KGB Interview: Woodside's Peter Coleman

Woodside chief executive Peter Coleman tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz: 

– What the miner's opportunities are in Israel.

– The current cycle of rising costs in his sector can only be broken with new technology. 

– To what extent project cancellations have strained Woodside's relationship with the Western Australian government.

– What effect the US shale gas revolution will have on LNG pricing. 

– His views on forced reservation of gas for domestic use.

– That it's export opportunities, not domestic prospects, which drive global gas development.

– Woodside expects to hold to an 80 per cent dividend payout ratio for the next few years.

Alan Kohler: Peter, welcome to Business Spectator. Thanks for joining us.

Peter Coleman: Good morning. Thank you very much.

AK: Now Peter, now that Pluto is in full swing, obviously you’re producing a lot of cash now and also your cash reserves are very high, $1.8 billion, and your gearing is down 26 per cent. So, the question is: what are you going to do with all the money?

PC: Well, that’s a good question and that’s a good intro. It’s really a testament to our capital discipline that we have. Yes, year-on-year production numbers are up just on 22 per cent. A lot of that is due to Pluto, but also we’ve had some excellent cash management along the way. Our profit is up. Debt is down. It’s almost half. Our gearing ratio is down. It’s actually about 13 per cent. And our cash and available cash have almost doubled. That provides a lot of opportunities for us.

We announced what we’re going to do with the Browse project or at least how we’ll take that forward to the joint venture partners. But that’s still long days; that’s a 2015 final investment decision.  But we’re also returning a lot of dividends to our shareholders, so we announced an increased payout ratio earlier this year, so we’ve increased our dividend return by just on 30 per cent or just under 30 per cent compared with last year.  So, we’re getting that cash back to shareholders pretty quickly.  We’re not sitting on it.

AK: No, but when do you think you’ll be start paying cash out for Browse? That won’t be until 2016 or so, will it?

PC: Well, we managed with the floating LNG concept that we have for Browse and you may recall we announced in April of this year that we’d struck an agreement with Shell to be able to leverage their floating LNG technology. The real advantage of that is a lot of the upfront expense has already been made by Shell and the development of that technology over time. We really won’t see significant cash outflows starting probably till 2015, 2016.

Robert Gottliebsen: Peter, your shareholders are petrified or some of them are that you’re going to take a big slab of that money and gamble it in Israel.  You’re not going to do that, are you?

PC: Absolutely not. And of course what you’re seeing with us, we’ve been very patient with Israel to make sure…

RG: But don’t put any money there at all. If the Middle East blows up, you’ll blow it. That’s a very dangerous thing to do. This is an Australian stock with Australian assets, a secure political situation, and you’re going to take some of that money and instead of giving it to the shareholders and put it in Israel.

PC: Well, we think we’re investing it very wisely. If you look at the Middle East region, Israel itself is very stable. If you look at the development concept we have and of course we’ve looked at the security situation very, very closely, it’s actually one of the lower risk concepts we could have. Now, I think more importantly if you have a look at the asset in Israel and the opportunity there, Leviathan is a world class asset by any measure. Companies not like Woodside need to be able to develop business models that we can access world-class assets. That’s what we’re about in Israel. I would remind everybody, though, we haven’t paid anything yet to that entry. We need clarity and certainty around the export policies that Israel will have and we need to finalise some things in the agreement with our joint venture partners.

RG: How much will it cost you if you do go in?

PC: We’ve told the market it will cost us about $696 million on an upfront payment. We then have some conditional payments. Again, we’re managing that potential risk through a milestone payment. Those milestone payments are actually based on achieving something. They’re not time-driven. It assures us again that we’re not risking it all upfront; we’re making sure that we make the payments when we can actually realise its value.

RG: But once you put the money in, it’s hard to pull back. A large amount of your cash is in fact really going along the way to earmarking it for Leviathan.

PC: Well, if you look at Leviathan and you look at the size of the entry, it’s quite manageable for Woodside in both our cash flows and our debt profile going forward. We changed our business model last year. We completely revised our strategy and we looked at a couple of things to try and manage this sort of risk as we were making country entries around the world. 

The first thing we looked at was to make sure that we team up with a very reliable and prudent operator and the operator at Leviathan has been there ten years. They’ve demonstrated very clearly that they’re able to work and develop projects quite profitably within Israel. That was an important thing for us. The second part was: how much equity do we take? We’ve learned over time that taking big swags of equity in projects over long periods of time does lock up capital. Leviathan is at 30 per cent.  It’s material. It’ll make a difference for Woodside, but it’s not going to lock up cash for a long time for us. 

