Shut the gate on CSG debate (AFR online 17 August 2011)

Fundamental differences about property rights are emerging when debating whether farmers are at the wrong end of Australia’s expanding coal seam gas industry.

Understandably, not everyone is happy that Queensland now has three LNG projects based on coal seam gas (CSG) under construction.

 This became clear in Senate hearings last week when Nationals Senators, Barnaby Joyce and Bridget McKenzie, claimed that farmers are getting a dud deal from CSG, because compensation is miniscule in relation to project revenue.

However the Senators’ claims demonstrate a fundamental misconception both of Australian mineral property rights and resource sector economics. While their questions can be shrugged off as just another example of political argy bargy, they go to the heart of Australian property rights.

So what was the basis of the Senators’ case? According to Barnaby Joyce’s website, Santos (one of the CSG developers) revealed to the Senate that its GLNG project is set to produce $9 billion a year in revenue and that a landowner can expect on average, at most, $2,500 per year per well.

 “The Santos GLNG project is set to drill 2650 wells meaning that landowners can expect only about $6.6 million of the $9 billion in revenue, or about 0.074%”, said Senator McKenzie.

 “I think if someone was going to come on to my property to make $1000 and offered me 74 cents in return I would consider that grossly unfair.”

 There are two basic failings in comparing compensation to revenue.

 First, in Australia and unlike the United States, mineral resources are the property of the nation, not the landowner.  It is the state, not the landowner, which receives revenue related to petroleum production. Accordingly the State levies royalties (not the landowner) and the Federal Government levies the Petroleum Resource Rent Tax, which is designed to tax any super profits.

Quite appropriately, payments to farmers are compensation for loss of agricultural value and are assessed as such. They bear no relation to project economics and nor should they.

The second flaw is that even if compensation is compared to project economics, comparing payments to farmers with project revenue skips a number of important lines in the project cash flow, namely costs.

Some insights into current CSG economics are provided in the just completed annual review of the CSG industry, Australian Coal Seam Gas 2011: From Well to Wharf.

For instance, the CSG LNG projects cost roughly $20 billion each (including pre-sanction costs) for a two train project. This is only the cost to first LNG; there are further substantial costs for the subsequent 20 years for drilling further wells.

The $20 billion covers the cost of drilling the wells, connecting them up, disposing of the water, processing the gas, transporting the gas by pipeline to Gladstone, processing the gas again to make LNG and loading it on the ship.

The simple comparison of revenue and compensation completely ignores this $20 billion of up-front costs (an average $7.5 million per well).

Development costs have increased significantly since the CSG LNG projects were first proposed. The number of wells needed and the workforce needed have both doubled. Santos anticipates its overall internal rate of return from GLNG to be 11%-14% (in US dollar terms) based on the current contracted off-take of 7 million tonnes per annum. This is sufficient for the project to go ahead but is not a great return considering the risks involved. Returns would be even lower for the foreign companies that paid billions to buy into the Australian projects.

Future oil prices and exchange rates are major risks for investors. Returns will be higher if oil prices rise or the Australian dollar falls over the long-term. If this happens the Federal Government will benefit through PRRT. If oil prices fall or the Australian dollar rises further, returns will be cut.

Overall, the projects are not nearly as profitable as the Senators suggested.

Ambit claims are part of any negotiation process and relating CSG compensation to project revenue is an ambit claim, rather than anything that can be justified based on Australian property rights. It also creates a false impression of project profitability.

Clearly it is important that there be harmonious relations between farmers on the one hand and resources companies on the other. To paraphrase Rodgers and Hammerstein, the farmers and the miners should be friends.

It is also understandable that any landholder would feel resentful if they felt that resource companies were abusing their access rights. It is simply good manners for resource companies to respect the needs of the farmers and other landholders with whom they deal. 

However locking the farm gate (as the anti-CSG movement is called) to give landholders the right to deny access to land by resource companies would transfer ownership of the nation’s resource wealth from governments to individuals at no cost.

This would be expropriation on a massive scale.

Dr Graeme Bethune is CEO of EnergyQuest, an independent economics consultancy specialising in oil and gas.

Also appeared in The Australian, 18 August: