FYI | May 10 2006
By Greg Peel
"High energy prices are a double-edged sword. While they bring prosperity and the capacity for investment in exploration, production, new technologies, greenhouse abatement, and training; high prices can also give rise to community disaffection, political umbrage and resentment. As a consequence we can not take our place in the sun for granted, nor is a long-term prosperous future guaranteed."
So said Reg Nelson, chairman of the Australian Petroleum Production and Exploration Association, at its annual conference earlier this week. Reg was concerned that other energy industries – coal, renewables, nuclear for example – were rapidly and energetically working towards securing a long term future, and that if the upstream oil and gas industry did not do the same, it would "slide into policy irrelevance".
It would be easy to be sceptical and suggest that Reg is simply trying to ensure that the carbon-producing and continually more maligned fossil fuel industry does not suffer as a result of the community push for a cleaner environment (even coal is attempting to clean up its act). However, what we can glean from the chairman’s speech is a more measured approach to the problems of maintaining a viable oil and gas industry while addressing the needs and desires of a nation, both economically and environmentally.
Sure, the chairman would always push his own barrow. But pragmatism is a feature of his views. In order to paint a picture of his vision of the future, the chairman offers two potential scenarios for an Australia in 2015 based on the effects of 2006 policies of either status quo or pro-action.
What is the situation at the moment? Well firstly, out of 28 developed nations Australia pays more for petrol presently than only the US and Canada. Turkey pays A$4.40/l. Nevertheless, the price of petrol is high as far as most are concerned, and although we’d all prefer lower prices the reality is that low prices do not encourage investment and exploration.
It’s hard to believe, but it was only in 1997 that oil hit a low of US$11/bbl. Right up till 2004, crude prices were pretty much "low". We are now feeling the ramifications of a low oil price environment that turned oil companies inward to focus on production maintenance instead of outward to exploration and technological advancement. Moreover, there is a "lost generation" of people who chose not to enter what was then an insecure oil industry. We are really paying for that now.
At the same time there is a view, respected by many, that the world has passed its peak oil production and is now on a downward trend. Others disagree. Whatever the view, a study by Wood Mackenzie, to which the chairman referred, noted that in 1995 the companies within the study group produced 5 billion barrels of oil and replaced 5 billion barrels of reserves through new finds. In 2004, the same companies produced 9 billion barrels but still only replaced 5 billion. This trend is a concern to those relying on oil into the future.
Thus it is crucial, the chairman suggests, that Australia build its oil reserves and "release those resources sterilised by regulatory reticence or fiscal folly" (a nice swipe at the government) and furthermore address those "vast and unknown frontier regions of the Australian continent and adjacent waters".
At this point one is reminded of Barnaby Joyce, the National Senator who has advocated mining and drilling in untouched Antarctica for the wealth of resources that well may lay beneath. And of George Bush, who would love to attack Alaska.
Reg Nelson did not mention Antarctica, but he did note that the threat of climate change as a result of increased carbon emissions is real enough that the oil and gas industry across the globe will soon be operating in regulated system of carbon control. Thus, one assumes, simply tearing the world apart looking for whatever oil may exist is not necessarily his preferred solution. One solution that’s very real, however, is gas.
As a cleaner oil substitute, the chairman exhorts that the industry must "recognise the benefit of increasing the penetration of gas into the domestic and international markets".
Using this view as a springboard, let’s jump into the chairman’s two scenarios. The first is a scenario of "maintaining the status quo". One might also consider it the "lassez faire" approach. In each case we are asked to envisage the Australia of 2015.
Under status quo, the domestic "energy mix" of 2015 is little different to 2006. Coal is still the electricity generation fuel of choice, and in fact developments in cleaner coal technology have meant it has increased some of its share. Petrol is still used for transport, although alternatives of gas-to-liquid and coal-to-liquid technologies have begun to make inroads. Gas continues to be the fuel of choice for process industry.
Australia’s oil production rose slightly until 2008 when it peaked at 577,000 barrels per day. Therein began an irreversible slide of 6% over the next eight years that created a production deficit for Australia of 750,000 barrels per day. Whereas we were producing 80% of our oil demand back in the 90s, and 60% in the early 00s, in 2015 we now only produce 20%.
