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Interview

with Jürgen Hendrich, Managing Director and CEO, MEO Australia

24.03.2011 / Energyboardroom

You began as CEO in July 2008. That must have been either the best of times given the exciting pace of activity and pipeline of projects for this company; or the worst of times given the volatility in commodity and equity markets. Which one was it?

It was absolutely both. I knew that what was in store would be a roller coaster ride. Yet having worked for MEO for several years in a corporate finance capacity, I believed in this company and its vision.

Certainly in July 2008 the global markets were taking a turn for the worse and charting those waters was more difficult than we imagined. We got off to a good start through a deal with Clive Palmer who had an option over all of our projects. We were planning an initial public offering (IPO) to raise several billions of dollars.

Unfortunately, as 2008 progressed financial markets worsened, the IPO was cancelled, and the options lapsed. However, we quickly rebounded to put it behind us and rebuild the company as we had until the end of 2009 to secure another funding partner for a well obligation. Fortunately we negotiated a 12 month extension on our WA 360-B permit which bought us sufficient time to secure the right partner.

We certainly brought in a good one by securing Petrobras in late 2009. It was a long process to reach a binding agreement and to ultimately get cash in the bank. But as a result, all of our contingent liabilities were ameliorated and we secured nearly $40 million in cash from our funding partner with the equity markets providing the balance of the funds at a good price. Today we are now sitting at the end of that process with $100 million in the bank and no unfunded commitments. I can safely say that we are in the best financial shape that the company has been in after 2 ½ years.

Yes, it has been a roller coast ride to meet all of the pending commitments and we have not had the hydrocarbon success we were hoping for. But certainly in terms of establishing the foundations of this company and ensuring its future, it has been extremely rewarding.

Can we say that this is a new beginning for the company?

Indeed. There is the history of this company and its legacy projects which we took 2 ½ years to manage, unwind, and exploit. But as of January 1 of this year it has been a blank sheet of paper. We are now looking at the region very carefully to secure opportunities into the portfolio which reflect the values and the dynamics which we have on board.

It is a very exciting stage and I almost feel like a kid in a candy store. Our challenge is to take the fiscal strength, marry it with the talent that we have on board, and attract more talent to round out our skill set. I always believe that the whole is greater than the sum of its parts. If you select your parts carefully, blend them, and have people with complementary skills and values, then you will have a very powerful force.

You brought in the right partner indeed with Petrobras, marking the Brazilian giant’s first foray into the Australian market. Why did they choose MEO and how has the partnership gone so far?

I believe that large companies are attracted to projects rather than its proponents since, at the end of the day, it comes down to who is sitting on something interesting. We happened to have a very large prospect in the LNG province of Australia. A big company like Petrobras wanted to expand its portfolio into gas. While 90% of its portfolio is oil, it sees itself as an LNG importer by 2020. If you want to be in the LNG business these days, then Australia is obviously the place to be. Where else do you find a 10 Tcf prospect that is strategically located in modest water depths and accessible via a well that costs under $35 million? Their attraction was definitely driven by the prospect and its robustness.

Our partnership with Petrobras was also interesting for the government since it signified a large foreign entrant that was not previously present in Australia. The government would like to see more diversification in that sort of area.

It has been a tremendous relationship. We were delighted that Petrobras chose to let us continue operating. Petrobras being a big brand name with an esteemed reputation, it was an absolute privilege for a junior such as MEO to operate the well on their behalf. It certainly speaks to the quality of our technical team and their capabilities. Everything went very smoothly from an operational perspective but at the end of the day, unfortunately, we did not come up with the prize that we were looking for. We currently have one year to figure out the remaining prospectivity of the permit, why the well failed, and translate that thinking into a cohesive strategy to determine what we do with this permit when it expires at the end of January 2012.

Yes, the Artemis well was disappointing but we have been tried and tested on a number of areas in the past. Drilling a successful well is very difficult and Artemis only had a 32% chance of success.

The Carnarvon Basin where your permits are located is the “hot” gas province in Australia. With previous well failures behind you and a forward looking vision, what is your strategy to maximize value in what is known to be an active area?

The key to this game is having acreage of which there is very little in the Carnarvon Basin. Additionally, when you are a junior bidding for offshore acreage, you are competing against the largest companies with abundant balance sheets, which is always difficult. So how do we carve a niche? In the space where we cannot contend financially the only way for us to compete is technically and through alacrity. We obtained our three contiguous permits in the Northwest Shelf when those permits were reaching the end of their initial three year period and the work program had not been fulfilled. We were able to move in, structure a deal very quickly with the incumbents, and ensure that the work program obligations were met. The permits returned to good standing and we bought time to determine their prospectivity.

