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Interview

with Robert Michael Hosking , Executive Chairman, Karoon Gas Australia Limited

29.04.2011 / Energyboardroom

Karoon Gas’s acreage portfolio is comprised of offshore assets in Western Australia and with equally large operations in Brazil and Peru – unique for many Australian juniors. What does Karoon’s location say about its long-term strategy and appetite for diversity?

Our strategy is not dissimilar from the majors – we look for acreage with big upside. However, these days it is perhaps not as hard to look as it is to acquire since assets are so much more competitive now to procure. We like to be in and around proven fields so “closeology” is most probably our best geological strategy. In the Browse Basin, with Woodside and INPEX as our neighbors, we have fields next to us with two billion barrels of oil equivalent. In the Santos Basin in Brazil we have similar fields and in deeper water. Our prospects in Peru are not quite as large, but they are very greenfield and have good potential upside to them.

Still a young company that only listed in 2004, what have been the key turning points in the company’s brief history that enabled it to assemble highly valued acreage as attested to by your share price?

It really comes down to severe due diligence and having a historical education in international trade. 90% of all projects that comes on the table gets thrown out the door, so we place a very strong emphasis on due diligence.

Every junior in this industry prides itself on an “X-factor,” be it a fresh set of seismic eyes or a new technical expertise that sets them apart in a competitive field. What is Karoon’s differentiator?

We had established our offshore acreage in Western Australia relatively early when the LNG market was just arriving. Before that, a lot of those finds had been stranded gas for nearly 30 years. The major find next to our tenement was Woodside’s very first discovery in 1971 but had remained un-worked because there was no real market. However, there has since been a changing market in LNG since the early 2000s. Perhaps the most important contributing factor to rising LNG demand has been the high price of oil. Beijing is reported to be possibly putting 50,000 buses on the road which will be run by LNG and is one of many clear signs the LNG industry will only continue to strengthen. If you are going to pay half the price for a cleaner fuel, then isn’t it normal that demand will surge?

Can you elaborate on your perspective of the LNG market, namely, do you see it as a buyer’s or seller’s market?

I do not think most people understand how many unloading terminals there are in the world for LNG. Europe alone has close to 50 and is probably planning to build another 50 more. China, South Korea, and Japan will be consuming about 1 ½ trains in total per year of LNG. Australia will only have slightly more than 10 trains for the foreseeable future meaning that those three Asian countries will consume the equivalent supply of all of those LNG trains in 6 years. We are talking about a massive change from oil to LNG which, in turn, will most likely slowly shift in another 30 years to a different energy form such as wind and solar. Everything is changing in the same way that telecommunications have evolved since the invention of the phone only 130 years ago. We are now going to drive the world with gas and methane for a world population that has doubled since 1963. More people want energy and it has to come cleaner and cheaper. It is only natural that the world shifts to natural gas.

Imagine if every big diesel consumer – trains, buses, and trucks – all switched to LNG in the next 15 years, which is what I imagine will happen because of competitive costs between the two. If this happens, then LNG supply will double while pushing out environmentally unfriendly fuel sources and spending only half the cost of oil.

I sense a great deal of excitement, passion, and enthusiasm for what this energy industry has to offer. Compared to the career geologists or long-time industry veterans who typically manage junior E&P companies, you are a relative newcomer to the industry having transitioned into energy in the mid-1990s. What drove you into energy?

I got into the oil and gas industry in the mid 1990s when I started Nexus Energy, marking my first foray into oil and gas. Oil and gas is really just another commodity, but only this time it is called “energy.” I had a lot of experience in shipping and global trade so working in industries of international scope and significance is nothing new. Energy is not dissimilar to the arena I previously worked in.

Karoon Gas is the envy of many juniors in this industry with a share price that is trading exponentially higher than most others, despite having no production. What has been driving shareholder value?

We have seen shares reach a high of $12/share since first listing which has all been driven by good assets and sound management to get the assets.

Does having such a strong share price and equity base engender more of a conservative strategy to maintain the value that you have, or an aggressive strategy to grow the price even further?

You really just have to get quality. It is all about a search for quality that is supported by a good commercial background.

What was the process to forge the relationships that you presently have with majors such as ConocoPhillips and Petrobras?

ConocoPhillips approached us through a farm-in to our acreage. Again, the process stems from having quality assets which we were able to manage much like any property, buildings, or land. No matter who or where you are, if you have bad acreage then there will be no interest generated from any party.

How are the petroleum plays of your various tenements around the world similar, enabling you to build synergies and a common base of knowledge in developing them? How are they different?

