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2013 AGM Chairman's Address

At today’s annual general meeting, Metgasco shareholders will be making some very important decisions with regard to the composition of the Board.  These decisions will determine the future governance, management, strategy and direction of your company.

On 27 September the Company received notices from a minority group of shareholders to convene a general meeting in order to put resolutions to shareholders to appoint three of their nominees as directors to Metgasco’s board. In addition, this group of shareholders indicated they would not support any of the resolutions proposed by the current Board at today’s AGM.

In providing you with a summary of the events of the past two years, I would like to start in the first half of 2011.  This was a turning point for the NSW gas industry.

By mid-year, the recently elected O’Farrell government in NSW had commenced a comprehensive review of the coal seam gas industry following concerns raised by environmental activists during the lead up to the 2011 election. This soon led to a review by the NSW Legislative Council which had the effect of giving CSG activists a respected forum to vent their criticism of our industry.

The government announced their intention to develop a new Strategic Regional Land Use Policy to deal with farmers’ concerns about any potential for degradation of farming land and related concerns.  In addition the government foreshadowed a new Aquifer Interference Policy to deal with concerns about potential aquifer depletion and assertions of possible groundwater contamination.  Metgasco devoted considerable time and resources providing input to these processes with the aim of achieving acceptable outcomes for all stakeholders.

At the same time, the Company’s cash reserves were running down following pilot well drilling together with the drilling and testing of the Kingfisher well.  As a result, the Company raised funds during the September quarter of 2011 to underpin a program of core wells, pilot production wells and a seismic survey to follow up our Kingfisher conventional gas discovery.  This activity plan was fully consistent with our strategy of demonstrating commercial gas production potential, the success of which was expected to generate considerable shareholder value.

At that time no one in the industry anticipated how long it would be before CSG companies could actively explore again.

While the Legislative Council review was underway, the NSW government gave no new approvals of significance and we found that the officials with responsibility for overseeing our industry became extremely cautious.  It soon became clear to your Board that politicians and government officials sensed there would be no tolerance if they were to approve any activity that was later found to be environmentally sensitive.

From a practical perspective, our plans to test pilot production wells were hampered by unusually heavy rainfall in the region.  Our produced water holding ponds became very full and we needed to move water around for disposal.

Of huge political significance to our industry was the 10,000 litre salty water spill by Eastern Star Gas in the Pilliga state forest in June 2011 which became public knowledge in January 2012. At that point, water treatment and disposal became a major focus for politicians and the regulators. Obtaining permission to deal with water was difficult and slow and the approved processes expensive.

Work approvals were then at a virtual standstill and operational scrutiny was intense. Exploration Licences were not being renewed as would normally have been the case, but were the subject of ongoing deferral.

As a result of government inaction and delay, the timing of Metgasco’s planned drilling programs became uncertain.  At that time we were carrying a full complement of people in the expectation that the NSW government would restart activity in the near future with the announcement of the detail behind their proposed new CSG policies as well as renewal of the Company’s exploration licences.

We have at all times maintained a close and respectful relationship with the NSW government and in particular the Resources and Energy Minister and his staff.  Throughout we have strongly argued Metgasco’s case with politicians and officials.  We sought relief from the regulatory overload and the delays.  However, the whole industry was feeling the effects of a moratorium on new CSG field activity.  We were not alone.

In March 2012 the NSW government released a draft with more details of the Strategic Regional Land Use Policy and Aquifer Interference Policy.  It was generally believed that once these policies were finalised and adopted, the CSG industry would be given the go-ahead.

The finalisation of these draft policies was agonisingly slow and took until September 2012 to be finalised for release, at which time the green light was given for CSG activity to recommence. During the prior period no exploration licences were renewed which was a real discouragement for drilling or any other activity, to say the least.

With relief, the industry was able to re-start activity in the December quarter of 2012.  The NSW government announced that Metgasco’s exploration licences would be renewed and the requested production lease would also be granted.  With that knowledge and government support renewed, Metgasco raised $20 million to underpin a core well and pilot drilling campaign, together with a plan to provide gas supplies to the local area.

As I explained to you at last year’s AGM, we, along with other CSG companies with operations in NSW, effectively lost 18 months while the government put its new regulatory arrangements in place.  Throughout this time, as I outlined earlier, the Company was carrying a full complement of staff, particularly at our Casino office.  We succeeded in reducing costs during this period while retaining the ability to quickly re-start CSG activity.  This meant our cash burn was continuing with little new exploration or appraisal activity to show for it. We did carry out some well testing and essential maintenance.

With the moratorium lifted in September last year and the land dry enough to allow activity, we completed the 2D seismic survey in November and December 2012 and then successfully drilled two core wells, Thornbill 4 and Bowerbird 4 in early 2013.

However, after the 2013 New Year, the anti-CSG movement was re-energised by activities elsewhere in NSW.  At Camden, AGL was having difficulties with plans to develop its Camden North project. Under intense pressure, AGL announced that they were withdrawing the project from the planning review process. In addition to pressure from farming groups and other special interest groups targeting AGL and Santos, there was also a lot of political pressure on Dart with their CSG development at Newcastle.  We also experienced protests at our activities. In late January the Prime Minister announced a September date for the federal election and even further scrutiny of our industry began.