From a technical perspective we must understand what is going on in the area, know specifically what we are looking for, and assess what it might look like in an area where things are no longer obvious. In this game, if something is too obvious then the majors will outbid us and hastily pick up the acreage.

Our game is to selectively secure acreage that may not be obviously attractive at the time that we pick it up. Since we are exploring a trend, having that acreage and acquiring seismic will allow us to determine the prospectivity of certain factors that we think might exist. We then need sufficient time to work up a technical story and attract a farm-in partner. Our strategy is clearly to position ourselves in acreage which we think is attractive but the broader industry might not. That requires being a little bit ahead of the curve and seeing what trends are emerging.

Offshore exploration in Australia is breeding novel breakthroughs and world class engineering firsts – Shell’s floating LNG project with Prelude and INPEX’s Ichthys Project to name but a few. Then there is MEO Australia with its ingenuous Tassie Shoal and Timor Sea LNG ventures. What are the novelties that you bring to the game with these projects?

In the region where we operate there is the Evans Shoal Field which is owned by Shell, Santos, Petronas and Osaka Gas. This was actually a field originally discovered by MEO. There was a discovery well drilled by BHP Billiton in the 1980s, however BHP relinquished the permit considering it a small gas discovery. MEO picked it up at 100%, Shell farmed-in for 85% drilling two wells, one of which was the Evans Shoal 2 well. They found a 300 metre vertical gas column but with 28% CO2. At the time, doing anything with 28% CO2 was unfeasible so BHP divested the well to Santos and this is how the company acquired 40%.

At this point MEO looked at the engineering options on how to monetize high CO2 gas contents and that is how we came up with the Tassie Shoal concept. With these wells, the concern is not only distance from onshore infrastructure, but you have a CO2 issue as well. If you are going to make LNG you want gas to look very much like Bayu-Undan: clean, in reasonably shallow water, of fantastic reservoir quality, and lots of natural gas liquids which give a credit so that the economics of your projects are cost-competitive. If you can get your gas for free because the liquids pay for it, then you have one hell of a start. If you have no liquids and 28% CO2, then, beyond the absence of liquids, your CO2 is going to cost you and you must factor in its disposal. For example, in the Gorgon Project, Chevron has had to spend over $1 billion in carbon capture and sequestration infrastructure. CO2 is not a trivial issue.

The co-founders of MEO looked at Evans Shoal with its 28% CO2 and identified seven shoals (natural carbonate build-ups) which provide natural platforms of 15 metres depth. Placing infrastructure in this depth of water is much less costly than at deeper depths. Hosting infrastructure on the shoal provided a natural and immediate solution to the remoteness problem.

Secondly, they decided to deal with the CO2 issue. One of MEO’s breakthroughs was using CO2 to turn it into methanol by combining it with methane gas and steam. The ideal concentration of carbon dioxide in your methane feed gas stream is 22-25%. It consumes that carbon and locks it up into methanol. The steam methane reforming process is deficient in carbon atoms and locks up the CO2 in the methanol. In this way the company turned a problem into an asset.

Why do you think this has not been done before?

There are a few reasons that this has not been done before. There was a prevailing paradigm that methanol is a chemical and so does not belong in an upstream oil and gas business. Some of the larger companies are fully integrated but it is rare that the chemical division will talk to the E&P division. In addition, historically methanol has been perceived as a raw material for the chemical industry and was made when there was no other method for monetizing gas. These are what I call “legacy paradigms” which MEO has been I believe, successfully challenging. However when the challenge comes from a junior it sometimes carries less clout than if a major was to promote it.

This process could have been applied to the Gorgon project by Chevron. However, the sheer scale of the Gorgon Project means that it was possible to swamp the methanol market if you were making methanol out of gas. Additionally it is necessary to use three parts methane for every part of CO2 and Chevron’s methane is directed towards LNG. There was therefore an economic consideration for the company. There was also the Barrow Island for geo-sequestration. MEO does not have these circumstances.

There is a mantra that LNG is the only game in town for remote gas. I do not necessarily hold that same view. We are an energy company. We therefore consider methanol as an energy product. Yes, it is a building block for the petrochemical industry but it is also a building block for other things such as gasoline, plastics, petrochemicals, energy, or energy derivatives.

