KGB INTERROGATION: Peter Botten

Days after achieving a major milestone in his quest to build a $US11 billion LNG project in Papua New Guinea, Oil Search managing director Peter Botten explains why the oil price could triple and why his project can succeed.

On May 22, oil and gas explorer Oil Search and its partners ExxonMobil, Santos and AGL Energy signed an agreement with the Papua New Guinea government that allows the companies to start engineering work on a $US11 billion liquid natural gas project in that country. While a final decision on whether to go ahead with the project is yet to be made, the agreement with the PNG government is seen as an important milestone for Oil Search.

Robert Gottliebsen: Peter, thanks for joining us. Do you believe that the peak oil forecasts of a looming world oil crisis are now starting to come into play?

Peter Botten: I don’t think there’s any doubt that supply/demand scenarios are extremely tight. For the first time ever you see a significant decline in production out of Russia for this year and you see the Middle East frankly struggling to maintain, let alone, increase its production. Put that against the backdrop of an average decline rate across the world of the world’s oilfield of about 11 per cent and there is no doubt that the fundamentals of supply and demand will remain tight. I do believe that we are going to struggle to continue to materially increase production based on an outlook for demand growth.

RG: So unless demand falls we could see an oil price two and three times the present level.

PB: Some people would say that’s probably a matter of ‘when’ rather than a matter of ‘if’ and it really is a question of how do we approach energy usage in a slightly different way, more efficient ways. Technology can help, but broadly speaking, unless there are significant discoveries around the world and there are people and money and time to develop those discoveries which I think will be a struggle, certainly there will be continued pressure in the medium and long term on oil prices.

RG: So you believe that the reason OPEC's refusing to lift production is simply that they can’t do it?

PB: I genuinely believe they have no capacity to do it. Based on our information out of the Middle East and from where we work ourselves, they’re struggling. Saudi Arabia has got enormous development programmes planned and in part underway, but like everybody else, they’re struggling to find people, struggling to find equipment and it all takes time.

When you look at production performance out of some of the key fields in the Middle East, you do start to question the potential reserves that may be there. Not in a dramatic way, but certainly the reserve statements that have been done generally by the Middle East countries has been somewhat less than Society of Petroleum Engineers classification. While their fields are giant, I think some of the complexities are coming home now when they try and turn up the production tap.

RG: Are you saying that they’ve been misquoting the reserves and they are much less?

PB: I think getting reserves quotes out of any Middle East country is always a little difficult and obviously it has strategic and political implications. But certainly they haven’t possibly been quite as rigorous in terms of their analysis of reserves and I think that’s being addressed right now by those governments. And there may be some surprises in what they’re working on.

RG: Downward surprises.

PB: Look, like everything in nature there’ll probably be some positives and some negatives but certainly there are some who think that some of those fields aren’t quite performing as they anticipated and that will certainly have an impact on some of their thinking. The downgrade a couple of years ago in Oman has had a significant impact on the Omani government in terms of its long-term planning for energy use and they’re out there looking for energy and looking for coal imports, which is just quite unusual really.

Alan Kohler: As you look around the world, can you see any areas where there’s a prospect of finding the sort of oil reserves needed to replace the decline in supply that you’re seeing from existing fields?

PB: I’m sure there are some frontier areas which have got some substantial potential. But there’s only been one potentially significant field drilled in the last 15 years and that was recently by Petronas off Brazil in ultra deep water. Some of those areas certainly have some potential but again, you’re caught in this wonderful spiral of I can’t find a rig, I can’t find the people to go drill a hole. It just takes time to line those sorts of things up. If you look at the time it takes to actually develop oil fields, you’re probably looking at, certainly in ultra deep water, a minimum of five years to production and quite commonly a little longer in this environment.

So if you look out to oil supply/demand in 2013 and 2014 which is really when potentially that Brazilian field would come in, it’s still a relatively long time down the track when we are facing, as I say, an annual 11 per cent decline rate across the world’s oilfields.

