KGB INTERROGATION: David Knox

Acting CEO of Santos, David Knox, told Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz how the company is being transformed, and what the lifting of the SA Government's shareholder cap will mean.

David Knox is acting CEO of Santos at a pivotal moment in the company's history. Firstly, the South Australian Government cap that prevented any one entity holding more than 15 per cent of the company's equity is expected to be lifted in November. Secondly, it is making strong progress in expanding exploration and production in Australia's northern onshore and offshore gas provinces and increasing its exploration presence in Asia. Its Gladstone LNG project, which the company regards as "transformational", may be accelerated by the potential for joint venture development of one or more additional LNG trains.


Alan Kohler: David Knox, thanks for speaking with us.

David Knox: Thank you very much for the opportunity.

Robert Gottliebsen: Okay, David, a very specific question – what percentage of Australian domestic gas is sold way below world prices? Santos gas.

DK: Well if you look at world gas prices and where Australia sits in that continuum, I think everyone acknowledges that Australia is either at the bottom or very close to the bottom end of what you would expect. I used to work in Pakistan in my previous life and Australian prices are actually below the prices I could get in Pakistan. We’re currently in Bangladesh and Australian prices are perhaps comparable with what we achieve there – but in Bangladesh they’re talking about prices moving to $US4 per gigajoule and here we’re anywhere between $2.50 and $3.50.

RG: How far is that below world prices?

DK: Well US prices vary between sort of $6 and $9 or $10. That’s US dollars as against Australian dollars so we are well below world prices.

AK: When’s that going to change?

DK: Well I think part of Santos’s strategy – to step back a little bit – is that we’ve been delivering maybe a little bit more than 20 per cent of Australian gas and we continue to be absolutely committed to that. Parallel to that, we recognise that we’d like to expose the firm to more international prices in Asia and this is part of the LNG story we’ve got in Gladstone. We have a very large coal-seam gas reserve in Queensland. We also have another large and as yet unproven reserve in Gunnedah in New South Wales, so part of our strategy here is to expose our firm to Asian type LNG prices while continuing to deliver our domestic gas – our domestic gas commitments from the Cooper Basin.

RG: But is that domestic gas price going to rise in the next five years?

DK: My belief on domestic gas prices is that gas is a very good commodity. It’s relatively clean in comparison to some of the other choices. I think over time we will see gas becoming a fuel of choice, with power generators choosing to use gas. Gas demand is going up in Australia and therefore that will ultimately drive the prices higher. That will come but it will take some time, but I believe that will be one of the core drivers.

Gas is actually a very good fuel and in comparison to coal. It’s about 50 per cent lower emissions, so I think that over time, as the green agenda, the green story and the political momentum build in Australia around that, the penetration of gas will increase and that will drive prices up to a certain extent.

We’ve also seen that in Western Australia where we just recently sanctioned the Reindeer contract – when I arrived in Western Australia four years ago prices were really fairly low and over that last four years I think we’ve seen quite a considerable rise, especially in the last year, so it’s actually hard to predict when it will happen. But I believe it will happen in Australia over time. One of the big drivers will be economic growth. Another big driver will be this issue around the carbon agenda and the carbon story. And gas will penetrate.

AK: David could you talk a little about the importance of the Gladstone coal-seam gas project in Queensland for Santos and put it in context with the Cooper Basin – and to what extent it replaces or will replace the Cooper Basin for you.

DK: It’s not so much a replacement for the Cooper Basin. The Cooper Basin is our base business. We really have quite a strong base business there which is both oil and gas – and Western Australia which is also both oil and gas. Those are our base businesses and to a certain extent Indonesia is also becoming a base business. We're committed to having a base business – we’re committed to it and will continue to deliver.

Then we have a growth business which is the really exciting side. There's our LNG story which is both Gladstone and PNG and also to an extent Darwin, although that’s not quite as front and centre as the other two.

On Gladstone, I think it's absolutely transformational for Santos. We’re fortunate in that my predecessor has gathered and collected what is an extraordinarily high quality coal-seam gas portfolio.

