KGB Interview: David Knox

David Knox, chief executive and managing director of Santos, tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

• Long-term demand for LNG in Asia will be driven by a desire by countries to secure multiple sources of supply
• Despite lower prices, the Russia-China pipeline gas contract will do little to curb China's demand for LNG from other sources like Australia
• Modelling on the company's Gladstone LNG project will be unaffected by the China-Russia gas deal
• NSW will face a gas shortage in 2017-18 if it doesn't allow development on the Narrabri coal seam gas project
• If enough supply is unlocked, the price of gas on the east coast could come close to matching the export price
• Gas will play an important role in reducing Australia's carbon footprint in the medium to long term

Alan Kohler: David, thanks for joining Business Spectator. It’s great to have you with us.

David Knox: Thank you, Alan.

AK: Now David, leaving aside the specifics of the Russian gas deal with China and also the potential for LNG exports out of America, isn’t it the case that you are in a declining price environment for LNG and for gas in general?

DK: No. Quite the reverse, Alan. But I’ll give you a couple of really high-level reasons -- ones I’ve been talking about for years. 

The first is, as we all know, the nations that are typically reliant on LNG in our region are energy-short. They need multiple sources of supply. And just talking about Japan in particular, they want to buy LNG from as many suppliers as they possibly can. So, that’s one reason why I believe LNG is going to be very important in the long term. It’s because of those multiple sources of supply and ultimately requiring secure supply. 

The second reason that is becoming increasingly important is air quality. If you want to live in Beijing or if you live in Hong Kong or even in Seoul right now, air quality is becoming an increasing issue. Particularly gas, particularly gas that can come from LNG -- in other words, multiple sources -- can address the air quality issue. 

So, I’m actually more confident today in the LNG market and therefore the price of LNG than I’ve probably been over the last fifteen years I’ve been in this business.

Robert Gottliebsen: But David, just as an old-fashioned sort of viewer of the markets, we’ve suddenly seen the Russians come in and supply China with gas. I know it doesn’t start until 2018, but they have gas about equal to the total Australian output of LNG, they’re saying we can probably double it later on and they’ve cut the price to ribbons. They’re substantially below the Australian price, even substantially below the European price. 

Now, when somebody comes onto the market with that enormous quantity of material and cuts the price, you cannot but otherwise be affected by that. I accept all the things you’re saying about the demand. And there’s Japan and there are other places, but this is the most enormous contract we’ve ever seen and they’ve cut the price. A brilliant deal by the Chinese.

DK: Well, let’s just talk about the price. Obviously the prices haven’t been fully disclosed, but my understanding from analysts is that the price to the border with China is $9. That means that the price into Beijing is somewhere north of $10, $11. Today, if I sell my LNG into Beijing, I would bring it into Beijing at about $14. So yes, today there is a differential. But, as I say it’s about multiple sources of supply. 

Pipeline gas is going to be important in China, absolutely. From Russia into China, absolutely it is. But you’re not going to be dependent upon or entirely dependent upon gas coming from Russia. The Europeans know what happens if you put yourself in that space. The Chinese will not do that; they will also go for multiple sources of supply.

I don’t believe at the end of the day that the Russian pipeline deal is going to shut us out, as some people might have suggested, from long-term LNG deals into China. The other thing you’ve got to think about is that in total terms, that gas pipeline will supply 1 per cent -- 1 per cent of the total energy demands of China. In 2030, it’s likely to supply about six per cent of China’s gas needs. It is important, but it’s not an absolute game changer for us. It’s been in the wash for a long time. We’ve known about it for a number of years, so it has been factored into the equations. 

And even with that factored in, China still needs about a hundred million tonnes of LNG if you look forward to 2025 to 2030. So, I still believe China is going to be in the market, buying LNG for the next decade and the decades beyond.

RG: David, the Macquarie people are saying that that Russian contract equals about 20-25 per cent of the Chinese gas demand, nothing like 6 per cent. I’m not in the position to say whether you’re right or they’re right, but…

DK: In 2020, it’s 10 per cent of the demand, assuming they can supply it. 2030, it’s 6 per cent of the demand.

