20 Jan 2015

Just as in real estate, position is paramount in the upstream petroleum business – and Australia’s position is not to be underestimated as the latest version of the long-running oil-price roller coaster imposes itself on the world’s economies.

This is a thought worth holding on to in a confusing public debate, not improved by some analysts inclined to see only through a glass darkly.

There is no mystery to global crude prices: it’s the fundamental economics of demand and supply at work.

The global market is now correcting for additional new supplies over the past year (much from US shale gas regions) coupled with less robust global demand growth. As the chart shows, this is hardly the first time the market has undergone a commodity price correction – with five steep, inflation-adjusted dips (including the current one) in the past 15 years.

For Australian LNG projects, the price for LNG is linked to crude prices under long-term contracts.

However, successful players in the oil and gas industry operate in timeframes of a decade or more, taking into account a wide range of possible crude price, economic and policy developments.

Short-term fluctuations don’t affect major planning decisions.

What might be a surprise for some analysts and media commentators is not necessarily a shock for companies that have been around a long time and are managing multibillion dollar investments.

This is not to say sudden changes don’t have impacts.

A major price correction of the kind now being experienced is a sharp reminder to big, long-established businesses, as well as aspiring new entrants, that the need to keep a tight hold on costs, and other fundamental operating issues, is ever-present.

Such changes can, and do, come at awkward times for large-scale investors, requiring sometimes quite significant adjustments to plans and programs.

This is not a sign the sky is falling down, but one more reminder that, as with all commodity prices, shift happens.

Of course, big petroleum project prospects are coming under renewed scrutiny all round the world.

In the LNG business, where Australia is an emerging world leader, the current situation is a body blow for rival developers overseas who have hopes for fast forwarding their projects.

Their aspirations of sprinting past local developers to win shares of the still-growing Asian gas market are facing a reality check while Australian costs (for services and labour) now also face downward pressure.

Things may be tight in the short-term for Australian projects but it’s not all bad over the long-term – and the next oil price bounce could be stronger than expected by doom sayers today if sufficient supply is taken off the market.

Australia clearly has the gas resources to underpin significant future development and global demand for LNG remains strong.

Woodside projects that investment decisions need to be made in the next few years on more than 50 million tonnes a year of new capacity to avoid supply shortfalls as early as 2023.

It’s inevitable that immediate media coverage will focus on lower tax and royalty returns for government, both federally and at state level where LNG projects are located and, in some important cases, nearing completion.

Sensible governments view returns from these developments over long-term project lives and don’t get exercised about short-term revenue fluctuations.

To do so is to create unnecessary disturbance in the investment environment to the detriment of all concerned, not least the communities for which many of the new projects represent a substantial advantage over the years of their life.

Commodity prices may be an uncertainty beyond the control of government but there are areas where governments can manage risk and even take advantage of the present situation.

Now is a good time to redouble efforts to remove red tape, to streamline project approval times, improve our tax efficiency and competitiveness, and to make regulation an advantage in Australia’s global competitiveness rather than a burden.

Australia has made some progress here recently but there is a lot more that can be done to enhance the investment environment for the upstream petroleum industry, which is now moving towards its seventh decade of being a national economic advantage.

Regulations that restrict the industry’s capacity for innovation and flexibility, that impose unnecessary, duplicative or inconsistent bureaucratic processes unrelated to the risk of activity and that deliver no net benefit to the community can and must be addressed.

And the present price situation provides an additional incentive to policymakers to ensure petroleum investors continue to view this country favourably.

Many past regulatory decisions seem to have assumed future investment in the sector is guaranteed. The current situation underlines that this is most certainly not the case. For industry, the price change means a return to business fundamentals: watching cash flow; scrutinising investment proposals anew; keeping an eye open for opportunities.

What will work to both the industry and the national advantage in Australia is if governments and their advisors also exercise discipline in seizing this opportunity to drive policy and regulatory improvements to ensure the sector can be in really good shape to take advantage of the next upswing – whenever and to what extent it occurs, as it surely will.

First published in the Australian Financial Review, 21 January, p. 39.

See also a good, recent perspective on the economic impact of declining oil prices from ExxonMobil’s chairman, president and CEO, Rex Tillerson, in an interview with CNBC.