Woodside Energy Ltd v Federal Commissioner of Taxation (No 2)

[2007] FCA 1961

FEDERAL COURT OF AUSTRALIA

Woodside Energy Ltd (ABN 63 005 482 986) v Commissioner of Taxation (No 2) [2007] FCA 1961

TAXATION – petroleum resource rent tax – taxable profit – assessable receipts less deductible expenditure – assessable petroleum receipts – whether a net concept – net of expenses payable in relation to sale of marketable petroleum commodities – whether such expenses include hedging losses – range of expenses covered by connection – direct relationship to commodity sales required – text of provision – context and scheme of Act – legislative history – Explanatory Memorandum – hedging expenses  not able to be taken into account in determining assessable petroleum receipts – whether expenses comprised deductible expenditure incurred in carrying on or providing operations facilities and other things comprising the project – insufficient connection with the conduct of the project – hedging losses not general project expenditure
EVIDENCE  - expert economic and accounting opinion – economic rent taxing model said to underpin statute – evidence that proposed model initiated process leading to enactment of statute – economic model equating hedging losses – insufficient evidence of connection to actual terms of statute to provide assistance in construction – expert accounting evidence – treatment of hedging losses as expenses of sale – utility dependent upon anterior construction of statute

WORDS AND PHRASES  - “in relation to”

Petroleum Resource Rent Tax Assessment Act 1987 (Cth) s 21, s 22, s 24, s 32, s 38
Petroleum Resource Rent Tax Act 1987 (Cth)
Acts Interpretation Act 1901 (Cth) s 15AB
Petroleum Resource Rent Legislation Amendment Act 1991 No 80 of 1991
Taxation Laws Amendment Act (No 3) 1991 No 216 of 1991

Atlantic Sugar Refineries v Minister of National Revenue [1949] CTC 196 cited
Australian Gas Light Company v Australian Competition and Consumer Commission (2003) 137 FCR 317 cited
Australian Competition and Consumer Commission v Maritime Union of Australia (2001) 114 FCR 472 cited
Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 215 CLR 374 cited
Echo Bay Mines Ltd v R  [1992] CF 707 cited
Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) 205 CLR 1 cited
O’Grady v Northern Queensland Co Ltd (1990) 169 CLR 356 cited
Placer Dome Canada Ltd v Ontario (Minister of Finance) (2006) SCC 20 cited
Robe River Mining Co Pty Ltd v Commissioner of Taxation (1989) 21 FCR 1 cited
Stevens v Kabushiki Kaisha Sony Computer Entertainment (2005) 224 CLR 193 cited
Woodside Energy Ltd v Commissioner of Taxation (2006) 155 FCR 357 cited
Workers’ Compensation Board (Qld) v Technical Products Pty Ltd (1988) 165 CLR 642 cited

WOODSIDE ENERGY LTD (ABN 63 005 482 986) v THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
WAD 282 OF 2004

FRENCH  J
10 DECEMBER 2007
PERTH

IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY	WAD 282 OF 2004

BETWEEN:	WOODSIDE ENERGY LED (ABN 63 005 482 986) Applicant
AND:	THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA Respondent

JUDGE:	FRENCH  J
DATE OF ORDER:	10 DECEMBER 2007
WHERE MADE:	PERTH

THE COURT ORDERS THAT:

1.The application is dismissed.

2.The applicant is to pay the respondent’s costs of the application.

Note:   Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

Index

Introduction  [1] – [6]
Procedural background  [7] – [12]
The issues in this appeal   [13] – [14]
The witnesses  [15] – [16]
The Woodside Group  [17] – [19]
The Agency Deed  [20] – [26]
The Laminaria Project –
    assessment and commitment – 1996/1997  [27] – [39]
The Scheme of Arrangement – 1998  [40]
Market for crude oil and Laminaria crude  [41] – [43]
Woodside’s hedging policy – 1997-2001  [44] – [55]
Laminaria’s effect on the Woodside Group’s
    oil price hedging policy – 1997  [56] – [68]
Woodside Energy’s hedging policy reviewed 1999-2001  [69] – [99]
Management responsibility for hedging activities  [100] – [104]
Classes of hedge transactions used with respect to
   Laminaria sales  [105] – 108]
Oil production and sales from Laminaria - 1999-2004  [109] – [112]
The sale of crude oil – the use of term contracts and
   the role of production forecasts  [113] – [114]
Production forecasts and Laminaria contracts  [115] – [124]
Laminaria oil sales  [125] – [128]
An example of sales and hedging relationships
    – July to September 2001  [129] – [130]
Strategic hedging  [131] – [135]
Sample of strategic hedging by swap transaction 1999-2001  [136] – [143]
Cargo specific hedges  [144] – [147]
Rationale and practice of oil futures contracts  [148] – [156]
Basis risk  [157] – 159]
Recording strategic hedges 1999-2002  [160] – [163]
Highlander transaction  [164] – [166]
The return, the assessment and the objection  [167] – [173]
The quantum of the claimed hedge losses
   - Ms Rapinet’s evidence  [174] – [182]
Expert opinion evidence of Professor Ross Garnaut  [183] – [207]
Expert evidence of Professor Graham Walker  [208] – [218]
Expert evidence of Alan Miller  [219] – [227]
Statutory framework – The PRRTA and the PRRTAA  [228] – [234]
Statutory framework – Section 15AB Acts Interpretation Act [235]
Legislative history and extrinsic materials  [236] – [259]
Key findings of fact  [260]
The construction of s 24(b) of the PRRTA and its application
    to hedging expenses  [261] – [274]
The construction of s 38 of the PRRTAA and its application
   to hedging expenses  [275] – [276]
Conclusion  [277]

IN THE FEDERAL COURT OF AUSTRALIA
WESTERN AUSTRALIA DISTRICT REGISTRY	WAD 282 OF 2004

BETWEEN:	WOODSIDE ENERGY LTD (ABN 63 005 482 986) Applicant
AND:	THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA Respondent

JUDGE:	FRENCH  J
DATE:	10 DECEMBER 2007
PLACE:	PERTH

REASONS FOR JUDGMENT

Introduction

1. Since the late 1990s Woodside Energy Limited (Woodside Energy), subsidiary of Woodside Petroleum Ltd (Woodside Petroleum) has been a joint venture participant in a petroleum project in the Timor Sea known as the Laminaria Project.  Because of the volatility of oil prices it had at all times in place an oil risk management policy under which it entered into hedging transactions with respect to certain percentages of anticipated production and sales from the project.  The company’s profits from the project are taxed under the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (the PRRTAA). The company suffered substantial losses associated with its hedging transactions in the years ended 30 June 2000 to 30 June 2002 inclusive.

2. The company was assessed for petroleum resource rent tax for the year ended 30 June 2002 on the basis that its taxable profit was calculated without regard to losses which it had incurred in connection with its hedging transactions.  The company filed its return and paid the assessment on the basis that the losses were not to be deducted as it did not wish to expose itself to substantial penalties.  However it lodged an objection to the assessment which issued.  It did so on the basis that its taxable profit for the year ended 30 June 2002 should be reduced by hedging losses referable to that year and losses transferred under specific provisions of the PRRTAA for the two preceding years.  The losses were respectively $148 million for the year ended 30 June 2000, $299 million for the year ended 30 June 2001 and $106 million for the year ended 30 June 2002.

3. The Commissioner of Taxation (the Commissioner) disallowed the objection. Woodside Energy contended that its taxable profit should have been reduced by reference to the hedging losses. One of the components of “taxable profit” explained in the PRRTAA is “assessable petroleum receipts” defined in s 24 so as to exclude expenses in relation to the sales of marketable petroleum commodities. Woodside Energy says that its hedging losses were expenses of that kind.

4. In my opinion, on its proper construction, the expenses to which s 24 referred are expenses directly related to particular sales in a way that hedging losses are not. In so finding I had regard to the fact that the Act has extensive separate provisions relating to deductible expenditures which do not include such losses. A reference to “expenses” in s 24 was included as an amendment to the Bill to meet specific concerns about such things as freight, insurance and demurrage costs connected with particular sales. To give it the broad construction for which Woodside Energy contends would, in my opinion, undercut the essential scheme of the legislation and its specific provision for deductible expenditures.

5. In the course of the hearing evidence was received from an economist, Professor Garnaut, about the model for taxing economic rent which he first proposed in 1975. In his opinion losses on hedging transactions designed to minimise risk of price fluctuations associated with sales of a commodity can properly be treated, in the taxation of economic rent, as an expense in relation to sales. While not doubting the correctness of that opinion within the framework of the model which Professor Garnaut proposed, it turned upon an assumption, which he was asked to make, that the petroleum resource rent tax was intended to be a tax on “economic rent”. The Court, however, is constrained by the language of the Act. Having regard to the language of s 24, its context in the overall scheme of the Act and its drafting history in the Parliament, it cannot accommodate hedging losses as expenses of sale as the economic rent model would allow.

6. The application is dismissed.  Woodside Energy will have to pay the Commissioner’s costs of the application. 

   Procedural background

7. Woodside Energy’s financial accounts for the calendar years ending 31 December 1999 through to 31 December 2002 set out sales revenue derived from its Laminaria Oil Project after allowing for losses incurred in each of those years in relation to its hedging transactions.  In relation to the financial years ending on 30 June 2000, 30 June 2001 and 30 June 2002, the losses incurred in relation to hedging transactions were said to be:

   Year   Loss (A$)

   2000  148,784,120

   2001  299,593,710

   2002  106,399,732

8. The company claims that its entry into the hedging transactions was undertaken in accordance with its oil price risk management policy as set out in 1997 in Woodside Petroleum’s Treasury Policies Manual.  That Manual provided that:

   The aim of oil price risk management is to establish a prudential policy framework for the management of oil price risk associated with Woodside’s forecast sales.  Furthermore, the objective of the oil price risk management (“OPRM”) hedging policy is to contain the potential for financial loss arising from unfavourable movements in oil prices.
   …

   oil price hedging can only be undertaken in respect of identified barrel of oil equivalent (BOE) exposures, taking into consideration known and forecast product sales.
   …
   Speculative positions are not permitted.

9. In 1997, Woodside Petroleum resolved to fix the permissible hedge levels for sales of  Laminaria crude oil as follows:

   (a)Between 2 and 3 years in advance of anticipated production, up to a total of 20% of anticipated production from the Laminaria Project ought to be permitted to be hedged;

   (b)Between 1 and 2 years in advance of anticipated production, up to a total of 35% of anticipated production from the Laminaria Project ought to be permitted to be hedged.

   According to Woodside Energy, it would not have entered into the hedging transactions but for the forecast production and sale of oil from the Laminaria Project.

10. Tax is payable by the company in respect of the project under the provisions of the Petroleum Resource Rent Tax Act 1987 (Cth) (PRRTA) and the PRRTAA. The two production licences in which it has an interest are treated by the Commissioner, pursuant to a Ministerial Certificate, as sufficiently related to be regarded as a single petroleum project. The PRRTAA imposes tax in respect of the taxable profit of a person in the year of tax in relation to a petroleum project. The company did not have a taxable profit for the years ended 30 June 2000 and 2001 in relation to the Laminaria Project and no assessment under the Act was issued in either of those years.

11. Woodside Energy lodged a Petroleum Resource Rent Tax Return for the year ended 30 June 2002. An assessment was issued on 26 September 2002 in which the taxable profit was assessed at $429,825,898 and tax assessed at $171,930,359. On 21 November 2002 the company lodged a Notice of Objection to the assessment which, as its public officer indicated in a covering letter, related ‘… principally to a claim by Woodside Energy Limited … to deduct expenses incurred on hedges undertaken in relation to sales from the Laminaria Project as ‘expenses incurred in relation to the sale’ under section 24 of the PRRTA.’ An amended assessment was issued on 24 December 2003. This showed a lower taxable profit figure of $371,202,675 and tax assessed at $148,481,070.