RG: Right. That’s because what you’ve done is escalate their demand.

DK: Absolutely. Chinese gas demand is going to grow. As we all know, gas is the fastest growing of the energy sources and it’s growing at about 3 per cent per annum, so you have to take that into account.  And this is why I’m confident because if you look at projections of energy demand, they are very significant. If you look forward to projections for gas, they’ve even more significant. 

RG: Do you think the Chinese are going to pay the Australian price for future contracts when they can get it from Russia at a fraction of that price?

DK: Well, it’s not a fraction. It’s $10.50 to Beijing. Obviously, if you want to go into Shanghai, it will be a considerably higher price than $10.50. So, I don’t believe it is a fraction. If you do the maths today, there is a slight differential, but it’s not a massive differential as perhaps you were suggesting earlier. It’s a matter of a couple of dollars per BTU, and that’s not a massive difference when you consider some of the other factors that are critically important in supplying energy to nations such as China or into Japan.

Stephen Bartholomeusz: David, with the Russian deal, you’ve got a contract price. We know that the Japanese are trying to actively and aggressively shift their supplies over to a Henry Hub-based price. At a practical level, does it actually make much difference if we move away from oil-linked pricing? What would it do to you?

DK: For my company, Santos, it would make very little difference. We’ve just started up Papua New Guinea, where our operator Exxon’s done a wonderful job there. They started out and they’re delivering cargo. Those are at oil-indexed prices for the next 20 years. Our Gladstone project also has oil-indexed prices for the next 20 years. Our Darwin contract is exactly the same -- oil-indexed prices. 

So, for us in the near term, the next twenty years, it doesn’t make an enormous amount of difference. But frankly speaking, Henry Hub is very likely to be something like 15 per cent of global LNG demand. Japanese customers, as will other customers, will seek to have, say, 15 per cent of their LNG exposed to Henry Hub pricing. But they’re not going to go for percentages much higher than that. Again they want to make sure they’ve got multiple sources of supply and that those sources can deliver them with real confidence into their markets. 

If you were in Tokyo, the key thing you’re rewarded for is obviously keeping the lights on. That is the critical thing and therefore you want multiple sources of supply. Australia is in a great position to be one of those sources today and for a long time in the future.

SB: If those new sources of supply don’t affect your existing projects, could they affect future projects given has happened to development costs?

DK: If we’re talking about Henry Hub in particular, we’re already seeing a lot of companies in Japan and also of course coal gas in Korea maxing out on their exposure to Henry Hub already; they’re already at about the 15 per cent level. I think you’ll see them come back into the market over the next few years for reasonably-priced LNG. And I believe firmly that Australia’s actually in a good position to supply that, especially from brownfield expansions now we have a large amount of infrastructure on the ground. Expanding that in a brownfield sense is of course a far more economic proposition than doing the original greenfield. 

AK: Just to be clear, David, are you saying that the Russian deal with China has not resulted in any changes to your modelling on the Gladstone project?

DK: Absolutely none. The Russian deal has been telegraphed, signposted for years and years. It has been in people’s models for a very long time. It’s now obviously been consummated. It’s still for delivery in 2018 and beyond and maybe even 2020 before it starts to get up. It’ll ramp up over a number of years and it’s not cheap. 

You know, it is $9 to the border and $10.50 into Beijing, so this isn’t inexpensive gas. It’s an important deal, but it will not derail the global LNG supply which is about four hundred and fifty million tonnes by 2025.

RG: David, talking about Queensland, as it now looks, how much of Curtis Island's three LNG plants’ supply sourcing will come from coal gas in Queensland ,and how much of it will come from the Cooper, in rough percentages?

DK: For ourselves, we’re going to supply right now contracted about 140 terajoules a day from the Cooper, which is slightly less than 10 per cent of our total demand for gas into our plant. So, that’s from our project. The other two projects, well, broadly speaking, are meeting their own supplies from coal seam gas.

RG: So the Cooper’s providing only 10 per cent of yours, but nobody else’s?

DK: Right now, nobody else’s. Right now.

