Origin Energy chief executive Grant King tells Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:
AK: Well Grant, Australian industry, particularly manufacturers are getting quite anxious about gas supplies in the future. Have they got something to worry about?
GK: So, I think it’s actually true to say that gas prices will go up at what we call an ex-plant level, so you buy gas from a gas plant ex-plant, the price of that gas will go up. Depending on what sort of user you are, whether you’re a customer in a house or a small business or a major customer…
AK: Or a manufacturer of fertiliser perhaps.
GK: Yeah. You’ll feel quite different because the delivered cost of energy to households, of course, has all those network costs embedded in it and I don’t think you’ll feel much of a change at that level. It will go up, but not all that much.
AK: That’s right.
GK: Just say that if you are a wholesale buyer of gas for, say, power generation or a very large user of feedstock for example, you’ll see quite a significant increase.
AK: So, what is the clearing price of gas to get the supplies that industry in particular requires? What will they have to pay?
GK: So, the general belief between say 2014-16 as the LNG projects in Queensland come on mine, the prices will move somewhere near export parity, somewhere in that $7-8 range is a number that people typically talk about.
AK: How does that compare with what it is now?
GK: Wholesale prices have already moved, but compared to say two years ago, so they’d, say, give you a five-year view, you would have said say $3.50 to $4 two years ago, so prices have moved.
AK: So, doubled? Will double?
GK: So, over about a five-year period, the wholesale cost of energy, that is the ex-plant cost, will go double.
RG: Now, if the ex-plant cost doubles, what will that do to the supply? Well, first of all, have we got a shortage of supply?
GK: Right – I think it’s a very good place to start the discussion, actually. So, if we go back to the mid-1990s we only talked about conventional gas. Our main sources of gas in eastern Australia were the Cooper Basin and the Gippsland Basin. There have been no major discoveries of gas in those basins in the last 15 or 20 years, or any other basin for that matter, conventional. So, gas wasn’t in decline in a production sense, but in a reserve sense it was clear in the mid 1990s eastern Australian gas was in decline. And some of you and some of your listeners might recall that in fact even in the early 2000s, we were going to bring gas down from New Guinea because we didn’t have enough gas here.
Now, I can assure you that the key point there is that we would be paying those prices for our gas today if we hadn’t seen that the right response occurred to those higher prices which, of course, people risked money, explored particularly for CSG, and resources expanded dramatically in terms of the return available through gas price. So we do not have a supply problem. People will not run out of gas. It will not be a lack of gas in eastern Australia for anyone anywhere. But we will see prices move to the true value of that gas in the same way as we pay a national price for petrol or for iron ore or any other commodity that Australia produces.
SB: Grant, there are some conflicting strands to the story out there and the conventional view is that your plants in Gladstone and come on stream that the price will rise because of the access to the international price, but equally there’s a view that the US shale gas revolution is going to push some of that gas into our markets, putting down the pressure on the international price and therefore on domestic prices. How do you see that playing out?
GK: There’s been a lot of discussion about that. The US clearly has got a bountiful situation in respect of gas through much the same phenomena. Their prices were very high. People explored, figured out how to fracture shales and now they’ve got an enormous amount of gas and the price is falling. They will be exporting eventually. A number of plants have already been approved for export and some more almost certainly will be.
The general view is that the volume of LNG that will come out of the US will not fundamentally disturb particularly the Asia Pacific markets in terms of volume out of the US versus size of market. That’s the generally held view in the industry. So we’re not expecting that that supply of gas from the US will create, if you like, a step change or a huge reduction in the net back price of the gas to Australia or any other producer in the region for that matter.
SB: Even if the starting point is going to be the Henry Hub price?
GK: So here’s a very quick analysis. The opportunity in the US isn’t that the gas at Henry Hub is cheap because there’s a certain amount of gas in Australia that you can produce at the same price. The opportunity in the US is that there are stranded import facilities with storage tanks and walls that are now stranded because they’re not importing and therefore if you turn them around, the capital cost of producing energy is less by the amount that you can recycle those facilities.
So the disruptive opportunity in the US is those stranded facilities being turned around. Now when we look at these facilities they still have to have LNG plants built in front of them and those LNG plants are just the same as the cost to build an LNG plant in many other places in the world, maybe a little bit cheaper in the Gulf Coast of the US, and therefore still billions and billions of dollars. So the disruptive event isn’t the gas – because there’s lots of gas in Australia that can be economic at a price as well – it’s the ability to turn those stranded import facilities around at a lower capital cost and produce the LNG more cheaply, and that opportunity is limited. It’s not limited by the gas resources, it’s limited by the number of export facilities that could be economically turned around.