12. In a letter dated 15 October 2004 to Woodside Energy a Deputy Commissioner of Taxation informed the company that claims in its objection dated 21 November 2002 in relation to hedge expenses had been disallowed.  Claims in the objection in relation to non-hedge matters were finalised by notices of adjustment for the 2000 and 2001 years of tax and by notice of amended assessment for the 2002 year of tax, all of which were issued on 24 December 2003.  Woodside Energy lodged an application in the original jurisdiction of this  Court on 10 December 2004 appealing against the Commissioner’s decision of 15 October 2004 disallowing its objection dated 21 November 2002 against the Petroleum Resource Rent Tax Assessments issued on 26 September 2002 for the year of income ended 30 June 2002. 

    The issues in the appeal

13. The issue in the proceeding is whether expenses incurred by Woodside Energy in hedging part of its forecast production and sales of oil from the Laminaria Project are to be taken into account in calculating the amount on which it is liable to pay petroleum resource rent tax.  Paragraphs 25 to 28 of the Statement of Grounds of Appeal set out the contentions which it advances:

    25.On a proper construction of the PRRT Act the hedging losses incurred by Woodside Energy in relation to the Laminaria Project in the 2002 PRRT year in the sum $106,399,732 were “expenses payable” by Woodside Energy in relation to sale of a marketable petroleum commodity (being stabilised crude oil) from the Laminaria Project within the meaning of s 24 of the PRRT Act.

    26.Alternatively, under s 24 of the PRRT Act the calculation of “consideration receivable” by Woodside in relation to the sale of a marketable petroleum commodity from the Laminaria Project in the 2002 PRRT year required that the hedging losses incurred by Woodside Energy in relation to the Laminaria Project in the 2002 PRRT year be taken into account by deducting such amount from gross receipts.

    27.Alternatively, the hedging losses incurred by Woodside Energy in relation to the Laminaria Project in the 2002 PRRT year in the sum of $106,399,732 are to be taken into account in calculating Woodside Energy’s class 2 augmented bond rate general expenditure being general project expenditure within the meaning of s 38 of the PRRT Act.

    28.Further, the hedging losses incurred in relation to the Laminaria Project in the 2000 PRRT year and the 2001 PRRT year ought to be taken into account in ascertaining Woodside Energy’s taxable profit in relation to the Laminaria Project for the 2002 PRRT year.

14. References to the PRRTA in the grounds appear to be intended as references to the PRRTAA. The Commissioner takes issue with each of the alternative contentions. The debate in the end turned on the construction and application of s 24 of the PRRTAA. I have also considered the application of s 38 as it was formally before the Court, although not the subject of any substantial argument.

    The Witnesses

15. There were six witnesses for Woodside Energy.  They were:

    1.Robert Carroll who was, until his retirement in July 2002, Chief Financial Officer for Woodside Petroleum.

    2.John Richards.  Mr Richards is the General Manager, Marketing and Commercial Services with Woodside Energy (UK) Limited (Woodside Energy (UK)).  Between April 1996 and June 2000 he was Woodside Energy’s Oil Marketing and Shipping Manager.  From June 2000 until May 2002 he was its Manager, Marketing and Commercial Services within the Australian Oil Division of the group.  Between April 1996 and June 2000 he worked closely with the Laminaria Project team to ensure that Laminaria crude oil was introduced smoothly into the market. 

    3.Alan Miller. Mr Miller is a Director of Basis Risk Ltd (Basis Risk) who provided expert opinion evidence about the alternative and best forms of risk management for Woodside Energy in relation to the volatility of crude oil prices. 

    4.Laurel Jean Rapinet.  Ms Rapinet is the Assistant Treasurer Corporate for Woodside Energy’s Treasury Department.  In November 2001 she was Treasury Accountant for Woodside Petroleum.  In 2003 she became a funding analyst and was appointed an insurance advisor for about a year before being promoted to her current position in September 2006.

    5.Ross Garnaut.  Professor Garnaut is Professor of Economics at the Australian National University.  He gave expert opinion evidence, received subject to an objection as to relevance, as to the underlying rationale of resource rent tax (RRT). 

    6.Robert Graham Walker.  Professor Walker is Professor of Accounting at the University of Sydney.  He gave expert opinion evidence, subject to objection as to relevance, relating to the accounting treatment of hedging transactions.

    No witnesses were called by the Commissioner.

16. I accepted the evidence of all witnesses so far as it related to primary facts.   As to them there was little, if any, dispute.  The identification of corporate and individual purposes, the characterisation of hedging policy and transactions formed the bulk of the factual contest. I found the following facts, set out in the evidence of the various witnesses, outlined in the reasons that follow:

    (i)        The history and structure of the Woodside Group.

    (ii)       The formation and content of the Woodside intragroup Agency Deed.

    (iii)      The process of assessment leading to the decision to commit to the Laminaria Project.

    (iv)      The approval of a scheme of arrangement affecting the structure of the Group.

    (v)       The nature of the market for crude oil as described by Mr Richards.

    (vi)The content and development of the Woodside Group’s general hedging policy between 1997 and 2001 as described by Mr Carroll.

    (vii)The process leading to the variation of the hedging policy in relation to the Laminaria Project as described by Mr Carroll.

    (viii)The administrative arrangements within the Woodside Group for implementing and recording hedging arrangements as described by Mr Carroll, Mr Richards and Ms Rapinet.

    (ix)The classes of hedging transaction used with respect to Laminaria oil production as described by Mr Carroll.

    (x)The oil production and sales from the Laminaria Project for the period 1999 to 2004.

    (xi)The use of term contracts and production forecasts in relation to sales of Woodside Energy’s crude oil as described by Mr Richards.

    (xii)The practical operation of the Woodside Group’s hedging arrangements as described by Mr Carroll in a sample period from July to September 2001. 

    (xiii)The way in which the Woodside Group used strategic hedging as described by Mr Carroll.

    (xiv)The use of cargo specific hedges as described by Mr Richards.

    (xv)The nature and use of futures contracts as described by Mr Richards.

    (xvi)The nature of basis risk as described by Mr Carroll and the way in which the Woodside Group dealt with it.

    (xvii)The recording of strategic hedges as described by Mr Carroll.

    (xviii)The Highlander transaction as described by Mr Carroll and the way in which hedges relevant to it were applied to the Laminaria Project.  

    The Woodside Group

1. Woodside Energy is a wholly owned subsidiary of Woodside Petroleum and is its principal Australian operating entity. It was incorporated in 1954 as Woodside (Lakes Entrance) Oil NL to explore for oil in the Gippsland region of Victoria.  In 1963 it acquired petroleum exploration permits over an area of 367,000 square km off the north west coast of Western Australia.  It entered into what became known as the North West Shelf Joint Venture, initially with Burmah Oil and Shell, to secure funding for the exploration and for ongoing development costs. In the 1970s it discovered significant hydrocarbon resources primarily in the form of gas and condensate fields.  The North West Shelf Joint Venture today produces, through its projects, liquefied natural gas (LNG), liquefied petroleum gas (LPG) and natural gas.  It produces condensate as a by-product of gas production.  Condensate is a light oil used as a refinery feedstock.  The North West Shelf Joint Venture also produces crude oil. 

2. Woodside Energy’s first sales were effected in the 1980s under contracts with the State Energy Commission of Western Australia for the supply of natural gas to the domestic Western Australian market.  In 1985 it signed long term contracts with eight Japanese power and gas utility companies for the supply of LNG over a 20 year period.  The first shipments  commenced in 1989.  The contracts incorporated an element of price risk sharing.  They contained price “caps” and “floors” limiting the fluctuation ranges of the sale prices.  The potential upside attributable to significant price rises was limited as was the potential downside attributable to falls.  There however remained a risk that the price of LNG would fluctuate between the caps and the floors.  From 1989 Woodside Energy tried to “insure” against that risk by hedging.   

3. The Woodside Group expanded its operations into crude oil production in late 1995 with the Cossack and Wanea oil fields.  The participants in that project were the North West Shelf Joint Venturers.   The Group was small by comparison with other oil and gas production companies around the world and could not take significant financial risks in relation to any project.  Hedging contracts were entered into in relation to a proportion of the sales of crude oil made from the Cossack project to ensure that revenue was underpinned and to mitigate loss of revenue in the event of a decline in world oil prices.

   The Agency Deed

4. The hedging transactions which lie at the heart of these proceedings were said, by Woodside Energy, to have been made by Woodside Petroleum on its behalf pursuant to an  intragroup Agency Deed dated 5 November 1992. Under the deed Woodside Petroleum had the responsibility for entering into certain classes of transaction on behalf of members of the Group.  It was defined in the deed as the “Agent”.  Woodside Petroleum Development Pty Ltd (Woodside Petroleum Development), Woodside Oil Limited (Woodside Oil) and Mid-Eastern Oil Limited (Mid-Eastern Oil) were defined as the “Principals”.  Woodside Oil was then the name of Woodside Energy. The Deed recited that the Agent was the beneficial owner of all the shares held or was the beneficial owner of all the shares in the capital of the Principals.  It also recited:

   B.The Principals produce and sell in Australia and overseas petroleum in a gaseous and liquid state and in connection with that business enter into marketing and shipping transactions and related investment, interest, currency and product hedging transactions.

   C.In relation to transactions referred to in recital B entered into or to be entered into by the Principals, the Principals have requested the Agent to act as the agent of the Principals and to enter into such transactions on their behalf.

5. The term “Business Transaction” was defined in cl 1 and included:

   1(a)(i)any monetary hedging transaction including but not limited to transactions known as and described by the International Swap Dealers Association as Interest Rate Swaps, Currency Swaps, Interest Rate Caps, Interest Rate Collars, Interest Rate Floors, Swaptions, Currency Options and Forward Rate Agreements;

   (ii)any hedging transaction relating to the management of oil price exposure in respect of sales of petroleum and petroleum products including but not limited to natural gas, liquified natural gas, liquified petroleum gas, oil and condensate.

6. It was stated in cl 1(b) that for the purposes of the Agency Deed the Participating Percentage of each Principal should be:

   Woodside Oil 50%
   Woodside Petroleum Development  33 1/3%
   Mid-Eastern Oil 16 2/3%

7. By cl 4 of the Agency Deed each Principal was entitled to a proportion of all rights and benefits under each business transaction equal to its Participating Percentage. 

8. Clause 2 provided:

   Each Principal hereby acknowledges and confirms the authority of the Agent to negotiate and execute, and appoints the Agent to be its agent to administer and perform (herein together with any other authority granted to or duties imposed upon the Agent pursuant to this Agreement called “the Duties”), all Business Transactions on behalf of the Principal and each Principal hereby ratifies all acts of the Agent done in negotiating, executing, administering and performing Business Transactions on behalf of the Principal prior to the date hereof.

   The liability of each Principal for obligations and liabilities under a business transaction was to be several or joint and several (cl 4(b)). 

9. By cl 5 each of the Principals agreed with the Agent that it would have authority to do and perform all acts and things required of, or allocated to, the Principals for which they are entitled to do or perform under the terms and conditions of any business transaction.  The Agent was authorised to do all further acts and execute all further agreements and documents as should be reasonably required in order to perform and carry out its duties.  Each of the Principals agreed to indemnify the Agent against a proportion, equal to its participating percentage, of any loss, damage, claim or liability resulting from the acts or omissions of the Agent (cl 5(c)).  Each Principal also agreed to pay promptly to the Agent when requested a proportion, equal to its participating percentage, of all costs, expenses, fees, duties, charges and liabilities reasonably incurred by the Agent pursuant to a business transaction or the Agency Deed. 

10. Having regard to the Agency Deed and the evidence, referred to later in these reasons about the accountancy records relating to the hedge transactions in issue, I accept that they were properly attributed to Woodside Energy.

