The Australian Petroleum Production and Exploration Association, reeling from radical new gas export restrictions unveiled by Prime Minister Malcolm Turnbull today, commissioned Wood Mackenzie to review the likely impact of a 10% royalty on the Greater Gorgon, Ichthys, Pluto, Prelude and Wheatstone developments.

 

A review of the Petroleum Resource Rent Tax, crude oil excise and associated Commonwealth royalties by Michael Callaghan, announced last November by Treasurer Scott Morrison, was due report back to the government by April 20, but the government is yet to release the findings.

 

Using its models for the five LNG developments, Wood Mackenzie ran their economics at a long-term flat real (2017) oil price assumption of $US60/barrel to determine the royalty's impact, which falls within those which the operators use in their investment-making decisions.

 

 

Wood Mackenzie's analysis, published yesterday, revealed that on a life-of-field basis, the projects' economics are already highly marginal, as internal rates of return of less than 10% - which they all have - challenge the operators' ability to justify taking projects forward.

 

Under current terms, Gorgon (7.7%), Ichthys (9.2%), Pluto (8%), Prelude (4.8%) and Wheatstone (7.8%) all fall under the 10% threshold. 

 

This is in stark contrast to the estimated IRR at their time of final investment decision: 8.3% for Pluto in 2007; 12.6% for Gorgon in 2009, 14.5% for Prelude and 12% for Wheatstone in 2011, and 12.9% for Ichthys in 2012.

 

"With most of the projects [now] giving an IRR of 8% or less, it does mean that it is highly unlikely that most of the developments would have been sanctioned had such low IRRs been expected at FID," Wood Mackenzie said. 

 

Factoring in the proposed 10% tax reduces project IRRs by between 0.3-0.5% each.

 

Wood Mackenzie said that while that may not seem a significant amount, when dealing with already low IRRs the effect will be to reduce further the economic viability of the projects. 

 

"These changes should not be discarded as being immaterial for companies and having no effect on their likelihood of investing. Such a reduction for already marginal future developments will further reduce the attraction of investment in Australian LNG projects," Wood Mackenzie said.

 

The firm also revealed that the net present values for the overall project economics look "very poor", with all of them showing significant negative values at a 10% discount rate. 

 

"Companies are more likely to target higher IRRs for such projects, with 12% being currently a minimum threshold for the development of new LNG projects," it said.

 

While Australia's biggest rival as the world's largest LNG exporter, Qatar, has been held up as an example of a jurisdiction where the government share is higher than those in Australia, Wood Mackenzie noted that the returns in Qatar are also much higher with projects generating IRRs of above 30% for investors. 

 

"There might be a sense that all will be fine for existing projects if there is an increase in government share now," the firm said. 

 

"The driver for this opinion is that the majority of spending has been incurred and if projects are not yet producing, they will be producing LNG relatively soon. 

 

"The point forward economics show positive net present values, thus the argument continues that it doesn't matter if companies are hit with a royalty at this stage, they won't be walking away from these projects. 

 

"However, were the government retrospectively to introduce a royalty at this time, it will have presented industry with one set of terms prior to development, but after the companies have invested on this set of terms, the terms are changed to give the government a higher share when production is commencing."

 

Wood Mackenzie said any change to the terms will make future offshore LNG developments much less attractive at a time when, even under existing terms, their economics are likely to look marginal. 

 

For example, based on the firm's analysis, a 10% royalty would decrease the Scarborough field's IRR by 1.3%, from 12% to 10.7%. 

 

 

Wood Mackenzie also argued that it would wrong to think that there will be no effect on existing developments, particularly given the consensus view among industry and analysts that brownfields expansion are the likely future for Australia's LNG expansion.

 

"There will be additional investment required for these projects to maintain future production," the firm said. 

 

"However, any incremental investment that will be required in the future will be put at risk by the introduction of a 10% royalty. 

 

"Not only would the economics of these incremental projects be adversely affected by changes to the fiscal terms, but Australia would be seen as being much more fiscally unstable, with a willingness to let companies invest and then to change the terms after companies have made these massive investments."