KGB: Santos' David Knox

The Santos chief executive discusses why a domestic gas reservation policy is a bad idea and reveals how expensive it is to do business in Australia.

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

He is against reserving a proportion of gas for the domestic manufacturing sector because it would mean many projects would no longer be viable and gas reserves would stay in the ground instead of being developed.

Santos need the price of gas to lift from its current position around $4 to between $6 to $9 in order to justify drilling on projects in the Cooper Basin.

In terms of labour costs, Australia is roughly twice as expensive compared to projects in the Gulf of Mexico and more than three times as expensive in terms of the cost of building a small platform.

He does not believe he is personally to blame for the blowout in labour costs on many of Santos' projects.

There does not necessarily have to be a choice between the "gracious decline" of the resources sector and the manufacturing sector.

Alan Kohler: Well David Knox, you’re saying to manufacturers on the subject of the reservation policy that it will lead to a shortage of gas and the interference is bad in the market which is fair enough. But you’re really saying trust us; leave us to export and we’ll supply you as well. But the manufacturers are clearly worried about supply and price and you’re not providing them with any guarantees.

David Knox: Yeah. Look, what this is all about, Alan, is unlocking Australia’s gas resources and I do think North America is a good model because what happens there was that prices rose, they got out of the drilling rigs, they innovated really hard and then prices were forced down. Now, that is possible in Australia. We’ve got to allow it to happen. If we don’t allow it to happen, then frankly I think that’s what we call resources, they will remain resources, they will stay in the ground. What we need to do is bring in the innovation, bring in the technology, get the holes drilled, do it sustainably, do it safely and that will help us start to drive prices down. Now, it’s going to be a tough road. This is not going to be easy, but we’ve got to commit ourselves to doing it. The alternative is to reserve gas in the ground in which case it is going nowhere because we need price in order to allow us to do economic investments.

AK: I don’t think anyone wants to reserve gas in the ground. I mean the US is clearly prioritising jobs and President Obama is not allowing any exports at the moment. All the gas is going to US manufacturing.

DK: And to President Obama obviously we believe he is going to allow limited exports. So far one terminal has been approved which I think is a sixteen million tonne export terminal. I think the consensus is that they’ll probably allow five to ten per cent of the US domestic market to be exported. And yes, that will have an effect on global LNG sort of markets, but it will be on the margin in my opinion. But yeah, he is allowing exports to take place.

AK: No, but the point is he is prioritising domestic jobs and Australian manufacturing is in deep trouble. The last thing they need is a shortage of gas.

DK: Well, I agree with you. Absolutely we need gas in Australia, but the way to get gas in Australia is not to restrict prices or to keep it in the ground. If you do that, Alan, then we won’t get gas in Australia. Just think about my own company and Moomba. Moomba, in the Cooper Basin, has been around for forty years. Basically that was a declining business, a declining business until we started the potential of having an export linked pricing in Queensland which we now have. That now means I can invest in the Cooper Basin and we are doing so. We’ve bought three brand new rigs over the last 18 months. We’re just about to contract for another two or three brand new rigs. We’ve done the shale gas with extraordinary result in the Moomba 191 well. None of that would have happened had we not been able to link our product, which in this case is methane or gas, natural gas, to the Asian export markets. We wouldn’t have been able to achieve it. So, what we’re doing is unlocking the resources and that’s what Australian manufacturing requires.

Robert Gottlibesen: David, what approximate price do you want in the Cooper to justify the drilling?

DK: We’ve said it’s at $4 basically, then the business is, broadly speaking, in a gracious decline, but at $6 to $8 dollars, $6 to $9 dollars, then we can absolutely invest, grow the business, grow the jobs, grow the wealth and ultimately secure Australia’s future. And, as I say, talking about North America and using that as a model, potentially if we do this well, ultimately we’ll drive prices down as we really unlock the resources at scale.

RG: But in America they’re producing gas profitably at four dollars, so that’s half your top price in Australia. So, you’re saying that at least for quite a while we have to pay twice the American price.

