Santos Sets GLNG In Train

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This story features ORIGIN ENERGY LIMITED, and other companies.
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The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The oil price might have collapsed last year, but that didn’t stop the liquid natural gas (LNG) market being set on fire. The focus of Australian attention has been on the North West Shelf, where Woodside Petroleum ((WPL)) and international players of the likes of Exxon and Shell have swooped into the area to exploit what might soon become the world’s favoured, cleaner, cheaper hydrocarbon source.

But Queensland was also set alight, courtesy of British gas giant BG’s out-of-the-blue stunning takeover offer for Origin Energy ((ORG)). The takeover was not successful, but the offer sparked other global giants into action. This time the prize was LNG from coal seam methane (CSM), and Gladstone offered great potential. Malaysian oil giant Petronas entered into a joint venture with Santos ((STO)) to develop its local project. Analysts declared that the project could see the construction of up to four LNG “trains”.

To understand what an LNG train is, and to learn more about Australia’s prospective LNG market, see Gas, Carbon And Credit.

The sudden revaluation of LNG potential and subsequent re-rating of LNG stocks last year was nothing less than a frenzy. But while analysts were all forced to concede potential they had previously overlooked, or at the very least gone quiet on, they were still quick to point out that CSM LNG development was in its infancy across the globe and clear development risks lay ahead, in particular in gas demand and pricing. Until specific off-take agreements were put in place (and LNG is sold on very long term contracts), investors needed to be a little cautious.

Yesterday Santos announced it had signed a Heads of Agreement with Petronas for the delivery of 2.0Mtpa of LNG from Gladstone over a 20 year period, with an option, at the discretion of the joint venture, to increase that amount to 3.0Mtpa (expiring December).

Immediately this contract goes some way to “de-risking” the project, given it now displays commercial viability through demand from a consumer. In effect, the value of the deal underwrites the construction of the first 3.5mmtpa train. The Deutsche Bank and JP Morgan analyst teams were most enthusiastic about the deal this morning on that basis. Deutsche already rates Santos a Buy and JPM upgraded today to Overweight.

But the deal has its detractors, nevertheless. “Although we see the securing on any gas deal for CSG LNG as a marginal positive,” says Credit Suisse (Neutral), “we think this is a case of the GLNG project essentially selling LNG to itself and for us this raises more issues than it resolves”. Note that Santos owns 60% of the project in Gladstone (GLNG) and Petronas 40%.

Several of the brokers anticipated this argument this morning, and responded accordingly.

Citi (Buy) acknowledged that some may look unfavourably upon the deal, but the analysts point out that this is exactly what BG has done, successfully, in recent years, most recently at its 35%-owned Egypt LNG project.

JP Morgan agrees that investors may be sceptical, for both the incestuous reason and for the fact Malaysia is actually a net exporter of LNG and a rabid price discounter to its local market. But the analysts point out that Malaysia’s LNG comes from Borneo and is tied up in long term contracts, whereas on the mainland the government has left itself short.

All analysts are happy with Santos’ insistence that the (undisclosed) price agreed is consistent with recent contracts, and not some heavily discounted in-house market teaser. BA-Merrill Lynch (Buy) sums it up with “we conclude that despite domestic Malaysian prices being well below world standards, GLNG has been able to achieve robust pricing”.

Deutsche Bank agrees with pricing assumptions, but believes the deal is still a teaser of sorts. The analysts suggest it is a pre-emptive move ahead of potential third party buyers. Merrills agrees, suggesting “commercialisation could assist in creating competitive tension for the sale of remaining LNG volumes”.

Santos now boasts 8 Buys in the FNArena broker universe, two Holds and no Sells, on an average target of $17.38. Once considered the “Nigel No Friends” of the oil and gas sector, Santos is back with a Facebook page full of good mates.

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