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Lucky Australia is blessed not only with an abundance of recoverable minerals, but also with respectable quantities of the world’s major fossil fuels – coal, oil, and gas.  Coal, although abundant in Australia and in other parts of the world, is definitely a fuel of the past.  Regardless of whether you believe in global warming and climate change or not, few can deny that coal is a “dirty” fuel.  

And for that matter, so is oil, but the world cannot live without either. 

However, in a search for cleaner fuels that has seen the promise of renewable energy fall flat, it has become increasingly clear to many experts and investors that the fuel of the future is natural gas.

In the event more countries initiate some form of carbon tax, King Coal will begin to lose its major competitive advantage – it’s an inexpensive way to generate electricity.  

Currently Australia is a net importer of oil and the world’s leading exporter of coal.  The coal story is far from over and individual investors still have ample opportunity to make money through Australian coal producers. 

But the real money going forward lies with exploration and production companies in natural gas, with interest in petroleum for shorter to medium term safety. 

First, let us briefly review Australia’s place in the global petroleum story. 

The United States Energy Information Agency (EIA) provides comparative production and consumption figures for global oil and gas producing countries.  Here is a look at petroleum in Australia:

 

As you can see from the chart, Australian oil producers cannot meet domestic demand and as a result we are now dependent on importing oil from other countries.  However, this is no reason to shy away from investing in Australia’s Oil and Gas Sector, as in the modern world there are few, if any, pure oil plays out there.  Although most Australians would think of BHP as a mining company, they describe themselves as a natural resources company.  As such, they are involved in the exploration and production of both oil and gas.  

Volatility in oil prices is a major reason some investors avoid oil and gas shares.  There is no denying that in today’s environment the price of oil is impacted by more than real supply and demand issues.  The increasing role played by speculators in oil futures contracts accentuates the greed and fear cycle of market movements.  The mere hint of demand destruction through another global recession or a supply interruption through a closing of the Straits of Hormuz sends tremors through the market.  The share prices of major oil producers react accordingly.

Investing in oil explorers and producers with substantial interest in gas can provide a margin of safety.  Australia’s major players, BHP, Woodside Petroleum, Santos, and even Oil Search Limited all have gas exploration assets as well as gas production capability.  Although 2011 was not a good year for the ASX, two of the top performing shares for the year were Oil and Gas companies – Aurora Oil and Gas (AUT) finished up 51% on the year while Beach Energy (BPT) finished 42% up.  As you know, the ASX ended down approximately 15%.

No discussion of the outlook for the petroleum contribution to the Australian Oil and Gas Sector would be complete without considering the issue of Peak Oil.  For Australia, Peak Oil is the date oil production begins to decline until all reserves are exhausted.  According to the APPEA (Australian Petroleum Production and Exploration Association), that date was reached in 2000 and in the absence of the discovery of major new fields, the decline will be terminal.  

The cries that the world is running out of oil have been around a long time.  Although it is inevitable that petroleum is a finite resource which one day will be exhausted, the question is when.  The factor ignored by many Peak Oil Predictors is technology.

Concern about Peak Oil reached a crescendo during the Oil Crisis of the 1970’s.  At that time, had any futurist predicted we would soon be drilling for oil over a mile below the surface of the ocean, he or she would undoubtedly been carted away for a psychiatric evaluation.

The fact is technological advancements in both exploration and production technologies keep pushing the envelope on the true limits to the world’s available oil and gas resources.  If you are a doubter, consider the following chart of know petroleum reserves in Australia:

Australian Petroleum Reserves 29 Year History

 

Between 2009 and 2010 known Petroleum Reserves in Australia more than doubled – rising to 3.4 thousand barrels a day from 1.5 thousand barrels.  Although Peak Oil may have already been reached in Australia, there is little doubt new technologies can continue to slow the pace of decline.

There is perhaps no better evidence for this claim than the discovery of shale formations in the United States containing both gas and oil.  Since the turn of the 21st century, two new technologies – horizontal drilling coupled with hydraulic fracturing – have opened the potential to turn world oil and gas production upside down.

Prior to the discovery, Oil and Gas Companies – including BHP and Woodside Petroleum – were planning to build LNG (Liquefied Natural Gas) Terminals along the coastal US to import the badly needed commodity.  Supposedly, US Gas production peaked in 2000.  The following chart shows what has happened to gas production there over the past 29 years:

US Natural Gas Production 29 Year History

 

By 2006 production of natural gas from large underground shale formations (shale gas) reversed the downward trend, averaging a 17% increase.  From 2006 to 2010 production grew an average of 48% a year.  The EIA anticipates a tripling of production by 2035.  While BHP and Woodside wisely decided against those import terminals, companies like Cheniere Energy that did are now considering refitting those facilities to serve as LNG export terminals.  The US is now facing the enviable prospect of becoming a net exporter of natural gas, and oil production from shale formations is exploding as well.  