    The Laminaria Project – assessment and commitment – 1996/1997

11. In 1970 the Woodside Group had acquired exploration permits in the Timor Sea in an area now known to contain the Laminaria and Corallina oil fields.  In 1991 three Woodside Group companies, Woodside Petroleum Development and Mid-Eastern Oil and Woodside Energy, then Woodside Oil, together with Shell Development (Australia) Proprietary Limited (Shell Development (Australia), BHP Petroleum (North West Shelf) Pty Ltd  (BHP) and BP Petroleum Development Australia Limited (BP Petroleum), acquired exploration permit AC/P8 which largely covered the Laminaria field.  The Woodside parties’ participation in the permit was as follows:

    1.        Woodside Petroleum Development  – sixteen and two thirds per cent

    2.        Mid-Eastern Oil  –  eight and one third per cent

    3.        Woodside Energy – twenty five per cent

    This gave the Woodside Group a 50% interest in the permit.  In 1992 the three Woodside participants in the Laminaria field entered the Agency Deed referred to above.

12. Mr Carroll described the discovery of the Laminaria oil field and the adjacent Corallina oil field as significant in the history of the Woodside Group.  They were the first discoveries in respect of which the Group was the principal participant with a 50% share prior to unitisation.  The size of the reserve is known to be in excess of 300 million barrels of economically recoverable oil.  It was inevitable, he said, that a significant capital commitment would be required to develop the project. 

13. The process leading to the decision to go ahead with production on the Laminaria field  involved extensive testing and appraisal and modelling of various kinds of design for the development of a profitable petroleum producing project.   The use of a floating, production, storage and off-loading (FPSO) vessel was identified as the best way to exploit the field.  Following that decision, which was taken in early 1996, production forecasts were prepared of the volumes of crude oil to be produced and sold from the project.   Mr Carroll said that production forecasts generally become more accurate as a project is defined and developed and more information becomes available about the reserve.  They were updated and revised throughout the life of the project from testing and appraisal to the final investment decision and through project development to the point when “first oil” is produced and thereafter. 

14. The Woodside Group’s Northern Business Unit, later renamed the Australian Oil Division, used production forecasts to produce predicted balance sheet, profit and loss and financial data for the Laminaria Project.  These formed the basis for the Business Proposal.  Woodside Energy used the production forecasts to prepare “lifting schedules”.  The schedules set out on a monthly basis when the FPSO was required to have product available for collection by tankers to be taken to customer refineries.  They were prepared by Woodside Energy in its capacity as “Off-take Coordinator” of the joint venture facility on behalf of all joint venture parties so as to enable allocation of cargoes between the joint venturers in accordance with an Off-take Agreement between them. 

15. One of the significant price risks associated with the Laminaria Project was price volatility which is a feature of the market for crude oil.  Long term contracts are not generally used in that market.  Another significant risk was that the project production profile anticipated high volumes of production taking place over a short time. 

16. A Business Proposal for the project was prepared in October 1996.  It appears to have been prepared by Woodside Offshore Petroleum Pty Ltd (Woodside Offshore Petroleum).  The executive summary of the Proposal included the following statement (at [1]) :

    Total Capital Expenditure for the development is A$1074 million (MOD) with a Project Master Schedule Ready for Start-Up (RFSU) date of 1 February 1999 (50/50).  Base case NPV 10% of the development is A$318 million (RT ’96), with a Real Terms Earning Power (RTEP) of some 27% and Value/Investment Ratio VIR (10%) of 0.39.  The development is economically robust over a range of sensitivities to oil price, production, capex, opex, RFSU date and reserves.  In the event of a low reserves outcome and shortened field life, the residual value of the FPSO provides significant protection against low or negative NPV. [emphasis added]

    The sentence emphasised was the focus of some debate in these proceedings about the characterisation of the hedging arrangements in issue in these proceedings and going to the question whether they were necessary to the viability of the Project.

17. The economic analysis of the proposed development was carried out using project economic assumptions (PEAs) set out in Table 5.1 of the Proposal. 

1996	1997	1998	1999	2000	2001+
WT1 Oil Price (US$/bbl, RT 1.1.96)	17.00	16.50	16.32	16.22	16.11	16.08
Premium/Discounts (US$/bbl – RT 1.1.96)	-1.50	-1.45	-1.41	-1.36	-1.31	-1.27
Australian inflation rate (% pa)	4.0	4.5	4.5	4.5	4.5	4.5
USA inflation rate (% pa)	3.0	3.5	3.5	3.5	3.5	3.5
Exchange rate (US$/A$)	0.76	0.76	0.76	0.76	0.76	0.76

Basic assumptions underpinning the economic analysis were also set out in Table 5.2:

1.  Oil price A$20.4/bbl (RT 1.1.96) in 1996
2.  No revenue attributed to associated gas
3.  Capital Expenditure A$1074 million (MOD) which equates to A$988 million (RT 1.1.96)
4.  Operating costs A$60 million (RT 1.1.96)
5.  Field abandonment cost of A$60 million (RT 1.1.96) IN 2008
6.  FPSO salvage (NPV 10% effect is A$13 million)

The Proposal noted that the development would attract petroleum resource rent tax at 40% of net revenue after deductions. 

1. The project economics were tested to sensitivities.  Their effects on project NPV were set out in Table 5.4.

Project NPV	Reserves MMbbl	RTEP (%)	NPV (10%)	NPV (10%) Incremental
Base Case	182	27	318	0
20% lower oil price	179	18	145	-173
20% higher oil price	185	36	493	175
20% higher capex	182	20	231	-87
50% higher opex	174	25	265	-53
20% higher capex and 3 month delay to RFSU	181	19	211	-107
P90 Ultimate Recovery	99	9	-12	-330
P10 Ultimate Recovery	282	36	629	311
Production Constrained to 145,000 bbl/d	181	25	303	-15
RFSU 1.10.98	183	29	336	18
RFSU 1.04.99	181	25	300	-18

The conclusion was offered:

It can be concluded that the Laminaria/Corallina project is economically very robust with a positive value (NPV 10%) for a wide range of downward sensitivities and substantial upside in value for the P10 STOIIP and higher oil price scenarios.

1. The Business Proposal was submitted by Woodside Offshore Petroleum to the Woodside participants, to Shell Development Australia and to BHP on 15 October 1996.  The covering letter sought what was called the “Prime Scope Approval”.  Mr Carroll called it “the go ahead” from the other joint venture participants.

2. Mr Carroll discussed the project economic assumptions used in the Business Proposal.   One was that the West Texas Intermediate (WTI) price of US$17 per barrel would hold for 1996 with prices in real terms in 1996 dollars of US$16.50, US$16.32, US$16.22 and US$16.11 for each of the years 1997 to 2000.  An assumed price of US$16.08 was adopted for the year 2001.  The assumption of declining oil prices reflected the fact that oil futures markets set prices for periods closer in time higher than for periods later in time.  The sensitivity analyses showed a base case net present value (NPV) of the project as a whole, assessed on the basis of a 10% discount rate, as A$318 million after tax.  A 20% decline in oil price would have seen a 54% decline in the net present value of the project from A$318 million to A$145 million.  Mr Carroll said that this demonstrated the extent to which the project was highly sensitive to changes in the oil price. 

3. The final decision on whether the Woodside Group would go ahead with the Laminaria Project was taken by the board of Woodside Petroleum at a meeting held on 6 November 1996.  The other joint venturers also decided to proceed. 

4. In 1997 the Woodside Group and its joint venture partners entered into contracts for the construction of the Northern Endeavour which was to be the FPSO vessel for the production of oil from the field.  Total capital expenditure on the development of the project and the construction of the Northern Endeavour was ultimately in excess of A$1.35 billion, of which the Woodside Group’s contribution was 50%.  This expenditure exceeded the base case estimated costs set out in the Business Proposal by approximately 25%.  It represented a major commitment.

5. Mr Carroll agreed in cross-examination that the decision to invest in the Laminaria Project was based upon the assumption that the initial price of oil sold from the project would be US$17 per barrel and that it would decline to US$16.08 by 2001.  The Business Proposal considered the extreme case of a 20% decline in oil prices.  Mr Carroll, rightly I think, did not accept that this meant the project would have been regarded as viable even in that extreme event.  That was not the way in which, on the face of it, the Business Proposal was presented. The extreme case was a risk to be weighed up in deciding whether to proceed.    Mr Carroll accepted that the Business Proposal said nothing about the need to implement hedging to protect against the risk of oil price volatility.  Nor was hedging mentioned in the minutes of the board meeting which approved the Project.  It was not a condition of board approval.  The hedging of Laminaria oil sales was first raised at the Finance Committee meeting in July 1997, eight months after the final investment decision was taken.  This was relevant to a line of argument advanced by the Commissioner that the hedging arrangements the subject of these proceedings, were not related to risk management on particular sales of oil.

   The Scheme of Arrangement - 1998

6. By a scheme of arrangement approved by the Supreme Court of Western Australia in 1998 all the undertakings and property, liabilities and obligations of Woodside Offshore Petroleum, Mid-Eastern Oil and Woodside Petroleum Development were assumed by Woodside Energy.  Following that reorganisation hedging transactions entered into by Woodside Petroleum under the Agency Deed were said, by Mr Carroll, to have been entered into by it as agent for Woodside Energy.  It was Mr Carroll’s evidence that all of the revenue earned from the Laminaria Project (which did not start producing until late 1999) was earned by Woodside Energy.  All of the hedge expenses, the subject of the present proceedings, were paid by Woodside Energy.  Payments and receipts arising upon the settlement of the hedging transactions were recorded in the accounting records of Woodside Energy rather than in the books of Woodside Petroleum.  They were brought to account as part of Woodside Energy’s sales revenue.  The recording of hedge expenses as part of Woodside Energy’s accounts in its general ledger as items 6350H and 6350SH.

   Market for crude oil and Laminaria crude

7. It is a feature of the world oil market, as described by Mr Richards, that crude oil cargoes are sold by reference to inherently volatile pricing bases.  Crude oil is generally priced by reference to one of a number of benchmark grades.  Prices of benchmark grades for crude oil are published at varying intervals.  These benchmark prices are as follows:

   (a)West Texas Intermediate (WTI), or low viscosity oil which is “sweet”, meaning low in sulphurous compounds.  WTI futures contracts are traded on the New York Mercantile Exchange (the NYMEX). 

   (b)Brent crude, which is heavier than WTI and is produced in the North Sea.  The principal market for exchange traded Brent crude oil derivatives is the International Petroleum Exchange based in London.

   (c)Tapis crude is produced in Malaysia and traded in Singapore.  The Tapis price is a regional benchmark in the Asia Pacific.  It is based on the Asian Petroleum Price Index published daily in newspapers or other media.  During the time that Mr Richards was responsible for what he described as the Laminaria “cargo specific” hedging program, there were no exchange traded derivatives operating by reference to Tapis.  

8. The use of price benchmarks to sell crude oil contrasts with the pricing bases for the sale of other hydrocarbon products such as domestic gas and liquefied natural gas.  The world oil market is subject to particular volatility because:

   (a)Refineries are generally suited to processing specific types of crude.  Crude oil is fungible and can be blended if necessary and economical to do so at a particular plant.

   (b)Refineries are unlikely to obtain all of their crude from one source.  Because crude oil is relatively easy to transport, buyers shop around.

   (c)Demand fluctuates according to seasonal and economic factors – eg a mild winter in North America could lead to a decrease in the use of heating oil which would be reflected in a decline in crude oil prices.

   (d)Supply fluctuates because of a variety of factors such as the discovery or development of new fields and the imposition and periodic adjustment of production quotas by the Organisation of Petroleum Exporting Countries (OPEC). 

