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Interview

with Keith Jones, Partner, Energy & Resources, Deloitte Australia

14.02.2011 / Energyboardroom

When meeting with the other “Big 3” firms last year the resources super profits tax (RSPT) was still being debated between industry and government; there was neither clarity nor certainty. While still no definitive legislation has been passed, there are clearer signals today about which direction a tax regime on the resources and energy industry will go. What do you assess is the new risk paradigm facing businesses in this industry?

The important thing to consider is that the tax, as now announced, is considerably different than what was originally proposed. Essentially the government is applying the offshore oil and gas regime to onshore opportunities, which is a significant change for the better in many cases. However, it does still leave considerable uncertainty which will remain until the drafting of the legislation is complete. But by and large, the situation has improved a bit. People can at least make educated estimates of the tax’s impact.

Perhaps the major negative as it presently stands is the conflict between the state royalties and the proposed new mineral resource rent tax (MRRT) and petroleum resource rent tax (PRRT). State royalties will still apply to revenues, but will only become refundable once profits are being made by producers. There will be a deferral of the recovery of state royalties until later in the tax regime that exists at federal level.

Most people would look at the tax regime proposed as much more reasonable and affordable than the original proposal. In a real sense, industry would of course prefer that no new tax exist. But it is a significant advantage over the original RSPT and is much more conciliatory to the industry. There will be questions about the amount of revenue raised as well as the extended time frame particularly in relation to emerging industries such as coal seam gas (CSG). I think at this stage it is an affordable tax on the industry.

Has the debate since last May proven to be an injection of new business and re-strategizing for Deloitte?

The initial stages of the PRRT and MRRT were very political debates. That has moved on and we are now in the situation of advising clients and modeling outcomes. We are advising on tax structuring and the valuation issues which will reside within the tax for both the mining and oil and gas sectors. The tax debate has provided us with an opportunity to provide those services to the industry. From an industry perspective, they still want to see the fine print to make sure that they are getting the appropriate advice.

Mega-resource and energy projects in Australia are very dependent on foreign capital given the limited size of the domestic financial market, relative to other developed economies. What do you believe will be the implication for Australian energy projects of ongoing trends in global capital markets that seemingly favor equity over cash – the gradual devaluation of the US dollar, sovereign debt in Europe, et al?

Since the global financial crisis (GFC) there have been capital constraints in the Australian market almost across the board. But it has not held up the major projects that have had big backers. Many of the big players have been generating cash from their incumbent projects to invest in their ongoing projects on a worldwide basis.

For some time now, China has been a source of capital for the whole of Australia’s energy and resources sector. I see that continuing. The Chineseare matching capital with off take as part of a number of transactions currently occurring. I expect that to be a continuing, if not growing, factor in future funding of significant projects.

The flow of capital in worldwide terms is getting more expensive. It will get more expensive in Australia and it will challenge the viability of some projects.

Recent final investment decisions of Queensland Curtis and Gladstone LNG have positively reinforced the timely development of major Australian energy projects. However, last year saw several delays in final investment decision and expansion for various projects. Collectively, is Australia on track to meet global demand?

There is an important issue that this touches on with regards to global demand. Australia is not the only source of opportunity for global gas. We do face significant competitors. If we look at our major markets – China, India which is emerging, and Japan which has long been a customer – we see potentially piped gas from Eastern Europe and CSG from coal supplies from within China itself or Mongolia. Australia’s key market within China is the southeast corridor which is clearly highly populated and prosperous. While it is a big consumer, we are facing significant competition. Any comment I make is based on Australia not being the only source of opportunity for gas.

Are we on track? There are a lot of complications in getting major projects off the ground: environmentalapprovals, government regulations, and a range of other development issues. There are also technical issues for CSG projects. After all, producing LNG is a complex process. I think the industry is ticking off the challenges, but perhaps a little more slowly than it would like causing both a slip in time schedules and a blow out in project costs. The markets are not saturated, but with few unsigned markets there is minimal room to move.

You are the Australian leader of the Deloitte Chinese services group. In your many visits to China and discussions with oil and gas leaders there, what is the mood that you are getting from them about the pace of development of Australia’s energy projects? The Chinese are eager customers, but with many markets willing to supply them, I imagine that the waiting time can only last so long.

On balance, China sees Australia as a very good investment destination, but it is concerned about the time it takes for us to build and deliver projects in this country. I do not think development times will get any shorter for reasons such as talent shortages which will be the major challenge over the next 5-10 years. Building the projects on the books is now complicated by the necessary rebuilding of flood damaged infrastructure in Queensland which is going to challenge the supply of experience, talent, andcapital.