RG: Do you think it’s possible later that the Cooper will have to supplement the others?

DK: I wouldn’t like to speculate on that. I think you’d really have to ask the others. But I think what’s important is that we’ve now exposed the Cooper to the LNG plant. That gives us the opportunity to really invest in the Cooper. What you’re seeing is us investing, you know, a very large sum of money. I’m talking about a billion to a billion and a half dollars upgrading the systems in the Cooper, adding more equipment in the field drilling more wells. 

We’ve got six rigs operating there now, so that we can really unlock the Cooper wealth. And we’re also of course, in parallel with this, looking at the shale also that’s in the Cooper Basin. And that’s a very exciting aspect of the, the new opportunities open to Santos to unlock new sources of supply -- which can then go either to the LNG plant or our Gladstone LNG plant for the long term or can go into the domestic market. Which we believe firmly in 2017 and beyond, you know, is going to need more gas supply.

RG: Is there enough gas in the Cooper? Let’s assume that the coal gas exercises nearer to Sydney don’t happen. And that’s just an assumption and it may not be right, but let’s assume that for the minute. Can Cooper supply Sydney?

DK: I think Cooper can certainly supply help Sydney, the Sydney market. In order for us to do that, we’ll also be looking to unlock our shale resources, so we can pipe them to the Sydney market as well. So, as a company we’re doing everything we can that is reasonable, as far as the business case is available to us, to unlock our sources of supply. 

And the Narrabri project in New South Wales, obviously is one for New South Wales, but also the shale in the Cooper which I think has got prospects, but it’s very early days yet. We’re just fracking our big horizontal well right now. We’ll see what the results are over the coming months. But, you know, you need to drill at least 10-15 wells to really decide whether you’ve got something truly viable. Indications are good so far. Well, we’ve got quite a long way to go before we can really be certain.

RG: But if Narrabri doesn’t go ahead, what you’re really saying is that there’s a lot of drilling before we can actually supply Sydney without Narrabri?

DK: Yeah, without Narrabri, as I’ve been saying very clearly to New South Wales, you know, it’s going to be hard. You’re potentially running the risk of running short of gas in 2017 and ’18 and beyond. We need to get the Narrabri started up. That’s why we invested in it as a company. We’ve rigged the resources in the ground. It’s a good quality resource. We need to move it forward and we believe we can and have the ability to do that and to do that in a sustainable and acceptable manner.

SB: David, on Tuesday IPART announced that New South Wales regulated gas prices are going to rise by almost 18 per cent from next month. Do you think the reality of these surging prices is going to weaken some of that really bitter opposition you faced at Narrabri?

DK: No. I think the opposition is more fundamental than that and it’s more based on a fundamental set of beliefs that we don’t want hydrocarbons to progress in the Australian economy. We want to oppose all hydrocarbon development, whether that be oil, gas or coal, and so I think that’s a very fundamental opposition there.

But I think the IPART decision which has come out today is just an indication of why, just in basic economic terms, we’ve been saying for a long time that we’re keen to get on with this project -- because we want to get the gas out of the ground.

We want to get it into the pipes, so that we can supply New South Wales and that’s been something we’ve been saying for, I’d say, three to four years now. It’s truly important we do it and extremely important we get on with it. 

AK: David, do you think the political situation in Australia and in particular in New South Wales and, more recently Victoria, means that the only fracking that’s going to be possible in Australia is in the Cooper Basin?

DK: Well, no, I don’t agree with that. I think at the end of the day while we can’t frack in Victoria today, we’re not looking to do so. In New South Wales we don’t require to do so obviously for the Narrabri project.

In the Cooper we’ve done it for the last forty years, we’ll be doing it for the next forty years. And in Queensland we do a small amount of fracking. Maybe to 10 per cent, 15 per cent of our wells are fracked right now. Fracking is not an unsafe process. It’s a process that’s been used for a very long time throughout the industry globally and what we had to do is we had to tell the story around what we’re actually doing when you talk about fracking. 

