Chevron's (NYSE:CVX) Gorgon LNG project, a massive 15.6 million ton per annum liquefied natural gas plant on Barrow Island in western Australia, is now expected to cost more and take longer to complete than previously expected, according to a recent company statement.
The San Ramon, Calif.-based oil major has seen its cost estimates for the project soar from $37 billion when it began work at Gorgon in 2009 to $52 billion last year. Now, the company expects the project, which is roughly 75% complete, to cost $54 billion. Chevron also stated that it doesn't expect to begin shipping first cargos of LNG from Gorgon until mid-2015, having previously guided for production to start in early 2015.
While the six-month delay doesn't appear too significant for a project that will be producing for decades, the $2 billion cost increase is concerning and highlights some of the major challenges facing all Australian LNG projects.
Why costs in Australia are so high
Despite the nation's vast resource wealth, the economics of Australian LNG projects are threatened by spiraling labor costs, a strong Australian dollar, and the technical and logistical challenges of extracting gas from remote, offshore locations.
Operating costs in Australia are the highest in the world and roughly three times greater than in the U.S. Gulf Coast, another hotbed of energy activity. According to a survey by recruitment agency Hays, oil and gas workers in Australia are the highest paid in the world, earning an average of $163,600 a year. That's about 25% higher than their counterparts in the U.S.
The main reason behind these extremely high labor costs is a strong Australian dollar, which has surged from roughly $0.50 against the greenback in 2001 to around $0.90 currently, making it much more expensive for U.S. companies to possess manufacturing operations in the country.
Cost overruns and delays in Australia
Besides Chevron, several other operators have also reported significant cost overruns and completion delays. Earlier this year, Australia's Woodside Petroleum (ASX:WPL) threw in the towel on its proposed Browse LNG export project after the project's cost escalated from an initial estimate of $30 billion in 2010 to more than $50 billion. At that cost, the project simply wouldn't have been commercially viable, according to Woodside CEO Peter Coleman.
Similarly, the Australia Pacific LNG Project in Queensland, being undertaken by ConocoPhillips and partner Origin Energy (ASX:ORG), saw its cost estimate surge from an initial $20 billion to $24 billion. To help contain expenses, Conoco and Origin recently signed gas-swap agreements with Santos (ASX:STO), which is building a separate $18.5 billion LNG project nearby, to share pipelines and connection points.
What's next for Chevron in Australia?
Despite these challenges, Chevron Vice Chairman George Kirkland maintains that the economics of the Gorgon project are still "attractive." Furthermore, he said that the company can leverage knowledge it has gained while developing Gorgon to avoid some of these issues at its Wheatstone LNG project, which is located in western Australia's Pilbara region and is only 25% complete.
Chevron views Gorgon and Wheatstone as two of its most crucial "future legacy assets." Owing to their flat production profiles and minimal capital requirements after start-up, they will generate massive amounts of cash flow for decades to come. Also, Chevron has already inked long-term contracts for 75% of Gorgon and Wheatstone's future expected production, which provides greater investment certainty.
Though Chevron's deepwater operations in the Gulf of Mexico, Thailand, and West Africa will be the main drivers of the company's growth in coming years, Gorgon and Wheatstone should also provide a major boost to production and cash flows once they come on stream in 2015 and 2016, respectively. Combined, they will contribute roughly 400,000 barrels a day of net production when operating at full capacity, which should help offset production declines from the company's older fields.
Fool contributor Arjun Sreekumar owns shares of General Motors. The Motley Fool recommends Chevron and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.