In February 2013, before we got to the drilling of our planned pilot wells, the NSW government responded to continuing anti-CSG pressure by announcing a proposed but undefined 2 kilometre exclusion zone for CSG around townships, together with a transfer of CSG regulatory administration arrangements to the EPA.   The Chief Scientist and Engineer was asked by the government to investigate and report on the alleged problems in the CSG industry.

This was a devastating and unexpected blow to the whole industry, not just Metgasco.   There was absolutely no government consultation with industry prior to this announcement.  The proposed new exclusion zones covered areas with certified reserves that we had developed over the past 10 years with shareholder funds.  Furthermore, there was little definition of how the zones were to be applied and given that the concept was totally arbitrary, with no scientific or engineering basis, there was a real concern that it would be expanded to cover very broad areas.

In addition, the change in regulatory responsibilities created a real concern that the already very slow and cumbersome approval system would be even slower.  The net effect was to destroy investment confidence in the NSW industry – finding farm-in partners or raising more funds became impossible.

In response to the NSW Government’s announcement and its effect on the industry, we had no choice but to secure our acreage rights, suspend operations and dramatically reduce costs.  Other industry players including AGL and Santos also suspended activity and some companies withdrew from NSW altogether.

We advised shareholders last March that the best way forward was to prepare for what was an indeterminate period of time before a sufficiently supportive environment for the gas industry would return to NSW, given the anti-CSG lobby was in the ascendancy and a Federal election was approaching.  In discussions we had with representatives at state and federal levels, it became clear that there was no support at that time for new field activity, whether that be for coal seam gas activity or a conventional well like Rosella.

With the imperative of cash preservation, we had to do more than just suspend new field activity; we had to make a meaningful reduction in ongoing costs.  As a consequence, head office and field staffs were reduced substantially and we moved into smaller offices.  We carried out a thorough program of old well decommissioning and site restoration, removing a significant financial liability and reducing ongoing field maintenance and monitoring costs.

Importantly for our industry, the NSW Chief Scientist and Engineer released her report on the CSG industry in July.  Although the report covered a vast range of topics and considered submissions from numerous anti-CSG lobby groups, it was unable to identify any reason why the CSG industry should not proceed in NSW subject to an appropriate regulatory regime.

While the looming Federal election caused politicians of all persuasions to be very sensitive to issues involving the gas industry, those close to the industry knew that it would be important to get NSW’s gas industry back to work.  There was general recognition that gas supply shortfalls and higher prices in NSW were inevitable and the problems likely to arise from surging gas prices had to be addressed.

As it turned out, last September the Coalition was elected to office in Canberra and the Hon Ian Macfarlane was appointed as Federal Minister for Industry. Like other CSG companies, we briefed Mr Macfarlane on the importance of the gas industry, particularly to the Northern Rivers region.  Pleasingly, the new Minister is very supportive of the NSW gas industry and has personally assisted in bringing together the key stakeholders that have the ability to get the industry moving again.

The NSW government has recently publicised more openly a serious problem emerging with gas supply for consumers in this state. When the big interstate supply contracts come to an end over the next two years or so, NSW gas retailers will have to secure extensions of these agreements or find new supply sources.  Gas is expected to be in short supply as the Queensland LNG projects begin to export gas.  Gas prices on the east coast of Australia are already on the rise towards the LNG netback level which is considerably higher than gas prices today.

To put a focus on the gas supply problems facing NSW, the Minister for Resources and Energy hosted a Summit on Energy Security in late September. There was acceptance by stakeholders that something needed to be done to put downward pressure on gas prices, and that finding new supplies was the best response.

In October this year, the NSW government finally announced the new regulations relating to exclusion zones for CSG operations, together with more detail on Biophysical Strategic Agricultural Land.

With indications that political and community sentiment was starting to become supportive again, the Board decided that it was time to recommence the preparatory work for drilling the Rosella-1 conventional gas exploration well.  This well is designed to test the potential of the Greater Mackellar structure which is mapped to the northeast of Casino and its location has been determined following the recent interpretation of the seismic survey completed at the end of last year.

Many months back we lodged the request for environmental approval and this approval is expected shortly. We have also been working to ensure we have landholder support for our preferred drilling location.  We will be undertaking a community consultation program with key stakeholders specifically related to Rosella-1.

For Rosella-1, the main technical task ahead is to identify suitable drilling rigs and to assess their availability.  Providing that there are no political or regulatory events that further discourage exploration, we should be able to take a decision to commit to the expenditure on a drilling rig later this year and hopefully be able to drill in the first half of next year.

The Rosella exploration well is a conventional well, testing conventional and tight gas, not CSG.  The factors that discourage us restarting CSG operations are not the same as for a conventional well.   A single conventional well can give immediate, significant results, whereas numerous CSG wells will be required for the same impact.  Furthermore, we can test a conventional well relatively quickly and learn what we need to, whereas we need to flow a CSG well for 6 months or even longer and handle formation water production.  The approval processes for a conventional well are also less complicated than for a CSG well.