   The sale of crude oil between a producer and a refiner is typically priced by reference to a premium or discount on one of the benchmark prices at a given point of time or over a period of time.  So Woodside Energy might agree to sell a cargo of Laminaria crude oil for a price of “Tapis plus 10 cents per barrel”.

1. Laminaria crude oil was never sold on the basis of a fixed dollar price per barrel.  During the time that Mr Richards was responsible for marketing all Laminaria sales were undertaken by reference to one or another of the benchmark grades of crude oil, usually Tapis or WTI.  This did not extend to oil sold to Shell International Eastern Trading Company (SIETCO) under a term contract which was entered into and ran from May 2000 until May 2003.    

   Woodside’s hedging policy – 1996 - 1997

2. Mr Carroll’s testimony included a number of statements about the reasons or purpose of Woodside Petroleum or Woodside Energy for adopting particular policies or practices.  In the area relevant to his function as Chief Financial Officer for the Group, I take them to be statements of reasons and purposes which he adopted or treated as his own.  Given his senior position and subject to challenges to specific elements of such testimony in cross-examination, I accept that his statement of purposes and reasons can be regarded in this respect as those of Woodside Petroleum and Woodside Energy. Much of what he had to say in this respect was reflected in documentary evidence setting out the relevant policies and practices of the Woodside Group concerning risk management and hedging.

3. Mr Carroll’s evidence was that, as a crude oil producer, Woodside Energy’s reasons for entering hedging transactions differed from those of other actors in that field such as traders or speculators.  As a producer it was concerned about falls in the price of oil and entered into hedging transactions in respect of anticipated oil production and sales to ensure that its revenue in relation to the hedged proportion of anticipated production and sales was guaranteed at an amount determined by reference to a “forward oil price curve”.  The oil price curve was produced by plotting the future prices for WTI contracts traded on the NYMEX.  That curve was based on information about the market’s expectation of future oil prices. 

4. It was Mr Carroll’s evidence that because Woodside Energy was exposed to a price risk arising from specific underlying sales of crude oil it accounted for hedging “losses” or “gains” by offsetting them against gross revenue derived from the sale of crude oil.  The “net” revenue amount after allowing for such gains or losses was reported as sales revenue in Woodside Energy’s accounts in accordance with “hedge accounting” principles.  Woodside Energy had always accounted for hedging transactions in that manner.  Its approach was later recommended by the Australian Accounting Standards Board in its Urgent Issues Group Paper produced in May 2000 entitled “Abstract 33: Hedges of Anticipated Purchases and Sales”.  That approach was made mandatory in the 2001 calendar year when Accounting Standard AASB 1033 was introduced.  The accounting treatment differed from that which would have applied if Woodside Energy had entered into hedges for speculative purposes, that is to say, where there was no underlying sale. 

5. The Woodside Group was small (by world standards) compared to other major oil producing companies such as Shell.  The size and extent of productive assets and reserves held by major companies provided them with a natural hedge as did their vertical integration into the market for the sale of petroleum.  At the end of 1996 Woodside Energy had  relatively few “proven” and viable reserves.  Its only producing assets were in the North West Shelf area.  

6. The hedging of projected sales within the Woodside Group was implemented before 1996 under the direction of the Oil Marketing Department which was monitored by the Treasury Department.  The Treasury Department then became responsible for implementing “strategic” hedges.  The Oil Marketing Department retained responsibility for cargo specific hedges.  Strategic hedges were long term hedges placed as much as three years in advance of anticipated production and sale of crude oil from a particular project.  Cargo specific hedges were short term hedges intended to manage the risk of prices decreasing between the time of ascertaining a lifting schedule by which cargoes were allocated to the joint venturers and the time that oil was actually sold to a customer.  

7. Mr Carroll produced a document, current as at April 1996, called the “Finance Register”.  It set out Woodside Petroleum’s hedging policy at that time.  In a section headed “Risk Management Overview” it stated that Woodside Petroleum had a policy of “active management” of its exposures to oil price inter alia.  Management was subject to the guidelines approved by the Board of Directors.  The document stated:

   Woodside’s approach is one of risk minimisation.  Hedging transactions are only undertaken against an identified underlying exposure.  There is no speculative trading.

   If it became apparent that hedge levels were expected to exceed sales volumes for a period, eg if there were a plant shut down or a down turn in production not foreseen at the time hedges were placed, a proportion of any hedge loss or gain attributable to excess hedges would immediately be brought to account as a loss or gain in Woodside’s profit and loss account as an ineffective hedge.  It would not be offset against sales revenue at the time of an underlying sale.  Losses attributable to such hedges do not form part of Woodside’s claimed deduction.

8. In 1997, Mr Carroll developed a Treasury Policies Manual. This set out the basis for the hedging transactions which gave rise to the losses the subject of this proceeding.  It was formally approved by the board of Woodside Petroleum at a meeting on 3 September 1997.  The document began with a statement of Treasury Policy Objectives.  They included the following:

   1.1       PURPOSE

   The purpose of this document is to establish a prudential policy framework for the management of Woodside’s financial risks associated with the treasury function.  This is an essential component of Woodside’s corporate governance.

   1.2POLICY

   The objective of these policies is to specify Woodside’s approach to financial risk.  The policies also state the parameters within which these financial risks are to be managed.

   A number of areas of financial risk were then set out.  Woodside’s Petroleum approach was said to be one of “risk mitigation”.  The statement of policy went on:

   Speculative transactions are prohibited.  Hedging transactions are only undertaken against an identified underlying exposure. 

9. Treasury policies  were designed to ensure that financial risk was managed so that:

   .Shareholders obtain some protection against adverse price movements whilst maintaining some participation in favourable price movements; and

   .Protection of net profit and cashflow through the active management of Woodside’s exposures is achieved, which is crucial to the Group’s long term stability and the achievement of a competitive return on shareholders’ funds.

   Under the heading “APPROACH” it was stated that consistently with the preceding principles, policies were to be reviewed and any changes approved by the board annually for identified areas of financial risk which included:

   Oil Price Risk – to contain the potential for financial loss through the unfavourable movement in oil prices. 

10. Section 4 of the document dealt with “OIL PRICE RISK MANAGEMENT” and included the following provisions:

    4.1      PURPOSE

    The aim of oil price risk management is to establish a prudential policy framework for the management of oil price risk associated with Woodside’s forecast sales.  Furthermore, the objective of the oil price risk management (“OPRM”) hedging policy is to contain the potential for financial loss arising from unfavourable movements in oil prices. 

11. Under the heading “POLICY”, the following statements appeared:

    .Oil price hedging can only be undertaken in respect of identified barrel of oil equivalent (BOE) exposures, taking into consideration known and forecast product sales.

    …

    .Speculative positions are not permitted.

    …

    .Writing of options is permitted only when premium income is used to offset the cost of purchasing option cover or otherwise applied in reducing the cost of cover.  Writing of exposed option positions for the sole purpose of generating premium income or mismatching the timing of bought and sold option positions is not permitted.

    .The maximum duration for an oil price hedge is 3 years.

    .Hedges may be lifted prior to maturity on approval of the Finance Committee

12. A weekly meeting was required between the Treasurer, Assistant Treasurer – Risk Management, Treasury Officer, the Liquids Marketing Manager and the Liquids Marketer to discuss the current market, Woodside’s strategic oil price exposure and future hedging strategies.  Three people, including one from the Commercial Division, were required to form a quorum.  Minutes were to be kept of those meetings.

13. Mr Carroll said that the aim of the hedging policy set out in the manual was borne out in 1998 as explained in the Managing Director’s report to shareholders for that year contained in the Woodside Petroleum 1998 Annual Report.  A record profit by Woodside for that year of A$300.2 million was obtained despite a drastic decline in oil prices. 

    Laminaria’s effect on the Woodside Group’s oil price hedging policy - 1997  

14. The relatively small size of the Woodside Group, the fact that Laminaria was a new project in a new area and involved technical and other risks, meant that the Group was not prepared to take the full risk of a decline in oil prices.   Woodside Petroleum’s management and its board considered it desirable from the outset to implement a level of hedging in respect of anticipated sales from the Laminaria Project to help protect against falls in the oil price.  This consideration did not appear anywhere in the Business Proposal.  However the minutes of a meeting of the Finance Committee of Woodside Petroleum held on 15 July 1997 recorded that the Managing Director, Mr Akehurst, proposed that an exercise be carried out to quantify the benefits of hedging half of Woodside’s Laminaria sales volume in the period 1999-2001 when the output from the project was at its peak.  The minutes recorded that he said:

    In the context of the 10 Year Business Plan, this may present a unique opportunity to lock-in sales revenue at a defined level and provide cash flow to fund growth opportunities in a period of possible low oil prices. 

    The Committee agreed that this option should be analysed thoroughly and a report on the issue presented at its meeting in August 1997.  It also supported the recommendation that current cover be increased to maximum levels at prices above US$19.00. 

15. A Ms Del Vescovo presented a hedging analysis to the meeting which confirmed previous results.  The minutes record her as saying that the company could meet peak commitments over the following three years even with oil prices down to US$12 with the existing loan facility and hedge cover in place.

16. In his evidence-in-chief Mr Carroll described the expected production profile for the Laminaria Project as “peaky” with an anticipated spike in production and sales shortly after the first oil of some 18 months duration.  Production and sales would peak followed by a decline in sales over the remaining life of the project.  This was illustrated by the project cashflow projections in the Business Proposal.  With many oil projects production typically has a steady increase to a peak which may be several years after production begins.  Given that Laminaria was especially “peaky” it was highly desirable that the sale price should meet the PEAs as set out in the Business Proposal in the early years and, in particular, during the 18 month peak when a significant proportion of the reserves were to be extracted.  In Mr Carroll’s opinion if the PEAs were not fulfilled the project might have been unviable. 

17. Mr Carroll said that hedging was more important for Laminaria than for the North West Shelf project because the production profile in respect of the North West Shelf development was relatively flat and the project life expected to be in excess of 20 years.  Peaks and troughs in oil prices could be ridden out over the life of the project.  The Laminaria Project on the other hand had an 18 month window in which production was expected to peak. 

18. It was put to Mr Carroll in cross-examination that the Finance Committee, at its meeting in July 1997, was concerned about the opportunity that production of Laminaria oil would afford in terms of achieving the Group’s corporate objectives.  He said that the Committee’s consideration was “based on the achievement of certain levels of cash flow”.   He said that the reason for hedging in the first place was “to make sure we can protect cash flow [sic] and maintain the business in a healthy basis to achieve our long term objectives to shareholders”.   He said:

    … the raison d’etre for risk management was to look at securing the cash flow against the downside in oil price to meet our ongoing commitments; to pay dividends to shareholders and obviously to secure the cash for our long term objects.

    He agreed that Mr Akehurst by his memorandum was “perhaps considering an extension of the rason d’etre” [sic].   The Finance Committee discussion about Laminaria on 15 July 1997 took place, Mr Carroll agreed, in a context in which Woodside Petroleum had a prudent level of cover in place and that it could meet its current commitments, that the Laminaria exercise was considered.  

