Australia | May 09 2012
This story features ORIGIN ENERGY LIMITED.
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The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS
– BG has announced major LNG cost blow-out
– Moelis believes Santos and Origin must also suffer
– Citi disagrees
– Broker views discussed
By Greg Peel
The market, it would seem, is not ascribing very much value to Australia's plethora of LNG developments, possibly because they are still a-ways off in time, possibly because they keep running into problems, possibly because despite a higher oil price, oil producer shares have proved disappointing over the past few years, or probably some combination of all of the above.
The result has been that a majority of, but not all, local stock analysts rate the various listed Australian oil & gas majors as worthy investments in the longer term view, with share price undervaluation as the popular argument. Taking the FNArena database of eight leading brokers as a proxy, a Buy/Hold/Sell basis shows Woodside ((WPL)) scoring 5/2/1, Santos ((STO)) on 7/1/0, Oil Search ((OSH)) on 7/1/0, and Origin ((ORG)) on 7/1/0.
Fund manager Alphinity recently promoted its positive but qualified view on Australian LNG, which can be examined in LNG: Where The Resource Sector Upside Lies.
All four majors are currently developing LNG projects in the race to secure long term gas supply contracts to China and others in the future. All four face competition from foreign Big Oil companies competing in the same Australian race, as well as a diversified BHP Billiton ((BHP)). While stock analysts are swooning over the value on offer to the winners, they do acknowledge that not all can be winners. To differentiate, Woodside's LNG is sourced from offshore WA natural gas, Santos boasts large conventional gas supplies in central Australia, and interests in the PNG LNG and GLNG projects – the latter sourced from Queensland coal seam methane (CSM). Oil Search has an interest in PNG LNG, while Origin's business is split between downstream gas supply and the upstream APLNG development in Queensland.
It was back in 2008 that British gas giant BG made an out-of-the-blue, lucrative offer for Origin Energy, thus alerting oblivious local analysts to the value of CSM LNG and sparking the Great Australian Gas Race. The rush has been on ever since on both sides of the Australian continent, with stakes being acquired, LNG trains being built, offtake agreements being signed and gas sources hurriedly being explored for. With developments running side by side with an equivalent Australian (and global) mining boom, and a more recent Great American Shale Gas Race, costs for the development LNG projects have been accelerating rapidly.
Last week BG announced that capex expectations on its QCLNG project in Queensland had blown out from initial estimates by 19% in Aussie dollar terms, or 36% in US dollar terms. Aside from the obvious surge in the value of the AUDUSD in the time period, BG cited “local market effects, increased costs of compliance with regulatory processes and some scope change” as reasons for the blow-out.
The Arrow LNG project (Shell/PetroChina) has never published its costings, notes stockbroker Moelis & Company, but Reuters reports cost rises of 30-40%, expected to move to 50%. More wells and infrastructure are the reasons.
The gas companies are currently trying to leverage off these cost blow-outs to garner government sympathy, in the hope of having CSM exploration regulations watered down. They have little chance of success, Moelis suggests, given the current public perception of CSM. Exploration has moved outside of company-owned acreages and into state forests and private farm land. Now that political reaction means farmer consent has to be obtained to set up exploratory wells on private land, access will become “increasingly tricky”.
[Note: Land owners in Australia “own” only the surface layer. State governments own the trees, and the crown owns whatever lays beneath. Until the situation blew up into a recent political backlash, gas companies have been within their rights to not only enter private farms or state forests but to apply for drilling permits whatever the farmer's or environmentalists' thoughts on the matter.]
Santos has been claiming the need to rapidly find “the resources to power NSW” as its principal argument against regulatory restrictions coming into force in that state. It is a disingenuous argument, Moelis points out. Santos has enough conventional gas in the Cooper Basin to power NSW but has redirected that gas to the more lucrative potential of its export LNG project. (GLNG is joint owned by Santos, Petronas, Kogas and Total.)
In the recent round of resource sector quarterly updates, both Santos and Origin (Origin owns APLNG alongside ConocoPhillips and Sinopec) declared their CSM LNG projects to be on time and on budget. This declaration seems to the Moelis analysts to be somewhat incongruous in light of BG's more recent capex blow-out admission, and similar assumptions for Arrow.
