Santos, coal seam gas and the disappearing $2 billion

by | Aug 2, 2017 | Energy & Environment

Researchers Tony Shields and Rod Campbell at The Australia Institute expose Santos’ wilful and exaggerated economic assessments (known in the trade as “strategic misrepresentation’) to win government approval for its controversial Narrabri coal seam gas project.

WHEN SANTOS submitted its Environmental Impact Statement (EIS) to get government approval for its Narrabri coal seam gas project, their consultants, GHD, estimated the project would provide net economic benefits of $2.2 billion.

Strangely, in Santos’ financial statements the project is worth a bit less. Actually, a lot less. In December 2015 Santos was forced to “write down the remaining book value” of its stake in the project. On Santos’ books, the project is worth nothing, zero, zip, zilch.

Santos isn’t alone. Given the “challenged commercial viability of the project”, Santos’ partner in the project – EnergyAustralia – has also “made an impairment provision for its interest in the project” and written it down to zero.

To be clear, Santos and GHD are telling the NSW government that the Narrabri project is worth $2.2 billion, while Santos and EnergyAustralia are telling their shareholders it is worth nothing.

Welcome to the world of major project approvals where proponent companies are allowed to exaggerate the economic benefits of their projects in order to get government approval. State government agencies almost never take issue with proponent’s economic assessments.

The incentives to exaggerate the economic benefit of a project are huge because having government approval for a project can add tens, if not hundreds of millions of dollars to a project’s value. This is particularly so for a controversial project like mining coal seam gas. Invest a hundred thousand dollars in glossy economic assessment, then hopefully get approval and your project is worth millions more. There are few investments so profitable.

Importantly, although the value of the project has gone up, the proponent has the right but not the obligation to develop it. Once the project is approved, it can be sold on to someone else, who may or may not put money into developing it.

Furthermore, the more you exaggerate the value of a project, the more likely a government is going to approve it. The economic literature even has a polite term for this exaggeration — “strategic misrepresentation”.

Even without strategic misrepresentation, estimates of net economic benefits are still likely to be over-optimistic because as Nobel Prize winner for Economics, Daniel Kahneman, and Amos Tversky have highlighted, humans tend to be optimistic. We have a strong tendency to over-estimate the benefits and under-estimate the costs and time required to complete a project. If you have built a house or even renovated a kitchen you will know this firsthand. In a resource project where there many more ways things can go wrong, the likelihood of over-optimism increases.

Strategic misrepresentation and over-optimism both work to push up revenue estimates and push down cost estimates. Combine the two and you are quite likely to end up with deadly misleading estimates of project net benefits.

As the world’s most cited scholar on mega-projects, Bent Flvbjerg, writes:

‘When cost and demand (revenue) forecasts are combined, for instance in the cost-benefit analyses that are typically used to justify large infrastructure investments, the consequence is inaccuracy to the second degree. Benefit-cost ratios are often wrong, not only by a few percent but by several factors. As a consequence, estimates of viability are often misleading, as are socio-economic and environmental appraisals, the accuracy of which are heavily dependent on demand and cost forecasts. These results point to a significant problem in policy and planning: More often than not the information that promoters and planners use to decide whether to invest in new projects is highly inaccurate and biased making plans and projects very risky.’

In the case of Santos’ Narrabri gas project, Santos appears to have seriously underestimated the cost of producing gas. It is hard to ascertain how Santos has estimated the project costs in their EIS, which they claim are around $2.48 per gigajoule (GJ) at the wellhead. This is way below estimates commissioned by the Australian Energy Market Operator which estimated the cost of production at Narrabri at $7.25/GJ (Table 3.1 under ‘Gunnedah’) and Macquarie Bank which in its May 2017 ‘Australian Energy Outlook” estimated it at $7.87/GJ.

Core Energy Group: Gas Production and Transmission Costs Eastern and South Eastern Australia, February 2015

This underestimation of costs is the key reason why GHD’s cost benefit analysis estimates project value of $2.2 billion while investors think it is worth nothing. GHD were told to assume very low production costs, while investors know better.

Optimism also appears in Santos’ estimate of the price it is likely to receive for its gas. Santos estimates that it will receive $8.75/GJ for selling its gas. We estimate that, based on current gas prices, that it would only receive $7.16/GJ, eighteen per cent less.

Another way Santos’ EIS produces an over-optimistic estimation of the Narrabri project’s net economic benefit is it leaves out costs that are hard to pin down but could be significant. These include: ignoring fugitive greenhouse gas emissions — which research indicates are significant; ignoring health risks and ignoring risks to groundwater. Try telling a Narrabri farmer there are no risks to their groundwater from Santos’ proposal.

Governments should not approve major projects based on commissioned economic assessments that are clearly contrary to what markets and financial statements are saying. At the very least, assessments should be compared with “reference class forecasts” that estimate values based on the actual costs and revenue of past and current resource projects.

If a company lies in its financial statements there are serious consequences. If the same company presents wildly optimistic and exaggerated economic assessments and EIS documents there are no consequences and potential benefit. The public deserves better.

Tony Shields, TAI

Tony Shields works in funds management and is an Adjunct Fellow at The Australia Institute.

He has a strong interest in transport planning and advocacy, particularly in the ACT.

You can follow Tony on Twitter @cheesytony.

Rod Campbell is an economist with over ten years experience and is the Director of Research at The Australia Institute, an influential think tank, based in Canberra.

Rod Campbell, TAI

He has been involved in planning hearings, court cases and political processes relating to mining and energy in all states and territories of Australia. He has economics qualifications from University of Melbourne and Kyoto University and worked as a consultant in Melbourne before joining the Institute in 2013. He also spent five years working in China, Japan and SE Asia.

You can follow Rod on Twitter @R_o_d_C

Rod Campbell is the Research Director at The Australia Institute.

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