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After 25 years of laissez-faire government involvement in the development of our hydrocarbon resources should the state be reviewing its involvement? By Dr George Hooper and Sir Colin Maiden, with contributions from John Duncan and Gary Eng from the Centre for Advanced Engineering at the University of Canterbury.
If we are to realistically exploit these opportunities the way forward will require a combination of financial investment by the State, and a more prominent role by state agencies than recently has been the case. However the argument for state involvement in the development of our resource industries too often raises the spectre of ‘Think Big’, and the implied financial failure of some of the previous government-inspired projects. In this paper we present a post facto review of government involvement in the Synfuel gas-to-gasoline plant, which shows that if the state had maintained its shareholding then losses in the early years would have been largely recouped as the price of oil increased and project debt repaid. By relinquishing its role in Synfuel the government not only triggered a loss to the taxpayer of over a billion dollars but also, unfortunately, effectively dismantled the well-considered energy strategy that existed up until that time. Whilst not suggesting a rerun of ‘Think Big’ we argue that strong leadership will be required from any government if we are to realise the potential of our substantial coal, oil and gas reserves. Recognising resources opportunitiesThe New Zealand Energy Outlook 2009/2010 offers a number of scenarios describing future energy pathways for the country. The futures described by these scenarios paint a vivid picture of our continued vulnerability to international petroleum markets and the uncertainties that would arise from a tightening supply situation. Often overlooked when considering future energy pathways for this country is that our largely unexplored petroleum resource could be one of the country’s most significant economic opportunities. The petroleum sector currently accounts for around $3 billion per annum of export revenue. And, according to some estimates1, should the inferred resources in our unexplored basins be developed, revenues could increase to $30 billion per annum by 2025. If the present Government is “determined to see New Zealand realise the benefits of its petroleum resources”, as the Minister of Energy Gerry Brownlee states, then focus must go beyond simply increasing exploration activity to thinking more broadly about the role of Government in realising the value opportunity that will arise from successful exploration. The role of governmentThe New Zealand Centre for Advanced Engineering (CAENZ) has undertaken significant work over recent years examining the country’s resource opportunities. An important finding from these studies is that, if we wish to exploit potential economic opportunities within the petroleum and minerals sector, the way forward will require the Government to amend existing regulatory regimes and, sometimes, for the State take a prominent role in front end developments and make financial investments.
The Synfuel plant at Motonui came on stream in late 1985 and for several years produced about one-third of the country’s gasoline requirements. The company was a joint venture between the State (75 percent) and Mobil Oil (25 percent). The plant was built in just over three years, at 17 percent under budget, and operated extremely well, consistently producing high quality gasoline at well over nameplate capacity. The Synfuel initiative was part of a well-considered strategy, recommended by the Liquid Fuels Trust Board and adopted by government in 1979, whereby New Zealand would look to maintain at least 40-50 percent self-sufficiency in transport fuels. Priority was given by the government of the day to the use of Maui gas for the production of such fuels and its direct use in transport, rather than allowing the gas to be used for the generation of electricity. Maui gas was used to produce methanol, which was then converted into gasoline using a novel process developed by Mobil. A key consideration to the selection of the Mobil route was that the intermediate product, methanol, was seen as a future option for meeting New Zealand’s transport fuel requirements . There was also a compelling motivation for the government to see Maui gas used for these purposes, because it owned half of the Maui gas field, had signed a thirty year take-or-pay agreement for gas, and wished to realise the associated production of valuable condensate (light oil). In 1990 the then government decided to sell its shareholding in Synfuel to Fletcher Challenge. Two of the factors leading to the sale were the increased costs of the company’s loans, due to the dramatic fall in the value of the New Zealand dollar in US dollar terms, and the significant fall in oil prices in 1986. These events impacted negatively on the financial return of the venture at a time when Government was in a haste to privatise state-owned enterprises. As part of the sale arrangement, Government repaid the balance of Synfuel’s debts ($1196 million, December 1989) and Fletcher Challenge was paid $112 million. The overall cost to the taxpayer was thus around $1300 million. Subsequently, ownership of the plant passed to Methanex Corporation of Canada and gasoline