It’s in three assets in Queensland. Roma, which is relatively young in its maturity, but which for a lot of reasons we believe will be very, very good. Fairview, which is in production right now and produces 75 terajoules. It’s very high quality. And there's Scotia, which is in production right now producing 25 terajoules.

Those three assets are going to underpin the Gladstone project. In those three assets alone we believe we have many TCF [trillion cubic feet] of gas. In our analyst presentation we’ve said that in total, Santos has somewhere between 50 and 70 TCF of total ultimate recoverable molecules. So in those assets we have a lot of gas and that gas will underpin our first train which will come on line in 2014 – but it’s not a single train. We also believe we’ll have a second train in something like 2016, so that’s going to absolutely transform our firm from principally a more domestic east Australian gas business into what I would describe as an Asian energy company, and I can tell you it will be truly transformational.
When we add onto that the PNG project, where we have strong government support, it will be very significant. When we add those two together we’re going to start to look much more to investors – the market likes an LNG firm with a strong domestic gas, a strong base business here in Australia.

SB: David despite the British Gas deal with Queensland Gas – I think from memory it’s about an $880 million commitment all up – there’s still a lot of scepticism in the market about the viability of a coal seam methane LNG plant. How do you address that? I mean how confident are you that this plant will actually work?

DK: For myself, I joined Santos last September and one of the reasons I joined is I thought coal-seam gas to LNG is a very interesting proposition. I’d quite like to get involved in that and also I believe Santos had a very good 'store cupboard' of resources. Since I joined we’ve been drilling with three rigs absolutely solidly. We're now drilling a well a day. Our drilling terms have come right down. Those well results have been very, very good. We now have eight wells that produce more than five terajoules a day. We have two wells that produce more than 10. These are not standard coal-seam gas wells. These are absolutely world class and we’ve further explored in Roma and found that that potentially is also very good, so our deliverability model appears to be proving up and we’re drilling faster than we’ve historically done.

AK: David are you preparing Santos for sale?

DK: Absolutely not. No quite the reverse. My objective here is very much to make sure that our true value is reflected in our stock price. The way we do that is not by talking about it, but by actually delivering. And that’s why we announced going into pre-FEED [front-end engineering and design] last week with two world class contractors – Foster Wheeler and Bechtel. That was very good.

That’s why we’ve said on Gladstone that we’re also looking for a partner. That partner will bring credibility. Bring technology. Bring manpower and expertise to us. And we’ve also said that we’ll be going to FEED either late this year or beginning of 2009, so I think what we’re doing is rather than talking about it, we’re actually delivering on some actions. The other reasonably sized lever we’ve got is PNG and I would expect that that will move forward once the gas agreement is finalised with the PNG Government in the near future as well.

SB: Still on Gladstone, is there a coal-seam-methane-fed LNG plant anywhere in the world?

DK: No, there isn’t, so this is a first. To me that’s another advantage. If you’re going to do something new then being the first mover is clearly a good place to be and I think that’s one of the reasons that we’ve got Bechtel and Foster Wheeler so interested in us – that this is first mover advantage. The person who delivers this first is going to have an edge and obviously we’ve got multiple trains. We’ll be able to replicate this and we’ll be able to replicate it for Australia, but we’ll also be able to replicate it in other parts of the world and that’s a very exciting proposition both for us and for our partner and for our contractors who work with us on this.

And not only that – what I haven’t talked about is Gunnedah in New South Wales. We have a very good position in Gunnedah. That will be another opportunity for us to replicate, assuming it proves up.

SB: Just to finish the Gladstone bit of this – British Gas is also building a plant at Gladstone, an LNG plant. There’s been some talk that you might actually merge that project?

DK: BG as they’re now called…

SB: ...BG as they’re now called. There has been some speculation that you might actually merge the two to produce one shared LNG processing plant.

DK: I wouldn’t want to comment in any great detail, but clearly there probably will in the future be opportunities for synergies between us. I think the way that will work is, as we get nearer to that time, there may be discussions between the two parties but I wouldn’t want to prejudge where those discussions will go. I believe that both projects can coexist and at some stage in the future we may or we may not enter into discussions. That will be something for both parties to decide at the right time.