But what of Australia?  We are also well positioned for the expected increases in world demand.  As countries like China, India, and even Vietnam and Africa expand and grow their middle class citizenry, the need for electricity will sky rocket.  If oil powers the global economy, electricity truly powers the urbanised world of the middle class.  All those new toys require electricity to run.  And increasingly natural gas is seen as the fuel that can begin to replace coal as the primary source for generating electrical power. 

Nuclear power plants take years and even decades to complete and although their use will continue, they will never do more than provide only a portion of a burgeoning nation’s electrical needs.  Here is what the International Energy Agency sees as projected growth in demand for natural gas through 2035:

 

There are 34 member nations of the Organization for Economic Co-operation and Development (OECD) – all developed nations.  The non-OECD countries represent the emerging markets of the world where the growth in natural gas consumption is expected to far outstrip that of the developed nations.  

Australia is already the world’s fourth leading supplier of the product of another new technology – liquefied natural gas (LNG).  Time was when natural gas could only be extracted from a conventional reservoir style well.  Once out of the ground, natural gas had to be transported to its destination via a pipeline, since by definition natural gas exists in a gaseous state. 

Times have changed and natural gas once out of the ground can be cooled with sub-freezing temperatures with the result being gas in an essentially liquid state.  This Liquefied Natural Gas (LNG) can be transported without the need for a pipeline, revolutionising the practical applications of natural gas.  

The majority of Australia’s gas reserves are coal bed methane, or as more commonly known, coal seam gas (CSG).  As the name implies, this is gas trapped along the outer seams in a coal bed and it is more permeable, and therefore easier and less expensive to extract, than gas trapped in shale rock formations.

Australia is already an importer of natural gas, as seen in the following chart, and the LNG projects underway across the country bode well for the future.  Woodside Petroleum, Santos Limited, Oil Search Limited, Origin Energy, and several international oil companies all have major LNG projects underway.  Woodside’s massive Pluto Project is expected to be producing in March of 2012 with the 30 billion dollar Browse project on hold.

 

The LNG boom is not without its problems, as cost overruns due to shortage of skilled labor and other factors have led to construction delays.  However, perhaps the best evidence for the continued promise of LNG lies in the planned Floating Liquefied Natural Gas Platforms (FLNGS).  Essentially giant barge-like ships, these FLNGS will allow extraction of conventional gas from wells off the Australian coast.  

Both land based LNG trains (think processing plants) or Floating platforms need natural gas to process, whether from a conventional well, or an unconventional coal seam or shale formation.  A few naysayers express concern that Australia may not be able to keep up with the demand from the LNG processing facilities as they ramp up production.  Here is a chart of Australia’s proven gas reserves through 2010:

Australia Natural Gas Proved Reserves 29 Year History

 

While Australia has the technology and the reserves to emerge as a world leader in gas exports, the technologies used to extract gas from unconventional sources like coal seams or shale is not without risk.  While shale gas exploration in Australia is in its infancy, coal seam gas extraction has been around long enough to raise a fire storm of controversial opinion.

Coal is permeable and contains water, which must be removed to release the trapped gas.  Once a steel-encased hole is drilled into the seam, water and chemicals may need to be pumped in to free the gas.  The resultant water is pumped out, complete with a variety of contaminants from the coal bed and surrounding rock.  What do you do with the water?

Shale rock extraction is even more controversial as toxic chemicals are mixed with the water in supposedly safe proportions and the less permeable shale rock formation must be fractured via explosive charges.

In the United State there is some concern the water and chemical mix can contaminate water supply, although nothing has been proven.  A recent rash of earthquakes in an area of Ohio not know to be at risk has added ammunition to the opponents arsenal as they claim the fracking in the area is causing the earthquakes.

Controversial or not, shale gas exploration and production is on its way to Australia and coal seam gas extraction is here to stay.  The carbon tax provides an added incentive for the already attractive proposition of gas as an alternative to coal. 

Opportunities for investors who have the time and energy to follow the technological developments as they play out are there.  We have players like Woodside and Oil Search on the cusp of LNG production and Aurora Energy and Beach Energy in the shale gas hunt.

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