production eventually ceased with the plant now being a major export earner through the production of chemical grade methanol. With the passage of time it is now possible to assess the wisdom of the sale by comparing the consequences with those of the alternative had government retained its shareholding and continued the venture with Mobil without change. This scenario is a worse case as it presumes that the State continued to be exposed to the full risk of the project and did not, instead, look at a different operating arrangement with Mobil to provide a more equitable risk-share position. The resulting analysis is shown in the graph below. The analysis uses the actual cost of the project of US$1218 million (original estimate US$1475 million), an average plant output of 634,000 tonnes per year (1989 actual, original estimate 570,000 tonnes), and the actual oil prices, NZ$ to US$ exchange rates and CPI data for the remainder of the design life of the project (1990-2003). Also used in the analysis was information from the “White Paper on New Zealand Synthetic Fuels Corporation, July 1982” and the annual reports of Synfuel. As can be seen from the graph above plant economics over the period can be characterised by three distinct phases; early stage of operation combining debt and low gasoline prices, a middle period of continuing low gasoline prices, and the later stage coinciding with significantly improved gasoline prices. Also presented is the authors’ calculation of the levy that would be required over all gasoline sold in New Zealand to arrive at a breakeven situation for the government in each year. The analysis shows that from 2000 onwards the State would have been able to meet all of its costs in the venture – the cost of gas under the Maui take-or-pay agreement, the processing fee to Synfuel and the Energy Resources Levy, and realise a cash surplus. This surplus would be much greater today with higher energy prices. On average, over the period from 1990 out to the end of the original contract period of 2003, a levy of between 3-4 cents/litre (1990 real) on all gasoline sold would have been sufficient to recover the operating losses to government from its participation in the venture. Reflection thus suggest that, had this option had been followed, the company would have held its value and there would have been a significant incentive for further oil and gas exploration during the 1990s. As it was, the sale of Synfuel triggered a substantial loss to the taxpayer, our self-sufficiency in transport fuels declined from a peak of around 65 percent in 1986, and electricity generators obtained access to cheap gas that ended up being used in outdated generation plants, delaying the introduction of higher efficiency combined-cycle plant. This option would still have allowed the development of sales of chemical grade methanol, at the expense of gasoline. Such a development, which is what actually happened, would have enhanced overall economics. ConclusionsThe significant extent of the country’s hydrocarbon resources suggests an essential role for the State, acting as a channel for stimulating investor interest and reducing development risk, if New Zealand is to fully realise the potential of its hydrocarbon endowment. The Synfuel story shows that there is a role for the State in the development of projects beyond the capacity of the private sector, but such projects are likely to be long-term in nature and should be persevered with despite the short-term volatilities of markets. It was a poor decision of government to sell its shareholding in Synfuel in 1990. By selling government realised a loss, whereas Fletcher Challenge acquired a bargain. This conclusion is, of course, with the benefit of hindsight but one can reflect on how different the present energy scene in New Zealand would have looked if government had not earlier sold its interests in Petrocorp, the state-owned oil company, and subsequently Synfuel. Petrocorp’s activities surely would have added to New Zealand’s oil and gas reserves and Synfuel would have been producing significant cash surpluses from 2003 onwards. In conclusion, the argument for on-going State involvement in the development of our hydrocarbon resources is a strong one. Not only does government have the ability to overcome institutional barriers to investment, but also it can set strategic direction and help realise resulting policy goals through co-ordinated action with industry. The challenge will always be to initiate, accelerate and control resource development in ways that ensures that we achieve fair value for its resources. Active participation by the state, including investments, provides a valuable means of ensuring such an outcome.
Energy NZ Vol.4 No.6 November-December 2010 |
New Zealand is an energy-rich country with significant proven reserves of coal and indicated potential resources of oil and gas that, if realised, would offer one of the more significant economic opportunities for this country to transform its economy.
CAENZ and others argue that state involvement sometimes is required because the nature of discovery is such that development won’t proceed by the private sector without some form of partnership or risk sharing. There is no simple answer, but an earlier example worthy of further examination is the role of the government in the development of New Zealand Synthetic Fuels Corporation (or Synfuel).