AK: What about Iraq. Is there likely to be enough coming out of there to replace the decline?

PB: I think Iraq has the potential to provide some material contribution and certainly there are a whole range of fields or discoveries there that still remain to be fully appraised and developed. But you’ve got to work pretty hard to get it out. Both the work environment and the political environment in that country still has to improve to really change that position and probably in the medium term that’s quite possible. Will it change the overall trend and make that contribution? Personally, I doubt it.

Stephen Bartholomeusz: Peter, can you tell us a little bit about the relationship between liquefied natural gas and crude oil prices, because it seems to be changing in LNG’s favour.

PB: From what we’re seeing over the last six months or so, there’s been a strong and growing correlation between the oil price and LNG pricing. I think most of the contracts are being done at close to Iraq’s oil price parity and some of the spot market is actually above oil price parity. It depends a little bit on the contracting style of the country or group that you’re actually dealing with, but broadly speaking there is a view that the numbers aren’t going to get any lower. If you want to secure energy, which is a key goal for certain governments and certain countries in our region, then I don’t think you are going to necessarily see LNG slip back into a substantial oil price discount. The demand is so strong at the present time that unless there’s something that really seriously knocks demand I think oil price parity or close to is here to stay.

SB: There’s a lot of new LNG capacity coming into the market. In this country alone there are three projects mooted in Queensland and the North West Shelf is expanding at a rate of knots. What does the supply/demand equation look like going forward?

PB: Firstly I’d challenge or at least ask the question as to how many of those projects are going to get up in the medium term. Although Don Voelte’s talking his own book a little, the reality is that while you have got quite a few projects in Gladstone and quite a few projects on the North West Shelf, if you look out to 2012, 2013, 2014, how many of those projects are actually going to get up in that time frame is questionable.

I think some of them will in the medium term but again, you’re facing supply shortages and labour shortages. In certain cases there are questions about resources and in certain cases there are questions on some of the commercial aspects of the projects and bringing fields together, etcetera. So there’s plenty in the pipeline, but I genuinely believe that very few of those are actually going to meet a target of delivery in 2013. Really, the customers are flocking to projects that they believe that will make that timeframe.

SB: If they were to get up, would that affect the economics of your project or is there enough demand in any event to support them?

PB: To be honest I don’t necessarily think we’re impacted by too many of those projects. I think we’re ahead of the game in terms of a number of the things – the commercial agreements are done, the fiscal agreements are done and certainly there is very strong interest in the market.

There are some very strong competitors, as we’ve seen with BG entering the coal seam methane game. And they’re very, very good at what they do especially in the LNG side. But we don’t see ourselves frankly in competition. We’ll do what we’ll do and we believe the market at the moment is well and truly able to cater for us and probably one or two others in the window we’re aiming for. But again, I don’t necessarily see us being impacted by Gladstone or the North West Shelf particularly. I think we’re reasonably well situated in the queue.

AK: What percentage likelihood would you now put on your project getting up?

PB: It’s always difficult to estimate that. I think our project has got pretty robust economics based on what we’re seeing now. Clearly the high commodities prices, high oil prices are having an impact. I suppose I see a couple of criticalities insuring where the capital costs are going. I don’t believe the market is an issue. I think there’s an awful lot of work to do in PNG to get the licenses signed off and the final investment decision to happen. Financing also needs a lot of work but again, I think the fundamentals are there.

I’d say it’s a pretty reasonable possibility. I’m not going to give you percentage terms but I think when I look around at some of the other projects we’re extremely well situated. I mean, just bringing the fields together in an integrated way so that you can dedicate resources and know what share of the value you’ve got in each part of the project, that’s a very, very difficult set of negotiations. We’ve got a very simple model where interest in the upstream, midstream and downstream parts of the project are all the same. If you start at scratch in having different equities in the upstream, downstream or midstream and downstream areas, immediately you’ve got a negotiation of transfer pricing and negotiation of where the value train is cut. And the protagonists that are all in that game don’t take a backward step. I think that’s going to take them some time. I think our project is pretty well situated but we’ve got a lot of work to do.

