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Australia has ambitious plans to unseat Qatar as the world’s leading supplier of Liquefied Natural Gas (LNG) but internationally renowned oil and gas consulting firm Wood Mackenzie warns we Aussies should be looking in the rear view mirror.  The Yanks are coming.

At the dawn of the 21st Century natural gas prices in the US were high and domestic gas production was in decline.  Major international oil and gas companies stood ready to invest in import terminals for foreign LNG to fill the void.  Then the discovery of several massive shale formations filled with trapped gas changed all that.

The twin technologies of horizontal drilling and hydraulic fracking allowed the trapped gas to be freed and brought to the surface.  The end result is the US is on the verge of becoming an exporter of natural gas.  Companies like Cheniere Energy and Conoco Philips are making plans to convert those import terminals into export terminals.

According to an article in The Australian, Frank Harris, the head of Wood Mackenzie’s LNG consulting team thinks “Australian LNG companies have not yet woken up to the challenge emerging from the United States.”

Maybe so, but it appears some Australian investors have been looking behind the LNG story at what started it all for the Yanks.  And what they see in the rear view mirror is the explosion in the production of shale gas.

In a dismal year, one of the top performers in the Australian share market was Beach Energy (BPT), recognised as one of Australia’s first movers in the exploration and production of shale gas right here in Australia. Here is a one year price movement chart for BPT compared with the ASX energy index, the XEJ:

While the XEJ is down more than 10% year over year, BPT is up an impressive 90%.  The other Aussie energy sector share that broke through the calamitous 2011 with massive gains was Aurora Energy (AUT).  Here is how AUT stacked up against the XEJ last year:

Finally, there are two more energy sector shares that are continuing the upward momentum they had in 2011 into 2012.  The companies are Drill Search (DLS) and Senex Energy (SXY).  Here is the chart:

What these four high performing companies have in common is shale gas assets and plans to bring them into production. 

Aurora Energy is a bit out of place here, since although it is an Australian company, their shale gas assets are in the United States in the Eagle Ford shale formation in the state of Texas.

Beach, Drill Search, and Senex, all have interests in the Cooper Basin, which as you may know is Australia’s principle source of onshore gas.  Logistics are excellent as a pipeline to Sydney and other eastern markets is already in place.

Intelligent investors who have done their homework know there is some concern about Australia’s ability to supply the huge LNG infrastructure under stgelopment through conventional gas sources and coal seam gas production, which may not be enough.  Industry experts are well aware of what happened in the US and they are casting a keen eye on Australia’s estimated 396 trillion cubic feet (Tcf) of recoverable shale gas.  This estimate is from the US Energy Information Agency and while less that half the US shale gas reserves of 863 Tcf, when coupled with conventional sources and coal seam reserves it is still substantial enough to supply the anticipated explosion in demand for LNG in emerging Asian markets.  

There is one final company to add to the mix of Australian companies moving rapidly into shale gas – Santos.  The following table shows the market cap of all five companies as well as their current share price and 52 week highs and lows:

Company

Code

Market Cap

Current Share Price

52 Week High/Low

Beach Energy

BPT

$1.95b

$1.765

$1.79/$0.78

Drill Search Energy

DLS

$418m

$1.37

$1.38/$0.37

Senex Energy

SXY

$965m

$1.05

$1.08/$0.30

Aurora Energy

AUT

$1.4b

$3.40

$3.71/$2.11

Santos

STO

$13.3b

$14.07

$16.90/$10.11

   

With the exception of the much larger Santos, one would expect the next step in a fundamental assessment would be considering long term debt and the company’s cash position to finance the significant cost of turning a shale gas asset into a producing well.

The beauty of the position the Australian shale gas sector is in right now is any company with sizeable shale gas reserves is a potential acquisition or joint venture target.

According to Bloomberg, an oil and gas major could buy an acre of shale gas property from Beach Energy for $406.  Property in a US shale formation is just a little bit more expensive.  They have been at it for a few years now and drilling cost are cheaper there than in Australia. If you are interested in an acre in a shale asset in the US state of Texas, the price last year was $25,000 an acre, in US dollars.

When you consider that well over 50 billion dollars has already been spent stgeloping LNG capability in Australia with more projects on the way, it is little wonder large producing companies may be willing to pay to ensure unconventional gas resources will be there to ensure a steady supply of gas for liquification.

Now let’s look at a few valuation and fundamental performance measures for the five target companies:

Company

P/E

Div Yield

LT Debt

Gearing

BPT

22.11

1.0%

0

0

DLS

N/A

0%

0

0

SXY

61.11

0

0

0

AUT

49.20

0

0

0

STO

26.52

2.1%

$2,787m

41.5%

Energy Sector

20.07

2.9%

 

DLS and SXY are takeover targets, and SXY’s high P/E’s reflects that.  SXY’s share price experienced a dramatic and unexplainable upturn a few days ago in response to a rumored takeover offer.  Investing in these companies would require a thorough review of their management and technical capability to see if they have the potential to stgelop their shale gas assets on their own.

Aurora (AUT) operates outside Australia, eliminating them from the potential gains of a shale gas mining boom.  BPT and Santos are both established companies and BPT’s debt position bodes well for raising needed capital.  However, Santos has the advantage of also being involved in the LNG undertakings in Australia.

Although Santos holds a 66.6% interest in the main Cooper Basin joint venture, they seem content to continue with conventional gas extraction for several years since it is less expensive and more accessible.  In an investor presentation in September 2011 Santos revealed its plans for its first shale gas production in 2015.

Beach Energy, on the other hand, appears to be interested in moving ahead at a faster pace.  They expanded their shale asset properties by acquiring Adelaide Energy and are in talks with potential partners to stgelop its shale assets.  They are currently drilling test wells.

Although both Senex and Drill Search appear to be the likeliest takeover targets, each company has been involved in partnership discussions.  Drill Search recently got a 130 million dollar stake from UK energy producer BG Group to search for additional unconventional gas formations in the Cooper Basin.

Finally, the Cooper Basin is basically a sparsely populated desert region.  You may know that the hydraulic fracking involves injecting water and chemicals into a well with the use of explosives to fracture the shale rock formations in which the gas is trapped.  There are environmental concerns about possible contamination of water aquifers and more recently of spawning earthquakes.  Nothing has been proven but fracking in populated areas can be problematic.  The Cooper Basin is the ideal location to avoid all that.

What is the average retail investor to make of all this?  First, if you believe natural gas is the fuel of the future, you should give some thought to investing.  If the promise of shale gas seems too risky for you, look into Woodside Petroleum (WPL).  They are the most involved of any Australian oil and gas company in the LNG wave.

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