The depressed oil price environment provides a window of opportunity for the Australian resources industry to curb rampant cost inflation and increase productivity, making it more competitive internationally and better placed to ride an anticipated upswing in LNG demand next decade.
It follows a five year period of unchecked growth in costs, wages and currency which has made Australia one of the least competitive countries in which to develop oil and gas projects, despite its vast cache of natural gas, willingness of investors and proximity to major buyers in Asia-Pacific.
The need to cut costs and increase operational efficiency is becoming a lead theme across Australia’s resources sector as the industry emerges from five years of high capital expenditure on a host of large-scale LNG export projects, including four in Western Australia, three in Queensland and a second in the Northern Territory.
With an LNG supply surplus and sluggish demand in Asia-Pacific set to last well into the next decade, Australia needs to grasp the nettle and slash costs to remain competitive for the future, experts say.
During a speech at the Australian Petroleum Production & Exploration Association (APPEA) conference in May, Chevron’s Australian managing director Roy Krzywosinski warned that Australia’s “falling international competitiveness” could mean it misses out on a second wave of LNG investment. The US major has faced a host of delays and cost blowouts since starting construction at its Gorgon LNG project in Western Australia, not least because of the deployment of a vast and expensive workforce in a remote location.
“The industry would be wise not to waste a good crisis,” Geoffrey Cann, National Director for Oil and Gas at Deloitte Australia, believes. “The Australian dollar has been a huge boost to the LNG industry by falling when it did. It has moderated quite significantly the collapse in commodity prices,” Cann said.
“The change in currency profile removes the pressure that industries have to confront the poor overall cost and productivity equation. If the industry simply relies on a constantly falling dollar as a way of dealing with some of its structural challenges the industry will not set itself up for the eventual day when commodity markets tighten up which will see the Aussie dollar strengthen again or demand picks up again and the consequence to the industry is that it will not have structurally repositioned itself to be sustainable in the lower environment,” Cann added.
In the next 10-15 years, global LNG demand is projected to reach nearly 500 million tonnes per annum (m t/y), nearly double today’s production, with Asia responsible for around 70% of the forecasted growth. Australia is well placed geographically to meet much of the demand but, with a host of other LNG export projects on the horizon, it cannot afford to rest on its laurels for long.
In North America there are more than 30 LNG export projects proposed, with those currently under construction set to add nearly 50m t/y of liquefaction capacity. Canada is also positioning for exports while Russia and Qatar continue to be potential competitors in the Asian market.
While petroleum industry development costs have increased globally since 2000, the rise has been particularly acute in Australia. According to a recent report commissioned by the Australian Petroleum Production & Exploration Association (APPEA), the average cost of developing LNG projects in Australia jumped 33% between 2009-13, driven by rising upstream and plant construction costs. In the three years to 2013, finding and development costs (F&DC) for new reserves averaged A$4.16 (US$3.01) per gigajoule (GJ), 2.7-times the average for the three years to 2007.
Speakers at the Committee for Economic Development of Australia (CEDA)’s West Australian resources outlook briefing in Perth in October stressed the need for belt-tightening in the face of what could be a prolonged period of depressed commodity prices.
Hitoshi Okawa, Director of Corporate Coordination at Japan’s Inpex – which is building the Ichthys LNG with France’s Total – said there is now a “pessimistic sentiment” in the Australian oil and gas industry where the mantra has switched to “doing more with less” as expensive and complex projects are deferred, budgets are slashed and jobs are lost.
“It is an understatement to say that the oil and gas sector is facing challenging times at present. We are experiencing a cyclical downturn in price that may be with us for some time,” Okawa said.
Rising labour, material and exploration costs have all contributed to high cost inflation in Australia, though there has also been an opportunistic premium added on as restrictions on companies wanting to import cheaper foreign labour has led locals to escalate wage demands on large infrastructure projects. There is plenty of anecdotal evidence of workers commanding huge salaries for construction work during the peak of Australia’s resources boom.
