unlucky country

Everyone's a Loser in Australia's LNG Boom

The government's tax take has slumped and energy companies are hemorrhaging money.
Photographer: Patrick Hamilton/Bloomberg
CHENIERE ENERGY INC
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ORIGIN ENERGY LTD
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Why is it that one of the world's top five energy exporters can barely keep the lights on? That's not as much of a contradiction as it sounds.

After all, the interests of a country's energy exporters and its domestic consumers are fundamentally opposed. Exporters want high fuel prices to ensure the best profit margin. Households and businesses want cheaper electricity bills.

I've Got the Power

Australia is already a top five global energy exporter. LNG will put it further ahead

Source: BP Statistical Review; Energy Information Administration, World Nuclear Association, Gadfly calculations

Note: Mtoe = million metric tons of oil equivalent. 2019 figure based on assumption of no change in coal, oil or uranium exports and LNG exports rising to 11.5 billion cubic feet/day. Natural gas converted at rate of 0.025mtoe/bcf. Uranium converted at rate of 0.013mtoe/ton. Biofuels and electricity exports not included.

Between those two poles something's got to give, so it's left to government -- which typically depends on the first group for revenue, and the second for votes -- to divide the baby.

In Australia, the result has been dysfunction. Bitter divisions over resource taxation and climate policy have contributed to a turnover of five prime ministers in the past seven years. 

South Australia, which saw the country's first oil well drilled in the 1880s, is threatening to pull out of the national electricity market following a series of blackouts. The government is holding an inquiry into how revenues from a tax on oil and gas production have slumped, even as output has soared.

Energy companies have booked billions of writedowns on LNG projects, and Chevron Corp. has said it's unlikely to build a large gas-export plant in Australia's west again. Meanwhile, the government is offering subsidies for a new mine development to export coal to India, despite protests from environmentalists and New Delhi's pledge to end imports of the commodity.

Less With More

Australian petroleum revenues are slumping even as output surges

Source: Kevin Morrison, UTS Institute for Sustainable Futures

The LNG debacle provides a good test case of what's gone wrong. Australia is on track to overtake Qatar as the world's biggest exporter of shipped gas by 2019 -- but getting there hasn't been a success for the government or petroleum companies.

Canberra's revenues from its Petroleum Resource Rent Tax fell 60 percent to their lowest level since 1999 in the year through June 2016, despite a 50 percent increase in gas export volumes. Petroleum tax and royalty revenues per oil-equivalent barrel came to about 4.2 percent of the local price of crude -- the lowest share since 1990, and well below the 25-year average of 10.4 percent.

The dip is unlikely to be a blip. Thanks to the way the government allows expenses to be deducted before a project makes a taxable profit, it could be decades before the country starts to receive a better return on its mineral wealth. The vast sums spent building Australia's LNG projects have created a tax shield of carried-forward costs that was worth A$238 billion ($182 billion) in 2016, with the figure rising each year 5 percent faster than the yield on government debt. 1  

One for You, 19 for Me

The value of the carry-forward costs that Australian petroleum producers can offset against tax has ballooned

Source: Australian Taxation Office

With LNG prices on the floor amid a glut that could last the rest of the decade, it's likely to be many years before petroleum companies generate the profits to overcome this formidable offset. Even rising prices are unlikely to be much help to the government: Thanks to the way the regime is set up, a brighter outlook for gas would generate further tax offsets from fresh exploration and development spending.

It's tempting to view this as a case of big bad oil companies ripping off the taxpayer, but the status quo hasn't been a bonanza for businesses, either. The rush to build in the 2010s prompted labor shortages and cost overruns in the region of $45 billion at the country's eight newest LNG plants.

Santos Ltd. and Origin Energy Ltd., local companies with LNG projects on the east coast, have seen their stock prices slump, with little sign of the sort of recovery enjoyed by Cheniere Energy Inc., a comparable mid-sized business that operates the Sabine Pass LNG terminal on the U.S. Gulf coast.

Deflating

Of Australia's LNG companies, only Woodside has escaped the share-price slump suffered by Santos and Origin

Source: Bloomberg

Note: Rebased. March 28, 2014=100

How has the country's energy policy failed for all parties? It's not really such a surprise. Australia is unusual globally in choosing to take a cut of its petroleum wealth not through royalties levied on production, but through taxes on income. The explicit intention is to encourage energy companies to develop fields that would otherwise be too marginal, by promising a more lenient floating charge on profits rather than a fixed charge on output.

As several of the corporate submissions to the inquiry make clear, Australia's high costs and distant location mean it wouldn't be a very attractive investment destination if not for these incentives.

By transferring a share of risk from petroleum companies to its own budget, Australia appears to have done a favor to big business. But the gesture has a sting in its tail, because while governments don't like risk much, businesses should. Internalizing project risks is the best way for companies to ensure they don't waste capital on money-losing developments -- say, A$200 billion worth of gas-export terminals selling to an oversupplied Pacific market.

While that devil's bargain between taxpayers and shareholders has ensured Australia's place as the world's biggest LNG exporter, neither side has done well out of the transaction -- and the development mania isn't over yet. The same dynamic is now affecting coal, another commodity for which Australia is the world's biggest exporter. We'll address that subject in next Monday's column.

First of three columns on Australia's energy policy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. The 5 percent rate is for development and operating spending. Exploration expenditure is uplifted at 15 percent above the bond yield.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net

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