed, after a long construction dry spell, the Qataris were even able to negotiate some fixed price construction contracts with some of their EPC suppliers, who were subsequently badly burnt when the price of steel began to rise and they were not hedged.
Australia tried a few of their own tricks. The LNG plants were built overseas in construction yards and floated to site. LEAN teams prowled the field and offices to try and capture savings.
But in the main, Australia’s LNG projects struggled to contain costs. Salary surveys showed that Australia had almost the highest wage rates globally in the oil and gas sector. The projects have all taken very painful write downs, a sign that the economics of the projects are in poor shape. EPC contractors were careful to insist on cost-reimbursable contracts, passing on all the cost inflation risk to the owners. Australia built 10 projects at the same time, rather than in sequence, which minimised the potential for shared infrastructure, common contracting, and shared lessons.
Going back to the rule makers, the governments of the day didn’t show much restraint in regulation either, convinced too that the high prices of the product meant the rules were affordable. Same for the unions with their constant escalation in wages.
The net effect is that the costs of the Australian projects are now the absolute highest in the world. I would posit that some in Australia made pots of money during the construction boom, effectively taking full advantage of the rush mentality in the industry, which should have translated into taxes on wages, including many of those now agitating for a review of the tax rules. Now the investors in these projects want their money back, and the rules are set so that they get paid next.
Qatar is the Apple of the LNG industry
Could LNG exports begin to resemble the mobile phone industry? Apple captures all the profits with its clever range of phone handsets while the rest (Blackberry, Samsung, Microsoft and Google) scrape for scraps, or burn up in flames. Qatar is starting to look like Apple to me.
Hindsight is always 20-20, but complaining about the outcome of the game because you don’t like the score is curiously un-Australian, and out of character for one of the world’s great sporting nations. Changing the rules after the fact is a sure fire way to alienate investors who seek stability and consistency in the rules.
What I don’t quite understand is why squabble over who gets what share of the pie in the first place. Why not concentrate on the far more important question of how to grow a bigger pie.
Australia’s rules, work practices, union activity, labour productivity and red tape make it fiendishly difficult to launch any new LNG projects (the last one approved was the Inpex project 5 years ago), with the result that the Browse, Arrow, and Fisherman’s Landing projects are all stalled, and the potential for the brownfield expansions is a distant dream. Meanwhile, the Americans have stolen the march and have approved 5 projects, with another 40+ on the books.
Australians would do themselves a huge service and get on with the real challenge of becoming globally competitive in this big new industry, rather than fighting over tax scraps.
As for the Canadians and Africans keen on LNG, here’s a few lessons from this story.
- Price forecasts for oil and LNG should look at the prolonged possibility of very low pricing ($30).
- Regulators should encourage collaboration by imposing restrictions on the projects.
- Regulators should take a full life cycle cost approach to regulation, including the cumulative effects of regulation, before layering them on.
- Encourage wet, rich gas production.
- Resist the temptation to fiddle with the rules after they’re set.