SB: Peter, your share of this project would be $US3-4 billion and an equity contribution of over $US1 billion. Can you fund that?

PB: Our equity share is certainly something we’re talking about. I think the bank loan share that we see ourselves coming up with is manageable and the banking syndicate that we’re talking to now are extremely supportive. Clearly pricing has tightened a little bit but we’re in the right space. We’ve got a quality operator who’s got a track record of delivery on time and on budget, even through this period of rampant inflation in our business. The banking side, I think we are reasonably comfortable with. We’ve got close to $US1 billion in cash at the moment and a continued very strong cash flow based on our oil fields and we believe we’re pretty comfortable about our equity contribution as well.

RG: Peter, go down the track five or 10 years. How big are the possible Papua New Guinea oil and gas reserves and what could the country look like in 10 or so years?

PB: I don’t think there’s much doubt that there’s probably a little bit more oil to find and we’re working at that extremely hard right now. There’s no doubt that there’s a lot of gas. Maybe there needs to be a little bit more infrastructure to pull it together but there’s no doubt that PNG could be a very substantial gas province in the future. And when you look at the impact of just one train or one development, three million tonnes and it more than doubles the GDP of the country.

I believe that you’ll progressively see that when one project gets up others will not be far behind and that country therefore will never be the same. It will be a very, very different beast in terms of its size, shape and economy. So it’s got to be good news for Australia, given they’re going to put $400 million a year into the place.

RG: Is China starting to be a key player in PNG or can Australia get back into the game?

PB: It’s not a secret to say that the Australia/PNG relationship has been strained over the last probably two or three years. Since the change of government in Canberra relationships have thawed enormously and there’s a well of warmth and co-operation that’s presently being worked through the system in both PNG and Canberra. It’s a completely different approach and Australia’s relationship is probably the best I’ve seen it ever since I’ve been working in PNG. Right now, that’s got to be turned into real projects and real help.

SB: You will have an astonishingly large exposure to PNG. Is there an issue in terms of political stability and political risk?

PB: Since 1929 Oil Search has been dramatically exposed to Papua New Guinea. I don’t wish this to appear blas about that, but it’s something that we understand and have understood for many years. PNG has actually been pretty good for the last ten years. In 2003 we were an $800 million company and by re-investing in PNG and with a bit of help from the oil price we’re substantially larger now. So despite the vagaries of PNG, I think we’ve actually done reasonably well. It’s a dynamic process but it can be managed.

AK: What’s your current thinking on buying the AGL stake in the project?

PB: I think a lot of people are going to look at it. I think there will be a queue to go into that data and to understand the project value and the look-through value from the project to the various participants, including us. Whether we’re interested or not will depend on a number of things. It will depend obviously on what price we have to match, the strategic value against that price and of course it still has some financing aspects. Obviously we understand the asset pretty well and we’ll be keeping a very close eye on the process, but whether we do it or not will depend a little bit on the final value and its strategic value to us and our friends.

AK: When do you think you’ll go to final investment decision?

PB: I think the critical part of that is frankly the process to get to all the licences approved and all the processes with the PNG government done. That’s an area which we’ve sought help from the Australian government. The PNG government have sought that help and it’s coming into place. I think the final investment decision is possible before the end of 2009. Certainly the stuff that we’re actually doing such as the engineering etcetera will be finished well before that. Our experience in PNG is that you’ve got to drive a date. If you leave a date open, there’ll always be some things to stop you, so let’s get to the cliff edge and drive it to that discussion. Same with getting the gas agreement to signed to be honest. But I think we’ll make our decision before the end of 2009 and that will put us in place for first LNG before the end of 2013.

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