China has an economy that can harness the manpower to solve these problems more readily than we can. They appreciate the delays, but would like to see us manage the timeframes better and more consistently. Getting final investment decision on a project and not seeing first gas until 4-5 years later is quite an extended time frame. China perceives Australia as a very good investment destination with attractive assets that they want to get involved in; but they do see the downsides in getting projects approved and the cost structures to build projects.

Looking domestically, the number of projects in Western Australia is matched by the resource size of CSG on the east coast. What is your assessment of the viability of CSG as being the future of the country’s oil and gas industry?

CSG and CSG-to-LNG will grow to be a significant part of the Australian energy supply. There is no doubt that the major projects in Western Australia will remain a core element of LNG supply to China and other parts of the world. But I believe that a balance will be struck. It is hard to make estimates at this stage because they have yet to deliver CSG-to-LNG on the east coast, with many barriers still in place. It will still be five years before we can see Queensland gas consistently capable of supplying even the first of its shipments to offshore markets. Many of the “new” projects in WA are essentially brown fields in their development style and operation. I see that growing significantly and probably with less technical challenge than CSG. I do see CSG-to-LNG on the east being significant, but a much longer term proposition than the growth in Western Australia’s gas supply.

Perhaps there is a rivalry developing between the two markets?

There will be intense competition between the two for talent. If you are going to develop CSG you need qualified expertise, which is of limited availability. Whoever has the best economic platform will eventually be the project that attracts talent to drive it. I think some projects will stumble in Australia over the next few years through talent shortages. It all depends on the preparedness of investors to see these projects through and work with the available talent or find solutions to recruit and retain the appropriate talent which will involve a huge range of responses.

There has been growing momentum in Australia behind the shift to a low-carbon economy. In your interactions with industry clients, to what extent do you see this transition becoming a reality?

The debate on a carbon tax will go on until the political end of it is resolved. The production of CSG is quite intensive. These are not carbon neutral businesses.

In general and in the longer term, industry must come to grips with a cost a carbon. They must understand what is required and there is a need for them to adapt their business where they can and minimize the outputs. There is no doubt that carbon costs will need to be considered by projects on an ongoing basis.

What is the role that Australia plays for Deloitte globally across its energy business?

Australia has significant contributions in the resource sector in total. We have considerable interface between Houston, London, Australia, China, and Singapore. We just moved the head of our global oil and gas team, Adi Karev, to Beijing and the focus on the China market is a big part of our business. Deloitte believes in the integration of the consumer markets and the capital that they bring to bear. The emerging industries that are affecting energy supply are going to become and remain very significant as we move forward.

We interface with our international players on an ongoing basis by exchanging talent and assisting with project work. Our interface is all about how we can best serve our clients and ensure that we bring our best talent to bear on issues. We are very strong in the US, especially across the utilities sector. The biggest part of our business is consulting – helping businesses get themselves established or improve the way they operate.

How does Deloitte continually differentiate its services from the other Big 3 in the industry?

The other Big 3 are only part of our competitors since we all brush into smaller players and consultancies across the industry. The only way that you can differentiate yourself is through expertise and track record. There is a strong belief in this industry that the ones who can best help industry are those who come from industry itself. This is not an industry that embraces external ideas. Safety risk and capital investment decisions are very large and need to be managed on an industry basis. The familiarity with the industry and having worked within industry is the core requirement of the marketplace. It is a very risk averse industry so if you have that track record then the industry is prepared to buy your services.

While you have a wealth of experience in this industry you are relatively new to the position of Deloitte’s Australia head for energy and resources. What are the main challenges that you have encountered in your learning curve?

I have a history in the oil and gas and mining sectors. My expansion has been in the other sectors that come into play under my current brief such as the utility market, power generation, transmission, and supply. I am learning about those industries as we move forward.

Collectively do you think Australia is aware of its role and ready to embrace its identity as a global energy superpower?

I think Australia is significant in the supply of LNG to emerging markets. But we are going to be resource challenged – in human and financial capital – to deliver the potential that we have. The opportunity does indeed exist but we are going to be really challenged to live up to what our potential could be as a major player. We are not a major player in energy consumption or financial markets, but we have an opportunity to be a significant player as a supplier to the emerging energy markets of the word.

Do I think we will step up to it? It is hard to forecast but we need to be very committed to resolving talent issues – flexibility around workforce – and focused on the supply of capital to the industry to make it work. That requires careful attention because Australia needs to be cost-competitive and currently there are a lot of cost imposts in the industry.

Are there any final messages that you would like to convey to our readers?

We have a very exciting time for the industry over the next 10 years. It is now very much a question of can we manage the opportunity effectively, which is a challenge that we all face.

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