Is the LNG Boom on Life Support?

Australian investors in LNG (Liquefied Natural Gas) stocks hoping to cash in on the alleged “golden age of gas” got a little worried when Russian natural gas behemoth Gazprom signed a 30 year deal to pipe gas into China.  The deal is valued at around $400 billion and the worry for our LNG exports is cost. China pays around US$15 per BTU for Australian LNG and although no one knows for sure the pricing on the Russian deal, some say it could be as much as 40% cheaper than seaborne LNG.  

The news was released on 21 May and the two largest ASX Oil & Gas companies with big stakes in the future of LNG exports are Woodside Petroleum (WPL) and Origin Energy (ORG).  Here is a one month chart for the two:

What happened with the other major LNG players on the ASX, Santos Limited (STO) and Oil Search Limited (OSH)?  Here is the chart:

Woodside took a hit to the share price following the news that Royal Dutch Shell was looking to cut its stake in WPL as part of its global asset fire sale.  Origin announced a capital raise to fund its acquisition of assets from Karoon Gas (KAR), sending ORG southward.   The charts demonstrate that Aussie investors en masse did not push the sell button following the news of the Russia/China gas agreement.  Should investors be overly concerned or is the relative price stability a sign of contrarian sentiment?

LNG projects in Australia have seen exploding cost overruns, which, coupled with generally higher costs of doing business in Australia, have prompted some experts to caution that the major LNG players are in danger of pricing themselves out of the market in the face of lower cost competition.   According to some, the Russia/China deal China could lead to the abandoning of high cost LNG projects.

Less than one month later on 19 June, French based energy company GDF Suez and our own Santos Limited were dropping plans for the multi-billion dollar development of the Bonaparte Floating Liquefied Natural Gas (FLNG) project.  What should be troubling to investors is the fact FLNG was touted as a lower cost alternative to onshore construction of LNG processing facilities, with Royal Dutch Shell claiming FLNG projects would be 30% to 50% less costly than onshore developments.  However, some experts disputed the cost saving estimates due to the complexities of building ships that double as floating liquefaction platforms.  Shell has the world’s first vessel under construction with LNG production expected to begin in 2016.  The ship is reportedly longer than four soccer fields.  

This announcement from GDF Suez/Santo is likely to fan the flames of scepticism that swelled following the Russia/China deal.  A 06 June article in The Australian online included a chart from analysts at Macquarie Research comparing development costs for Australian LNG projects with the pipeline and other costs for the Russian project.  Here is the chart:

Macquarie analysts predict the price of LNG exports will fall, threatening the margins of Australian producers.  On the other side of the debate, industry executives, most notably the CEO of Santos, predict that demand in China will grow sufficiently to require supply from multiple countries.  What’s more, the Santos CEO points to the fact much of Australia’s projected LNG output has already been sold under 20 year contracts.  In addition, Santos considers it likely that China and other countries will look to protect national energy security by diversifying sources of supply.

Some support this view.  Queensland University energy expert Dr. Vlado Vivoda remained upbeat about Australian LNG exports, despite the Russia/China deal.  Vivoda claims China is on a path to almost triple its current gas consumption over the next few decades, requiring Australian gas as well as Russian gas.  

The International Energy Agency (IEA) released its Medium Term Gas Market Report on 11 June, forecasting a 90% rise in demand for gas in China to 2019.  However, the report also notes that domestic gas production in China will rise by 65% over the next five years and cautions that the long project development cycle for LNG facilities and the industry halt in new construction could result in less than adequate supply of gas, opening the door for greater use of coal.  The IEA also says higher LNG pricing could lead to more demand for coal as a cheaper alternative

The predominance of analyst and expert opinion on the future of LNG seems to be negative, to say the least.   Perhaps the most extreme comes from LNG expert Dr. Fereidun Fesharaki who reportedly referred to the assumptions our LNG exporters have about Asian demand as “crazy.”   According to Fesharaki “the customer that everybody assumes is there based on these crazy demand forecasts is just not there.”   However, he believes the long-term LNG contracts already in place for existing projects should still lead to Australia overtaking Qatar as the world’s largest exporter of LNG exporter by 2018.

Given these opinions, one has to marvel at how well the share prices of the major LNG players on the ASX have held up.  Granted these companies are also in the oil business which has benefited from the worsening situation in Iraq, but the LNG boom was to be their future.   While analyst forecast revisions may be in the offing, as of 19 June the picture in terms of forward growth is far from bleak.  The following table illustrates the point.

