BLUE ENERGY LIMITED. — Management Reports 2015

Oct 11, 2015

Chairman and CEO’s Letter to Shareholders

Year in review

Your company continued its cost reduction drive throughout the year and recorded its lowest overhead spend since listing. This, coupled with our careful stewardship of non-discretionary work program yielded a robust cash preservation program. Despite the low on ground activity, Blue Energy still managed a significant upgrade of its gas resources over the year. This is the result of a long standing and unique data sharing agreement which allows Blue to benefit from data acquired from all wells drilled in the northern Bowen Basin.

We continue to look for the optimal timing to monetise our assets in sequence, and return value to shareholders, and the growing gas demand in Gladstone as new LNG capacity becomes operational is providing an environment where gas supply tightness is now being reflected in domestic pricing. In addition, the expansion of renewable energy is also good for gas demand as there is a symbiotic relationship between renewables and gas as the back-up energy source for electricity generation at peak times or when the wind isn’t blowing or the sun instant shining. We therefore see a bright future for gas as a clean, reliable and instantaneous energy source both globally and in Australia.

Oil

Since last year the global oil price environment has deteriorated significantly. The benchmark Brent oil price is around US$50/barrel. Whilst the fundamentals of supply and demand show a modest oversupply of oil of around 2 million barrels per day, the resultant price correction has been disproportionate. This would suggest other factors at play globally. Factors such as Saudi Arabia maintaining market share by boosting production to levels of 10 million barrels per day has contributed to the oversupply, and the rationale for this might be to squeeze out higher cost US shale producers, and to also bolster Saudi’s proportion of OPEC output ahead of resurgent Iranian production. Clearly other OPEC member states are suffering significantly from low oil prices and their faltering economies might be of concern for the continuing stability of OPEC. The question on most people’s minds is the forward oil price curve and how long this price slump will continue. It should be remembered that the world consumes 32 billion barrels of oil each year and this consumption is growing, however global exploration efforts only find approximately 10 billion barrels annually. When the oil price drops, the first casualty within oil companies is usually exploration expenditure. Therefore low oil prices yield lower levels of exploration, which in turn yield lower discovery volumes and thus the gap in replacement of production widens, which leads to higher prices, and so the cycle repeats.

Gas

Fuel Switching

As the trend in the western world continues away from using coal for power generation, and the rise of renewable energy in the energy mix sees tax payers subsidising expensive, low energy density power projects, we are also seeing displacement of diesel and coal by gas in many parts of the world as the reality of baseload power requirements and the atmospheric particulate pollution impacts coal and diesel usage on health become more compelling. South Africa recently indicated it was considering

addressing the 90% reliance of power generation from coal in the country by installing significantly more gas fired generation capacity to replace its aging coal fired generating fleet and cited not only the better carbon footprint that gas offers, but the difficulty in financing new coal fired generation capacity.

Given the developed world cannot sensibly convert to a zero carbon dioxide emitting energy source overnight (and assuming the global climate is as sensitive to CO2 as the IPCC suggests), displacement of high CO2 emitting energy sources by lower CO2 emitting energy sources (ie gas) seems to be a logical transitional strategy. Australia is in the unfortunate situation of not having all energy options available to us, new hydroelectricity capacity is precluded by environmental objections as is the nuclear energy option – both of which however are embraced by China, India and most OECD countries. We are endowed with huge quantities of low sulphur coal, uranium and natural gas that the developing world and Asian manufacturing economies still value, yet we penalise our own use of this cheap fossil fuel energy to embrace a global push for an interruptible high cost non base load renewable energy mix of solar and wind energy.

LNG

The huge effort to develop three standalone CSG-LNG projects in Gladstone is now nearing completion, with half of the name plate liquefaction capacity now functioning in Gladstone, and LNG being shipped from two of the 3 LNG plants. The upstream gas supply infrastructure that has been installed (wells, gas gathering, dewatering capacity and treatment, compression and pipelines), is of an order of magnitude not seen in this country before. This achievement should not be underestimated and the significance of bringing reliable and clean energy to developing economies and to the manufacturing powerhouses of Asia should bring great credit to the proponents.

It needs to be remembered however that the genesis of these projects occurred immediately prior to and after the onset of the global financial crisis, when the oil price had peaked and a cost effective secure and reliable energy supply was not at all automatically assured in Asia. LNG demand growth projections in Asia seemed robust and the oil linked pricing preference seemed a win for Australia’s previously cheap onshore gas reserves. Very few people in the market predicted anything but oil price stability, albeit within a range. Fast forward 7 years and we see the consequence of the economic risks (calculated) taken by the proponents playing out. That is, the enormous cost of these plants, the debt taken to finance construction of the plants, and the pricing environment. It is true that the oil linked LNG contracts signed to underpin these massive investments should probably have price floors and caps built into them, however the revenue generated by these plants as they come on line this year will be significantly lower than expected at the time of FID, and may only be breakeven currently. The debt servicing required by some of the proponents therefore becomes the overriding issue for some players new to the LNG operating world. However, that said, these plants will continue production for decades, in which time the oil price will rise and fall, and the LNG demand will grow, and so the longer term view would be that they will be profitable. The challenge is now to maximise production from these plants to generate the revenue at the lowest possible cost and hope the oil price recovers soon.

East Coast Gas

The endless postulation over the last several years about East Coast gas demand tripling with the advent of LNG in Gladstone is now emerging as reality. Three of the six LNG trains (2 x QGCLNG and 1 x GLNG) are now operating and together, they are consuming approximately 1,700 Terra Joules of gas per day.