In early March of 2012 the price of gold dipped below $1,700 an ounce and has remained under that level to this day. Investors everywhere who have sought refuge at the feet of the golden bull are wondering if their investment is as safe as they believed it to be.
Meanwhile, other Australian investors who still believe in the truth that Australia is a country of abundant resources have begun to notice something going on in our mining sector that, over time, could turn into a game-changing source of a different kind of gold – natural gas. If you have been following this story you know the explosive capital appreciation experienced by some of Australia’s junior oil and gas companies, like Beach Energy (BPT). Will this gas revolution turn into “gold?”
As is the case with the vast majority of history’s game changing stgelopments, the natural gas story has been driven from the beginning by technology. Those of you who are aware of LNG (Liquefied Natural Gas) may be surprised to learn the technology to transform gas into a liquid, and therefore transportable state, was stgeloped in the late 1800’s by British physicist Michael Faraday. However, it was not until 1917 that the first LNG plant opened its doors in West Virginia in the United States and it would be 1959 before the world’s first LNG shipping vessel, the Methane Pioneer, would transport gas in a liquid state from the American state of Louisiana to the United Kingdom.
It is hard for younger investors to imagine a world with plenty of cheap oil but that is once the way it was. In addition, there was scant concern for the impact of carbon emissions on the environment and the notion of renewable resources was in the eyes of many nothing more than science fiction.
Although back then natural gas was an expensive fuel, its higher price in comparison to coal and oil was not enough to justify the massive investments needed for LNG facilities. So natural gas production remained largely dependent on the availability of pipelines and terrain suitable for their construction. Demand for LNG was largely restricted to countries with minimal natural gas resources of their own.
The more recent technological stgelopments that have pushed natural gas to the forefront are horizontal drilling and hydraulic fracturing. Traditional natural gas wells were vertical and it was not possible to extract gas from unconventional sources. Geologists have long known of these sources – gas trapped in shale and other rock formations as well as gas trapped in the seams of coal beds.
With these new technologies it became practical to extract gas from these unconventional sources to be used as “feedstock” for LNG processing facilities. Australia is already the world’s fourth largest exporter of LNG and has ambitious plans to be number one. Santos (STO) and Woodside Petroleum (WPL) have made heavy investments here, betting on the future of natural gas.
Some investors shy away from the LNG phenomenon due to the high costs of building LNG processing plants and storage facilities. Others look at the deteriorating price of natural gas in the US as another chink in the armor of the gas story. However, there are other sides to these stories.
First, long term contracts for LNG are in place before the processing facilities are in place. Thus, Australian majors like Santos and Woodside and their international competitors here in Australia have already sold LNG they have yet to produce.
Unlike oil, the price of natural gas is regional, not global. So while a million BTU of natural gas in the US is now below $2.00 – a level not seen in ten years – a million BTU of natural gas transformed into LNG trades for over $9.00 in the United Kingdom and $15.00 in Japan. The significant upside to lower natural gas prices everywhere is increased demand. With oil prices high and possibly going much higher, companies like the Apache Corporation- the largest oil and gas explorer in the US – are beginning to switch the fuel used by its drilling rigs from diesel to natural gas. Canada’s giant EnCana Corporation has already switched 15 of its forty rigs with plans to switch more.
There are other factors that bode well for natural gas demand going forward and perhaps the most significant is environmental. Coal is currently the cheapest, and dirtiest, means of generating electricity but government interventions like Australia’s recently introduced carbon tax will make coal more costly. Emerging markets like China where they are literally choking in the smoky haze of their own success are desperate to move towards cleaner fuels. Despite years of promise, renewable sources of energy have yet to deliver. By some estimates natural gas burns 50% cleaner than coal and is seen as the logical fuel of the future, filling the gap until renewable energy sources finally become cost effective.
Global energy demand is exploding as the economies of stgeloping nations pick up steam and natural gas is expected to get a larger slice of the energy pie in the future. ExxonMobil has published a comprehensive “Outlook for Energy: A View to 2040.” From that study, here is a chart breaking down global energy demand by fuel type in the year 2040:
Although ExxonMobil expects oil to remain the world’s number one fuel, the percentage growth of natural gas from 2010 to 2040 is higher. What’s more, they expect natural gas to supplant coal as the number 2 fuel, with coal actually showing a decline.
There is little question that energy demand is growing, but as yet, some investors have failed to see the potential of natural gas in that mix. In Australia, we have the resources as coal seam gas – or coal bed methane as it is sometimes called – is already replacing conventional gas wells as our primary source of supply. Development of shale gas reserves are only beginning. Both our conventional and unconventional gas sources will feed the gigantic LNG processing facilities under stgelopment in Australia.
The pieces are in place for a new Australian resource boom, yet some experts warn our LNG expansion could be threatened by competition from the United States, which currently has the capability to tap shale gas resources in that country that will transform their gas reserves into a major export commodity. To address that issue, we turn to figures provided by the United States Energy Information Agency (EIA).