Given BG reports in US dollars the currency shift is not a lone explanation, suggests Moelis. APLNG is in the early stages of developing its first train and has not yet ramped up its (costly) well drilling. Talk from contractors is that Santos is struggling to find gas and applications have been submitted for another 4,000 plus wells. The writing that Moelis sees on the wall is that of the inability of all four Queensland CSM LNG projects – QCLNG, APLNG, GLNG and Arrow LNG – to succeed in unison. The broker sees all four being forced through their own individual difficulties to aggregate.
“The logical solution,” the analysts suggest, “is that the current four trains under construction (2 at QCLNG, 2 at GLNG) and the one APLNG so far to be sanctioned are opened up to competitors' gas going into the plants to ensure maximum capacity utilisation. These are, however, defensive moves to protect returns which are heading to single digit”.
On a projected debt/equity basis, Santos is more robust than Origin, Moelis calculates. Yet “we see no reason to own [either of] these stocks as their path of discovery has just begun”. Moelis recommends switching into Woodside, which is also suffering from rising costs but can boast quality projects with known geological quantities. Proof of such was provided recently when MIMI took a saving grace stake in Woodside's Browse project.
Interestingly, of the four listed gas majors, Woodside attracts the weakest Buy/Hold/Sell ratio from the FNArena database, as noted above (Moelis is not included in the database). Positive views are based largely on the aforementioned undervaluation of LNG potential, while negative views include consideration for ongoing delays, cost blow-outs, and a lack of gas-finds, as well as Shell's 20% shareholding “overhang”.
An interesting view to make note of is that of BA-Merrill Lynch in regard to Santos. Merrills puts very little faith in Queensland CSM LNG, considering such long term developments to be beholden to too many risks. Yet the broker retains a Buy rating on the stock.
The reason is that Santos controls, as noted earlier, the Cooper Basin conventional gas resources which supply the bulk of east coast domestic gas requirements. As the race to find enough gas for export LNG hots up, the price of domestic gas will rise to match that being offered by LNG hopefuls. On that basis, Merrills sees Santos as well placed either way.
Citi, on the other hand, has provided a capex blow-out counter-argument to that of Moelis as explained above.
BG was the “first mover” notes Citi, and while being the first mover is usually of great advantage, in the case of the LNG race it may not be such an advantage after all. BG had internally sanctioned QCLNG before publicly announcing final investment decision status as the company awaited the outcome of the ultimately ill-fated Resource Super Profits Tax. Hence internal capex estimates were made at a much earlier time than those made later by Santos and Origin for their own respective projects. At that time, the Aussie was at US$0.83, and local CSM projects are Aussie-denominated.
Being early into the game also meant BG could run around securing exploration sites with impunity ahead of the groundswell of opposition that was to eventually build. It is for that reason BG has cited “costs of compliance with regulatory processes” as a contributor to increased capex.
Thirdly, BG had difficulty with pipeline quality for this new gas concept and ended up having to relay a lot of pipes, and fourthly, BG's CSM fields are a lot closer to Brisbane than those of Santos or Origin and having started in 2010, BG has copped “the full wrath”, as Citi puts it, of the Queensland floods.
All these factors add up to a suggestion from Citi that BG's capex blow-out does not thus provide a direct “read-through” to Santos and Origin, which would thus explain why those two companies were able to claim “on time and on budget” status at their recent updates. Both companies have built in greater capex contingencies into their original estimates, and Santos, for one, has been praised for its “best in class” approach to community liaison and regulatory issues.
Citi can understand why the market is nervous, given an earlier admission by Woodside of a capex blow-out at Pluto-1 had shareholders running for the exits. Citi nevertheless retains Buy ratings on all of Santos, Origin and Woodside.
Citi is, on the other hand, the only FNArena database broker to have a Hold (Neutral) rating on Oil Search. While PNG LNG keeps impressing with the possibility of a third, and perhaps now even fourth, LNG train, its start-up schedule of 2018 leaves it lagging the pack.
So what is the humble, and no doubt confused, investor to think? LNG good or LNG bad? Which stock is best? Perhaps the way to perceive is that all Australia's oil majors offer potentially high reward for potentially (and become more apparent every day) high risk. They do not pay much in the way of dividends, and their share prices have not improved much for the last few years. One day they might.
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