Stephen Bartholomeusz: Peter, can we get back to Browse for a moment? Did you look really hard and long at onshore processing at James Price Point before you decided that it’s un-economic?  Can you tell us what the major cost elements or issues were that drove that conclusion?

PC: Well, there are two parts to James Price Point. The first one is we did work long and hard on it. We worked for just over four years on the current concept and spent almost $1.8 billion as a joint venture on getting to the point where we could make an informed decision on commerciality. We made that in April of this year. Unfortunately, we couldn’t we make James Price Point commercial. It was just too expensive and too long-dated and there was just too much risk on the execution side of it. So we needed to turn it around. We have been looking for some period of time at alternative technologies. Alternative technologies or technology growth is a key tenet for Woodside as we move forward. 

We believe this current cost cycle that we’re in can only be broken through changes in technology. So, we moved forward very quickly into floating, but we’d already done a lot of work in understanding floating technology and the risks around that. We’re pleased because what it does is it offers us early is commerciality. It gives us early entry into what we think is the game-changing technology for industry. And, just as importantly, it allows us to manage the capital risk as we go through.  We get bite-sized chunks of this and we get to learn as we go along the way.  

SB: Given that cycle of escalating costs that you’ve referred to, are we ever going to see another greenfields onshore LNG plant in Australia?

PC: Look, it’s really difficult for me to predict that. It’s going to be a function of the offshore component of it, how close it is to shore, how large it is and so forth. All I would say is the cost structure is a difficult one and it’s a difficult one because of things that are very important to Australians and to Australian culture. It’s making sure that we do manage the environment appropriately. It’s making sure that we do interact with communities appropriately. Making sure that we have a sustainable development project over the long term. When you weave all of those things in, it does affect cost structure for us, but they’re important things, so they’re things you can’t walk away from and things you can’t compromise. That’s just says you need to get your best minds at work to say ‘OK, guys how do we unlock this? How do we break this cycle that we’re in?’ Because if we keep doing what we’ve been doing, these projects won’t go ahead. We’re in a cycle here where the cost escalation has got to a point where you’re seeing it. The first of the projects, being Browse, didn’t go ahead. You’re seeing expansion as other projects now being deferred. So, this is real. This is real. This is not somebody forecasting something. Real decisions are being made in boardrooms today about projects and we as an industry need to apply the very best technology and the very best minds to it.

SB: So, is that process here reversible or are there things we could do to reverse it?

PC: I think the process will balance out over time. But I think, you know, what you’ll find over time is we’ll get off the back of this current cycle of projects which is driving costs up. There is some inflation in cost due to market demands. There are also some inefficiencies that are currently in the processes because so much work is being done at once. I think once we get off the back of that and we all have time to pause, we’ll be able to pull some of this cost structure down. We ourselves at Woodside have already spent some time on what we call lean construction technology. That just applies to the LNG plant. We believe we can get about 20 per cent reduction for lean construction technology, but even that wasn’t enough to get us across the line at James Price Point.

AK: How much damage did you do to your relationship with the WA government? I mean they don’t seem to be getting over this in a hurry. They’re still quite upset.

PC: Well, I think we share their disappointment with respect to James Price Point. We’ve probably had a little longer to think through all of the issues with respect to the commerciality and how that was going to play itself out. So, I expect over time we’ll get back together with the WA government. We’ve had an excellent relationship over many years. We’re very committed to WA. We’re very committed to making WA a smart state. So, what we’re really looking for is, let’s move technology to WA. Let’s take advantage of this $90 billion of expenditure that’s happening in the oil and gas industry at the moment. And let’s make sure that we develop a lasting legacy in this state that eventually we can use either on Australian projects or export it.

AK: Yeah, but they seem to be mad at you. They’re not just disappointed.

PC: Oh, I wouldn’t say that. I would say they’re expressing disappointment. They’re expressing natural disappointment. We’ll work through the relationship. It’s a very strong relationship. As you know, from time to time relationships become strained, but the strength of the relationship is still there.

RG: Peter, we saw with Gorgon, where the management signed very bad labour agreements with the help of the WA Chamber of Commerce, and that contributed substantially to their cost blowouts, do you think the restoration of the possibility of erecting LNG plants on mainland Australia will require a completely different approach to labour agreements to Gorgon?