DK: So, clearly the American market is blessed with huge amounts of infrastructure. It’s a much larger market. It’s a growing market. So, clearly they do have a different pricing point. You know, right now and this is an absolute key thing, as I’ve been saying, to employ a construction worker in the Gulf of Mexico, say it costs $50 an hour right now; to employ that same construction worker in Australia costs about $100 an hour, so their costs are much lower than ours. Now, what we need to do is bring in that technology, and it’s very much what Santos is doing; learning from the Americans, bring the technology, learn how they do it and then really start to drive costs down. And that’s really our ambition and our vision for the future. And by doing so, we’re going to unlock these gas resources, but it is not an easy road. It needs, as I say, team Australia to play. It needs the energy industry to join forces. It needs governments to join forces. And obviously we need to have the labour force in which to deliver this.

Steven Bartholomeusz: David, before we leave this micro topic, if I remember correctly in the US originally before the shale gas revolution, prices were around about 10 bucks per molecule and that then ignited lots of drilling activity. Are you saying that that is the pattern we need to see here?

DK: Yes. They did in the States go up to 10 and at one stage they went even higher and then they came down as the rigs came up. We don’t need 10 dollars. As we’ve said, we need the exposure to Asian export pricing. Relatively in Australia it’s $6 to $9 right now. So at those prices, as you’ve seen, a company like mine can really invest and that’s exactly what we’re doing. And, as I say, we’ve brought in the rigs. We’ve had the success with the shale well. Let’s just be clear – it’s very unlikely we would have been able to economically justify to our shareholders to start spending money on that shale well if it hadn’t been for the higher gas prices. We can now look forward to it.

SB: Prices are only one side of that equation. Costs are the other. Where are we on the international cost curve at the moment?

DK: Well, as I’ve been saying, the cost of an hour’s labour in Gladstone right now is, let’s say, $100 an hour. That same hour’s labour in North America and the Gulf of Mexico is about $50 an hour. So we’re about twice as expensive as the average labour cost in the Gulf of Mexico. When you look globally at the cost spaces, if you want to build a platform or a small platform in the Gulf of Mexico, let’s say it costs $100 just to use a number, in Australia, then that same platform would cost $330. So, it’s an extraordinarily expensive place to do business. We need to build the scale. We really need to bring in the skills. We need to innovate. And we need to drive those costs down. Otherwise, we’re not going to be competitive and we’d love to be competitive.

AK: David, Martin Ferguson says that the costs blow out here because everyone, including you, took your eyes off the ball. Is that fair?

DK: I don’t recall Martin saying those words because I think Martin and I are very much on the same page here.

AK: He said those words to me on Inside Business over the weekend.

DK: Yeah. I think Martin is really pushing the fact that we need to get cost competitive now and in order to do that Martin is right. The industry needs to play its part. It’s not just about government and regulations etc. albeit that’s important. The industry needs to play its part. We need to get better at collaborating. We need to join forces. We need to do it sensibly. And we need to all seek to drive our costs down. The third thing that perhaps that needs to happen is we need to allow the service sector to really innovate. We need to attract them into Australia. We need to build the size of that service sector and the beauty of doing that is that will also allow us to export those skills and services as we go beyond just the current LNG sort of revolution that we’re currently experiencing.

RG: David, I think it’s sort of time to sort of stop the sort of general talk. You are personally responsible for a big portion of the rise of those labour costs. You and the Gorgon CEOs and the CEOs of all our LNG groups signed stupid deals with the unions – absolutely stupid – and the costs escalated. It’s not the unions you blame – it’s the bad CEOs.

DK: Yeah. We ourselves of course use Bechtel as our main contractor in Gladstone...

RG: No, you can’t put it off. You allowed Bechtel to do stupid things and you’ve got to take personal responsibility.

DK: I don’t think we have done that. We’ve had an excellent relationship with our unionised staff from the Cooper Basin over a very long time of forty-five years. I think the deals we’ve done there are perfectly superfluous. They’ve served both sides well.

RG: But not at Curtis Island.

DK: So, I frankly disagree with you in my particular case. I think we haven’t been doing that at all. And I can’t comment on what’s happening in the west because that’s not my area. But certainly in our business and working with our own staff and the contractors who work for us in the Cooper Basin over the last forty-five years, we’ve had excellent relationships and frankly that’s delivered good outcomes for us.