RG: But Grant, isn’t it a deeper story than that? Because what you’re seeing is the US becoming virtually independent of oil and gas from the Middle East and the rest of the world, and that’s going to cause surpluses of Middle Eastern gas and oil that wouldn’t otherwise be there.
GK: I think again that’s a very good observation. The US is the only place in the world where gas, in a sense, has fundamentally disconnected from oil. So in Asia Pacific obviously gas in the form of LNG is linked to an oil price index. I don’t think I’m expert enough to offer a view on the trajectory of oil prices. It is right to say that most of the increases in production have come out of the US and the US oil story is a phenomenal story in terms of moving towards self-sufficiency, but at the very same time, oil is still sitting at about $US106 today a barrel, knowledgeable of that change, so it’s not feeling disruptive in the way that people might envisage.
AK: Grant, the quota you’re talking about, price versus volume and so on, fine in a pure sense, but of course it’s not pure. What you have is a lot of emotion, particularly in New South Wales and the Hunter Valley, about the access to land for coal seam gas in particular. What impact do you think that is going to have on supply, if anything?
GK: Let’s work backwards in answering that question. It is right to say that the establishment of LNG plants in the east coast of Queensland will pull gas towards them and that’s what will drive the movement towards export parity for gas, but at the end of the day that gas is going to be produced in Queensland and imported to Queensland through pipelines, but there’s a natural constraint. Those pipelines can only deliver a certain amount of gas, and it’s therefore right to say that if supply can be increased south of that constraint, then if supply exceeds demand, you could see a downward pressure on price, south of that Moomba-Wallumbilla pipeline. Now, that’s only going to occur if we commit to developing the gas resources and understanding those gas resources and whether or not they can be economically produced.
That’s a sort of structural point. The second key point is it takes our industry probably at least five years, and often longer, to go from an idea to producing something and the risk we run is that if we don’t come to grips with the production of gas in NSW pretty quickly, when we do – and at five years we’re now talking the end of the decade at the earliest when that gas production could come out of NSW begins to make a difference.
And then the final point is it is also right to say that it’s not going to be easy everywhere to produce coal seam gas to be a little bit pejorative, I mean it was the plan to drill the coal seam gas well near Sydney Airport. I have to say I don’t think that made any sense and I don’t actually think governments should have permitted that and allowed that possibility to occur. So, there are clearly some areas where you could say the value of land and the use of land does not suit the production of coal seam gas, but there are large areas of NSW…
AK: So, what is the line? Is the line at Gunnedah? Like, anything east of Gunnedah is no good, but the other side of Gunnedah is fine, or what?
GK: Well, certainly the further you get from areas of urban concentration the more the use and value of the land should coexist with the production of CSG. In Queensland, CSG production coexists with agriculture and it coexists evidentially because of the number of agreements that producers and landowners have voluntarily entered into in order to allow that production to occur. So yes, certainly you’d think the upper Hunter Valley up into Gunnedah there should be a solution. They should be able to find a way of coexisting.
RG: Grant, I want to take you back to Gladstone. You took an enormous risk in Origin Energy in taking 35 per cent of that project, and you borrowed quite heavily to do that. The market is petrified that your plant is going to cost more than was expected and that there’ll be more money that needs to be raised, which is very difficult when you’re hardly leveraged. Are they right? Are you going to need more money?
GK: My consistent position has been that we don’t need to raise equity to fund our interests in Asia Pacific LNG and, given that I’ve said that so many times, I’m pretty committed to that position occurring. But your diagnosis is right – even for Origin, which is a reasonable sized Australian company, it’s a big project and funding big projects is a challenge. Now, having said that, we believe we can continue to fund our interests in APLNG from cash flow and borrowings and that’s what our plan continues to be.
AK: But your cash flow needs to hold up though, doesn’t it?
GK: Correct. Yeah.
RG: And your costs must not rise?
GK: Yeah, and that’s a fair point. I mean, all of that is premised on costs remaining what we expect them to be. I have to say in October, November, December of the prior year we went through a very extensive review of project costs and in February we announced in aggregate a 7 per cent increase including of that nearly half was increase in contingency, just allowing enough for things that we don’t know, but we believe that estimate remains appropriate and we believe the schedule that we articulated which was mid-2015 for first shipment remains appropriate.
RG: Are you vulnerable on price on those shipments?
