Queensland's gas grab

PORTFOLIO POINT: Reserving a big portion of the state’s coal seam gas for the domestic market could snuff out the industry’s prospects.

Queensland's coal seam gas fields – containing five times more gas than the Bass Strait ever held – are among the most important discoveries of natural resources in recent memory. They have the potential to deliver untold billions to investors through exports, and simultaneously secure our domestic energy needs for a decade. But if the Queensland government goes ahead with its Gas Reservation Policy, many projects may never get off the ground.

Last month the Bligh government released an innocuous looking 12-page document called the Blueprint for Queensland’s LNG Industry. It’s artfully put together pages talk of encouraging job growth, environmental responsibility and the half a dozen new committees that have been created to oversee the process. So far, so good.

Tucked away on page six it drops a bombshell. The government is considering reserving up to 20% of this gas for domestic use only. An idea so mind-bogglingly stupid that it may just stop the development of this rich resource dead in its tracks.

Right now in Brisbane there are teams of bankers being flown in from New York, Hong Kong, London and Singapore to crunch the numbers on these projects. To see if they can make the maths work on the projects from Arrow Energy, Santos/Petronas, Origin/ConocoPhillips, BG Group and Shell. To get off the ground the industry needs the high export gas prices that come from exporting LNG, but LNG projects only work with lots of debt provided by foreign banks.

You can just imagine the reaction of these overseas bankers: sovereign risk writ large. Currently one the biggest fears among foreign bankers about CSG-to-LNG is that some companies may have trouble converting their gas reserves into actual production due to technical problems, and therefore most banking syndicates will be demanding that the coal seam gas developers have up to two or three times the gas reserves they actually need to meet their LNG contracts. If 20% of their current reserves are “locked up” to provide cheap gas for domestic industries, some projects will clearly fall short of the gas they need to win financing.

What we are talking about is $80–100 billion in capital expenditure, 60 billion tonnes of LNG per annum and about 40,000 jobs. In terms of taxes collected by the Queensland Treasury, the worst-case scenario is probably about $1.8 billion a year. But that’s not enough. Premier Anna Bligh has waltzed off the set of Celebrity MasterChef and decided to put a new spin on a recipe made popular by Venezuela’s Hugo Chavez (see Risky businesses).

These things don’t just happen. A reasonable person would have to suspect that there has been some fairly intense lobbying going on behind the scenes. With eight projects in various stages of development there’s a huge amount of gas coming out of the ground. All the big gas users such as Incitec-Pivot, Wesfarmers, CSR, Boral and the three big power generators are able to buy it at the current rates of about $3 a gigajoule and bank big profits. Once the rest of them come on stream and start selling it overseas that price is going to roughly double to $6 a gigajoule.

There’s a lot of intimidation and bullying going on. The big gas buyers are trying to lock in these cheaper prices for years into the future and the producers are resisting. They claim that the newer gas projects are never going to get off the ground, lean on the smaller producers and say, 'You’re going to have to sign a 10 year contract at less than $3 a gigajoules, take it or leave it.’

It’s not the first time a state government has put the screws on the gas industry. In WA they’ve reserved 15% of the gas, but they had the common sense to wait until the industry was up and running, generating billions a year in profits. Queensland doesn’t have a mature gas industry and because there are doubts about the economics of coal seam gas. This push has just added a whole new element of risk to the equation.

Another difference between the WA and Queensland projects is the multiplier effect. The WA projects are offshore. Take a look at Gorgon: it’s run by big oil multinationals such as Chevron, Shell and Exxon Mobil, and the vast majority of the goods and services used in building offshore projects come from overseas.

Because the Queensland projects are onshore, most of the field development and LNG plant construction will be Australian companies using Australian people and Australian components, which is why it’s all the more important that these projects go ahead.

The big gas players can’t really believe what they’re hearing. They are just kind of stunned. They knew the government would jack up the gas royalty rate somewhere down the track, but to do it when most of them are trying to get a final investment decision from a group of gunshy bankers beggars belief.

And the money men, well, if you’ve just dropped $5 billion on subprime you’re not going to be especially keen to drop another few billion on a project because a government on the other side of the world has a change of heart.

No decision has been finalised but it is expected soon. At that point it will have to go to cabinet. If you have high hopes for growth in the Australian gas sector then this should be on your radar.

Queensland has a god-given opportunity to ride a 20 year energy boom. Heads of agreement have been signed for an opportunity that could add two or three percentage points to the state’s GDP. It’s a brave and foolish assumption that reserving 20% of this gas won’t affect the viability of these projects and is a real 'Let them eat cake’ moment from the Bligh government.

Ivor Ries is head of research at EL&C Baillieu Stockbroking. He may have interests in any of the stocks mentioned.