19. As a result of Mr Akehurst’s request, Mr Carroll undertook an analysis of a specific hedging policy for Laminaria.  He said in cross-examination that a specific hedging policy for Laminaria would lock in revenues “… to allow the company to be robust to meet all sorts of situations, including any possible growth opportunities”. The presentation was about the benefits of a specific hedging policy for the project.  It involved a number of PowerPoint slides which included the following statements:

    .Laminaria startup in 1999 causes oil production to increase significantly

    .Currently, opportunity exists to “lock in” oil prices above 1997 PEA’s of USD 18.50

    .Provide some cashflow certainty with regards to the spike in oil production 1999-2001

    .Positions Woodside for business opportunities

    .Specific Laminaria hedging policy

    .Woodside’s forecast oil production jumps in 1999 due to Laminaria startup

    .Laminaria oil field depleted rapidly, and oil production tapers off

20. Mr Carroll told the meeting that Woodside’s revenue would spike in 1999-2001 because of Laminaria and the opportunity existed to lock in some of that spike at prices above the 1997 PEAs of USD18.50.   He presented a slide with a table in the following terms:

Laminaria Exposure (MMbbl)
Other Exposures (MMbbl)
Total BOE Exposure (MMbbl)
Current Cover in place Current Laminaria Cover (MMbbl)
Current Other Cover (MMbbl)
Total Cover (MMbbl) Ave Hedge Price (USD/bbl) 1998 24.7
24.7
41% 10.2
10.2 19.5 1999
28.2
27.8
56.0
15% 4.1
4.0
8.1 19.8 2000
22.4
26.4
48.8
3% 0.6
0.7
1.3 20.1 2001
11.6
27.0
38.6

The presentation also included a table showing the impact of hedging and various graphs.  At one point the following statement appeared:

Prices within a band of USD18-22 are possible.

1. He offered the following conclusions:

   .Oil prices predicted to remain within a band of USD18-22

   .However, the potential for price spikes due to just in time inventory policy and inherent volatility in oil markets exists

   .Increasing Laminaria hedging cover would involve significant volumes which may have a negative impact on the oil futures market

   .Futures market illiquid, therefore placement would take time, even given immediate approval to place additional cover

   .May wish greater participation in possible upside

   .Consider the inclusion of options

   .Upfront cost should be regarded as the premium paid for this “insurance”

2. Mr Carroll told the meeting that he agreed with Mr Akehurst’s suggestion at the July meeting that at current prices the opportunity existed to lock in oil prices above the 1997 PEAs of US$18.50.  He accepted in cross-examination that the purpose of the proposed hedging policy for Laminaria was to provide cash flow certainty in light of the spike in oil production and to position Woodside Energy for business opportunities should the oil price drop significantly. He agreed that his focus was on locking in oil prices above PEAs of US$18.50 “for the purpose of making sure that the Woodside group could exploit business opportunities in the future.”  He added that it was primarily “to ensure that Laminaria’s cash flows were available for us to do that”.   Mr Carroll accepted that if his proposal had not gone forward existing hedging policies would have adequately covered hedging arrangements with respect to Laminaria.  It was put to Mr Carroll that the hedging he proposed above US$19.00 per barrel was not essential.  He responded:

   Absolutely, in terms of the company’s strategy.  I mean Woodside is a public company, its objective was to maximise value to shareholders and to pay dividends.

3. Mr Carroll prepared a memorandum to the board of Woodside Petroleum in the name of the Managing Director.  He stated in the memorandum that oil price hedging policy had been reviewed in the light of the significant increases in oil production which the company would experience upon the start up of Laminaria in the first quarter of 1999.  He identified as the options available to the company:

   1.        Continue with the current hedging policy limits (see table overleaf);

   2.        Reduce the approved maximum hedge percentages;

   3.        Increase the approved maximum hedge percentages.

   The existing approved hedge limits and planned minimum hedge price at the time, as set out in a table were 50:25 and 10 for the first, second and third years on a minimum hedge price of US$18.50/bbl.  He continued:

   Analysis of the company’s projected future cash flow profiles incorporating existing oil price hedges has confirmed that, utilising existing debt facilities and maintaining a reasonable gearing ratio, currently planned capital and operating expenditures can be achieved and reasonable levels of dividend paid even if prolonged periods of low oil prices ($12.00/bbl real terms) are experienced.

   While this could be argued to remove the previous justification for defensive hedging, requirements for additional capital expenditure are expected to be firmed up as a result of exploration success and the definition of other new business opportunities.  It is also expected that the years immediately following the start-up of Laminaria will provide a key opportunity for a corporate acquisition, particularly if oil prices are low.

   He made three recommendations.  His first recommendation was that the approved maximum hedge percentage remain at 50% for year one of the project.  His second recommendation was that the minimum hedge price should be increased to US$19/bbl.  In support of this recommendation his memorandum stated:

   This reflects the reduction in the requirement for defensive hedging at lower prices.  It is also recommended to increase the flexibility to achieve longer term hedges in the 24 and 36 month periods at or above this higher minimum hedge price.

   The third recommendation was that the approved maximum hedge percentages for years 2 and 3 be increased to 35% and 20% respectively.   At that time they were 25% and 10%.

4. Mr Carroll agreed in cross-examination that his reference to “defensive hedging” was a reference to the risk minimisation which he called “the low end of your hedging profile”.  Two key elements in moving away from defensive hedging were the Group’s additional capital expenditure requirements that would be firmed up as a result of exploration success and the identification of new business opportunities.

1. The Finance Committee met on 2 September 1997 and considered Mr Carroll’s recommendations.  The minutes recorded two views.  Mr JL Stitt reminded the Committee that the current hedging policy involved the management of financial exposure.  Hitherto, the hedging policy had been based on risk management linked to identified commitments such as bank loans, capital expenditure and dividends.  He expressed concern that the proposal represented a significant change in the raison d’être for hedging and was driven by desire to lock in future revenues unrelated to underlying commitments.  The level of hedging proposed was based on a view of market prices and increased the potential for hedging at a time when Woodside’s financial position was strengthening.  Other committee members were said to have supported the recommended approach which they saw “… as an appropriate way to provide certainty in planning investments and to lock in profit expectations”. 

2. The Finance Committee’s recommendation was considered by the board of Woodside Petroleum on 3 September 1997.  The minutes recorded an extended discussion with all directors expressing their views.  Most were supportive, recognising the need to protect planned revenues in order to achieve the company’s future growth targets. Mr Stitt maintained his opposition to what he regarded as a fundamental shift in hedging policy.  Mr Carroll accepted that the existing hedging policy was “… based upon risk management linked to identified commitments such as bank loans, capital expenditure and dividends”. The minutes stated:

   Any perceived difficulty with the wording of “speculation” in the Treasury policy needed to be reassessed to accommodate the desirability of protecting and supporting sound business judgements.

   Mr Carroll said in cross-examination so long as there was an identified underlying exposure that the Group was hedging they would not have considered that to be speculation.  The proposals contained in his memorandum were adopted.

   Woodside Energy’s hedging policy reviewed 1999-2001

3. The period 1999 to 2001 saw a continuing process of review of the Woodside Group’s hedging policy which became more focussed as the Group emerged from the initial predicted spike in oil production associated with the Laminaria Project.  Late in 1998 Woodside Petroleum retained Westpac to report on Woodside Petroleum’s Treasury function.  Westpac prepared a report which was circulated to members of the Finance Committee on 4 February 1999.  Management’s response was sent to the Committee with a covering memorandum from Mr Carroll on 10 February.  A Mr Gunston from Westpac made a presentation to the Committee about the review on 17 February. 

4. Westpac recommended adoption of a “proactive hedging philosophy”.  This would allow percentage cover limits to be varied from time to time based on a strategic approach to exposure and associated cover.  Management saw the recommendation as consistent with its view of the Woodside Group as a mature group with strong and steady cashflow.  It proposed “a more proactive approach in seeking to add value in executing its risk management transactions”.  It accepted that such a “fundamental change” could only be implemented after Treasury had developed the requisite competency.

5. Mr Carroll said that the board endorsed the adoption of a more proactive approach but “… within the confines of active management as defined in the policy”.  He said that in reality there was no shift to a more proactive practice.   Treasury remained within the overall policy guidelines and simply finetuned their wording.  The same principles continued to be applied.  Hedging was done within pre-approved limits having regard to underlying exposures with the objective of protecting cashflow.  In this context he defined “active management” as “the ability to place or lift hedges within existing policy guidelines at the most opportune time, because we’ve got experienced and skilled treasury people to implement that outside of finance committee approval”.

6. In June 1999, Westpac was undertaking a further review of the oil price hedging policy with respect to maximum and minimum levels of cover.  Mr Nelson, who was by then the Treasurer, made a presentation to the Finance Committee at its meeting on 15 June 1999  He reported on a recent upward trend in oil prices which had been affected, inter alia, by high compliance with OPEC agreed production cutbacks.  He reported on recent oil swap deals and the current status of the oil price hedging portfolio.  In relation to the Westpac review he told the Finance Committee that because of the recent recovery in oil price the company profile had changed significantly since 1997 and it was time to review oil price hedging philosophy. 

7. The Finance Committee recommended to the board an interim portfolio balance in circumstances in which oil prices exceeded US$17 per barrel of 50:35:30 swaps and 12:12:12 options in years 1, 2 and 3 respectively.  This meant that in year one Treasury staff would be able to effect swap transactions up to a maximum level of 50% plus option transactions up to a maximum of 12% for an overall maximum hedging level of 62%.  The board adopted the Finance Committee recommendation at a meeting held on 15 and 16 June 1999.  As at 16 June 1999 therefore the maximum permissible hedge percentage levels for years 1, 2 and 3 were as follows:

   (a)       swaps 50:35:30
   (b)       options 12:12:12
   (c)       cargo specific hedges – balance of exposure

   Cargo specific hedges could be entered into up to 184 days (6 months) in advance of sales.

8. A statement of “Treasury Risk Management Objectives” was attached to the minutes of the Finance Committee meeting.  Mr Carroll identified the attachment in cross-examination as produced by Westpac to say where it thought Woodside sat in terms of Treasury risk management.  The attachment stated, inter alia:

   Woodside’s Treasury does not operate as a profit centre and is therefore not empowered to take speculative positions.  As such hedging transactions may only be undertaken against clearly identified underlying exposures.

   Mr Carroll agreed that the statement of policy did not preclude him from taking what was put to him as “your active approach” to maximise value provided that hedging remained within the prescribed limits of cover.  

9. On 20 July 1999 the Finance Committee approved a level of year 4 cover hedging above US$17.50 in increments of 0.5 million barrels was recommended.  That approval was noted by the board at its meeting held on 20 and 21 July 1999. On 17 August 1999 the Finance Committee resolved that, pending a review by Westpac of the year 4 hedging level approved at the July meeting, the level would be revised.  The minimum hedge price target would be lowered to US$17 per barrel with cover to be placed in small tranches of no more than 0.5 million barrels.  The change was noted at the meeting of the board held on 17 and 18 August 1999.  Those limits remained in place until March 2001. 

10. The second Westpac review was completed in September 1999.  Westpac recommended setting hedge parameters for all of Woodside Petroleum’s price risks including commodity prices, foreign exchange and interest rate risks.  As a result of the review, Mr Carroll prepared a memorandum dated 2 September 1999 for the Finance Committee.  He recommended that hedge parameters should be set with minimum and maximum levels within which Treasury, with Finance Committee approval, would have the flexibility to increase or decrease cover as appropriate.  Treasury also wanted to identify performance measures at benchmarks and manage and report currency exposure in US dollars.  The proposal was not approved by the Finance Committee.

11. In a PowerPoint presentation to the Committee Mr Carroll described the objective of hedging thus:

    … to facilitate and complement the business unit pursuit of … growth by focusing on reducing the earning volatility around the growth rates achieved by the underlying business.  Earnings volatility management, not absolute earnings growth, is the risk management focus.

    He observed in cross-examination that the stated objective could be achieved by protecting cashflow.

12. Further into his presentation Mr Carroll observed that, as Laminaria production reduced, Woodside Petroleum would be proportionately less influenced by oil and currency changes.  He also noted that, in undertaking any analysis of hedging, oil price risk could not be divorced from exchange rate risk.  They were looking at “a corporate plan”.  He accepted that the discussion in his presentation went well beyond issues relating to Laminaria.