GK: Ah – only on oil price. So the contracts are linked to oil price. Make no mistake, these projects are sold in US dollar oil price and somewhat paradoxically, because we’re an Australian dollar balance sheet, the fall in the Australian dollar is substantially improving the economics of the project. And largely I think the extent that investors might perceive a risk around say oil price or costs, the fall in the Australian dollar is very substantially offsetting or mitigating that risk because being an Australian dollar balance sheet we’ll receive our revenue in Australian dollars against the US dollar index.
SB: Grant, we saw quite recently BG Group and the Santos-led project announce a fairly limited bit of cooperation in terms of being able to ship gas between the two projects. Are you looking at similar sorts of arrangements and do you think there’s scope for deeper cooperation than we’ve seen so far?
GK: I think you’re referring to the announcement of an interconnection agreement between BG Group– or Queensland Curtis and BG Group projects – to be formal.
GK: I’m pretty sure we’re just about finished the interconnection our project and the QCLNG project with BG. We agreed that a long time ago and we expect similarly to interconnect. I think all of the projects will interconnect their transmission pipelines which will greatly facilitate both ramp up and also operation of the plants going forward, so if there are disrupts in either production or supply, those disrupts can be mitigated through sharing transmission capacity.
SB: Is that where it stops though? I mean, given the scale economics of adding trains to a particular project, could we see joint venturing of third or fourth trains between two projects?
GK: Well, I think notwithstanding you haven’t directly asked the question, I think the question that’s often asked is what does everybody think Arrow will do because there is potentially another project and having raised that question myself, the answer is well that’s for Arrow to determine. But quite clearly, as you’re asking me, each of the projects would say there are opportunities to work more cooperatively with others, for example like Arrow who would still want to bring their CSG resources to the market.
So that is a matter for Arrow, but that’s an example of something that could happen. The interconnection of transmission pipelines is quite significant in terms of both cost and ramp in operability and I’m quite sure that going forward – and I’m saying this because I know people are having the conversation – the projects now that they’re all happening are no longer competing against each other, they’re now competing to produce the best returns, but I don’t mean against each other, just in aggregate. And therefore I think they’ll look for all forms of cooperation to improve returns.
AK: Grant, will the bringing forward of the emissions trading scheme by a year, as has been announced by Prime Minister Kevin Rudd, will that be disruptive of your industry and industry generally?
GK: So based on obviously my knowledge of our own circumstances, which I think are probably fairly typical for the energy sector, if they’d brought it forward any further than where they have – remembering that it’s only policy, it’s not implemented – but to the extent that if they’d tried to bring it forward earlier than July 1, 2014, we and others have contracts that were carbon inclusive and we would have therefore incurred a cost if the carbon price was lower, so yeah, there would have been a long conversation about how that was dealt with. But because it was a tax, or a fixed price, we weren’t buying that far forward, so we weren’t buying forward into the floating price period yet and therefore we haven’t also written contracts against a pricing regime that’s now been brought forward a year. So… when I say a sweet spot, I’m not commenting on the policy itself, I’m saying probably July 1, 2014 was probably the most practical and least disruptive date to bring it forward to.
AK: And how do you now reflect on the competing climate change policies of the Coalition and the ALP?
GK: I guess the first thing we’ve got to say is that there’s what’s legislated and then we’ve got two policies either side of that fact and so we’ve got the Coalition policies and a policy change, if you like, where the government is moving.
AK: So the one certainty is that there will be a change.
GK: Yeah. The one thing is that is actually really unclear and that’s not all that helpful frankly, and I think I could speak on behalf of all industry and say what we’d really like is to know where this is all going to settle.
AK: Well, it won’t be long.
GK: Yeah. I’m not in charge of the election date, but in terms of the details, or a little bit more of the detail of the policies, I think what still stands true is that both sides are committed to this 5 per cent reduction over 2000 levels. A bit of a debate about how many tonnes that is – we think it’s about 100 million tonnes of reduction by 2020.
The difference in the policy positions is how much of that is reduced from within Australia, because somewhat paradoxically the Coalition policies would see that reduction emission occur in Australia whereas of course when you can buy international permits, much of that that corresponds to the internationally bought permits is acquitted overseas. So there are underneath it some substantively different ways in which the policies work.
RG: And the ETS means that you send your money abroad – it leaves this country.
GK: So you buy international credits.
GK: Then the reduction is occurring overseas and the money is going overseas. Correct.
RG: Yes. A massive transfer of wealth out of Australia.
GK: Certainly, money is going out of Australia. There’s no question about that.
