Australia | Jul 15 2011
This story features ORIGIN ENERGY LIMITED.
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The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS
(In yesterday's story we accidentally reported BHP Billiton had acquired Fayetteville assets from ConocoPhillips. That should have been from Chesapeake Energy. We have corrected the information inside the story and republished).
– Beach Energy's initial shale gas testing is positive
– Costs are potentially overwhelming
– Most analysts doubt commercial viability
By Greg Peel
Shale is hot. A few years ago it was coal seam methane that was hot and now much faith is being placed in the capacity for Australian CSM LNG projects in Queensland's Bowen and Surat Basins to expand to multiple trains and provide untold export riches. It's a crowded market, and not everyone will win, but analysts acknowledge the earnings upside for the likes of Santos ((STO)) and Origin Energy ((ORG)) which are leading the race.
Many foreign companies are joint venturing in Aussie CSM, including America's Big Oil. But with CSM suddenly offering such potential, Big Oil turned inward and realised America boasted vast equivalent resources of its own. Not coal gas, but similar shale gas. As it is in Queensland, suddenly the rush is on in the Azlatex region in the south (Arizona-Louisiana-Texas) which boasts the massive Fayetteville, Haynesville and Eagle Ford shale reserves.
BHP Billiton ((BHP)) has placed a lot of faith in shale gas, having recently acquired Chesapeake Energy's Fayetteville tenements at a substantial cost. Aussie listed junior Aurora Oil & Gas ((AUT)) also has acreage at Eagle Ford, and the market has sent its shares through the roof.
Too far through the roof for BA-Merrill Lynch's liking, with the analysts calculating a price of $3.35 implies a “staggering” US$85/acre which is far more than any of Aurora's neighbours and far more than recent M&A transactions imply. Merrills likes Aurora and believe it's a great story, but on current valuation, the analysts can only apply an Underperform rating.
Australia – land of just about anything one might find under the ground – also boasts shale gas reserves. One of the most promising shale areas is the Cooper Basin in South Australia, an area which has long provided conventional oil and gas production, gave birth to Santos, and currently provides Beach Energy ((BPT)) with its conventional earnings stream.
This week Beach released the initial test drilling results from its Holdfast-1 shale gas well in the Cooper, and they were better than anyone expected. Despite having been forced to wait an eternity to see whether CSM LNG ever actually gets going in Queensland, the market got all excited and bid Beach shares up 10%.
It may be all very exciting for Beach, but there is a bit of a problem. America's shale reserves lie right in the middle of the legacy oil fields which originally provided the US oil boom. Existing infrastructure abounds, and shale gas equipment is plentiful. The Bowen and Surat Basins are not far from the coast, and thus from port facilities, and the areas have long been established for other mining projects.
Beach's shale gas reserves in the Cooper Basin, on the other hand, lie 1000kms from the nearest source of labour and supplies. There has not been much call for shale gas equipment in Australia to date, so its current cost is substantial. Indeed, the costs of producing shale gas in the Cooper would work out at about three times that of equivalent US operations, Citi analysts suggest. And given Australia's shale industry is very much in its infancy, it would be a long time before that gap ever closed. Given the low level of unemployment in Australia, and the desperate shortage of resource sector experts and workers, the cost of labour alone for Beach would be 40-50% higher than in the US, Citi estimates.
Those old enough to remember the global Oil Shocks of the 70s-80s might also remember that shale oil (as opposed to gas) was then touted as potentially the great black saviour of America's crude oil deficit dilemma. Then, as now, shale oil was always going to cost a lot more to produce, so as soon as OPEC turned the taps back on the whole shale idea was pretty much abandoned.
This time around the world is not suffering from a supply shock, other than perhaps dwindling commercial crude resources, but a demand shock from China and its emerging friends. This time around, energy prices will stay stronger for longer and as such shale is considered not only commercial, but a potential source of US exports as LNG.
Global energy analysts are convinced not all of Australia's CSM LNG projects in Queensland or conventional LNG expansion projects in offshore Western Australia will even be commercially viable (and there's PNG) and the same goes for projects all over the globe. This includes US shale oil, which by the time shale LNG is ready for export around 2015 will be hitting a world swimming in natural gas. Where does this leave a fledgling, far more costly shale gas industry in the middle of the Australian outback? Not looking good as far as many analysts are concerned.
Funny isn't it, say those analysts, that the Cooper's veteran resident Santos has made no attempt to date to pursue shale. Santos might be tied up right now with trying to maximise Gladstone LNG, but realistically one would expect any Cooper resource to be Santos' domain. Beach Energy is putting a lot of faith in Cooper shale nevertheless, but that faith is not being shared by the analyst community.
Given a relatively damning report from Citi, the analysts are understated in concluding “marginal economics make [Cooper shale] development challenging”. UBS points out that by definition a “resource” – and Beach hopes to officially book a shale gas resource by next month – is not “economic”, and suggests “the economics of unconventional shale…at the current Australian gas price is questionable”.
JP Morgan sums it up by noting, “Our current view is that the level of information on the economics of shale gas in Australia does not justify inclusion of a significant value premium for shale potential”.
But not everyone's a wet blanket.
Macquarie analysts acknowledge that despite promising results from Holdfast-1 testing, Holdfast is unlikely to ever be commercial. But it's early days, and the analysts at least see Holdfast as a step in the right direction. Macquarie believes that with further development those exorbitant costs will fall, and if you throw in the carbon tax, which should be supportive of Australian east coast gas prices (given gas is cleaner than coal), “shale gas production in the Cooper Basin could well turn out to be commercial in the longer term”.
If it does, look out. The value of shale to Beach could “dwarf” the valuation of the company's existing conventional operations, Macquarie suggests.
Macquarie has a lone Outperform on Beach in the FNArena database, while UBS, JP Morgan and BA-Merrill Lynch (which hasn't reported since Beach's interim result) are all on Hold equivalents. Citi has set a Sell rating with a Speculative Risk tag.
Beach is currently trading just under $1.00 and the consensus price target is $1.09, but that's from a range of Citi at $0.88 to Macquarie at $1.50.
For those prepared to back Beach's shale possibilities, patience is very much required.
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