They have studied energy demand through 2035 and see growth in natural gas in non-OECD countries growing by about 2.2% per year, which is almost three times the growth rate in OECD (Organisation for Economic Cooperation and Development.) Think of OECD members as stgeloped countries and non members as emerging economies. Of the anticipated growth in natural gas, about 76% will come from Non-OECD countries. The following chart puts the numbers in perspective.
What is relevant for Australia and for the argument of competition from the United States is the projection that demand for natural gas will double in Non-OECD countries in the Asia Pacific region – our neighbors. The government of China has officially stated its preference for natural gas as an energy source. Their plan is to increase the use of natural gas in its energy mix to 10% by 2020, which breaks about to about 8.8 TCF (Trillion Cubic Feet). India is expected to double its consumption of natural gas as early as 2015. The next chart says it all:
The key markets for natural gas are right at our doorstep, giving Australian producers a cost advantage over their potential American competitors. With the ingredients for success in place, the question for investors becomes how do we play this?
There are major players building up the LNG infrastructure and then there are others who will provide the natural gas for those facilities. In the short term, companies like Woodside (WPL) and Oil Search (OSH) bear the risk of cost overruns and production delays in their LNG projects. However, their prospects over the longer term appear bright.
Right now the natural gas that will flow to these LNG facilities will come from conventional wells, which are dwindling in production capability, and coal seam gas wells, which are exploding. Shale gas, although it will play a central role in the supply chain in the future, is still in the very early stages of stgelopment. Beach Petroleum (BPT) is likely to be the first Australian company with producing shale gas resources.
The “smart money”, as they say, should be looking at coal seam gas explorers and producers. For one thing, coal seam gas is cheaper to produce since the wells are shallower than shale and do not always need to be “fracced.” While no one yet knows the extent of shale gas reserves here in Australia, some experts say Australia has up to 100 years of proven and probable coal gas seam reserves, located primarily in Queensland. The chart below, although technical, shows the proven and probable (2P) coal seam gas reserves (in Petra Joules or PJ) in Queensland alone:
While there is reason to believe one could cash in on the anticipated gas gold rush with LNG companies like Woodside, here are four Australian companies more heavily involved in coal seam gas production and exploration in Queensland. Two are majors you should recognize and two are juniors you have never heard of:
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Santos and Origin are the lower risk plays here. Both have other sources of revenue and as you know with diversification comes increased safety for investors. Santo is already the country’s leading domestic supplier of natural gas. With conventional sources on the decline the company acquired Easter Star Gas for its coal seam gas assets and Santos now produces about 25% of Australia’s coal seam gas, with additional reserves under exploration. Origin’s balance sheet swelled with a $5 Billion dollar payday from Conoco Philips for 50% of the company’s coal seam gas assets.
As of now, Australia has no production facilities linking CSG mining operations with LNG processing facilities. Both STO and ORG are partnering on what will be the first CSG-LNG operations in Australia – the Australia Pacific LNG Project partners Conoco and Origin with others; and the Gladstone Project (GLNG) partners Santos with PETRONAS, Malaysia’s national oil and gas company and the world’s second largest LNG exporter, French energy major, Total, the world’s fifth largest publicly traded integrated international oil and gas company, and KOGAS, the world’s largest buyer of LNG. Santos is the majority owner at 30%.
Although the coal seam gas expansion began in Queensland in 2000 when the government changed the energy mix to reduce carbon emissions, and the LNG expansion projects have been underway for more than five years, market participants appear to remain unconvinced that a “golden age of gas” is indeed on its way. Here is a one year chart showing share price performance for these two companies:
The rewards here will come to those with the patience to watch and wait. In contrast, some junior explorers have seen dramatic share price appreciation. Others however, have not. Blue Energy and Westside Corporation both have multiple permitting licenses for CSG exploration in Queensland’s most prolific source – the Bowen Basin.
Westside, however, has already begun drilling test wells while Blue Energy is still in the exploratory phase. In March of 2012 Westside raised $25 Million dollars in a share offering to fund expansion of its CSG operations. In a positive sign, the offering was oversubscribed. Here is a chart for the two juniors from our table, Westside Corporation (WCL) and Blue Energy Ltd (BUL):
WCL has so far rewarded investors with higher risk appetites who were willing to take a chance on them. With more than 8 exploration permits in desirable locations, Blue Energy might experience similar appreciation once they begin drilling. Both shares should be at least on a watch list of investors interested in the potential of turning “gas into gold.”
No discussion of the future of coal seam gas production in Australia would be complete without acknowledging the controversy surrounding the technologies used in the mining process. However, we no longer live in an age when a business owner could place a water wheel into a local river to power machinery and toss whatever waste material was produced into the river with neither comment nor complaint. As long as producers and community members affected by the production process acknowledge negative side effects, technologies can be stgeloped to deal with the problems.
CSG mining uses large amounts of water injected into the wells which upon its return to the surface is laced with potentially toxic chemical cocktails. Rather than simply dump the waste water back on to the land, CSG mining includes waste water treatment operations where the water is restored to a useable condition. Technologies like hydraulic fracturing are here to stay, but with some effort, additional technologies can be stgeloped to deal with whatever negative side effects they might create.
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