Drunken insights lead the LNG debacle

Who would have thought that my chance meeting and drunken conversation at a wedding last weekend would prove so swiftly prophetic? It’s worth revisiting for a moment what I discussed with my serendipitous friend:

I spent Saturday night sipping beers with an oil and gas executive (who wished to remain nameless). His views on the mining boom were no different to my own. But the perspective was less macroeconomic and more operational. Basically, he reasoned, that between the dollar and rising input costs, the current LNG pipeline was a total fiction, that existing projects will be completed but on a longer time-frame than currently assumed and that all of the current projects under construction were going to weigh heavily on the firm’s return on equity for a long, long time. The next phase of the boom, in his view, was one that will prove quite costly to rest of us, which I will come back to.

His firm had significant maritime reserves but has effectively shelved all plans to develop them. They were looking instead at West Africa, the US and the Middle East, where returns were far more attractive.

This week has been entirely dominated by a news flow from LNG projects confessing massive cost blowouts and delays, first from Santos and BG and now from the mother of them all, Chevron:

Australia’s biggest ever resources development, Chevron’s Gorgon liquefied natural gas project, faces a $20 billion cost blowout to more than $60 billion because of the high dollar, union demands, high-cost local manufacturing and productivity issues.

…Chevron launched a cost review in July for the initial three-train venture on Barrow Island. The review is expected to reveal the cost surge and a potential delay to the schedule of first gas in late 2014.

Chevron has blamed the cost problems at Gorgon on foreign exchange movements since the go-ahead was given in September 2009 and on delays in construction on Barrow Island due to “weather, logistics and labour productivity”.

Blame whatever you like but I’m very unimpressed if I’m a shareholder. This level of cost blowout can’t be suddenly discovered. It can only happen if management is comprehensively pissed, figuratively or actually. As a quick aside, the AFR reports a similar outcome too for the Wiggins Island coal terminal:

Australia’s resources sector continues to be hit with cost overruns and project delays, with the latest issue surfacing at the $2.5 billion first stage of the Wiggins Island Export Terminal (WICET), whose delivery will now be delayed until March 2015, seven months behind schedule.

These LNG cost over-runs reek of a drunken investment binge: massive over-investment, hugely inflated asset prices, cheap finance on faulty ROI assumptions, labour market distortions on irrational expectations.

When was the last time you heard a story like this end well? As this comes off the negative income impacts on the economy are going to  be greatly exaggerated. I can’t help wondering how long it is before one of the major projects collapses into the gutter and is carted off in an ambulance.

Comments

  1. What’s $20 billion between friends? Its no biggie, they can just write it off against their tax.

    Criminal.

  2. From my experience, the problem is this:

    A company gets rid of all its expertise by ‘cost cutting’. Then when conditions improve, they get outside consultants and subcontractors to do the work (“Build me a mine,” says Clive). The consultants and subbies then say, well, what exactly is it you want us to do? It is at this point that the problem manifests. Quite often the mining company, having divested itself of expertise, cannot state precisely what it is it wants its consultants and subbies to do. This is bad enough if it merely leads to design delays, but often it is only when there is infrastructure on the ground, does the mining magnate realise that it is not quite what was required, and work is just torn down and restarted twenty metres away. On well run projects where the mining company has in house expertise, this happens rarely. On projects where the mining company has no in house expertise, tens of millions are squandered in re-work because the client does not have enough of an idea of exactly what it is they want – other than ‘build me a mine for X million tonnes per year at location Y’. It is not a matter of being pissed, it is a matter of complete buyer ignorance.

    This has been pointed out by professional bodies such as the Institution of Engineers, Australia ad nauseam for years. Nobody listens, and everybody pays. Let’s blame the greedy workers when the shareholders get upset.

    It is not only in mining either. I am personally aware of several multi million dollar projects outside mining where lack of buyer knowledge is doubling the cost of the project. But hey, it is all adding to GDP, right?

    • +1 emess

      Also not forgetting that the consultants designing and building these projects usually either get paid a fixed percentage of the total cost or indirectly are able to bill more hours if the project is gold plated, gets bigger, gets more complicated or runs longer. There is a massive conflict of interest as generally the consultant has a huge amount of power to influence the direction of the project.

      When the fox is in charge of the hen house you shouldn’t be surprised when you have half the chicken you expect.

  3. Looks like the rumours I heard of $200 million cost overruns here at Curtis Island probably weren’t rumours after all.

    I drove past the Wiggins Island site the other day – a very impressive sized piece of mudflat has been filled, I can’t see much more than that.

  4. Most of this sounds like they’re blaming delays on unproductive and overpaid Australian workers! They’ve been drinking the same booze as Gina Reinhardt. Can’t make a project pay without slave labour!

    I’m sure labour is much cheaper in West Africa and the Middle East where they import 100s of thousand of workers from India and Pakistan who passively work 12 hour shift 7 days a week for a few gold coins, but Australia isn’t some 3rd world dump! We have OH&S up the clacker!

    Sounds like a massive project planning failure.

    • Here’s how it works:

      You are a middle level ‘manager’ tasked with project managing a huge project. Due to staff cuts (which gave the CFO a huge bonus), you have nobody who knows how to build a mine. You then employ consultants, who you cannot give any detail to, because you have nobody on staff who can provide that detail. The consultants have an incentive to gold plate, since their fee is a percentage of the price, and they cannot read your mind. Result, disaster. The job gets reworked and reworked in attempts to get it right. The time of practical completion breaks out to forever, and the costs double.

      You, as project manager, are in the gun. Your job is gone most likely.

      What do you do?

      Simple, blame the unions. If you have a right wing boss like Rinehart, or shareholders who are the small stockholders who consider themselves right wing, such blame is ALWAYS accepted. In fact you can be totally incompetent, but if you can plausibly blame a union, you will get away with it, because with right wing management, there is such a fixation with the union bogey, they cannot focus on anything else if there is union presence.

      This does not mean that unions do not do some pretty bad things. Merely that failing project managers know that they can get away with it if they can somehow blame a union.

  5. Chevron…. if you are silly enough to want to build something of this scale on an a-class nature reserve, you can’t complain about logistics problems.

    +1 to emess’ comments too, spot on.