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Interview

with Stephen Keenihan, Managing Director, Latent Petroleum

10.06.2010 / Energyboardroom

What were the origins of Latent Petroleum that led to its founding as a company?

Latent Petroleum is a company that was created specifically for the Warro Project. After leaving Apache we saw the opportunity that the Warro field presented and, together with several Apache colleagues, who left the company around the same time, we created Latent. The project has also been supported by a group of venture capitalists in Perth – Craig Burton, Charles Morgan, and Eddie Rigg of Argonaut Capital – with whom I had been working on various projects since leaving Apache. Latent still remains a private company. Warro is a tight gas project in the onshore Perth Basin, it had see very little activity for a long time. We believe that we picked it up at the right time. We acquired the Warro field from its then-owners, a company called Ausam in 2008. We spent about a year doing technical work on the field, then sought farmin offers, and soon afterwards stitched up a deal with Alcoa to appraise and develop the field. We originally wanted to call the company Latent Energy to reflect the hidden nature of the field, but that name had already been taken. So we adopted Latent Petroleum.

With drilling scheduled to reconvene by the end of this year and production expected for 2012, what is the mood of the company today as the project that the company was formed to develop comes closer to fruition?

It is an exciting time indeed. A frustrating part, however, is the lack of equipment in Western Australia (WA). There is one drilling rig in WA capable of drilling to the depths of Warro and we now have to wait in line for it in order to start drilling again by the end of this year. There is even a possibility the rig may be moved overseas in the near future. The other issue is the lack of availability of fracturing equipment. There is virtually none in WA and we have to mobilize a very substantial amount of it from the eastern states to carry out our work. It is exciting that we are doing the work, but somewhat frustrating knowing that we could do it so much quicker if we were in the US, for example, where equipment is readily available. But we are steadily tackling that issue and hopefully by this time next year as the project progresses we can bring in more dedicated equipment and have a tight gas industry based in Perth.

However, we heard from previous conversations with other Australian oil and gas companies that Latent had already brought in a rig.

In 2009 we recognized that we needed a rig capable of drilling 4,500 metres deep at Warro but there were not any rigs in WA that could do so. So we worked with a company called IPS to put a deposit on a new build rig from Houston with the idea that we would bring the rig over to Australia and IPS would operate it for us. Weatherford ended up buying that option from us. We then formed a rig club which included AWE Limited and Origin Energy and between the three of us we brought in the rig (Weatherford Rig 826) to drill wells in the Perth Basin. It started off at Warro and has since drilled seven wells. We cannot be sure whether it will stay in WA because there are always other parties elsewhere looking for rigs. If it goes, which would be a pity, we will need to repeat the exercise.

How do you see tight gas revolutionizing the energy landscape in Western Australia?

The most important thing is that it will provide an alternative supply of secure, competitively priced energy. Western Australia relies heavily on offshore fields for its gas supply. Recent events have shown it is dangerous to be too reliant on offshore facilities. A tight gas field produces from hundreds of wells. If one or two wells fall over then it does not matter so much as compared to offshore fields where if you lose one of your wells it will have a dramatic impact on your supply. Of course the explosion on Varanus Island also showed that offshore pipelines are a weak point in the supply chain.

As we have seen in the US, unconventional gas developments create a big industry with lots of drilling and fracing activity whether it be for tight gas or shale gas. We hope to establish a similarly large industry in the State of Western Australia.

We have spent a lot of time talking to Government about the importance of creating an onshore tight gas industry something which they are very supportive of. We achieved a royalty reduction from the Government last year specifically aimed at tight gas. Even so, it will still generate substantial royalty payments for the State Government. They also see the positive impact on employment opportunities and regional development that creating an unconventional gas industry in WA will have.

Could you describe the resource potential that the Warro field contains?

The Department of Mines and Energy assessed the Perth Basin and estimated it to contain around 10-12 tcf of recoverable gas reserves. The Warro field is by far the largest of those accumulations and has about 5-7 tcf in place of which we believe we can recover 40-50%. It is potentially a 2 tcf gas field and therefore very substantial. It is not going to replace the North West Shelf but it will certainly provide a substantial alternate and importantly a lot of backup. We are planning on the field producing 100-150 terajoules per day. A good thing about onshore fields is that you can tailor the production level it to suit the market. If we want more production then it is just a matter of drilling more wells. For Latent, it is obviously a very important project. For our partner, Alcoa, it is important as well.

What drew Alcoa into the partnership?

Their strategic objective is very clear. Approximately 1/3 of their costs are energy related. They are one of the largest consumers of gas in Australia. Depending on the price of gas they probably spend more than $300 million each year on energy in WA alone. Achieving greater energy security and controlling their energy supply is an important strategic driver for their business. In the long term, energy prices are only going in one direction. When major suppliers have a clear LNG option, there is not a strong incentive for them to sell gas at a lower price into a domestic gas market. Alcoa probably sees it as a way of providing them some price stability as well. Overall, I believe they see Warro as a very important opportunity to not only to add substantial gas reserves but also to act as a catalyst for other onshore projects. This would improve their security of supply so if the system breaks down, as it has a couple of times, they are not as vulnerable and need to import diesel.

While it is good to solely concentrate on one field so as to devote all resources and attention to its development, is it too risky placing all eggs in one project basket?

It would certainly be beneficial to have a broad portfolio of activities. But Warro itself is a demanding project because its in its infancy and we are bringing technology from overseas and applying it here. There is a lot still to be learned. We hope that in time we would be able to leverage what we learn into other opportunities in the Perth Basin and perhaps elsewhere.

