Transcript of Peter Botten interview

Michael Pascoe: What’s the feeling working at Oil Search at the moment?
Peter Botten: Busy '¦ buoyant '” if you wanted to use two words. Oil Search is a relatively unique company in the fact that it works primarily in developing countries. It has probably struggled for 70-odd years of its life under the realms of larger organisations on which it was dependent for technical and financial help. That’s no longer the case and I think it’s blossomed since it’s taken over operation of its core assets from Chevron Texaco back in 2003. Since that time, it’s delivered some positive results in terms of production and profits.

Positive is a bit of an understatement. Your total shareholder returns have grown at a compound annual growth rate of more than 100% for the past four years. You’ve just reported a profit of more than $US200 million. How sustainable is that sort of growth?

Well, it’s always a challenge and clearly we’ve been lucky on the basis of getting control of our business, investing in our business and growing our production base at a time when the oil price has also been high. An unusual combination, generally speaking in the oil business, in my experience over the past 30-odd years. But the reality is that Oil Search is in a good position on the basis that a lot of its assets still remain to be commercialised and that obviously revolves around the commercialisation of its discovered gas resources.

We don’t have to go out and find resources to commercialise; we have them there. They’ve been there for some time and it’s been frustrating for all of us, including our shareholders. It’s taken time to get up but the commercialisation of that large resource is now well under way. More so in the first phase for the pipeline project to Australia, but also very much concentrating on the second and third phases of development for gas.

From an investor’s point of view, those who have had faith in Oil Search have done very well. They’ve come along a very good ride '¦ understandable if they want to take a bit of a profit now, or will the gas project change the company again?

Well clearly the gas project in our view commercialises about a third of our developed '¦ or our present gas resources. There are a range of other development options for gas that we’re working on in a similar timeframe to the pipeline project, and building off that infrastructure spine, which obviously looks at the last two-thirds of our discovered resource.

As well as that, there’s a lot of exploration and a lot of potential further development in PNG and our growing Middle East business, so there’s a lot of value left in Oil Search and shareholders will always make their decisions if they’ve made a handsome profit. I’m pleased to say some of them have, but the reality too is that our focus is '¦ board and management is very much to develop that next layer; I’d say we’re in an advanced stage. You can actually see the growth potential because you’ve got a lot of resource still to commercialise.

You also have a very conservative balance sheet. You’ve got no debt and a lot of cash and you’re unhedged on oil. Is that going to change?

Obviously as you develop the gas project, the pipeline project to Australia '¦ potentially do a lot more exploration '¦ Based on statistics, we should have success in that exploration and obviously spend some money on new developments but we also have a range of new venture opportunities that we look at. But we are very measured in the way we pick up assets. The reality is that we have good homes for our capital generally, including paying dividend.

And the dividend payment '” it used to be a rare thing in the resources industry. It’s obviously an area though that you take seriously.

I think it’s a reality that we don’t want to take a step back from paying a dividend. We started paying dividends when we got control of our business some years ago and the results started to be more positive than previously. The reality is, though, that Oil Search is a combination of both a dividend and a capital growth stock and we will continue to work with our shareholders to deliver that value.

Aside from exploring and producing in some extremely difficult terrain, how much of your job has been about overcoming country prejudice about operating in Papua New Guinea.

Well it’s pretty much the largest company in PNG and the largest investor in PNG. A significant portion of my job over the past few years has been to manage investor expectations in PNG and to give them confidence that you can actually make money there. That’s sometimes been a difficult position because clearly there have been times over the past 10 or so years that I’ve been involved in this company where PNG has not looked particularly good and that has been a problem to go and sell to the world investing market.

However, in recent times the present government and its policies combined with a very buoyant resources market, the economy in PNG is booming and stability of fiscal policy and fiscal discipline has led to a positive investment climate there, which is demonstrated by our continued profit growth and delivery of value to our shareholders. So PNG’s not a bad place to go.

And the country risk? The pipeline risk when it’s up and running?

Look, again, PNG in my opinion has a very good track record of delivery. I think in 14 years of oil production there have only been two days lost production in terms of delivery of oil into tankers caused by land owner disruption. That’s a pretty good record overall and compares very favourably to many other countries around the world. So PNG will continue, in my view, to have that record based on sound policy and management of land owner issues.

You’re also expanding in the Middle East: Yemen, Egypt '¦ Libya. Is it a good thing to be able to turn up in those countries and say you’re from Papua New Guinea?

Our view is that a core competency of the organisation is how we manage developing countries; how we manage land owners and how we are politically sensitive to local aspirations. And although dealing with a land owner at Hides or at Kikori in PNG is one thing, the same questions are asked if you go and deal with a land owner in Yemen or in Egypt and the reality of life is that if you have good systems you can apply them anywhere.

But politically, is it handy to be able to turn up in the Middle East and say you’re from PNG, not from one of the more militaristic nations?

There’s no doubt that being from PNG does open doors that companies in this region and in other parts of the world that are presently closed to those people, and we do play on that as a strength in the organisation. But primarily it comes down to people and their approach, and I suppose our approach is different to many of the larger organisations worldwide.

Watching all the good figures you were putting up in the analysts’ presentation, one of them was particularly, surprisingly good. Despite operating in an extreme environment in a developing country with a very varied workforce, you have an excessively low injury rate. Much better than the Australian average. How?