RG: But not at Curtis Island that didn’t happen and it didn’t happen in the West.

DK: But just again to interrupt, In Curtis Island a union deal has been signed, agreed by all that runs right the way through the three projects on Curtis Island, obviously signed by Bechtel who are building the project. It’s been done through negotiation and I don’t agree that that’s a bad deal at all. But it does of course reflect that you need to attract labour onto your projects. So yes it does reflect that there is a high cost, but that’s just to attract them.

RG: It’s not the costs that are the problem. It’s the work practices. The costs are one thing. It’s the work practices that were agreed to.

DK: Well, in our particular case I don’t think our work practices that we’ve agreed as announced on Curtis Island are at all unusual in any particular way. Obviously staff have to commute – a number of staff have to commute across the Bay. The accommodation is of a very high quality, but it needs to be if you’re going to live there for four weeks every five. You want to provide good accommodation. So, actually I don’t think our work practices are out of order and we haven’t agreed to motelling, for example. I don’t think that’s appropriate. But overall we’ve got good relations through obviously the Bechtel who are managing this with a staff who are operating Gladstone. So, actually I disagree with you on this when it comes to Gladstone and I disagree with you when it comes to my own company, Santos. I think we’ve been quite responsible in the way we’ve worked with the unions and frankly I also believe the unions have been quite responsible in the way they work with us.

RG: So, Cooper Basin, I’m agreeing with that. That’s right. It was Curtis Island and the west that I was referring to.

DK: No, no I can’t talk to the west because really our only operation in the west is on FPSO, so there we’ve had good relations. We haven’t had a problem at all.

SB: David, as we’ve just witnessed, there’s been a lot of focus on labour costs in the discussion around cost inflation in the sector. The currency has been a real issue, hasn’t it? If you look at Curtis Island, a large part of the inflation in US dollar terms has come through the Australian dollar. How big an issue is it for you?

DK: That’s right. It has. If you were a US company with US revenues or a US dollar company with US revenues, it is a real challenge, especially when you take into account the high cost of labour. For Santos, it’s much less so because we earn US dollars, we earn Australian dollars, we have deposits in both US dollars and Australian dollars, so we’re in a good position in fact to almost eliminate completely the currency fluctuations to our own shareholders, but it doesn’t apply to all the investors in Australia and it’s an issue for people investing in Australia, but of course an even bigger issue probably is for the exporters from Australia which I think is a real concern.

SB: If the currency stays where it is and we can’t reign in the cost inflation generally, what happens to the economics of the 170 billion that’s already in the pipeline and the 230 billion that might be developed?

DK: The economics are influenced by whether your account’s in US dollars or in Australian dollars, but principally in an ideal world what will happen is the US dollar will strengthen as we go into production because our revenues and the product in this case are basically priced in US dollars, so in an ideal world the US economy will strengthen relative to the Australian dollar from sort of 2015/16 and beyond. That would be perfect for us. If it remains the same, our produce is still economic, you know, very good economics, but obviously they are influenced really by two important things. One is the exchange rate. And two of course is ultimately our price. And those two factors are the biggest influences on final economics.

AK: David, you mentioned before that if you were to get four dollars for your gas, that would lead to the gracious decline of the industry in Australia and that you need sort of six to eight or whatever it is dollars which obviously is, as Bob pointed out, twice what the price is in the United States. I mean just stepping back a minute, do you think that given those price differentials and the exchange rate issue, that Australia needs, or is going to have to decide between the gracious decline of the gas and resources industries and the gracious decline of the manufacturing industry?

DK: Well, it’s certainly not my vision or aspiration. I think we can be successful in both areas if we are smart and do it well and do it thoughtfully. We have the opportunity to unlock the extraordinary resources in Australia. We can do that. We’ve got to bring in the technology. We’ve got to do a lot of learning ourselves and we’ve got to bring in the skills. By doing that, we can supply the Australian manufacturing business with reasonably priced gas to allow them to be competitive. I think we can do this, but let me say this is not an easy road to go down. Team Australia needs to pull together if we’re to pull this off. It’s a very competitive space we’re in. Asia is, as we’ve said, is growing. It’s growing extremely hard. And we can play our part in that. We can get onto the field of play and we can be successful.