13. Mr Carroll’s recommendations were considered by the Finance Committee on 15 February 2000.  The Committee did not accept the recommendation that maximum hedge cover limits in year 1 be lifted to 70%.  It recommended that management review the wording of the Group’s hedging philosophy.  Mr Carroll rejected the suggestion in cross-examination that there had already been a shift in hedging policy.  Rather there had been a shift in the risk profile of the business.  In answer to the proposition that Woodside Petroleum was managing its hedge portfolio more actively within the specified parameters, he said that the staff were much more experienced and adept in their ability to implement hedges.  Asked by the Court to explain what he meant by “active management”, Mr Carroll said:

    … basically it is giving the expertise within treasury the flexibility to use the skills they have got in terms of what is the most appropriate instrument and what is the most appropriate timing in which to place the hedge.

    He agreed that so called “active management authority” had been in place for the whole of the first half of 2000.  The authority extended to place, lift, adjust and reallocate hedges.  There was a price risk involved every day.   

14. In cross-examination Mr Carroll explained that “placing” a hedge referred to entering the market to buy a contract.  “Lifting” referred to negotiating with the bank to cancel a hedge.  “Early lifting” was a term used to describe a change in the timing of a hedge.  The term “closing a hedge” was used to refer to settlement by expiry or renegotiation of the hedge to close it out early.  He initially denied that reallocation of hedges between projects occurred.  He then accepted that there had been a reallocation to the Laminaria Project of hedges placed in relation to an abortive acquisition (referred to below as “Highlander”).  Reallocation in that case was just an administrative process of identifying certain hedges with the Laminaria Project. 

15. Late in 2000 consideration was given, by the Finance Committee, to its remit, which was changing because of the risk management responsibilities of other committees, the issue of petroleum resource rent tax and the reduction in hedge cover generally.  These matters were discussed at a meeting held on 7 December 2000 which was not attended by Mr Carroll.  At about this time BHP had announced that it intended to cease hedging. 

16. On 10 February 2001 a memorandum on the 2001 oil hedging strategy for members of the Finance Committee was prepared over Mr Carroll’s name.  He recommended the following oil hedging strategy for consideration by the Finance Committee:

    .         no additional oil hedges to be placed in 2001, 2002 or 2003 hedge periods

    .use price opportunity to reduce current committed hedging cover levels in 2001 and 2002

    .limited additional hedge cover to be placed in 2004 and 2005.  Cover to be placed within policy limits and with the objective of ensuring that the company’s gearing levels remain below 60%

    .the strategy to be reviewed periodically or whenever a significant acquisition or development is contemplated which could significantly increase the company’s exposure to oil prices or has the potential to push gearing above the 60% level.

17. A PowerPoint presentation made with the paper identified hedging policy objectives as the mitigation of risk, the pursuit of growth and the addition of value.  In that presentation Mr Carroll made the point that there was little market risk or need to mitigate risk under current forecasts but hedging could not be ceased as Woodside Energy was not diversifying.  Small amounts of hedging in 2004/2005 would protect the company’s future financial security, reduce risk, increase financial flexibility and support growth targets.  Value could be added by opportunistically reducing cover in 2001/2002.  Committed hedges could be rolled into uncommitted hedges wherever possible.  Basis risks should be covered opportunistically and advantage taken of anomalies in the oil curve. 

18. At its meeting on 20 February 2001 the paper from Mr Carroll was presented by Mr Hill of the Treasury Department and the recommended hedging strategy for 2001 was approved.  Mr Carroll said in cross-examination that the Group had successfully risk managed the peak of the Laminaria cashflows in the first two years of high production.  He agreed that as a result the review had been carried out to determine whether or not a revised hedging strategy reflected the increased capacity to withstand risk while continuing to support corporate growth objectives.  Asked about the meaning of the term “adding value” used in the paper of 10 February 2001, he said:

    Adding value is to optimise the placing of your hedges over and above the target price where appropriate.

19. Early in 2001 a paper was prepared within the Group entitled “Financial Risk Management – Policy, Objectives and Implementation”.  It set out further revised hedging limits.  It stated, inter alia:

    Woodside’s risk management approach is currently positioned towards an opportunistic/active management method…

    Hedging transactions could only be undertaken against clearly identified underlying real exposures.  In relation to oil price risk management the paper stated:

    The minimum and maximum permissible hedge cover limits, expressed as a percentage of Woodside’s total “barrels of oil equivalent” (BOE) oil exposures, shall be as follows:

Minimum Committed & Uncommitted	Committed	Maximum Uncommitted	Committed & Uncommitted
1 year	30%	50%	20%	70%
1 year to 2 years	20%	35%	15%	50%
2 years to 3 years	10%	30%	10%	40%
3 years to 4 years	0%	15%	10%	25%

1. The paper led to changes to the hedging parameters most significantly by the implementation of a minimum hedging policy.  It was approved by the Finance Committee at its meeting on 26 March 2001 subject to minor modifications.  A draft was presented to the board on 27 March 2001 with advice that a final paper would be presented for review.  The revised policy was presented by the chairman of the Finance Committee, Mr Vines, at the board meeting held on 3 May 2001.  The board agreed to adopt that policy on the basis that the company’s hedging philosophy would be reviewed again in October 2001.  No new oil price hedges could be entered into until the fundamentals of the philosophy had been reviewed and agreed upon.  Under the new policy, minimum and maximum permissible hedge cover limits, expressed as a percentage of BOE’s, were as follows:

Maximum
Minimum Committed & Uncommitted	Committed	Uncommitted	Committed & Uncommitted
1 year	30%	50%	20%	70%
1 year to 2 years	20%	35%	15%	50%
2 years to 3 years	10%	30%	10%	40%
3 years to 4 years	0%	15%	10%	25%

1. The term “committed hedge cover” referred to hedge cover under which a member of the Woodside Group had contracted a financial obligation (such as swaps).  Uncommitted hedge cover referred to the case in which the Group member had been granted the right to exercise a hedge but had no contractual or financial obligation to do so. 

2. By July 2001 PricewaterhouseCoopers had been engaged to assist management to undertake a philosophical and fundamental review of risk management.  The PricewaterhouseCoopers’ team included Mr Alan Miller who was called as an expert witness in these proceedings.  Macquarie Bank was also engaged to review risk management operational areas.  These matters were discussed at a meeting of the Finance Committee held on 17 July 2001.  The Finance Committee also considered a paper entitled “2001 Oil Hedging Strategy Update” which presented a review of Woodside’s crude oil risk mitigation strategy in relation to risk profile and the internal outlook for crude oil prices.  Mr Hill outlined progress to that point in ensuring that the methodology used to determine exposure recognition criteria for hedging was as accurate as possible.  Having noted from another paper that early closeout of hedges did not have an accounting impact on profits until the underlying transaction matured, the Finance Committee:

   .confirmed that active management authority (ie authority to lift, close or reallocate hedges) was not limited to the current financial year;

   .endorsed the strategy of extending premium on purchasing call options for 2001 and 2002; and

   .approved the allocation of an additional US$5 million budget for the payment of option premium

3. Mr Carroll prepared a paper entitled “Hedging Philosophy and Fundamentals Review” for members of the Finance Committee on 9 October 2001.  He attached to it a paper outlining the results of the PricewaterhouseCoopers’ review.  His paper offered the following conclusions:

   .Hedging should remain part of Woodside’s financial risk management strategy;

   .Hedging should not be implemented by way of a base cover level requirement, but rather individual hedging decisions should be made based on the specific circumstances facing the company at any point in time;

   .At the current time, no increase is required in Woodside’s oil price, currency or interest rate hedging (modelling supporting this conclusion will be demonstrated at the Finance Committee meeting of 16 October).

   Questions posed for the Finance Committee by Mr Carroll were:

   .To what extent should hedging activities be directed toward managing accounting profit?;

   .What is the company’s attitude toward risk leveraging (ie profit motivated) hedging activities, such as position taking, trading etc?

   He described the existing hedging strategy as one which included an element of risk mitigation where the intention was to reduce exposure to market risk and risk leverage which implied taking positions based on a year of market prices or otherwise driving superior business performance from market volatility.  He accepted in cross-examination that the hedging strategy at that time also included a small element of “risk leverage”.  Risk mitigation did not preclude risk leverage.  Individual discretion could be used to place and lift hedges.  When it was put to him that there was a profit motive in that aspect of hedging practice he said:

   Motivated by optimising the placement or the withdrawal of hedges.

4. In an associated PowerPoint presentation under the heading “Should risk mitigation be extended to risk leverage?”, Mr Carroll said that the role of risk leverage could include strategic position taking, tactical trading, operation of hedging and enhanced customer contracts, optimising execution and optimising investment and production profiles.  It was put to him that each of those things was done under the existing strategy at the time in managing the portfolio.  He said:

   Yes, it was done under the policy in terms of our active management approach.

5. A meeting of the Finance Committee held on 16 October 2001 endorsed the approach proposed in the paper.  The minutes noted that while future policy or guidelines would be drafted to ensure that recommendations were consistent with the Committee’s consensus, Mr Akehurst, the Managing Director, recommended that in the meantime Woodside Petroleum should begin to test the proposed hedging model against its current activities in order better to understand any issues associated with its application. 

1. Under the heading “Deductible Expenditure” the Minister said (at 3943):

   Expenditure of either a capital or a revenue nature which is directly related to a petroleum project – again reflecting the cash-flow basis of the tax – will be deductible in the year of payment against any assessable receipts for the year.  Any excess of deductible expenditure, other than closing-down expenditure, over assessable receipts at the end of a year will be compounded forward for deduction against receipts in future years.

   He then went on to describe what would constitute deductible expenditure.  He listed exploration expenditure, general project expenditure and closing-down expenditure, subject to the exclusion of specific items.  He discussed the elements of exploration expenditure.  In relation to general project expenditure, the Minister said (at 3943):

   General project expenditure comprises expenditure in a production licence area, or combined production licence areas, on the establishment of a project and on recovering and producing a marketable petroleum commodity.  It includes relevant expenditure on storage and processing facilities and employee amenities.

   Expenditure to be specifically excluded included interest payments and payments made under a cash bidding system.   

2. Debate on the Bill resumed on 23 March 1987.   The Bill was passed by the House of Representatives and was before the Senate when Parliament was dissolved for the 1987 Federal election.  

3. Significantly the Bill was amended on the motion of the Treasurer on 25 March 1987. Prior to the amendment paragraphs (a) and (b) of the proposed s 24, defining “assessable petroleum receipts”, ended with the words “the consideration received by the person for the sale”. After the amendment each paragraph ended with the words “the consideration received, less any expenses payable, by the person in relation to the sale”.

4. The only deductions in the Bill as first presented to the Parliament were those set out in Div 3.  Government received submissions on that matter from the petroleum industry.  Letters were tendered from BHP Petroleum and the Australian Petroleum Exploration Association Ltd (APEA) to the Federal Government in February 1987 which asked that the Bill be amended to allow deductions for costs incurred in selling marketable petroleum products post production.  The relevant part of the BHP Petroleum submission, which was contained in a letter dated 3 February 1987, was as follows:

   Freight, Insurance, Demurrage and such Expenditures

   As outlined above, costs incurred after a product has attained a marketable state will not be deductible.  However, prior to the assessable receipts being received from the sale of the product, other costs, such as those mentioned above, depending on the term of sale, may be incurred.

   Under the general application of petroleum resource rent tax in the Explanatory Memorandum, it is stated the tax is to apply to profits from the recovery of petroleum.  As the tax is a profit based tax, certain expenditures incurred after the production of a marketable commodity which relate directly to the receipt from the sale of the product should be deductible.

5. APEA’s submission stated, inter alia (at [5]):

   Assessable Petroleum Receipts – Clause 24

   Clause 24 states that assessable petroleum receipts are the consideration received by the person for the sale of the commodity.  APEA recommends that the legislation specify that in a situation where part or all of the production from a project is disposed of on behalf of the project by a marketing company the amounts of assessable receipt received by the person will be net of marketing  company fees and costs such as freight, demurrage etc.