The capacity to meet the bulk of our own oil needs was one means of keeping interest rates lower, but that is no longer the case.
While the oil scenario is pretty bleak, we find that we have created a valuable growth industry in liquid natural gas (LNG), of which we are now exporting 44 million tonnes annually compared to 13 million in 2006. However, we have found that lower cost international producers, particularly state-owned companies, have begun to undermine our competitiveness.
Irrespective of increased competition, production costs across the whole petroleum industry have risen exponentially and we still cannot seem to catch up the lag on equipment, infrastructure, tankers, and skilled people.
We do have a fast growing domestic gas industry, which is satisfying increased demand from industry and peak electricity production, but given health and environmental impacts have not been sufficiently addressed it is still the case that coal is the fuel of choice.
Petroleum exploration has increased since 2006, but only around proven areas and prospects dwindling in size. As production has fallen, Australia’s trade deficit has blown out to $27 billion compared to the $19 billion of 2006. This is an uncomfortable number.
Money has been spent in technological advancement, such that some new exploration opportunities have opened up, but nothing staggering. While other industries have campaigned hard to attract and foster skilled and professional employees out of the ranks of students, 50% of oil and gas employees of ten years ago have not been replaced.
On a brighter note, the industry has begun to look into expertise in carbon capture and storage – something the exploration and production industries can develop as an offset to the emission problem, and even as a viable standalone that could service the coal industry.
That is the bleak scenario for a status quo 2015. Now let’s consider the chairman’s vision of a 2015 reached after a period highlighted by a proactive industry and government approach beginning in 2006.
In 2015, gas is making great in-roads as a source of energy for industry and electricity generation. The industry has responded with a range of economic and environmental issues which have improved its overall competitiveness.
After some long term supply planning, productivity improvements, enhanced production programs, innovative product development, and tackling climate change policies head on, the petroleum sector has held its own. 120 million barrels have been added to reserves from known areas, but mostly from new finds in previously unexplored and frontier areas. The gross revenue of the industry has increased by $1.5 billion since 2006. The government’s revenue is up by $500 million.
The government had woken up a while back that in order for the Australian industry to be globally competitive, the regulatory and fiscal framework needed to reflect the level of risk investment, and recognise the costs of exploration in isolated areas as well as the large distances involved in selling oil and gas both domestically and internationally.
The specialised equipment required to be imported is now free of import duties, the fuel required is not subject to excise, and transaction charges have been reduced. Depreciation provisions have been put in place to attract investment into value-adding, capital intensive industries. Incentives have ensured that Australian junior exploration companies form a sizeable and vital chunk of the upstream exploration industry.
The government has been fiercely determined to maintain the country’s position as one of the world’s most competitive suppliers of LNG. More than 50 million tonnes is being exported in 2015. Domestic gas has become very competitive with coal as a fuel source, given the increased cost of coal and the now equalised tax treatment of gas with other energy sources. Gas now represents 70% of new electricity production and has enjoyed substantial growth in industry use.
Given the increase in LNG exports and the stabilisation of oil production as a proportion of domestic demand, Australia now enjoys a trade surplus in petroleum products.
Technological advancements have ensured that oil recovery rates have increased by 5%, and fields once given up as uncommercial have been reopened. A range of measures instigated back in 2006 to address the acute workforce shortage now ensures the industry has access to a well-trained and appropriately educated workforce.
Australian industry now has burgeoning expertise in the field of carbon capture and storage.
It was back in 2006 that the oil and gas industry realised that it was never going to win the hearts and minds of the Australian people, but it did realise that the industry could be seen as making an economic and environmental contribution, and that a strong, innovative and proactive industry can deliver benefits to the country in the long term.
And then the chairman woke up from his wonderful dream.
While it is clear that the bulk of the scenario comparison is an exhortation to the current government, there is a wake up call thinly veiled within for the industry as well. As to what degree the chairman’s opinions are duly considered, perhaps we will need to wait for next year’s APPEA conference. From an investor’s point of view, the utopian 2015 scenario throws up some interesting longer term possibilities.
From the average Australian’s point of view, it’s all pretty scary really.