Bechtel, the lead contractor on LNG projects in Queensland and Western Australia, has quoted earnings of A$3,000 per week for special class welders, the equivalent of an annual salary of A$156,000.
On the exploration side, Western Australia’s offshore region has seen a steep increase in exploration costs over the last decade from A$10m per well to A$90m, APPEA data shows, reflecting higher rig rates and more challenging drilling.
Onshore, the pattern is similar with F&DC in Queensland rising 6.5-fold, from an average of A$0.83/GJ in the three years to 2011 to A$5.37/GJ in the three years to 2013.
Such increases and the hard landing associated with the downturn mean that Australia’s economy has been hard hit by the 12-month sustained fall in oil prices.
Coupled with some of the highest costs in the industry, this has stifled growth and put pressure on the balance sheet of almost all developers of LNG export projects, leading to a flurry of merger & acquisition (M&A) activity as the upstream and support services industry scramble to consolidate in order to maintain growth.
The fall in investment, particularly in exploration, was flagged in data from the Australian Bureau of Statistics (ABS) in September. The trend is continuing with Deloitte Access Economics (DAE)’s latest Investment Monitor showing that Australian business investment is falling away dramatically.
“Total private construction work is down notably on last year and engineering activity has contracted in nine of the last 10 quarters,” DAE said in the monitor, noting that this phase is expected to continue until 2017-18, although the pace of decline will slow.
The downturn does have a silver lining for some though. Energy consultancy Wood Mackenzie believes the heightened competition in the engineering, procurement and construction (EPC) sector will provide an opportunity for operators choosing to proceed with new LNG projects to achieve lower costs and better contracting terms.
Alasdair Cathcart, general manager of Bechtel’s LNG business line, said the group is already helping customers to be competitive by finding ways to do more with less in today’s constrained commercial environment. “We are pushing the limits of technology and looking at restructuring costs internally and externally in the supply chain. Bechtel has launched its own efficiency initiative aimed at reducing our cost base by 20% over three years,” Cathcart said.
“Labour is only one element of cost when you look at overall project development costs. Other elements require project management expertise and offer many opportunities for efficiencies,” Cathcart added, noting the importance of vertically integrating all phases of project delivery from conception to start-up.
This view is emphasised by Chevron’s Krzywosinski who said co-operation in non-competitive areas can deliver shared benefits which can drive down costs. “In Australia, there are too few examples of co-operation during the development and construction phases of projects, and we need to move to a more collective mind-set,” he said.
There are also plenty of cost efficiencies to be had once LNG projects make it to their operational phase.
Potential savings from collaboration between operators on Queensland’s Curtis Island alone could be measured “in the many tens of millions of dollars,” Cann believes.
“With three LNG plants operating on the single island there is ample room for the three projects to consider opportunities to share facilities, such as having a single emergency response capability on the island and single training,” Cann said. He added that on Australia’s west coast, opportunities for rationalisation centred around emergency rescue and response, safety induction and training for offshore workers.
Inpex’s Okawa also stresses the need for collaboration between operators to boost mutual productivity.
This goes beyond just reaping operational efficiencies like sharing helicopters and supply vessels to include companies aggregating gas and processing it through facilities operated by others. It is a tried and tested model that has worked well elsewhere in the world.
“Driving operational efficiencies and resetting the cost base have become top priorities for the industry,” Okawa said. He added that “virtually all oil majors have been actively negotiating cost reductions with contractors and suppliers and with considerable success”.
“Opportunities that provide flexibility in capital allocation and the ability to make incremental investment in scalable projects are today favoured over those requiring a commitment to large-scale upfront capex,” Okawa noted.
Gas in the pipelines
Looking ahead, Western Australia’s Mines and Petroleum Minister Bill Marmion is keen to stress the upside.
“Despite challenging market conditions, today there are oil, gas and condensate projects committed or under construction in WA valued at A$87bn. Gas production is at record levels and will increase further as projects such as Gorgon and Wheatstone come on stream,” Marmion said, adding that the State “is ideally placed for the next period of expansion”.