with Mark Remond, Director and Head of Energy & Infrastructure Finance, BOS International
What is the strategic and niche role that BOS International plays within the larger Lloyds International Framework?
BOS International (Australia) Ltd. is a subsidiary of Lloyds International Pty Ltd, which is wholly owned by Lloyds Banking Group plc.
By and large, 2010 was a steady recovery year for the energy industry in Australia from the nadir of the GFC. How did results fare for BOS International’s energy and infrastructure stream?
Because energy and infrastructure covers project finance we deal with public private partnerships (PPPs), economic infrastructure, renewable energy, power, and oil and gas. 2010 was a good year for energy and infrastructure and the project finance part of the business did very well.
The oil and gas sector, however, was a little subdued over the year. BOS International has historically had a dominant position in the mid-market because of the strength in our project finance capability; we have added benefit to the mid-cap companies by providing the finance they need for efficient funding. That part of the market was a little quiet over the past financial year and 2010-2011 is somewhat “business as usual” for oil and gas. While we did not see much new activity we are now looking at a fairly solid pipeline going forward.
There is much talk about a two-speed economy in Australia between energy & resources and “the rest.” When considering that mid-cap companies were adversely affected by the GFC and saw their activities subdued, yet major companies had resilient operations with mega-LNG project planning carrying them through the crisis, is there a similar two-speed economy within the energy sector itself?
That is a fair analysis. After the GFC many companies found it difficult to raise capital other than equity; even the equity market proved difficult for that matter. My view is that there is still a bit of a hangover from the traditional funders – namely banks. However, not only are we moving back to a stable environment where the mid-caps are able to find finance from the banks again, I believe funding is warming up very quickly.
What is driving the confidence?
I place oil prices at the top of the list. There has always been a debate in the industry about the peak oil scenario. Whenever prices start heading north, confidence in the industry returns. We saw oil go from $140 per barrel to less than $40 per barrel. It is now steadily climbing back up to highs around $100 creating an overall renewed confidence in the industry.
Even though many mid-caps struggled during the GFC, most of them survived quite well. The demand for energy saw them through those troubled times. Many clients who perhaps overstretched themselves were able to raise capital without too much trouble. There was a period in which cashed-up oil and gas companies were sitting back waiting for opportunities to buy the more leveraged ones, which never came through. Even the leveraged companies were able to raise equity. The M&A activity amongst oil and gas companies in Australia has never emerged to the extent that many had predicted and I would be loathe to say that it would come back at this stage.
What we are seeing, however, are some of the majors selling their assets which creates an interest for the mid-caps. Larger companies such as Santos or Woodside, for example, are focusing on the bigger projects which will carry them into the next century thereby getting rid of mature fields that are reaching end of life. As assets become available, it draws attention to mid-cap, mid-sized oil and gas companies.
Oil and gas being a global industry that procures capital from international markets, it is affected by trends and events in the international economy. Sovereign debt issues in Europe and the gradual depreciation of the US dollar are creating a flight away from traditional cash investments. Do Australian resources benefit from this trend as an attractive go-to investment?
I think that is a fair assumption. When the GFC hit, a lot of foreign banks pulled capital out of Australia not only in oil and gas but on the infrastructure side of the business as well. But capital has been coming back and we are seeing a return of interest by some of the major foreign banks.
Australia is also a relatively safe place to invest politically, which naturally generates a lot of interest. Specifically, the Asian region has always had a key focus on this part of the world which has only heightened over the past few years with the growth of China and India and the ongoing needs for energy out of Japan, South Korea, and some of the more developed Southeast Asian countries.
Do you sense that international investors have a re-assessed, higher risk profile of Australia since last year’s proposed super-profits resources tax?
There was initially a bit of a backlash, but I am not really seeing a longer term impact. Offshore oil and gas fields have always had the Petroleum Resources Rent Tax which will now apply to onshore production through the Resources Rent Tax. The rise in oil price and continuing demand for energy seem to have ironed out a lot of qualms that investors previously had. I would not go so far as to say that last year’s mooted tax discussion has damaged investment appetite, but I am only one voice and it is a very political decision.
How risky for project finance and international investment do you rate industry skilled labor shortages?
That is indeed much more of a concern. The Northern Territory, for example, only has approximately 200,000 people in its entire jurisdiction. The Ichthys project alone will bring several billion dollars of investment. When considering Darwin’s port development plans and numerous PPP projects, there is a lot of demand for investment in the north of Australia which will inevitably have an impact on capital costs. We are such a big country and cannot easily migrate a workforce from the southeast up into the north. We have to manage that demand for skills and labor. When multiple projects come online at similar times it is bound to have a capital cost inflation component. If you look at the data, Queensland’s wage price index already exceeds 5% compared to Southern states much lower 3%. There is indeed a very real two-speed element to the economy that industry will have to deal with.
Yet final investment decisions move on for several mega-projects without clear, innovative solutions to plug human resource deficits…
There is definite robustness to each project which drives final investment decisions. As with any project you have to balance all of the risks and nothing is easy. Inflationary elements to projects have always been a problem that industry has had to deal with; but nothing is particularly unsolvable. As we saw in the last oil price boom the cost of offshore rigs doubled. How this particular issue will be addressed has many differentfacets to it and the government is currently being lobbied to relax the skilled worker rules for immigration. From our point of view we have to be cautious about it [cost inflation] and speak openly with project sponsors about how they will manage the risk.
