Australia | Sep 09 2011
This story features ORIGIN ENERGY LIMITED.
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– Capex and costs key points of focus in LNG market
– Australia to enjoy significant growth in LNG from stronger Asian demand
– Citi revises oil price forecasts and oil sector earnings and price targets
– Brokers list preferred exposures in the Oz energy sector
By Chris Shaw
With the oil and LNG sectors having reported earnings last month Credit Suisse has reviewed the sector to account for new information contained in profit results and associated commentary. The review reflects the importance of the sector, Credit Suisse noting there are currently 43.7Mtpa of LNG projects in construction in Australia and a further 6.6Mtpa in Papua New Guinea.
Total capex for the projects is around $160 billion, which Credit Suisse notes has spurred some investor concerns about cost overruns and slippages in schedules. This is weighing on LNG construction exposed stocks.
A number of things were picked up from company reports that are impacting on Credit Suisse's view on the various companies. For Woodside ((WPL)) it is that new CEO Peter Coleman is more cautious than his predecessor, as the unwillingness to confirm a Pluto expansion implies the gas volumes are simply not there yet. A more conservative view may also see the Browse project being tied back to Pluto and the North West Shelf may come back on Woodside's radar.
For both Oil Search ((OSH)) and Santos ((STO)), respective LNG projects are progressing on time and on budget, though Credit Suisse remains of the view there is scope for delays to still cause timeline and so cost issues before either project is fully up and running.
Caltex ((CTX)) has announced a full review of its refinery business and expects to make a decision by the end of this year. Credit Suisse sees two possible outcomes, either the closure of one or two gasoline catalytic crackers or the closure of both refineries and a shift in focus to the marketing business. At Australian Worldwide Exploration ((AWE)) the new CEO appears willing to clear the decks, but with recent market volatility Credit Suisse is of the view any associated deals may not occur prior to 2012.
In terms of how this impacts on Credit Suisse's order of preference the top pick is now Woodside, while Santos, Oil Search and Origin Energy ((ORG)) are also all rated as Outperform.
Goldman Sachs has conducted a similar review and like Credit Suisse suggests LNG project costs and risk mitigation appear core points of focus across the sector. Most at risk from a cost perspective are WA projects such as Pluto and Browse given a skills shortage and remoteness perspective, while a relatively balanced market at present suggests further high-cost greenfield Australian projects by independent players are unlikely to be supported.
Operating costs are under pressure but Goldman Sachs takes the view capex risks are of more concern than opex risks at present. To deal with rising costs companies in the sector have raised equity via underwritten dividend reinvestment plans, a trend expected to continue to the point value dilution could become meaningful according to Goldman Sachs.
As with Credit Suisse, Woodside is the top preference of Goldman Sachs in the energy sector, followed by Oil Search. Santos, Origin and Caltex are all rated as Holds by Goldman Sachs.
Looking long-term, RBS estimates Asia ex-Japan will produce 43% of world GDP by 2025, which implies a threefold increase in electricity output to 18,500Twh. China will be a major driver of the increase, while RBS also expects significant growth from India as it also lifts generating capacity.
While not expected to grow as strongly as other countries in the region, Japan will still see an increase in LNG demand according to RBS as current nuclear capacity is decommissioned. At present Japan generates about 27% of electricity from LNG, but BS expects this will increase to about 34% by 2025. This implies LNG imports of around 130Mtpa.
Australia is expected to supply much of this energy to Japan and the rest of Asia, RBS forecasting exports of 116Mtpa of LNG by 2020 and 286Mtpa of thermal coal by 2025. These are increases of 640% and 90% respectively from current levels.
Under such a long-term theme Australia could potentially becomes the world's largest LNG exporter by 2020, from fourth largest now. Given this scenario, the key stock picks in the view of RBS are Oil Search and Origin as both have LNG facilities under construction and offer significant expansion potential. BHP Billiton ((BHP)) is also preferred given exposure through both thermal coal and gas assets.
While Woodside has significant exposure to the expected growth in demand through a range of growth projects, RBS suggests the company needs do a lot of work in terms of repairing relationships with stakeholders and this will hold back investment returns for some time.
Cit has turned its focus on oil and downgraded near-term oil price forecasts following a review. Having previously forecast an average price of US$100 per barrel for 2012, Citi now expects an average of US$86 per barrel (West Texas Intermediate).
The change reflects expectations of new supply given increased production by the Gulf Cooperation Council, higher Libyan supplies and the release of of the majority of the International Energy Agency's strategic reserves.
When changes to oil price and foreign exchange estimates are factored into models, earnings for oil sector stocks have been reduced marginally in 2011 and more significantly in 2012 by Citi. Next year the cuts range from 24% for Woodside to more than 100% for AWE.
Price targets have also been adjusted, in most cases being reduced modestly. Despite the changes Citi has upgraded Oil Search to Buy from Hold on valuation grounds, while AWE, Caltex, Santos, Karoon ((KAR)) and Woodside are also rated as Buys. Beach ((BPT)) and Eastern Star Gas ((ESG)) are the exceptions, Citi continuing to rate both stocks as Holds.
Looking at the US market, JP Morgan expects total oil demand to be essentially flat year-on-year in 2011. This means previous expectations of some growth in demand have been revised down to reflect lower growth expectations and ongoing macroeconomic concerns.
There will be a split though, JP Morgan noting gasoline demand is running lower in year-on-year terms by about 2% so far this year, while distillate use has strengthened moderately. Jet fuel and diesel usage are also up on the year.
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