PC: Yeah, I look I’m not intimately familiar with these Gorgon agreements. What I can go back and look at is the Pluto agreements and what we were able to achieve with those at Pluto. We achieved a labour downtime rate of less than one half of 1 per cent at Pluto and working through the proper processes in that regard. So, we actually like to believe we’re a preferred employer in WA. We have historically had a very good relationship with the unions and, more importantly, with the workforce. So, you know, without looking at the details of agreements and so forth, I’d look at it more holistically. I’d say this challenge is more than simply a labour relations agreement – there’s more a planning, a logistics, an execution issue. That then is exacerbated by some of the labour agreements that we have.

RG: Are you saying Gorgon was really a one off, but that you can do deals that make sense? You don’t have to go down the Gorgon route.

PC: Well, again I don’t want to get caught in making comparisons with Gorgon. What I would say is, you really have to spend the time to get this right up front. If you don’t spend the time to get these agreements right up front – and as you need to spend time to get your logistics right up front, as your execution planning and so forth. If all of those things aren’t absolutely perfect up front, given the size and complexity of the projects that we’re now executing – and remember these projects are unprecedented in Australia and almost unprecedented in the industry – you know, there are less than 10 of these sorts of projects globally running around; there’s not a depth of knowledge and experience with people executing these projects and putting that planning together, so I would say that the reflection that industry has is ‘wow, we can’t do the same thing again, we can’t do it the way we used to do it, we really need to take the time to step back and to think about it and think about it long and hard’. There’s an old rule in projects: you don’t start before you’re ready.

SB: Peter, looking at your presentation this week, you don’t seem particularly concerned about the potential impact of US shale-fed LNG hitting your markets. Could it have a material impact on prices or more particularly could it have an impact on the way LNG is priced?

PC: Well, there are probably two impacts of that. Firstly, the impact of US shale gas is quite clearly improving productivity in the US and making the US actually a more attractive place to invest, particularly for some industries around chemicals and plastics. And so, those energy intensive industries are actually moving back into the US and will soak up some of that excess supply. The supply that may get into LNG , and remember there’s not very much that has actually gone to FID yet …

AK: Sorry Peter, we’re getting some static.

PC: Yeah, so I was saying, the shale gas industry and the surge in gas available and into the US has really made the US attractive as an investment destination for those industries that are very energy intensive or turn gas into something else, being the chemicals and the plastic industry. The gas that’s left over and, you know, the gas that will be exported, you know, there are a couple of things there to consider. Firstly, there are a lot of projects at the moment on the drawing board. Not many have gone to a final investment decision. When you look at the total cost structure, the landed priced into Asia will be competitive but it won’t be low cost by any means. So, the headline price of $4 gas hitting Asia is just simply untrue. Now, the price is going to be in the low to mid-teens and it doesn’t really take very much of a rise in gas prices in the US to in fact make it marginal to uneconomic. So, I think that we a balance will occur, and an equilibrium point will occur, within industry within the next five to 10 years. What does that mean? There’s going to be an evolution in the market. The market is already evolving to become a more fungible commodity. I see trading hubs will be established. True training hubs will be established. Will that be in Singapore, Shanghai, Hong Kong? I can’t say, but Woodside is preparing ourselves for the advent of trading hubs. So, all of those sorts of things will come into play. The consumer is starting to see. You’re starting to see a proliferation now of regasification terminals being put into Asia. As many terminals that as currently exist are now being built in Asia, so there are 40 currently underway. So, clearly the buyers can see that the market is changing. It’s becoming more commoditised. Henry Hub gas just simply puts another gas stream into that. I wouldn’t see Henry Hub any differently from gas that’s going to come out of East Africa or other parts of the world. It’s just another gas stream that’s going to come in.

SB: The growth of that shale gas industry in the States has ignited a debate about reserving for domestic purposes.  We have a similar debate in Australia.  Have you got a view?  Because you are actually subject to some reserve in Western Australia.

PC: Well, firstly I respect governments’ rights to reserve domestic gas.  I think the issue here is are you reserving molecules or are you trying to control price or manage price over the long term.  The US has an open market.  You know, one could argue one of the reasons that you’ve seen shale gas take off in the US is because there is no domestic obligation – although currently there’s only a domestic market in reality, but the fact that people now have an expectation into the future that they’ll be able to export is a real positive for that market. I would suggest quite strongly that a number of the projects in Australia would not go ahead unless there was an export component to it.  So, we are actually enjoying low domestic gas prices today because major export projects have been built and those domestic gas projects have hung off side. We often get this conversation the wrong way round. Domestic gas projects don’t drive development.  Export projects drive development.  Domestic gas projects are then complementary to the export projects. 