Our blocks in offshore Brazil are salt basins much like what you would find in the Gulf of Mexico, but unlike what we have in Australia. However, some of the tenements in Brazil are very large and deep tilted fault blocks which do present some similarities to our Australian acreage. But every basin is a bit dissimilar to other basins, which always makes it interesting to look at. Most of the areas where we have decided to operate in are not high risk. In the Browse Basin, subject to obtaining regulatory approvals we will conduct appraisal drilling with a 60-80% success rate; it is far from high risk. The pre-salt oil fields off Brazil have a 75% drilling success rate. The post-salt fields in the southern Santos Basin where we are located have a 56% drilling success rate; the industry has had 23 successes out of 41 wells. That was not the same risk that we had three years ago when first entered Brazil. If we want to talk about risk, then we have to look back three years since the risk has changed ever since then.

Is Karoon Gas therefore the risk-free investment?

We are not risk free but the risk that we did have has decreased significantly over the past 2-3 years. We, of course, are still subject to exploration risk. A 53% chance of success still leaves 47% change of failure. In Peru we have a 60-70% chance of failure, but the new 3D seismic results coming through have again helped the risk profile. In the Browse we have a 30% chance of failure. We have defined exploration risk as a statement of fact.

What are the main timetables and targets that you are looking forward to for your acreage over the coming year?

Subject to obtaining regulatory approvals, we will embark on a 5-8 well program in the Browse Basin to drill around the Poseidon well and its satellites. The aim of the program is to confirm the reservoir’s quality – how much methane, and condensate and CO2 is in the mix – and quantity with 85% accuracy. Hopefully towards the end of the drilling program we can look at taking a sales position as a joint venture with a buyer of LNG for a train or perhaps even develop two trains which would give us a sales revenue on completion for the next 20-25 years of about $50-70 billion for one train followed by another $40-50 billion for a second train at a 100% share.

In South America, we are looking at chartering rigs very shortly in Brazil to commence a 3 well drilling program in the last quarter of this year which will be followed six months later by another rig charter in Peru. In total, we plan to drill 10-12 wells globally over the next 24-30 months with a minimum target of 100 million barrels per well.

Is there a rough estimate market capitalization that you are shooting for over the next 20-30 months?

On partial success of that drilling campaign we should have a market cap that is, let’s say, a lot higher than it is today.

We were speaking about risk earlier. In your discussions with the Brazilians and Peruvians, what was their reaction to last year’s proposed resources super profits tax? What is their perception of Australia’s oil and gas industry, in terms of its regulation and management?

They do not really know much about Australia’s industry. Instead, they are more concerned with what they have on their plate considering that the Santos Basin is one of the biggest oil discoveries in the world since World War II. Petrobras has a $300 – $400 billion capital expenditure over the next four years to satisfy.

Do you think the Australians know a lot about Brazil’s industry?

No.

As learnings unfold is there a competitive rivalry that can emerge between the two countries over resources and capital?

I think it is different altogether because of government structures and how the industries are run in each country. Brazilian oil and gas is run by a semi-government institution called Petrobras which controls the whole market, manages the entire basin, and requires a 70% local Brazilian content in everything project related.

Having activities in both Western Australia and Brazil, the two hotspots of today’s offshore hydrocarbon industry, is there any one region which excites you more?

Every time I think of LNG and its potential I am very excited by Australia; equally so about South America.

What are you still learning about this industry that continually fascinates you?

How big it is and how significant of a world trade play it is. I came out of the steel industry which is indeed a very large world play. But energy has become enormous in the past 10 years and it constantly changing. Gas, for example, was of minimal interest to investors just 10 years ago. Look at where it is today.

What are your growth expectations for Karoon Gas in conjunction with the important 5-7 year window that Australia is entering as new projects come online and production gets ramped up?

If we get into LNG production by 2018 it will have a positive impact on cash flows and further reduce our risk. The big upside for all companies is exploration success followed by production, which results in lasting value and positive, steady growth of funds. The excitement might be taken out of a company once it enters a production phase but if we can keep our growth rate up with exploration and production success, it will result in a lot more “bang for buck” with the company.

What would be your final message to our readers about Karoon Gas?

Can anybody out there pick another company that is drilling two billion barrels of prospective resource over the next two years with a $1.5 billion market cap? That is what Karoon is. We have a market cap of $1.5 billion and are possibly one of the only oil and gas companies who are drilling that much above our weight taking into account market cap. That is Karoon Gas in a nutshell.

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