Well, firstly recognising that it is a good performance, but that’s still not good enough. We have a creed in our organisation that all accidents are preventable and no one should go home from work injured. We have a very strong culture of safety, and the health and security of our workforce is of paramount importance to us in Oil Search. It really is a challenge in a difficult working environment, with a whole range of different cultures who may not speak English or let alone Pidgin English, to get a culture of safety, and we’re very proud of our safety performance. But we can do better and hopefully will do better because it’s unacceptable for any of our people go home injured.

What sort of a barometer do you think that is of management in general?

There’s no doubt that many correlations have been done in different companies. If you have good safety performance '” good attention to safety '” it commonly indicates that the overall process and the overall management is progressing well. But that’s a general industry trend, not blowing smoke in our own performance, but that certainly is a key part and it indicates to me a very strong focus within the workforce about something important, that is important to the company and that extends into our health programs. Clearly we have challenges around HIV in our national workforce, a challenge for any developing country or a company working in there around those sorts of issues.

The PNG story is relatively well known in Australia. The Middle East story perhaps isn’t. Is that a diversification? Do you eventually see that becoming the majority of your business?

Success in the oil and gas business is all about risk evaluation and how you manage that risk. PNG is a high-cost area for exploration generally. Its well costs are relatively high and our ability in the past to get holes drilled when we didn’t have control of our assets was difficult. It was attenuated. So we looked back in 2000 at diversification because we did see that without a change in PNG our value was going to go down.

Using our PNG culture and skill base, we approached the Middle East and it’s taken us three or four years to get a good position. The PNG exploration is a much lower cost. It has much lower reward overall. The fiscal terms there are not as attractive as PNG, but it’s an excellent risk balance between what we’re doing in PNG with what we’re now doing in the Middle East. It’s a good risk balance.

There’s an inevitable question that I have to ask: Oil prices '” you’re unhedged. Does that mean you see it rising or just staying high?

First, I’d like to say that we’re not paid to bet on oil prices so on that basis '¦

But being unhedged you are betting.

Yes, but in actual fact our core business is to actually deliver value through the development and production of oil and gas. The oil price is part of that process but the difficulty you have is, and our policy is very clear, that if you have major capital exposures into a major project we will review hedging against that capital repayment and the return expectations on that project.

If we do not have that, and our balance sheet is very strong as you’ve mentioned, we do not necessarily have to make that bet and frankly if you make the bet nine times out of 10 you’re wrong. And Oil Search had that experience through some forced hedging it made through a financing process in the late 1990s and it cost shareholders a lot of money.

The reality is if you get it right shareholders are not necessarily going to be particularly pleased with you and if you get it wrong they’re going to be very upset. On that basis, a very clear policy around hedging risk: which is if you’ve got a major capital cost project, hedge potentially against that rather than necessarily hedge on a day-to-day basis.

There was also a suggestion in the briefing that perhaps the pipeline could be a bigger volume than has generally been factored in. With the electricity industry moving towards peak-period, gas-fired stations plus more industrial use, is PNG going to be big enough for Queensland’s demand?

I think if you look out 15 years in the energy scene in Australia, there needs to be a new significant source of gas into the east coast market. We’ve obviously positioned PNG to be part of that equation and with the resource base in PNG there’s no doubt that through expansion PNG can supply a significant portion of that load. However, the reality is that the market is telling us right now and the companies’ actions, including the most recent ones in the past day or two, indicate that there is a changing of the guard around energy supply and companies are positioning themselves for 20–30 years of supply into the east coast market and I’m sure PNG will play its role but it won’t be the only group.

Does Alinta make any difference to you if it succeeds in its bid for AGL?

No. I believe that whoever owns the AGL assets will want to make maximum value out of those assets and our various transactions with AGL deliver value to AGL shareholders in terms of gas purchases as well as their upstream interests.

You also have a commitment to developing industry and the use of gas within PNG. One of the projects you mentioned, DME, an alternative fuel with Japanese interests '¦ how far advanced is that?

The first thing is that it’s a petrochemical chemical plant, which involves the production of methanol and dimethyl ether, which is a clean fuel as a diesel and LPG substitute. The Japanese have been working extremely hard on looking at a place to build a world-scale methanol plant. Obviously, a key component of that is competitively priced gas and an appropriate infrastructure. In PNG at the moment, we have substantial uncommercialised reserves of gas, which obviously may supply a DME methanol plant. Also, we have on the back of the PNG pipeline project, the capacity to build infrastructure that can deliver gas into Port Moresby, where port facilities and others can be designed to facilitate the development of that sort of plant. It is making progress. DME is a relatively new fuel but, given the pricing of diesel and petrol nowadays, DME as a clean fuel can be very competitively sold into markets and those markets are being very actively developed in places such as Japan.

Is that a potential project that Oil Search will have equity in, or would you just facilitate and try to attract a customer for your gas?

Clearly our primary role is to supply gas to that plant and we have already a conditional agreement for the supply of some 80-odd petajoules a year to that plant. So that’s a first step. Whether we necessarily need or want to take interest in the infrastructure portion, we have already an interest potentially in the pipeline project infrastructure. Whether that extends into the pipeline into Moresby or the plant itself, we will have to look at, depending on our return expectations and size and shape of the plant.