6. An internal government reaction appeared from a minute dated 4 March 1987 from the Senior Assistant Commissioner, Policy and Legislation Group to the Treasurer.  It recommended acceptance of the submissions and amendment of the Draft Bill.  It stated:

   Assessable Petroleum Receipts (clause 24)

   18.      In their submissions, APEA and BHP are concerned to ensure that assessable petroleum receipts will be net of costs such as marketing fees, freight and demurrage.

   Comment

   19.      It was intended that costs in the nature of those outlined above and directly related to obtaining assessable petroleum receipts would be taken into account in arriving at the amount of the assessable receipt.  However, in certain cases where a marketable petroleum commodity is sold at its point of production, the legislation in its present form would not provide deductibility of such costs.

   20.      OPC agrees that an amendment of the Bill is necessary to ensure that the costs in question are deductible and amendment is recommended.

   …

   Allowable Project Expenditure (clause 19)

   23.      The issues raised by BHPP and APEA under this heading follow on form those discussed under the immediately previous heading.  Deductions are sought for the cost of storage facilities and for other costs associated with selling a marketable petroleum commodity.

   Comment

   24.      Costs associated with initial storage at the site of production of the marketable petroleum commodity should qualify for deduction.  Similarly, costs involved in effecting the sale of a marketable petroleum commodity should be deductible against assessable receipts.  OPC is of the opinion that amendments, which are recommended, are necessary to achieve these results.

7. On 6 March 1987 instructions were given to the Office of Parliamentary Counsel by the Senior Assistant Commissioner in the following terms:

   Assessable Petroleum Receipts (clause 24) and Allowable project Expenditure (clause 19)

   8.        The Bill presently brings to account the value of a marketable petroleum commodity when it passes the point at which it is produced.  An amendment is to be made to provide for –

   .the bringing to account of the value of an unsold marketable petroleum commodity that is stored in an on-site storage facility, only after the commodity has left that facility; and

   .non-assessability of the value of a marketable petroleum commodity that is re-injected, flared off or provided for own use on the project

   9.        In addition, expenditure incurred on on-site storage facilities and in selling a marketable petroleum commodity is to qualify for deductibility.

8. The documents recording those exchanges were tendered. I marked them at the time, “MFI “D”, “C” and “E”” respectively. In my opinion, they are relevant to the construction of s 24(a) and (b) as explaining the amendment to the Bill which led to the present form of those paragraphs. They are materials not forming part of the Act which bear upon the purpose of the words “expenses payable … in relation to the sale” which are otherwise ambiguous as to the range of connections to which they apply. The materials should be received in evidence. They will be marked as exhibits “27”, “28” and “29” respectively.

9. The amendment to s 24 of the Bill was made in the House of Representatives on 25 March 1987. When moving the amendment the Treasurer said:

   Following introduction of this Bill during the 1986 Budget sittings, representations have been made by the petroleum industry seeking various amendments of the Bill.  After consideration of those representations the Government has agreed to certain amendments …

   E.Expenditure associated with an on-site storage facility will, by further amendment, qualify for deduction, as will expenses such as freight, insurance and demurrage in relation to the sale of a marketable petroleum commodity.

   Parl Deb, H of R, 25/3/1987 p 1521.

10. The Bill was reintroduced in October 1987 as the Petroleum Resource Rent Tax Assessment Bill 1987.  The Second Reading Speech was largely identical to the Second Reading Speech for the 1986 Bill.  The Bill passed the House of Representatives and was agreed to by the Senate on 15 December 1987.   The Explanatory Memorandum for the four 1987 Bills described the general application of petroleum resource rent tax.  In describing the main features of the principal Bill it said:

    Unlike royalty and excise arrangements, the petroleum resource rent tax is profit-based, rather than being based on production.  It will apply only where there is an excess of project-related receipts for a financial year over –

    .         project-related expenditure for the  year;

    .         undeducted project expenditure of previous years …

    .undeducted expenditure (generally exploration expenditure) of more than 5 years before the coming into force of the first production licence …

    .expenditure for the year in closing down the project.

    Petroleum resource rent tax assessed and paid will qualify as an allowable deduction for income tax purposes in the year of payment…

11. In discussing the term “assessable receipts” used in the Bill, the Explanatory Memorandum stated:

    Assessable receipts of a project will include amounts receivable from the sale, on an arm’s length basis, of petroleum or of a marketable petroleum commodity.

12. Under the heading “Deductible expenditure”, the Explanatory Memorandum stated:

    Expenditure of both a capital and revenue nature which is directly related to a petroleum project will be deductible in the year it is incurred against any assessable receipts for the year. … Deductible expenditure is of 3 types – exploration expenditure, general project expenditure and closing-down expenditure.

    The term “General project expenditure” was said to comprise:

    … all expenditure (other than excluded, exploration or closing-down expenditure) in a production licence area, or combined production licence areas, on the establishment of a project (including on any feasibility or environmental study) and on recovering and producing a marketable petroleum commodity, including expenditure on storage and processing facilities and employee amenities. …

    The Explanatory Memorandum pointed out that certain expenditure would be specifically excluded from deductibility.  These included interest payments, dividend payments and other classes of payments set out in the Bill itself.

13. In relation to cl 24 defining assessable petroleum receipts, the Explanatory Memorandum stated:

    The paragraphs of this clause describe, for the purposes of the Bill, what is meant by a reference to assessable petroleum receipts derived by a person in relation to a petroleum project.

    Paragraph 24(a) includes as an assessable petroleum receipt consideration receivable, less any expenses payable, in relation to the sale of processed or unprocessed petroleum (or a constituent of petroleum) before the production from it of any marketable petroleum commodity (as defined in clause 2).  Expenses payable in relation to the sale would include, for example, freight charges, marketing costs and demurrage. …

14. It was assented to on 18 December 1987 and commenced on 15 January 1988.  A number of amendments were made in 1991 by the Petroleum Resource Rent Legislation Amendment Act 1991 No 80 of 1991 and the Taxation Laws Amendment Act (No 3) 1991 No 216 of 1991.  

    Key findings of fact

15. The evidence as to primary facts which has been outlined is not substantially in dispute.  The evidence of the Woodside Energy witnesses is accepted in that regard.  It is desirable, however, to identify certain important factual conclusions which emerge from the evidence.  They may be summarised as follows:

    1.The commercial viability of the Laminaria Project as assessed by the Woodside Group in 1997 did not depend upon the existence or non-existence of hedging arrangements.

    2.The decision of the board of Woodside Petroleum to proceed with the Laminaria Project did not depend upon, and was not in terms conditioned upon, the application of hedging arrangements in relation to sales of oil from the project.

    3.At all material times crude oil cargoes in the world market for crude oil were sold by reference to volatile pricing bases.

    4.Crude oil produced by the Laminaria Project, save for oil sold under the SIETCO contract, was sold by reference to a benchmark guide usually WTI or Tapis.  The price for SIETCO oil was based upon GPW, which was related to prices for refined petroleum products in Singapore.

    5.At all material times from 1996 Woodside Petroleum and the Woodside Group had in place a risk management policy involving the use of hedging transactions to minimise risks associated with fluctuations in oil prices, interest rates and foreign exchange rates.

    6.The Woodside hedging expressly prohibited the use of hedging for speculative purposes.  The hedging the subject of these proceedings was not undertaken for speculative purposes.

    7.The stated and actual purpose at all times of oil price risk management was to limit the potential for financial loss arising from unfavourable movements in oil prices affecting returns from sales of crude oil products sold by Woodside Energy.

    8.A specific hedging policy was developed with respect to the Laminaria Project.  Its purpose was to provide certainty in cashflow by locking in oil revenue against an anticipated drop in oil prices generated by the significant availability of oil produced from the Project itself in the early years of its operation.

    9.It was a purpose of the Laminaria hedging policy to lock in oil prices received by Woodside Energy above the project economic assumption of US$18.50 in order to assure the availability of revenue flows so that the Woodside Group could exploit opportunities in the future including acquisitions of further assets.

    10.The approach to hedging in respect of Laminaria oil reflected a shift from a purely defensive or risk minimisation hedging. 

    11.In the relevant period the Woodside Group adopted an approach to hedging designated “active management” which involved placing or lifting hedges within policy guidelines but at times most opportune for the greatest return or smallest loss.  This involved an element of risk leverage which was not precluded by the overall objective of risk mitigation.  It included strategic position taking and tactical trading.

    12.There were three applications of hedging transactions by Woodside resources:

    (i)strategic hedges based on production forecasts and placed up to three years before anticipated sales;

    (ii)cargo specific hedges placed less than six months before anticipated delivery of oil;

    (iii)basis risk hedges known as spread locks designed to minimise risk associated with differences between WTI and Tapis or WTI and GPW pricing benchmarks.

    13.All of the revenue from the Laminaria Project was earned by Woodside Energy.

    14.All of the hedge expenses, the subject of these proceedings, were born by Woodside Energy.

    15. Payments and receipts upon the settlement of hedging transactions were recorded in the accounts of Woodside Energy and not in the books of Woodside Petroleum.

    16.Woodside Energy’s only use of the oil produced from Laminaria was to sell it.  It had a limited capacity to store oil for a week or so on the FPSO.

    17.Each of the Laminaria joint venturers was required to lift its share of oil production under a lifting agreement between them.

    18.There was a close correlation between production forecasts and expected sales of oil for the project.

    19.The extent of hedging transactions was at all times based upon:

    .production forecasts in relation to strategic hedging;

    .anticipated sales in relation to cargo specific hedging.

    20.Subject to the particular case of the Highlander transaction, strategic, cargo and basis risk hedges were placed and lifted by reference to anticipated sales of Laminaria oil primarily to mitigate risk associated with price movements in the global crude oil market.

    21.Consistently with the preceding purpose, the Woodside Group staff with responsibility for hedging transactions endeavoured to place and lift hedges at the most opportune time.  

    The construction of s 24(b) of the PRRTA and its application to hedging expenses

16. It is necessary as always to begin the task of construction by reference to the words of the Act applying their relevant ordinary meaning ascertained by reference to context and legislative purpose unless some technical or special meaning is indicated. 

17. The only formal statement of a statutory purpose is to be found in the long title of the PRRTA which describes itself as:

    An Act to impose a tax in respect of the profits of certain petroleum projects.

    The PRRTAA is incorporated in and read as one with the PRRTA by virtue of s 3 of the PRRTA.  The imposition of tax by the PRRTA is provided for in s 4:

    Tax is imposed in respect of the taxable profit of a person of a year of tax in relation to a petroleum project.

    The term “profit” is not defined in either the PRRTA or the PRRTAA. However the term “taxable profit” takes its meaning from s 22 of the PRRTAA.

18. The statutory purpose stated in the long title of the PRRTA, which may be taken as a reference to the statutory purpose of the PRRTAA, is the imposition of tax “in respect of” the profits of petroleum projects.  The purpose is not to impose a tax on profits.  The words “in respect of” leave open the question how tax is to be calculated.  They leave room for a concept of “taxable profit” which, while narrower than “profit”, is a function of it. 

19. The relevant ordinary meaning of the word “profit” as defined in the Shorter Oxford English Dictionary (5^th ed, Oxford University Press, 2002) is:

    The financial gain in a transaction or enterprise; the excess of returns over outlay; the surplus of a company or business after deducting wages, cost of raw materials, interest, and other expenses. 

    Section 22 effects a definition of taxable profit which is consistent with the ordinary meaning of profit, ie receipts less expenditure. However the receipts and expenditures relevant to the calculation of taxable profit are not left to be determined by reference to the ordinary meaning of receipt and expenditure, but by reference to definitions in the Act. So “taxable profit” is assessable receipts less deductible expenditure (omitting for simplicity the reference to transferred amounts under ss 45A and 45B).