There’s not a big explosion underground or anything like that. We’re pumping water at pressure with sand in the water to open up the fractures. We take the water pressure off. The fractures grow throughout the sand grains and the fractures that we’re opening up are only eight to ten sand grains wide, so they’re very small. And we try and get them to run away from the well wall for ten, twenty, thirty metres if we can.

AK: No, I wasn’t getting involved in…

DK: But it’s not a process that people should be at all concerned about, provided it’s done well and provided the well’s a good well integrity. And then it’s a perfectly safe and reasonable process.

AK: No. Well, I’m sure that’s what you say and that’s probably right. I’m not getting into that. It’s really a question about the issue in Australia being that there’s a lot of opposition to it. I mean, whether it’s right or wrong.

DK: There is some opposition, but I think as we explain its importance and people start to understand the process, then I find in my conversations that opposition falls away. Now, you know, where fracking is required I think we’ll be able to explain it and make the case provided we do that well.

RG: You’ve got a very big opponent in Alan Jones in Sydney. I think in that particular battle you’re against one of the toughest campaigners there is and I don’t know that there’s any corporation that could really succeed against that.

DK: Well, the time will tell. I think it’s extremely important that we unlock the Narrabri gas reserves and that’s what we’re seeking to do. We’ll do it applying really high quality technology. 

In that case, what we do is we drill straws. We basically drill three straws on top of each other, horizontal wells, and then we intersect the nose of the wells. So, that’s how we develop the coal seam gas in the Narrabri project and we’ll continue to do so. 

So, I believe ultimately that we need to be successful. It’s important for New South Wales. It’s important for Santos and my shareholders and above all it’s important, I’d say, for eastern Australia that we do develop that, what could be a very large resource.

RG: Do you think the price of gas on the eastern coast of Australia is going to become very close to the export price?

DK: I wouldn’t like to speculate on where it’ll go, but if you do a net back to Wallumbilla, the price of it's circa about $8 right now. I think if we can increase the supply, then we’ve got a reasonable chance of having a North American experience take place, which would be fantastic.

You know, who would have predicted that what’s happened in North America would happen ten years ago? I think virtually no one. What they did is, they went up to circa $12 per unit for gas and there were a few of their investors, there were 1800 rigs drilling and then their price came all the way down. 

It could happen here in Australia. It will probably on a longer timeframe, but certainly it’s my ambition to unlock the gas resources of this country and bring them to market both domestically and through our expanding LNG system that we have at Gladstone -- and that’s what propels Santos into its new place. We’re going from a domestic gas company into an Asian player led by LNG and that is the really exciting proposition for the company I’m fortunate enough to lead right now.

SB: David, with PNG LNG now producing and producing cash, Gladstone scheduled to start up next year, you’re going to have a lot of cash to play with. I assume that Shell is going to want their own share of it. But are you already thinking about your next big project? And is it likely to be the Browse Basin?

DK: Well, it’s a good question. You’re quite right. In 2016 our cash flow potentially will double, all other things being equal as we bring these two massive projects on, and that will give us the opportunity to balance rewards to shareholders with growth. I think when it comes to the growth discussion, what we’re doing today is an indication of where we think the growth may be in the future.

Today we’re doing a very big well in the Browse Basin called the Lasseter well. It’s a very big exploration well close to our crown discovery, a very exciting well there. In the Northern Territory we’re just about to spout. I think it’s this Thursday we’re going to spout a well -- start drilling a well, that is -- in the Northern Territory. A deep shale well, and that’s extremely exciting.

And also in the Northern Territory we’re drilling a three-well program in Caldita Barossa. So, you can see that’s where we’re putting our future development or exploration dollars and appraisal dollars and that gives you some indication of the type of areas where we’re looking to develop.

SB: In terms of that northern gas, the offshore northern gas, do you see the most probably course as a kind of a step out from Darwin LNG? Or are you looking at, say, floating LNG technologies?

DK: Well, I think it’s a combination of both -- where clearly others have invested in floating LNG technology. We have one project that is looking at LNG as a floating technology as well.  But equally in the Northern Territory we are owners of the Darwin plant and there are opportunities there for expansion of that plant which is operated by Conico.