SB: Will it be easier to coexist if you partner in your project with BG Group?

DK: I don’t think it will make any difference at all. There are many models for coexistence. But equally on our side we don’t require to join forces with the other parties – BG or QGC – because we have aspirations to do more than one train ourselves.

What we’ve applied for at Gladstone is 10 million tonnes of approval. Our first train will probably be around 3 million tonnes. We’re obviously going through pre-FEED to decide exactly what the optimum size is but we’re intending to bring on a second train as well not long after that, so we’re going to see the synergies of the second train ourselves. So we don’t need to collaborate, but if the opportunity arises and it makes sense, then obviously we’ll enter into discussions – but we have actually no requirement to do so.

We have a great project strongly underpinned by a very good resource and we're very confident about delivery. We also have a piece of land in Queensland which we have freehold access to in Gladstone. It’s a very good piece of land with access from the port side to it. We have what I would call major project status in Queensland. The Queensland Government is supportive.

So I think broadly speaking we need to run our processes and make sure that we manage the environment in an appropriate manner and satisfy those requirements while we prove up the reserves, while we do the engineering, I don’t see any actual major hurdles for this process. It’s markedly different from, say, the West, where the real struggle is getting access to a high quality site that you can build on. We have a high quality site.

RG: Your predecessor loved to put the graphs up showing that your share price is at a big discount to the reserves and values of rival gas producers. Does that make you a sitting duck?

DK: I won’t be putting those graphs up myself. I believe that we need to…

RG: Why not? Why not?

DK: Our share price is a reflection of how we are actually hitting our milestones and demonstrating our value, not the other way around, so we will be laying out our plans, hitting the milestones, and the share price will follow. And right now I believe we’ve got lots of good opportunities in front of us. We’re absolutely not in a position of looking over our shoulders in any way. We’ve got a number of very good plans. Our share price since I was appointed has been moving forward very nicely and I am looking forward to that continuing as we continue to develop on what we’ve said we’re going to do.

RG: Do you think you’re at a discount to the other gas producers?

DK: That’s for the market to judge. It’s not really for me. My commitment is to make sure that we deliver on what we say we’re going to do and demonstrate what our true value is, and we’re going to do that. But you do that not through talking about it, but through actually making a difference and actually getting on with stuff. And that’s my intent.

SB: As Bob intimated a moment ago, your predecessor John Ellice-Flint did a great job of setting you up strategically.

DK: Yes.

SB: Really good assets in really good places, but didn’t deliver in the near term. In terms of the sort of result that the market wanted, have you got a sharper focus on making sure that you actually do generate profits today rather than prospects tomorrow.

DK: Yeah. And my belief is.. I was brought up in the school of thought that you’re only as good as your last quarter, so you earn your future today and you earn it every single day, so we’ve got to deliver on the base. And the base businesses are Western Australia, what happens in the Cooper Basin and east Australian gas and, as I say, also I include Indonesia in the base. We’ll deliver on the base. That will earn you the opportunity to talk about the growth so we’ve got to do both.

AK: And does the prospect of a carbon tax represent an opportunity or a threat for you?

DK: In the long term, I think it actually represents a big opportunity. As a big gas producer we’re very well placed. Ultimately my vision is that the Cooper Basin in particular has the potential to be one of the world’s largest carbon sinks. It will require a lot of infrastructure to be put in place. It will require state and government and federal support.

My ultimate vision is that we would sequester up to 20 million tonnes a year of CO2 into the Cooper Basin. The reservoirs are proven there. We’ve obviously produced gas from them so the seals are tested so the ultimate vision is to take other people’s CO2 and sequester it into Moomba.

This would be a world scale project. It would help deliver on the ultimate vision of clean coal as well so I’m excited by that. In the short term – this is a long term project – the other area that we’re really working on is this coal-seam gas. Coal-seam gas is effectively taking the energy out of the coal. It effectively is clean coal. We’re sucking the gas out of coal – effectively what we’re doing with our LNG coal-seam gas to LNG is clean coal. It’s a very, very sizeable way of getting energy out of the coal in a fairly environmentally sound manner.