We could look to export gas in the future, but breaking into the LNG game is a big business to tackle. There is quite a lot of appetite for gas onshore. Western Australian gas prices are quite different from the eastern states. Prices in the east are presently held down as there a number of ready sources of energy from coal, Gippsland gas, CBM and Cooper Basin gas. LNG export is a way of achieving higher prices. In WA there are few sources of energy (coal is not a major factor) and the Northwest Shelf gas can readily place their gas into the higher priced LNG market already. It is a completely different market than the eastern states. We do not necessarily need to turn to LNG to reap some of the rewards of higher gas prices.

Who do you consider your main competitors in the Perth Basin in the race for tight gas?

There is clear competition of gas suppliers in the area but I don’t think anyone is where we are with tight gas. AWE Limited and Origin Energy are looking to do work with shale gas and their own tight gas. They may also be successful but we don’t necessarily see them as competitors at this moment. In any case, we have WA’s largest gas customer is our partner. For WA to have a thriving onshore gas industry would be a win-win as it will allow WA to supply its own needs and maximize its LNG export.

Overall, I do not think there will be a lot of competition in shale or tight gas supply market for some time to come. Only once something like Warro gets going, and there is that critical mass of people, knowhow and equipment in WA that can nurture the industry, will we see real competition. At the moment we are all working on one-off type projects and the industry is in its infancy – there a lot of work to be done. If we get Warro going and bring in the frac crews and drilling rigs and they have a permanent presence in WA then there will be a lot more action. I would expect at that stage that we could have a competitive advantage since we will know how to work tight fields. We would then be able to move in and help others replicate the model.

To what extent is the Warro projects an international project that compiles various elements from overseas?

Hugely so. We are building on all the experience and knowledge of the tight gas industry that has been developed in the US. The technical advisors who we draw on are from the US. The frac designs are done by people in the US. When we drilled our last well, Warro 3, and evaluated the results, we turned to analogies in the US and used them to help design and decide what to do with the next wells. We try to pick and choose the right approach for Warro from all the experience that has taken place in the US.

The US industry is changing all the time as well. The way wells were fractured ten years ago is not the same today. The success of the shale gas industry has had a big impact on the type and scale of the fracs. The technology is also moving along with the fracing monitoring techniques which are giving a better picture of what is actually happening underground. We are certainly looking to use the same technology at Warro.

Is there any discussion about taking the company public in order to access more capital and get involved with more large scale projects?

If we needed to we would certainly look into that. But going public brings with it substantially more administrative, compliance, and governance costs. We wish to avoid those expenses at the moment. Most companies who list can spend up to half a million dollars per year just on corporate compliance and reporting an expense which we can avoid while we stay private. We certainly won’t limit our growth by staying private. If we find that floating our stock is the right step then we will certainly look to do that. But at the moment we don’t need to do so as we have a very helpful partner in the form of Alcoa who is helping us by funding this part of the project.

Having worked for large oil companies such as Apache and Woodside, how do you apply the managerial mindset from a big corporate setting to a small but growing company like Latent?

In those companies I did not do a lot of work with tight gas so I cannot say that I have extensive previous technical experience working with tight gas reservoirs. But you do of course learn all the fundamentals of how the business works and the importance of bringing in the right experts at the right time to advise you. The other important element is that in all of those companies you deal a lot with joint ventures. You understand the dynamics of partnerships and how to get things done. The two crucial things you get from working with large companies are, first, the technical side and drawing in resources as you acquire them; second, the human side of how to get things done to keep everybody moving in the same direction.

Working with a company like Apache, you get a very strong sense of urgency with projects. You want things to happen right away. You develop the mindset of “if it is a good idea why wasn’t it done yesterday?” Some other companies assume a more methodical approach. I personally feel happier in the Apache mode – if it’s a good idea let’s do it now. Alcoa is a very methodical American company. So we are a good mix in the sense of getting things done quickly while taking enough time to think things through.

Where do you see this company being positioned in the next five years after production comes onstream in 2012?

There are a number of areas. We will have a good cash flow at that point and negligible debt. We will be in a strong position with a good annuity from the gas flow for many years. That is a good thing about tight gas fields – they have long lives. We would look to leverage that into other opportunities in Australia but we will continue to have an eye at opportunities elsewhere. We are not looking at that presently but through the associations that we have with our shareholders we stay aware of things that are appearing in other places. We keep flirting with them, but at the moment our focus is on getting Warro up and running.

Are there any final messages you would like to convey to our readers about Latent’s business approach?

Latent’s success reinforces the notion that it is important to always keep an open mind on what and when assets may be of value. We took an asset that was thought to be of negligible value at the time and applied a change in mindset. We were able take advantage of a significant improvement in the gas market to turn the field into something that could make a significant difference both to Latent and WA’s energy supply.
Also important, was knowing what our limitations were and understanding how best to commercialize the project. We did not go the route of trying to float our stock and getting a little bit of money in. We thought the best way of attacking this would be with a substantial partner who would have sufficient funds and incentive to do a thorough evaluation of the field. Tight gas fields are not something where you drill one well and expect it to work immediately. You have to drill a well, learn from it, and apply that knowledge to drill more wells. An important criterion for us was getting someone with enough staying power for the project and with enough incentive on the other end to make it work. So we benefited from the right location, right time, right partner, and the right technical advice to make sure we were doing things correctly. We have learned an awful lot on our first well that we are applying on the next one; and we will continue to learn. You always have to keep an open mind.

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