20. The classes of receipts which comprise assessable receipts are set out in s 23. The only class relevant for present purposes are those referred to as “assessable petroleum receipts”. The use of the term “receipts” in ss 22 and 23 is not suggestive of net payments calculated after some deduction. That is consistent with the structure of the Bill as it existed prior to the amendment to what was then cl 24 of the Petroleum Resource Rent Tax Assessment Bill on 25 March 1987.

21. The receipts from marketable petroleum commodities which have been sold comprise “the consideration receivable, less any expenses payable, by the person in relation to the sale”. Consideration in this context may be taken to refer to payment received in return for the delivery of the commodity pursuant to the sale in question. It is not a net concept. It cannot sensibly be construed as a sum calculated by reference to hedging losses. It is the payment received for sale of the relevant commodity. The assessable petroleum receipts, for the purposes of s 24(b) comprised payment for a particular sale less expenses payable in relation to that sale.  The language of the section suggests a close connection between the expense and the sale transaction.  Such a connection may have functional and temporal aspects.  While the word “direct” does not appear in the section to qualify the relationship between expenses and sale, the language of the section, in my opinion, suggests such a limitation. 

22. So much emerges from the terms of s 24(a) and (b) themselves. There is, however, a powerful contextual consideration which also militates against a wide construction of the connection between sales and the expenses which may be deducted from their proceeds in determining assessable petroleum receipts. The governing principle underlying the definition of taxable profit in s 22 is that it be calculated by subtracting deductible expenditure from assessable receipts. That principle is compromised by providing for the calculation of assessable petroleum receipts net of expenses payable in relation to sales. Division 3 sets out in some detail the classes of deductible expenditure to be brought to account in determining taxable profit by subtraction from assessable petroleum receipts. The wider the range of outgoings and their connection to sales that can be accommodated by s 24 the less work Div 3 has to do and the less coherent the scheme of the Act becomes. Division 3 picks up a range of exploration and general project expenditures as well as the so-called GDP (gross domestic product) factor expenditure which in various ways form part of the deductible expenditures brought to account in assessing taxable profit. A narrow definition of the expenses relating to sales referred to in s 24(a) and (b) is therefore supported by the principle informing the calculation of taxable profit as disclosed by the scheme of the Act.

1. In my opinion therefore the expenses contemplated by s 24(a) and (b) are outgoings incurred in connection with the actual sale process, that is to say, the formation of the relevant contract, delivery of the commodity and receipt of payment for it. Such a construction picks up the kinds of outgoings mentioned in the Explanatory Memorandum which referred to “… freight, insurance and demurrage in relation to the sale of a marketable petroleum commodity”. It does not extend to expenses incurred in relation to hedging contracts. Although such contracts reduce the risk to which the company is exposed by reference to oil price fluctuations, they are contracts in relation to different products and in a different market. As Mr Carroll accepted in his evidence, the timing of the entry by Woodside Energy into a sale contract was not dependent in any way upon the pre-existence of a hedge contract. While there was a good correlation between the production forecasts on which strategic hedges were based, the strategic hedges were placed well in advance of any particular contracts or deliveries. They were not functionally related to particular sales of marketable petroleum commodities. Such sales and deliveries pursuant to them are able to be affected independent of the existence of any hedging contracts. In so saying I allow that a functional connection may include expenses which are commercially necessary even if not required by the terms and conditions of any contract of sale. Insurance expenses in relation to a particular sale might fall into that category.

2. Hedging transactions were part of an overarching corporate plan to minimise the risk associated with oil price fluctuations. They had the related objectives of securing stable cashflow to the company. But however closely they are related, temporally and in terms of the extent of cover provided, to a particular sale, the expenses incurred in relation to them were not, in my opinion, payable in relation to the sale within the meaning of s 24(b). Moreover, they are strictly speaking costs incurred outside the framework of the project which is the focus of the RRT. They operate with respect to commodities other than those produced by the project and in different markets.

3. As I said in the interlocutory decision in Woodside Energy 155 FCR 357 at 374, the words “in relation to” and similar terms such as “in respect of” or “in connection with” or just “in” have been considered in many cases and many contexts. All of them indicate a necessary connection between two subject matters which may be activities, events, persons or things. The nature and closeness or remoteness of the connection sufficient to answer the statutory description depends upon its context. The term “in respect of” was said to “[gather] meaning from the context in which it appears …”: Workers’ Compensation Board (Qld) v Technical Products Pty Ltd (1988) 165 CLR 642 at 653-4 per Deane, Dawson and Toohey JJ. The term “in relation to” has been called a “prepositional phrase” which is “indefinite” and which “subject to any contrary indication derived from its context or drafting history … requires no more than a relationship whether direct or indirect between two subject matters”: O’Grady v Northern Queensland Co Ltd (1990) 169 CLR 356 at 376 (McHugh J). As the present case illustrates the extent of the relationship required depends upon the context in which the words are used. See also Australian Competition and Consumer Commission v Maritime Union of Australia (2001) 114 FCR 472 at 482. Context and purpose are everything in the construction of such indefinite phrases as “in relation to”. The citation of authorities, a number of which were canvassed in argument, is of limited assistance where they relate to different statutory settings.

4. One of the cases cited was Australian Gas Light Company v Australian Competition and Consumer Commission (2003) 137 FCR 317 in which I said (at [382]):

   Although there are some loose, but not entirely appropriate, analogies between the derivative contract and a form of insurance in my opinion, for present purposes, the derivative contracts ought to be regarded as an integral part of the pricing and payment arrangements between generators and retailers in relation to the underlying product, which is electrical energy, and which they deal with “as if” it had been sold from supplier to retailer.

   That observation was made in a statutory context quite different from the present. The case was concerned with whether a proposed acquisition of an interest in an electricity base load generator by an electricity retailer would have, or be likely to have, the effect of substantially lessening competition in a market in Australia. The question of the relationship between derivative contracts and sale of the relevant commodity which, in that case was electricity, was relevant to the question whether there were separate markets to be considered, one for the purchase and sale of derivatives and the other for the sale of electricity. The observation which was quoted from the judgment in that case reflects what Professor Garnaut had to say about the way in which an economist would regard hedging expenses in relation to sales. For the reasons which I have already outlined in discussing his evidence, that kind of equation does not assist in the construction of s 24(a) and (b).

5. Echo Bay Mines Ltd v R [1992] 3 CF 707, a Canadian Trial Court decision, was cited but was of little assistance.  It was a case concerned with the calculation of income tax.  The Court there held that the price received by the taxpayer for the silver it produced was the sum of receipts from delivery of actual production and from settlement of forward sales contracts.  The judge applied observations made in the Supreme Court of Canada in Atlantic Sugar Refineries v Minister of National Revenue [1949] CTC 196, another income tax case concerned with whether profits on sugar futures formed part of income.  In that case Locke J (Kellock J concurring) said (at [12]):

   In trades where natural products are purchased in large quantities, hedging is a common, and in some cases, a necessary practice, and the cost of such operations in trades of this nature is properly allowable as an operating expense of the business.  Where, as in the present case, the trader elects to close out his short sales and take a profit, this is, in my opinion, properly classified as profit from carrying on the trade.

   In Echo Bay Mines [1992] 3 CF 707, MacKay J said (at 733):

   I conclude that the price received by the plaintiff for the silver it produced was the sum of receipts from delivery of actual production and from settlement of forward sales contracts.  The business of the plaintiff was silver production.  In these circumstances where the plaintiff participated in forward sales contracts and settlements, however, as a hedge against price fluctuations in silver, and in which the commodity traded was silver futures, I do not conclude that the plaintiff was involved in futures speculation for investment purposes.  There was a clear business purpose in its sales and settlement of silver futures contracts, a purpose integrated with its sales of product to yield income; the plaintiff was trying to obtain an assured price for the sale of the silver it produced.  …

   Here the forward sales transactions were in respect of the same commodity as the plaintiff’s production; both were, in my view, integral aspects of the plaintiff’s business of producing silver, and returns from these activities were income from production of metals within Regulation 1204(1).

6. The decision of MacKay J in Echo Bay Mines [1992] 3 CF 707 was approved by the Supreme Court of Canada in Placer Dome Canada Ltd v Ontario (Minister of Finance) (2006) SCC 20.  In that case the Supreme Court held that hedging transactions fixed the price for the output of a mine.  It approved the reasoning of Gillese JA who dissented in the Court of Appeal of Ontario: Placer Come Canada Ltd v Ontario (Minister of Finance) (2004) 190 OAC 157.  Woodside Energy relied upon a passage from the dissenting judgment of Gillese JA as supportive of the position taken by Woodside Energy.  Her Honour said (at [119]):

   The general purpose of the Act is to tax output from a mine.  However, there is no reason to refer to anything but the first type of consideration in the definition of “proceeds” if the purpose of that provision is limited to taxing output.  The apparent purpose of including the second and third types of consideration is to tax gains arising from specified types of financial transactions (ie hedging, future sales or forward sales) that are related to the output of the mine.

   The view that hedging transactions were related to the output of the mine in that case was said by counsel for Woodside Energy to sit comfortably with the conclusion that hedge expenses can be incurred “in relation to” the sale of petroleum produced from a petroleum project. 

7. The question in this case is not whether the hedging transactions in issue did or did not have a relationship to future sales of crude oil by Woodside Energy. The question is whether that relationship fell within s 24(b) of the PRRTAA. For the reasons I have expressed, which turn upon the particulars of the statutory scheme and its legislative history, the relationship between hedging transactions and crude oil sales in this case does not fall within the narrow range of relationships contemplated by the section in question.

   The construction of s 38 of the PRRTAA and its application to hedging expenses

8. Little was said on this topic in either the written submissions or closing oral submissions. Section 38 defined general project expenditure for the purpose of assessing deductible expenditure of the classes mentioned in s 32(a) and (c) namely classes 1 and 2 augmented bond rate general expenditure. General project expenditure refers to payments of a capital or revenue nature liable to be made “in carrying on or providing the operations, facilities and other things comprising the project” and “in carrying on or providing operations and facilities preparatory to” such activities.

9. In my opinion the requirement that expenditure contemplated by s 38 is liable to be made in carrying on or providing operations, facilities and other things comprising the project is incapable of covering the hedging expenses the subject of these proceedings. The section contemplates a close connection between the expenditure and the physical activities involved in the petroleum project. Interestingly, one of the cases cited on behalf of Woodside Energy, albeit for a different purpose, was Robe River Mining Co Pty Ltd v Commissioner of Taxation (1989) 21 FCR 1 in which the Full Federal Court said:

   The use of the phrase “in carrying on prescribed mining operations” suggests a quite direct relationship between the expenditure and the operations, to be distinguished from the looser relationship which would be expressed by the words “in connection with” if they were used in a provision of this kind.

   The passage was used to support the proposition that by not using, in s 24(b), language suggesting the kind of direct connection required in the provisions under discussion in Robe River Mining Co Pty Ltd 21 FCR 1, Parliament had intended to provide for a wide range of relationships between expenses and sales for the purposes of s 24(b). As indicated above, for reasons which I have given, I do not accept that proposition. And it is plain that so far as s 38 is concerned it cannot extend to expenses of the kind in issue in this case.

   Conclusion

10. For the preceding reasons the application will be dismissed with costs.

I certify that the preceding two hundred and seventy-seven (277) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice French.

Associate:
Dated:       10 December 2007

Counsel for the Applicant:	Mr JW de Wijn QC and Mr AT Broadfoot
Solicitor for the Applicant:	Allens Arthur Robinson
Counsel for the Respondent:	Ms M Gordon SC, Mr SHP Steward and Mr A Pound
Solicitor for the Respondent:	Australian Government Solicitor
Date of Hearing:	11, 12, 13, 14 and 15 December 2006
Date of Judgment:	10 December 2007