AK: Have you got any idea what you’d be able to charge for carbon sequestration in the Cooper Basin.

DK: No. That will depend on where the carbon price goes. It will be set by the market.

AK: Would you do it as a toll? I mean would you charge rent for it?

DK: Yeah, ultimately for a company such as us it has to be a business proposition. So yeah, it will depend on what the carbon tax is.

RG: You have to park the carbon back?

DK: Yeah, we’d have to... there’d have to be a huge infrastructure network put in place which we would not be able to support on our own.

SB: It’s a billion dollar project isn’t it?

DK: Oh well, I wouldn’t like to call a number, but I’d say a billion would be very much on the low side. No, much bigger than that. This is a national project. A very big project. As soon as you run a pipeline you’re talking.. you know, the gas gathering system it’s…

AK: Do you actually own the reservoirs to put it into or did you have just rights to take the gas out of it?

DK: The legislation for that is right now in front of the politicians in Canberra and there’s been a lot of discussion around it and broadly speaking we would have access to our own reservoirs that we’ve produced from – the legislation is still being finely crafted which will allow us to do this, but I believe it will allow us to do it at the end of the day and so it should.

AK: Are you in negotiations with government officials on that subject?

DK: I’m not actively right now, but historically over the last few years I have been party to those discussions, yes. In my previous role, very much so. I understand that the legislation will allow us to sequester into our existing reservoirs. It hasn’t quite been ratified yet. I’m not quite sure when it’s going through. It was going to go just before… the Liberals were going to put it just before their last.. before the election, and didn’t quite make it. So it will be close.

SB: The South Australian legislation’s in place. So that’s...

AK: But the legislation would allow you to extract revenue from the sequestration.

DK: Well, it will allow us hopefully to run a business so that the existing reservoirs, which we’ve had stewardship of to produce gas from, we can also be used for CO2 sinks and obviously we’re very well placed to do that. We’ve got literally thousands of wells. We’ve got all the data maps. We’ve got the reservoirs tested, so it’s an ideal long term project for Santos to be involved in.

SB: Is Bass Strait in a similar situation?

DK: In Bass Strait the reservoir is a little younger, but Bass Strait would be another area that would be appropriate, yes.

AK: And is the jury still out on carbon sequestration?

DK: I think that if you ask the public there are still questions. It’s not for me personally. It’s something that is done internationally and obviously the Otway project, the CO2 CRC project, which is a scientific study, will help demonstrate that here in Australia, but there are a number of oil and gas companies that are doing it in other parts of the world.

Particularly Sleipner. It’s been done in Sleipner. It’s also been done in the field in Algeria and both those projects have been sequestering CO2 now for a couple of years. And in North America, for a very long time, they’ve been bringing CO2 down from the Rockies, down into the Permian oil fields and injecting it for tertiary recovery. So the oil and gas industry has been doing this for a very long time.

This isn’t new technology. It’s nothing fancy. It can be done, so it’s really just a matter of assuring the public that this is a safe thing to do – and I can certainly assure everyone around this table that as far as I’m concerned, as long as we have tested reservoirs, which we do have in the case of Cooper Basin, this is a very good way in fact of sequestering CO2 once and for all. After 10,000 years it becomes a solid, so it’s gone.

RG: Does that mean that we can then have coal fired power stations? Take the carbon…

DK: Well once you’re in that situation that’s the ultimate prize. You can do a number of things. First of all you can start to produce more electricity from coal and start to sequester all the flue gases and the CO2. Secondly, you can start doing things like coal to liquids. But you have to be able to sequester the CO2 that’s produced from that process because they all use a lot of energy.

So yes, the ultimate prize is a big one and for us in the gas industry. It’s going to be very important as well because we can use our gas resources.. some gas resources come with high CO2 so we can also use them as well. Areas like Evans Shoal which we own have high CO2 so we can... it’s a way of monetising those resources as well. So yeah, I think sequestration is one of the levers. It’s not the only lever for greenhouse gas abatement, but it’s an important one.

RG: What’s the time frame here? We’re talking one year, five years, ten years?

