Sovereign Risk and the PNG Gas Pipeline

Sovereign Risk and the PNG Gas Pipeline (2002)
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Major international companies have invested in developing plans for a possible gas pipeline from Papua New Guinea (PNG) - perhaps a $4-6 bn project. Basic facts about the project are available in Australian Energy News (Issue 9, Sept 1998) and on the PNG Government-backed Orogon Minerals' site.

The Queensland Government gave early indications of VERY strong support for the project.

Government support had been indicated by Ministerial statements, by signing a Memorandum of Understanding with the PNG and Commonwealth Governments, by signing of tentative contracts for 170 pj / annum of gas (effectively the entire supply expected from the field) and by the proposed involvement of Queensland Government-owned-corporations (Energex and Ergon) as marketing agents for the project before Chevron was replaced by Exxon-Mobil as the project operator (see Orogon Minerals).

The Queensland Government has since reversed what had seemed to be its strong early commitment to underwrite such a gas pipeline. In particular

In May 2001, a new Minister for State Development indicated that the government would not be willing to underwrite all of the gas from PNG to make the pipeline viable. The earlier understanding had apparently been that Chevron would deal only with the Queensland Government who would buy all of the gas and then find customers (see Parliamentary Statement by Minister Mackenroth);
PNG pipeline has been dealt a near fatal blow by decision to source gas for Townsville power station from state owned Enertrade - using coal seam methane from Bowen Basin (Wisenthal S and Strutt S. 'Beattie deals bitter blow to PNG project', FR, 5/6/02);
Queensland's reversal of its earlier indication that gas for the Townsville Power Station (potentially an important customer) would be purchased from the PNG gas pipeline appeared to surprise and upset the project promoters - who were reportedly seeking an explanation (see Wisenthal S and Strutt S. 'PNG pipeline chiefs want answers on Townsville', Financial Review, 11/6/02).

Moreover:

Plans for $7bn gas pipeline has been dealt another near fatal blow with loss of nearly 50% of its potential sales contracts (Howarth I and Wisenthal S., 'AGL deals brutal blow to PNG pipeline, FR, 19/12/02).
PNG gas pipeline proposal received strategic setback with announcement of major LNG gas project in NT (Syvret P 'Blow for state gas pipeline', CM, 16/6/03)

The official view seemed to become that the government was merely a bye-stander waiting for the pipeline to be developed.

Queensland has been waiting patiently for the $6bn PNG-Queensland gas pipeline to deliver gas, industrial development and a shift away from reliance on cheap coal. Comalco's alumina refinery and the AMC investment both happened without the pipeline. The pipeline's credibility is now in tatters. It was dealt another blow with failure to gain supply of Townsville power station - not a major market - but a strategic first step into country. But there are bigger markets in the south - and competitors in the form of Greater Sunrise's Timor Sea gas and from CH4's coal seam methane (linked with the government company Enertrade) which won the Townsville Power Station contract. PNG may need 175 petajoules / annum demand to be viable - which would currently require all Queensland demand to line up together. ACIL have estimated the construction-phase and subsequent economic benefits of the project. The Government's research shows that successful tenders for Townsville Power Station will yield large employment and economic growth - but many in the industry doubt that a small 220MW power station will have much economic impact. AMN Amro suggested awarding the contract to CH4 was amazing as it had limited gas resources, had not proven that coal seam methane could be competitive, and would not meet Queensland's 13% gas target. Enertrade's Moranbah to Townsville pipeline does not link North Queensland to Gladstone. The decision has however been very positive for coal seam methane generally - and for many potential customers who wondered if it could be a reliable source. Many observers doubt that CH4 will be able to obtain bank funding for its untested project - a view which does not consider its 90% ownership by the Macquarie Bank. (McCarthy J 'The power game', CM, 8/6/02)

The problem is that Queensland's reputation as a reliable administration may well have been tainted. Increased perception of sovereign risk in dealing with Queensland could be very significant because the economy has traditionally been highly dependent on foreign investors.

Regarding Queensland's hot and then cold approach to the PNG gas pipeline, it can be noted that:

informer industry observers had from the very beginning argued that a huge subsidy (say $2bn overall in the form of high prices paid for gas and other incentives) would be required for that project to be commercially viable;
such a subsidy may have been believed to be justified (without appreciating its financial implications) under the state government's gas-positive Cleaner Energy strategy. Natural gas is a premium fuel - with lesser greenhouse gas emissions. It also tends to be 2-3 times as costly. Major energy consuming industries in Queensland include light metals such as aluminium - 30% of whose production costs are accounted for by electricity, and whose competitive status would be seriously undermined if much higher energy input costs were passed on to them;
The Queensland Government reportedly disturbed some directors of Energex (a government owned corporation) by requiring it to carry the sovereign risks associated with taking gas from the pipeline (noting PNG's lack of political stability) without reliance on government indemnity (Note 52);
Queensland's financial position has deteriorated badly partly as a consequence of adventurous, but perhaps not wise, economic initiatives (see About Queensland's Budgets);
the Department of State Development's naive original acceptance of underwriting the pipeline apparently emerged when the Department was headed by a new appointee who had reportedly previously worked with Chevron - the pipeline's original promoter.

The Queensland Government was probably not foolish enough to give such a strong early commitment to the project that it might now be successfully sued for damages. Moreover so long as there is a prospect that the project could be viable (eg see McCarthy J. 'Lifeline revives $6bn gas pipeline', Courier Mail, 10/7/02). The pipeline promoters would presumably wish to avoid the negative publicity which such a option would attract. None-the-less ...

In considering the damage which may have been done to Queensland's reputation, it may be appropriate to consider The Growing Case for a Professional Public Service.

The latter points out that Enron's failure and other similar cases, have triggered a loss of confidence in the reliability of the accounting, auditing and management of many major US firms.

In particular the practice of 'politicizing' corporate managements (ie focusing management solely on shareholders' criteria through the provision of stock options which are the business equivalent of political criteria for a Public Service) is now apparently discredited (eg see Chancellor E. 'Perverse incentives', Financial Review, 7/6/02).

The latter article suggested that the when management is focused solely on financial-market (ie quasi-political) perceptions the result can be:

manipulation of financial results to maximize share prices - which has now led to a damaging loss of investor confidence; and

very poor investment decisions - to meet the expectations of those influential but perhaps technically and commercially ill-informed interest groups.

It can also be noted that the project appears to have subsequently been 'issue-managed' through the media with a view to persuading the Federal Government to provide the necessary subsidy.

June 2002