Australia's gas industry gets a second wind

Summary: Rising demand for LNG is proving to be the catalyst for developing a number of major new projects.

Key take-out: Investors can gain exposure through energy companies and service providers.

Australia's fascination with a worsening east-coast gas shortage has blinded some investors to what's happening on the west coast.

A gas glut there is dovetailing neatly with rising global demand to unleash the next phase of the liquefied natural gas (LNG) project-development boom.

Direct exposure to what's happening is not easy, with Woodside Petroleum the dominant local player in a business increasingly in the hands of international energy leaders such as Chevron Corporation and Royal Dutch Shell.

But that doesn't mean the development of at least four new gasfields, and perhaps a lot more, will not create opportunities in the engineering and services sector where a number of specialist companies are active, including Worley Parsons, Valmec and Matrix.

Suppliers of basic services, from transport to civil construction work, will also benefit from emerging opportunities that have a collective price tag approaching $50 billion.

What's happening is that gas demand, especially in the form of LNG, is easily outstripping forecasts made as recently as three years ago when the Australian LNG industry was said to have peaked. Since then there have been no new developments, after a hectic building boom that was marked by dramatic cost overruns and construction delays.

East coast LNG exports have certainly peaked and might even have entered a period of decline, with the possibility of government intervention in the market to force the redirection of gas earmarked for export into the local market.

In Western Australia, however, exports are very much on the agenda as LNG prices in Asia reach boom-time levels of $US11 per million British Thermal Units. Chinese demand is particularly strong as the central government in that country enforces strict new environmental pollution rules, driving out rival sources of energy such as coal and oil.

A secondary factor emerging in favour of Australian LNG exports is the China vs US trade war, which has seen oil and gas enter the picture. China is limiting imports of US oil and gas just as the US becomes a big LNG exporter – though with China becoming off-limits that means US gas will probably head to Europe.

Gas deals and developments

Hints that the LNG boom was returning in WA started to emerge earlier this year after Woodside acquired a 75 per cent stake in the long-dormant Scarborough gas field deep in the Indian Ocean off the coastal town of Exmouth, and Chevron started design work on its Clio and Acme gasfields which could, theoretically, share the pipeline Woodside needs to build to Scarborough.

Further north the Browse gasfields, also dormant for the best part of 40 years, are moving towards a development commitment thanks to technology advances that make the construction of a 900-kilometre-long submarine pipeline technically and commercially feasible.

The net result is that Chevron could get more gas from Clio and Acme to feed one of its LNG facilities (it controls the giant Gorgon project and has a major share in the North West Shelf and Wheatstone LNG projects) while Woodside prepares for a possible double-header, the development of Scarborough and Browse, probably not at the same time but sequentially.

Gas from Scarborough would most probably be processed in the Woodside-controlled Pluto LNG plant, which would be doubled in size, while gas from Browse would go to the North West Shelf, which shares a number of common owners.

Confidence in the timing of investment was obvious last week when Woodside invited a number of investment bank analysts on a site visit to show how the Pluto project could be expanded, with briefings also on the latest developments in planning for Browse.

Analysts from Citi and JP Morgan produced the most detail reports on their time with Woodside, and while neither changed their investment recommendations (which remain neutral), they were positive on the project development plants.

Citi noted that Woodside's $2.5 billion share issue in February, plus higher prices for oil and gas, had strengthened the company's balance sheet to the point where it could undertake most of its planned projects.

Those projects include Scarborough/Pluto, a stake in an oilfield development in the African country of Senegal, while Browse would be taken to a final investment decision – moves which still leave Woodside able to retain an 80 per cent dividend payout ratio.

Significantly, Citi said Woodside's balance sheet could support the capital requirements of the Browse project through to first gas, thanks to a reduced exploration budget and a possible sell down of the 75 per cent stake in Scarborough/Pluto and other changes.

Details of what's happening in the west coast gas industry are still to be settled, such as aligning the interests of partners in the Browse project with the owners of the North West Shelf. Other details to be sorted include the best way to treat BHP's 25 per cent stake in the Scarborough gas field, design work of the Pluto expansion, and Chevron's possible interest in the Scarborough pipeline.

JP Morgan said the Browse alignment was likely to take a big step forward later this month, or in early October, with the submission of a toll-treating proposal by the Browse partners.

Strong supply and demand

With several major new gas projects heading towards a development decision over the next 12-months, there will be a significant impact on the supply of gas in WA thanks to a State Government policy which sees 15 per cent of all gas retained for local consumption.

That almost certainly means the WA gas market will remain oversupplied for some time, with prices depressed rather than rising as they are elsewhere in Australia. That difference could appeal to energy-hungry manufacturers.

Behind everything that's happening in the west coast gas sector is the unexpected strength in the global LNG market.

Citi reported from its briefing that Woodside was optimistic about the LNG market, with spot (short-term) prices high at $US11/mbtu and with customers starting to return to the long-term contracting market.

“With PetroChina signing a 22-year purchase agreement with Qatar, Woodside expects Japanese customers to continue to support new project sanctions (approvals),” Citi said.

JP Morgan noted the same trends in the LNG market, adding that Woodside's customers were interested in signing 10-year deals to buy gas from the Scarborough project.

How the different projects are shaped over the next few months will be interesting because there is a possibility that Woodside will sell down an interest in Scarborough and the new Pluto LNG plant as part of the overall project funding process and risk mitigation strategy.

“We don't currently forecast a reduction in interest,” Citi said. “But the company suggested that 40 per cent-to-60 per cent could be an appropriate level longer term.

“There is interest from tier one LNG customers for both offtake volume and equity participation in the projects (Scarborough and Pluto), although discussions sounded immature on pricing to us,” Citi said.

Opportunities for investors

For investors, the detail of exactly how Chevron proceeds with its Clio and Acme development plans, or how Woodside juggles its double-header of Scarborough and Browse, is not critical to understanding what's happening.

The important messages are that Australia's LNG has not stopped developing because of the east coast gas shortage, that opportunities are opening in the west coast LNG industry, that WA is looking at a large and long-term gas surplus, and that the strong demand for gas in Asia as a low-pollution fuel is likely to continue for decades.