AK: But what do you mean by team Australia? What does that mean?

DK: Well, I think Minister Ferguson is a very fine example, as is the Opposition in the energy space, Ian MacFarlane. They’re fine examples of good ministers who work with the industry, who also can work with the labour force as well. They can bridge that gap, pull us all together and make sure that we do deliver things efficiently. And, you know, for example, there are opportunities for us really to collaborate right now in Gladstone. We are all talking together in order to see if we can lower our cost base. I think that’s all absolutely sensible. As I’ve said publically this morning, there are opportunities for us to collaborate in the Cooper Basin. There is infrastructure in place. It’s operated by Santos. There are opportunities for others to bring their gas and oil into that infrastructure.

AK: Oh, you mean a producer cartel.

DK: Well, no. These aren’t cartels. These are opportunities for us to use the infrastructure we’ve got; the pipelines, the kit on the ground which is billions of dollars’ investment to facilitate other investments which otherwise would just not have been economic. This has occurred in the North Sea, it’s occurred in the Canadian Oil Sands projects and I believe it can easily occur here.

RG: You’re saying basically our existing pipeline infrastructure can be used better and increased on the margin rather than to have to put new pipes in.

DK: Yeah. It’s not just the existing pipeline infrastructure. It’s facilities such as the Moomba area, such as the LNG plants that we’re building in Gladstone. These are things that can be used to maximise our productivity of Australia and we should do that. We should take the opportunities when they arrive.

RG: One last question. Are you concerned globally that when the US replaces Middle Eastern oil and gas or essentially those, that Middle Eastern oil and gas will come and supply and offer its services into Asia and our markets and depress the price?

DK: Well, just on oil itself, it does appear that North America, Canada and the US could potentially be oil independent by 2025. That’s completely extraordinary. And gas, they’re already supplying a very large percentage and more than ninety per cent in the US for their market from indigenous US gas. As I’ve said, I believe that the US will export between five and ten per cent of gas into the global LNG market. That will be about ten per cent of the global LNG market at maximum. It will have an influence, but it won’t be the only factor that will influence the future. I think the key things for us here in Australia are we must be cost competitive, we must continue to be able to deliver gas into Tokyo Bay at a $100 oil, less than $14 dollars and still make money. And if we can do that, then we’ll be successful.

RG: But what if we can lose it? What about the Middle East, that huge amount of oil and other energy which was going to the States will no longer go there and will come onto our market? That’s surely going to depress prices.

DK: So, I’ve just listened to the head of the IEA talking about that and what is remarkable, almost frightening, is the scale of the increase in energy demand, in particular India and China, particularly China, especially oil, so the reality is while I’d like to think there’s a lot of oil in this world, my personal believe is that oil supply is going to remain tight and potentially tightened as we go forward over the next twenty or thirty years. I think, even today when the world’s economy is slowing down in developed countries, we’re still seeing oil prices above a hundred dollars. It really concerns me is what will happen when the western developed economies start to really find their feet again is what will happen to oil prices. I think that’s the major concern and not the reverse.

SB: David, you referred earlier to the significance of the oil price. We’ve already seen the Japanese buyers trying to get the gas price delinked from oil. What would happen if gas were priced on its own as opposed to being linked to oil?

DK: Yeah I think this is a really key issue: is there another model for pricing LNG? Obviously a lot of the suppliers or the buyers are seeking to get some Henry Hub component into their portfolios. I think that’s sensible. But I believe that that will be a relatively small component of the total wealth supply and therefore of their portfolios. Oil link pricing has served us well, both as producers and as buyers and my personal view is it’s likely to continue. Not entirely, but a large amount will remain oil linked and the reason is because if you’re a buyer in Tokyo, ultimately the key thing you’ve got to drive is security of supply. And the way you drive security of supply is that you know that the molecules are in the ground, you have an involvement in those molecules and you basically have what we call tramline contracts, which go from those molecules into Tokyo Bay and the way, the best way to serve that has been through an oil linkage with the producers taking the oil price risk in that equation and that’s worked well.

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

RG: Thanks, David.

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

SB: Thanks, David.

Follow @AlanKohler on Twitter

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free