So, clearly there are opportunities for either floating LNG or brownfield expansions of existing facilities and potentially … well there is already a pipe from Browse that’s being constructed to come all the way in to Darwin. So, you can see there are a lot of options here available to us and to our partners to bring gas either through a floating system or bring it onshore and do a brownfield project and we will run those options in parallel as we go forward. 

The exciting thing is that we’re still finding gas in large quantities off Northern Territory and Western Australia and that’s very good for Australia.

RG: David, what the analysts tell us is that the cost of producing new fields in Australia is just way out of proportion to the rest of the world and Woodside are saying similar things to that. Are these projects that you’re looking at now, exciting as they might be, really dependent on some very big things happening in gas, so the high cost construction can be covered? And that’s our problem?

DK: Well, no, again I think you’re overplaying the hand there. I think if you were doing a brownfield expansion of Darwin, it’s very feasible for Australian expansions to be highly competitive. If we’re looking at the Gladstone project, if you look on a dollar per tonne basis, it will be tonnage that we’re all developing, but actually not bad on a global sense. 

And what we are seeing now, now that this massive wave of investment, $180 billion in the industry we’ve invested. Looking out the back of the wave in the last three years, two years to go for this investment. As that investment starts to come off, you’re going to see prices start to fall here in Australia for developments.

A number of factors involved in that, not necessarily labour costs but also the fact that we’ve just learned how to be more efficient in delivering these massive projects, that we’ve learned a lot from this world, our Australian contractors have learned a lot and the next time we do it, we’re going to do it better and I believe we’re seeing already, you know, when we’re going for the next tranches to work in our own Gladstone project, we’re seeing 20-30 per cent reductions for a very similar scope of work.

So, I am actually not a pessimist on this at all. I believe that going forward, provided we grasp the opportunities, we have good reason to be cheerful and that we will get the costs down and we will remain competitive.

AK: David, can I ask you, what’s your view of the long-term future of energy and in particular do you see gas…?  A lot of people see gas as a transitional form of energy towards renewable forms eventually, particularly in the context of the global moves towards some sort of emissions trading to deal with climate change.

DK: Yeah. You know, I think there are obviously five levels in this whole energy game.  You know, there’s how much coal, how much nuclear, how much gas, how much renewables and then how much you invest in energy efficiency measures. Those are the five things that you have to decide. 

And I think of those…Obviously I’m very closely involved in the gas and the oil business. Gas is unique in that it’s relatively low carbon footprint, about half of that of coal. It doesn’t use very much water when you’re in a power generation business. And above all, you can switch them on quickly.  You can switch a gas appliance on very fast. And therefore they’re a very good partner to renewables. Because you can bring a gas supply on quickly. It’s very good when basically the wind stops blowing or the sun stops shining. 

So, I think they sit extremely well together. The other thing that’s very good about gas is you can use it as a transport fuel. I think what you’ll see increasingly is gas will come into the transport mix, either for trains or big trucks and that will further reduce the level of emissions in both our economies but other developed economies around the world and I, for one, would believe that that’s a good thing if we can get our carbon footprint down and gas will play an important role in doing that in the medium to long term.

AK: In that context, what’s your position on the Coalition government’s policies on these things? Particularly with the declarations in Canada this week about, you know, that they’re all against emissions trading -- and then at the same time the United States seems to be moving towards that?

DK: Well, I support any policy that really sensibly allows us to conduct business, to do it competitively while seeking to reduce the level of carbon that’s going into the atmosphere. So, I support policies which allow us to stay competitive here in Australia, but equally continue to work on bringing the level of carbon down globally.

So, everything we do sensibly in that area I think should be encouraged and should be supported, and gas has an important role to play in that. If you look at North America’s emissions, it is quite extraordinary, but since they’ve started producing large quantities of gas, that country has done more to reduce global emissions than any other country in the world. And it’s done it through the substitution of gas into the generation mix and largely coal has been squeezed out.

AK: We’ll leave it there. Thanks very much, David.

RG: Thanks, David.

SB: Thank you, David.

DK: Thank you very much, everyone. Thank you.