QLD Appears Ripe For LNG Development

This story features SANTOS LIMITED, and other companies. For more info SHARE ANALYSIS: STO

By Chris Shaw

Liquid natural gas (LNG) has been a key growth theme for Woodside ((WPL)) in recent years given the market for the product from Japan and elsewhere in Asia, but until now this has never flowed through into any realistic plan to develop LNG operations in Queensland.

A recent market development appears set to change this though, as Queensland Gas Company ((QGC)) has entered a deal with BG Group where the two companies will work on developing a major LNG plant at Gladstone using QGC’s coal seam gas reserves as feedstock.

The proposal calls for the plant to produce 3-4 million tonnes of LNG annually, with BG to purchase the gas and to take both a direct stake in Queensland Gas and a share of its gas assets.

As Citi notes this brings to four the number of LNG proposals under consideration on Australia’s east coast, though all the projects are unlikely to go ahead as some consolidation in the market is likely, with Santos’s ((STO)) Curtis Island project a prime candidate.

In the broker’s view it means natural gas prices on the east coast will rise, particularly as there is a need for gas prices to move higher both to keep pace with inflation in the energy market and to justify go-ahead on the proposed LNG projects given the thin margins on offer in the business.

GSJBWere agrees prices will head higher in coming years, so the obvious beneficiaries are those companies with large gas reserves already in place. For the coal seam methane (CSM) companies the broker expects a two-stage process for price gains, the first being CSM prices moving higher to match conventional gas prices and then from a general rise in gas prices as demand increases.

The introduction of carbon trading should also be a positive for gas prices according to Citi, while GSJBWere notes if water becomes a more regulated commodity this could impact on the use of coal for energy as it is a more water-intensive process, so boosting demand for LNG.

The broker also suggests the increased willingness of CSM producers to arbitrage the spark spread, which is the margin made from selling gas versus producing electricity from gas and then selling the electricity, should also act to support prices in coming years.

Assuming then gas prices are on the way up the question becomes how investors can best play this via the alternatives listed on the Australian market. As already mentioned GSJBWere likes those companies with large gas reserves already in place and stocks it recommends under such a theme are Origin Energy ((ORG)) and Australian Worldwide Exploration ((AWE)). While Santos would also enjoy higher earnings the broker currently has a Sell recommendation on the stock.

While not covering the CSM stocks directly the rising prices scenario leads the broker to suggest the companies likely to benefit are Queensland Gas, Sunshine Gas ((SHG)) and Arrow Energy ((AOE)).

Deutsche Bank agrees there is scope for consolidation among the CSM companies operating in Queensland, while among the gas companies generally it has Buy recommendations on Santos, Oil Search ((OSH)) and Woodside.

For Santos the broker notes there is now a competing project on the drawing board, though there remains potential for the company to get involved in the QGC/BG project to create a single, larger operation, an outcome the broker suggests would have significant benefits for the company.

Oil Search has the advantage of already having sufficient reserves for its project and with its development likely to be a little ahead of the QGC project the broker sees little downside for the company, while it suggests there would be compelling strategic reasons to combine Woodside’s LNG Assets with those of BG.

While Origin would be a beneficiary of higher flow through gas prices given its coal seam gas reserves the broker sees no immediate boost, while also taking the view the company would have little interest in developing its own LNG project.

AGL Energy ((AGK)) is similarly unlikely to pursue its own LNG projects, though with a 28% shareholding in QGC the broker expects it will be an indirect beneficiary if prices rise as expected.

Citi points out the establishment of an LNG operation in Queensland would be the most surefire way to see gas prices move higher, as a similar scenario has played out in various other markets such as the North-West Shelf and Indonesia.

The broker notes the Arrow Energy proposal where it will supply gas to LNG Ltd’s plant in Gladstone requires additional reserves to be proven up and the buyer is unknown, so it suggests these uncertainties need to be addressed before the market will take the project seriously.

The Santos project is a little different as the company appears unlikely to have much difficulty in establishing the necessary reserves, while the broker expects the company may decide to establish a larger plant than is currently proposed.

Sunshine Gas appears to have sufficient reserves in place for its proposed 0.5Mt/year project, while the BG deal with Queensland Gas suggests it sees little risk in the company not being able to prove up sufficient reserves.

While none of the brokers are willing to predict exactly how the LNG industry will shape up in Queensland or where consolidation among the proposed projects may occur, the clear view is the sector is at the least worth watching closely as further developments appear inevitable.

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