AK: And the compensation is here?
GK: Yeah, well, that again is a policy matter. That’s a political decision, it’s not a carbon policy decision.
RG: The compensation is basically staying, isn’t it?
GK: Both parties, as I understand it, are committed to keeping the compensation in place.
AK: Well, household compensation, but not necessarily industry.
GK: Yeah. The generator compensation has been cut. The issuance of permits remains the same. So if you’re an industry that qualified for 95 per cent, or in the case of LNG only 50 per cent of free permits, those allocations remain but it was adjusted for the generation sector as well. So you’re absolutely right, Alan. It was left for households, left for permits, but reduced for generators.
SB: Grant, I assumed it’s a matter of simple maths, but you’ve been very critical of the 20 per cent renewable energy target being 20 per cent of the fixed amount, so it makes it something like 27 per cent today. If you assume that the price on carbon was a single digit going forward, how it would that interact with that kind of a renewable energy target?
GK: So, two sets of answers, two points. We were supportive of both the RET scheme and the carbon scheme in the form of an ETS. My position or our company’s position therefore has changed over the last few years because I think at the time that occurred there was a general consensus that carbon would be somewhere around $20 a tonne. The reality is we’ve ended up with carbon pricing out of sync with the rest of the world and, in my view, a cost of renewable energy out of the sync with the rest of the world and in today’s post-GFC environment, that makes our industries uncompetitive and I just think we’ve got to talk about that and recognise that’s something we’ve got to deal with. And my sense is both parties are responding to that from a carbon pricing point of view.
Of course, the important point is when a carbon price falls – and this is more directly to your question – the cost of the renewable scheme goes up by the same amount, so the renewable scheme is now costing more, or will cost more, by the amount that carbon is reduced.
RG: Why? Why is that so?
GK: Because the amount of subsidy you can think of as a Renewable Energy Certificate, so the REC is what we have to acquit, is the difference between the price necessary to cause an investment in renewable energy and the cost of buying electricity in the market. So if it costs $95 to cause a wind farm to be built, say, and energy costs, say $55 in the market, then that REC is worth $40 and that’s the extra amount you’ve got to pay to cause that wind farm to be built. If you take carbon away, you’ll take roughly… It depends what it falls to, but if it falls to $6, $55 will become, say, $45, so you now need $45-$95, you now need $50 to cause that wind farm to be built.
So the cost of the RET scheme goes up by the same amount as the carbon price comes down, so it in turn then becomes relatively more burdensome and so I don’t think the discussion is over. I think we still from a policy point of view not only have to think about the relative competitiveness of our carbon policies, but we do have to think about the relative competitiveness of our RET policies and that in turn is exacerbated by the fact that the target isn’t 20 per cent. And I notice over the last few days that the public commentary about the policy is where still we have a 20 per cent renewable energy target by 2020.
AK: It’s supposed to be 20 per cent, but it’s not.
GK: It’s a hard-wired number which is much more than 20 per cent.
AK: It’s a volume number, but it could change to being the percentage number, couldn’t it?
GK: It’s heading towards 30 per cent instead of 20 per cent. And that then creates a whole bunch of consequential effects. It becomes a greater part of your bill, so the relative increase in costs becomes more of your energy bill. Secondly, it moves from, if you like, being the benefit of a sort of a marginal supply benefiting from what I call the ‘free rider’ effect to a mainstream source of energy where it’s going to have to pay its way.
So my view is we are going to have to rethink how we price network charges and other things, because historically they’ve been priced on throughput and, for example, solar panels take throughput away. So in fact the cost of networks goes up to people who aren’t benefiting from, say, solar panels on their roofs.
So there’s a long way to go yet on fully understanding the way the RET scheme impacts on costs and my view is we missed an opportunity in 2012 to have the depth of review necessary to tell people what it was really costing. We better not miss the opportunity in 2014 to do the same.
AK: So you’re saying that whoever wins the election and however the climate change policies change, we need to have another look at the RET scheme?
GK: Yes. Because to the extent both parties are committed to getting carbon either gone or to a lower level, RET becomes a much greater proportion of your energy bill and it’s right to say that for a small or medium enterprise, for example in NSW a bakery or a small hospital or something like that, about 30 per cent of their electricity bill is green schemes. It’s carbon and renewables, about 30 per cent of their bill on current settings, so that’s not taking into account the recently announced changes in the carbon price. So for some sectors of the economy it’s a very material cost.
AK: Thanks for joining us, Grant.
GK: Thanks very much.