AK: Right. So, you’re saying that it’s export trade figures that actually create the domestic supply?

PC: Absolutely. You need the export project to sink the huge amounts of capital that are required to get the returns that you need.  The domestic gas projects then have the advantage that their cost structure then is much lower and you’re able to afford lower prices going into the domestic market. 

RG: Peter, the other big increase in potential supply is from the Middle East. We’ve talked about before the uncertainties in the political situation in that region, but if it was to settle down would we not have a second big increase in gas supplies from Iraq and places like that?

PC: Well, there are a couple of components to that. The Middle East post Fukushima – and of course with the downturn in imports in the US – has now redirected supplies to Asia. So, a lot of the uptake you saw in the marketplace or the increased supply coming into the marketplace post Fukushima came out of the Middle East.  That supply was originally designated to go into Europe or to the US. 

What we see happening over time is that supply will eventually get redirected back to Europe as Europe fixes up its economy. So, in the next five to 10 years we see that supply getting soaked up into Europe.  Now, with Iraq and others coming online, you know, it’s a long time before we even consider LNG coming out of Iraq. Egypt is only producing small quantities of its LNG capacity.

I think what you’re seeing actually is a fundamental change within the industry. Historical suppliers of LNG, whether it be in the Middle East or whether it’s actually here in Asia, whether it’s Malaysia, Indonesia and others, are actually now into significant decline. Those historic suppliers to the market place are actually now redirecting that LNG into domestic refinements – and you’re seeing that both in Indonesia and in Malaysia. So, actually, there’s another market demand, another market dynamic occurring there.  It’s not just simply ‘what’s the top line number for energy demand?’ It’s energy mix and then it’s also the fact that some of these LNG supplies have been redirected for domestic use.

AK: Could you just clarify what your development pipeline looks like now? I mean I guess Browse is next, but what comes after that?

PC: Well, we’ve got a few things in between on Browse. You know, Browse is really the signature project for us because it’s the largest undeveloped resource that we have and it provides now a technology and a development platform for us for the next ten years or so as we go out.  So, you know, we’ve got Browse now down into what we call kind of nice bite-sized chunks of investment and each part of that investment will be a separate investment decision for us. 

Prior to that we had some near term things that we’re doing around our Laverda resource.  That’s a hundred million barrel plus resource, so that will be oil and gas.  We’re also looking at monetising some of the North West Shelf resources as well. So, we have a number of things in the near term and as I speak longer out as well for us. So, you know, I think we’ve got a pretty good development pipeline.  In the meantime of course what we’ve been doing is returning dividends to shareholders. So, we’re generating a lot of gas, getting ourselves in good shape and getting it back to the shareholders.

AK: Do you think you’ll be able to hold to an 80 per cent dividend payout ratio?

PC: Well, we think based on our current capital forecasts we’ll be able to do that for the next few years. Those capital forecasts included Browse in it, so the announcement this week of moving forward are on a basis recommending that to the joint venture.  That already included those capital plans.

RG: What are the things that are disrupting your business right now? What are the immediate things that are causing the most difficulty?

PC: Well, there are two parts to that or two parts to that answer. The first one is US shale gas. It’s causing a disturbance in the business more from the point of view of uncertainty with investors. They’re trying to work out what this actually means in the longer term. You know, we’re quite confident because we know what’s in the contracts and we’re dealing with the buyers, but it is causing uncertainty with investors and they’re asking lots of questions. 

The other concern that’s in the business is our cost base. Our cost base has got to a point where we’re having to pause on a number of projects. And what it’s actually doing is, it’s allowing a number of other resources around the world to now be competitive, you know, in places that have higher political risk, have higher security risk and suddenly these places now are looking more attractive to invest. You know, that’s a break in the equilibrium and that’s something that’s disturbing us at the moment.

RG: And how do you adapt to those situations?

PC: Well, we’ve got to fundamentally change our business model and that’s what we’re doing. We’re developing capabilities and capacity in house to be able to deal with that. We’re a believer that opportunity lies where uncertainty is and so we’re changing the culture of the organisation, so that in fact uncertainty becomes a welcome visitor to our door. That means as these perturbations occur within the market, Woodside though would take early advantage of them.

AK: Thanks very much for joining us, Peter.

PC: Thank you very much.

SB: Thanks, Peter.

RG: Thank you, Peter.