Unfortunately I am unable to give a firm view as to when Metgasco’s CSG activity will resume.  We need to see a more supportive political and regulatory environment, and in turn a better investment climate, before committing the Company’s funds to more pilot well drilling.

If we are able to build on a good experience with Rosella-1 and develop a supportive regulatory and community environment, we can again address the need for pilot well drilling.  There is a need to continue to test the Richmond coals and also to plan a pilot test of the deeper I, J & K coal sequences where significant reserves are located.  Before conducting some of this work we will need to address the new regulations dealing with Bio-physical Strategic Agricultural Land which has recently been mapped over parts of our exploration licences.

I trust this description of the last two year’s activities provides you with context behind your Directors’ decisions around operational issues and the company’s operational strategy.

In summary, Metgasco remains firmly committed to maximising the value of its Clarence-Moreton Basin assets.  The next steps towards commercialisation will require demonstration of the Company’s ability to drill and sustainably produce gas from its planned CSG pilot production wells, together with a further test of the conventional gas potential of the Greater Mackellar structure with an exploration well at Rosella-1.  Execution of this strategy will require, in particular, the careful management of environmental and community relations and an improving investment climate for CSG in NSW.

As previously stated, although we welcome recent political announcements, we remain uncertain as to the timing of resumption of NSW CSG operations.

Your Board has previously announced it would consider opportunities outside NSW if these were value accretive. The aim would be to provide Metgasco with the flexibility and ability to execute the Company’s Clarence-Moreton Basin strategy in the future.   No such opportunities have been identified at this stage. 

Annual Accounts

There are some additional matters that I would like to address. First with respect to the accounts:

At the end of the financial year we had close to $21 million cash at bank and no debt.  The rate of monthly cash burn on overheads has been substantially cut since we suspended new field activity in March.

The annual report shows that the Company’s gas reserves are down by over 20%. As I outlined earlier, this reduction has been booked to account for the impact of the 2 kilometre exclusion zone.

We have closely examined the carrying value of the Company’s exploration asset in the accounts.  Despite the reduction in reserves, we did not see a need to impair the exploration asset and it currently stands at $78 million.  The Richmond Valley Power Station asset has been written down to land value to reflect the fact that current power prices, while increasing, are very low and a base-load gas fired power generation project would not be economic in the near future.

Appointment of New Non-Executive Director

In June this year the Company was deeply saddened by the passing of one of Metgasco’s Non-Executive Directors, Steven Koroknay.

After that loss, Metgasco had only its minimum of three directors, including the Managing Director.  After a period of review, your Board considered it prudent to appoint to the Board a third Non-Executive Director and specifically to seek someone with a strong geoscience background.

In August, Greg Short was appointed to the Board. Greg has had a successful career in petroleum exploration management and has worked not only in Australia but also in numerous oil and gas operations overseas. Those who have worked with Greg will attest that he uses his technical skills and management experience to great effect.  In particular, he has greatly enhanced the Board’s ability to address decisions that involve an extensive amount of geoscience.

Remuneration

One other matter that I should address before closing relates to remuneration.

As you will have read in the annual report, the Board took a decision last March when we suspended activity that a cut in directors’ fees was appropriate.

Later, in July, when the Board reviewed executive pay for the year ahead, we decided there would be no salary increases for senior staff, nor would there be any bonuses for the past year, regardless of the personal achievements of the staff.

This was all in the light of a poor performing share price given the impact of government policy on the Company’s ability to execute its strategy.

However, we did consider the vulnerability of the Company to the possibility that staff would be tempted to leave Metgasco and seek employment in the CSG industry across the border in Queensland, or even elsewhere in NSW in other industries that are not under such a cloud of regulatory and political uncertainty. Accordingly, we maintained the Company’s practice of making LTI awards which only have value to the recipients if the share price reaches pre-determined hurdles and the person stays employed with the Company for three years.

The subsequent LTI award to Peter Henderson, our Managing Director, has received criticism from some shareholders.  Because Peter felt that this LTI award was distracting shareholders from the other resolutions to be put to this AGM, he requested that resolution 5 be withdrawn and it has been.

Conclusion

There is no doubt that the past two years have not only been unheralded in terms of the challenges they have thrown up to Metgasco and other gas companies operating in NSW, but have also been very difficult and disappointing for Metgasco and its shareholders.

Your Board has done everything needed to address these challenges and to ensure your Company remained as well capitalised as possible and continued to retain ownership of its attractive Clarence-Moreton Basin assets.

Metgasco is well positioned to return to growth as the regulatory and investment climate continues to improve.  The planned commencement of drilling of Rosella-1 is the start of this next phase.

Finally, I would like to take this opportunity to thank those shareholders who have supported the board and management during this time and I acknowledge the rights of others to express their divergent views.

I would also like to acknowledge all staff, both current and past, for their dedication to Metgasco and the contribution each one has made to the Company. I would also like to thank my fellow Board members for their considerable efforts.

CONTACT US

North Sydney Office
Level 3, 2 Elizabeth Plaza
North Sydney NSW 2060

Tel: +61 2 9923 9100
Fax: +61 2 9959 5387

Metgasco Ltd  ACN 088 196 383