DK: For us to do a pilot project, a pilot project in Australia is probably two or three years. For us to start to take somebody else’s is probably three to four years. For us to do the really big scheme depends upon the political will as to when that occurs. It could happen in 5 to 10 years, it could take longer. It really depends…

RG: Why would it take that long? Why wouldn’t you start a project like this in say three years time?

DK: Because we have to be confident of the price of carbon. It’s expensive, so we’re going to need to be confident of the price of carbon. So you’re going to need a system, a trading system in place, which demonstrates the price of carbon and then once we get the price of carbon then we can run our economics and decide whether this is a viable project.

SB: David, you said a little earlier, you talked about how clean coal-seam methane gas is. I think John Ellice-Flint said you had enough gas in Queensland to supply the Australian market for a century at least.

DK: Yeah, he’s right.

SB: Why, in a carbon price environment, why wouldn’t you divert that coal-seam methane gas to the domestic market rather than export?

DK: Well we do have that choice and we have plenty of coal-seam gas to be able to do that with, so I think that choice is in front of us.

RG: Australians have to pay the world price though.

DK: Well we are going to expose our shareholders and ourselves to world prices through the LNG project and we will continue to have our Cooper gas assets and continue to supply about 20 per cent of Australian gas from them for a long time, but we have the opportunity to also supply gas from our coal-seam gas reserves absolutely and we’ll look at it when the time comes.

AK: Just on another subject before we finish, do you think that you will get a takeover offer after the shareholding cap comes off?

DK: I wouldn’t like to speculate on that. We’re just a normal company. We’re just becoming like everyone else out there, so we'll be absolutely no different at all from everybody else.

AK: Well have you had any indications that you’ll get a takeover offer?

DK: No, I wouldn’t like to comment, again. I’d say we’re just becoming exactly like every other company out in the street there.

AK: Is that a 'no comment' on the question on whether you’d had an approach or just…

DK: It’s not something that commercially we would ever discuss with the market or with journalists or anything at any time – so it’s not a 'no comment', it’s just something we would never discuss or speculate on.

As far as I’m concerned there’s no magic that happens at the end of November. We’re just becoming a normal company that’s in the ASX like everybody else. So I’m not expecting any change. My role here is to make sure we deliver. Make sure we deliver on the base, make sure we deliver on LNG, get PNG over the line and everything else will look after itself and then get the share price up.

SB: To approach that question from a somewhat different direction, there’s been a lot of talk over quite a long period about consolidation of the northern gas reserves, on actually the ownership of them.

DK: Northern as in Bonaparte?

SB: Well right across the north of the country. I think John Ellice-Flint talked to BHP about splitting up Woodside during the Shell takeover. Do you subscribe to that view, that there will be a rationalisation of the ownership of all that northern gas?

DK: Are we talking about the Bonaparte area?

SB: No, running all the way across the top of Australia.

DK: Well right now the discovered gas on the top of Australia is in the Bonaparte.

SB: Including onshore.

DK: There’s some in the Amadeus and all that sort of area and there is an LNG plant there, so there is export and there is also some domestic gas consumed in the Northern Territory. The real big discussion is whether all the owners of the gas up in the Northern Territory, can they get together and build a second LNG plant on a brownfield site. Conoco obviously has access to that site so can we work with Conoco and its leadership to get a second train up. I would see it as one of the few areas right now in Australia where there are molecules which are not dedicated either to the domestic gas or to an LNG scheme, so I would imagine over the next few years it is unlikely that they will remain undedicated.

SB: Some people see it more in terms of Santos consolidating or being consolidated as part of the rationalisation of northern gas sector.

DK: I don’t think it’s going to happen like that. No, I don’t think it will happen like that. No.

SB: Last thing David, at the moment you’re the acting CEO of Santos. The board is conducting a search even though they’ve indicated that they actually quite like the look of you. Do you expect to be permanent CEO?

DK: Well that of course is entirely up to the board. I’m the acting CEO and my intention is to do exactly that and get into action, which is exactly what I’ve been doing over the three weeks I’ve been in the role. So for me it’s all about action in this interim period and the board will decide as to whether I’m their best pick or not.

AK: David, thanks for your time.

DK: Thanks guys.

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