Oil Search Ltd (OSH) has the most impressive numbers due to the commencement of shipping from the PNG LNG (Papua New Guinea LNG) facility where OSH is a partner with operator Exxon Mobil.  Within days of the initial shipment Exxon upgraded its LNG production guidance for the remainder of 2014.   Analysts tell us Exxon and Oil Search plan an additional two processing facilities, or trains, which could double LNG output in 2015.

Investors who waited patiently for the project to come to fruition should be rewarded.  The operation will increase Oil Search’s production base four fold and could add as much as US$1.3 billion to the company’s operating cash flows.  Analysts like this stock with a consensus Overweight rating and nine analysts with a Buy recommendation.

Santos Limited (STO) also has an impressive two year earnings growth forecast.  The company will benefit from its small stake in the PNG LNG operation and is expecting to begin shipping LNG from the Gladstone LNG (GLNG) project in 2015.  Santos is the majority owner of the project at 30%, followed by Malaysia’s Petronas with 27.5%; France’s Total at 27.5%; and South Korea’s Kogas at 15%.  Santos management says the company’s cash flow will more than double over the next two years as a result of PNG LNG and GLNG coming online.  STO has a consensus Overweight analyst rating with seven analysts at Buy; one at Overweight; five at Hold; and one analyst recommends investors Sell the stock.

Origin Energy Limited (ORG) is an integrated energy provider, adding electrical generation and distribution to its oil and gas interests.  Origin’s entry into the LNG field is the Australia Pacific LNG (APLNG) which is expected to begin shipping in mid-2015.  Origin owns 37.5% interest in APLNG along with US based Conoco Philips, also at 37.5%; along with China’s Sinopec at 25%.  Forecasted earnings once APLNG goes online could come close to doubling EPS, although the timing does not allow the increase to be reflected in the current two year earnings growth forecasts.  ORG has a consensus Overweight rating with seven analysts recommending investors Buy the stock; one with an Overweight recommendation; and six at Hold.  

Woodside Petroleum (WPL) has a successful LNG operation underway at Pluto but the problem investors appear to have with the company right now is its future direction, or lack of it.  After what seemed to be a never-ending wait, Woodside shelved its plans for the US$40 billion dollar Browse LNG project in April of 2013, later announcing it would shift development at Browse from onshore to the more cost effective Floating Liquefied Natural Gas processing technology.  Investors were buoyed by the news Woodside entered into a partnership interest in the Leviathan gas field in Israel.  In mid-February of this year the company was reportedly considering a “fast-track development” at Leviathan but on 21 May the company backed out of the project, claiming it was no longer “commercially viable.”  

Conservative investors may be impressed with Woodside’s strengthening balance sheet due to these decisions, but analysts are decidedly Bearish on WPL, with a consensus Underweight rating and six analysts recommending investors Sell the stock with only one recommending Buy.

LNG skeptics could argue the share price action of these four companies can be attributed to the long term LNG contracts in place at high prices.  However, to gauge investor sentiment for the future potential of LNG, one only has to look at the amazing price performance of Liquefied Natural Gas Limited (LNG).  This company is strictly a development company, but one with an Optimised Single Mix Refrigerant (OSMR)  LNG processing technology that reportedly reduces processing costs by 50% while increasing efficiency by 30%.  On 19 June 2013 the stock closed at $0.16.  One year later the stock closed at $2.44.  A one year price chart shows the meteoric rise of LNG:

The company has been on the ASX since 2004 and has an LNG project at Fisherman’s Landing in the Port of Gladstone, which it put into a “care and maintenance” status pending an available source of gas for its revolutionary processing technology.  Prior to that decision the company announced on 19 December 2012 it had a subsidiary company, Magnolia LNG LLC, which was filing an application to export LNG in Louisiana in the United States.   A long series of strategic agreements and securing of funding partners kept investor hopes alive.  The company is also listed in US markets Over the Counter (OTC) exchange under the symbol LNGLF.  The stock price took off in mid-May following the announcement of a successful capital raise to US and Australian institutional investors and a few days later the announcement the US Federal Energy Regulatory Commission (FERC) had formally accepted Magnolia LNG Project’s (MLNG) filing application.  This was a major step in the permitting and approval process.  Another key driver has been the US DOE (Department of Energy) deciding to streamline the burdensome approval process for LNG export facilities.  The share price continues to climb as news that big name US hedge funds and institutional investors are buying in to LNG.

This despite the fact there is no guarantee Magnolia will get final permitting approval or that the technology will successfully yield the kind of cost benefits over which investors seem to be drooling.  One could draw the conclusion that investor sentiment for LNG projects is robust, provided the projects are cost effective.  The elusive LNG Boom may yet materialise, if the “price is right.”

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