The federal government, already very keen to eliminate budget deficits, has had to deviate infrastructure funds for natural disaster relief in Queensland and Victoria. Similarly, we see Infrastructure Australia running deficits in its budget leaving it unable to fund certain projects. What pressures does this place on the PPP model and how is it affecting BOS International’s PPP finance activities?
Some states have indeed pulled back spending. New South Wales has in the recent past put on hold some projects in their PPP pipeline prior to their recent change of government. But we are still seeing a strong pipeline out of Victoria, South Australia, and Queensland. While we are not as bullish as countries such as Canada, for example, who are rapidly expanding their PPP models, the PPP market in Australia has always been fairly stable as a percentage of national GDP. I do not see it abating too much. There is a fairly strong pipeline and I believe it will continue on well.
BOS International is a large player in the PPP market with a very strong expertise. Our parent, Lloyds TSB Bank plc, has 63 people in the project finance space who specialize in four infrastructure sectors: the PPP market, economic infrastructure, renewable energy, and conventional power. We have a global head for that sector with operations in Australia, NY, the UK, and the rest of Europe. Amongst this global group there is a great focus on this part of the world. We are very conscious of the strong pipeline and good deals that the PPP market in Australia produces.
Do you see a strong pipeline in renewable energy infrastructure given the growing momentum amongst industry for a carbon tax?
I do, once, of course, we resolve the carbon tax issue which still looms over investors’ heads. There is Commonwealth legislation in place for 20% renewable energy by 2020 and demand is being built up. While the brakes are slightly applied for renewable projects, I am confident that it will pick up as companies increasingly look for new investment in that space. The Australian government has also sponsored the solar flagship project. There is a continual pipeline of renewable energy projects going on, but still clearly smaller than what is going on in the LNG space, with coal seam gas (CSG) taking up a lion’s share of the investment as well.
Regarding CSG, the market highly values companies sitting atop potential CSG reserves. With large-scale CSG-to-LNG projects going forward and infrastructure being put in place, it seems that anyone with CSG on their books is a lucrative investment and in a good position to strike supply agreements. Is there a possible over-valuation of the CSG market?
While that could be a fair comment, there is a lot of capital expenditure needed to prove up sufficient reserves for a CSG-to-LNG project. There is a huge amount of drilling and infrastructure required, large amounts of water to manage, and complex steps to get the gas from the fields to the processing plants. You need a big balance sheet and an even bigger commitment to put these projects in place. I am a bit loathe to call it an overvaluation, because if we are going to be the second largest producer of LNG in the world then these assets could very well be valuable in the future. The analysis of CSG reserves is different from conventional gas reserves and there is a big variation between reserves from one gas field to the next. You have to take all things into consideration when working out the value of a field. The market is very well informed with learned people making decisions.
For example, when Santos purchased Tipperary’s gas field in Queensland, the market initially thought that they paid too much. But it has proven to be a success. It is a difficult question to assess overvaluation, but we can at least say that CSG fields are certainly not cheap. Whether it is over- inflated, we as bankers would be cautious about prices that are being paid. But perhaps not if I were a bullish equity investor.
If you were a bullish equity investor, is there any other oil and gas province in the world that rivals the attractiveness of Australia?
There is gas in place in countries such as Indonesia, but it is perceived as lacking the stable political environment of Australia. The Middle East is experiencing a lot of political problems that make it cautious as well for investment. Russia is also politically challenging. With the US being an entirely different investment market, Canada is perhaps the only other comparable place. I would be hard pressed to think of anywhere else that would rival Australia.
All of that is to say that we are in a good position. It is difficult to find an economist who would come up with the view that China and India will stop growing. The long term outlook for this region is very bullish. Many in the industry and I believe that oil is last century’s energy source. This century’s source will be natural gas of which there is plenty in Australia. It may not be the most environmentally ideal fuel source but it is better than coal making it the obvious choice for the 21st century. There has been a belief that nuclear will play a viable role in the energy mix, but events in Japan might have set back any momentum. Being politically stable, geographically well-placed, and with a plethora of reserves, Australia is very well positioned to provide the world’s energy needs.
How is this company in particular well-positioned to service the future financing needs of the oil and gas industry?
The oil and gas business in the Bank of Scotland plc started in the 1970s when they project financed the Forties Field in the North Sea. From that a strong legacy was maintained and kept a technical focus through their banking. Similarly, the group has maintained a technical focus through our two in-house engineers in the UK, three in our Houston office, and one here in Australia. We really understand the reserves and the assets that we lend against.
We have traditionally been a big player in the middle market and with medium capped companies. Meanwhile, the oil and gas team within the greater organisation has had very strong relationships with larger companies and supermajors. The merging of the two companies has created a strong oil and gas team globally that has been able to marry the relationships with the supermajors with our capabilities and skill base in the middle market. We are looking squarely at supporting our traditional mid-cap markets but also at project finance opportunities for LNG. We have a tremendous capability in CSG and we are one of the few banks with project finance activities for CSG. Through our ability to understand the different reserve classifications of CSG we are as well placed to support CSG as we are for the traditional arena of offshore oil and gas.
What would be your final message to our readers about BOS International?
Becoming wholly owned by Lloyds Banking Group means BOS International has a much greater global capacity as a financial services provider to the energy sector. We love the sector, we have been here for a long time, and we intend to continue to service the industry.