Is MEO actively seeking supermajor partners in order to bring more confidence and clout to overcoming these legacy paradigms?

First off we need access to that gas. Once we have secured that gas we need a funding partner to put that infrastructure in place.

MEO uses the latest off-the-shelf technologies including methanol plants sitting on a concrete gravity structure. There are 42 of these around the world. The methanol plant is a conventional plant and it is much cheaper than building a pipeline to Darwin. The methanol is stored in the hollow structure and there is a loading site on the shoal. It is a concept self-elevating platform which can use sea-water cooling – an infinite temperature mixing zone in the sea. This is a $2 billion plant for 3 million tons per annum output. Looking at dollars per ton of annual capacity, very few projects can come in with less than a thousand dollars per ton of capacity; MEO is achieving $660 and can increase this to 3.7 million tons per annum capacity with a modest increase in capital. This type of project has a lot of appeal and is a sensible technical option. Also, the fact that the shoal sits 375 km offshore is no longer regarded as a challenge and in terms of engineering uncertainties, they are essentially non-existent.

The engineering uncertainty is minimal, environmental approvals – often a difficult, litigious process – are obtained, and the offshore distance is much more proximate compared to other, larger projects. What is the inherent project risk?

The risk is that the kit is a long way from shore so servicing the infrastructure is a little more difficult. However most of the offshore installations around the world are used to operating remotely. There just needs to be an evolution of acceptance. The mindset is that because this has not been done before, this must be risky.

Australia is paving the way in hydrocarbon innovation with the world’s first floating LNG project and the world’s first coal seam gas (CSG) to LNG project (also started by juniors). I am therefore not concerned that it has not been done before. What I am attracted to is that all of the technologies are off the shelf and purposely designed that way so small companies can get sufficient financial backing. If you are using tried and tested technology with globally experienced engineers for its installation, then the chances of funding are commensurately greater than new technology risks such as floating LNG.

I often refer to the development and acceptance of CSG-to-LNG. Go back five years and if you had told someone that you wanted to make LNG out of CSG they would have recommended therapy for you! I look at what is being done here and although it is avant-garde, its day will come. This concept makes too much sense for it to continue being ignored.

Given the modest quantities of gas that will be produced is there any concern in securing buyers who will prefer to lock into longer term and larger quantity contracts?

Not at all. Three million tons per annum is an easy sell and the methanol output could be sold twice over. Difficulties are geopolitical, geographical, a matter of gas quality and reservoir quality. Although the area has already been cherry picked, MEO can develop all that is left over. I am excited about what this can bring to the Australian oil and gas scene. We just need to open the eyes of the supermajors who have held onto legacy paradigms of operating that no longer apply.

MEO is a junior in its structure and balance sheet but you rarely see juniors with projects of this size, scope, and significance. How do you classify MEO?

Admittedly, that has been part of the negative for us. People used to see us as a 10 year old prodigy who lacks the financial wherewithal to push it ahead. These concepts were not drawn up on the back of a napkin over lunch. This concept has been through multiple iterations with some of the smartest engineering minds in the world. “Small” in terms of market capitalization does not mean small in intellectual capacity.

Innovation normally comes from the smaller companies as we are not constrained by legacy issues or conforming to the corporate ego. As Einstein once said, “we cannot solve problems with the same thinking that created them in the first place.” Indeed one of the definitions of madness is doing the same thing repeatedly and expecting different results. We want to look at the input variables, the optimal outcomes, and how all stakeholders can win. We are a “win-win-win” type company. We do not win by having others lose; it is not good for repeat business. That type of thinking is a scarcity mentality. We operate in an abundant universe. I am confident that with this approach and with out thinking, this project will ultimately prevail.

Do you have a final message to send to the supermajors, investors, and other stakeholders about MEO Australia?

For prospective investors looking at MEO over the past 2 ½, notwithstanding the absence of success at Artemis, we have consolidated the company in terms of how to succeed as an energy company. We have a fantastic board which can run a $1 billion entity. The executive team is a world-class group that puts its shoulder to the wheel day in and day out. My message is to stick with us. There has never been a better time to get on board. We are off the radar screen while we are busily rebuilding the company and putting in place the portfolio to guarantee the future success of the company. One of those options is the Tassie Shoal concept.

To the super majors, I would say that there is nothing to lose from engaging in conversation about the feasibility of this concept for monetizing resources. They should lose the legacy and emotive thinking and do their own shareholders a favor by having a proper look at this option. Due the due diligence and let’s have a serious conversation about this.

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