|Summary: Liquefied natural gas is set to become Australia’s second-biggest export, as new projects come on stream and production from existing projects is ramped up. The financial consequences of this will be profound, with LNG revenues effectively wiping out our current deficit, leading to a sharp rebound in the Australian dollar. But a higher dollar, while good on one level, is also a resources curse.|
|Key take-out: A challenge for Australian LNG producers will be our high production costs as well as fierce competition from overseas producers, particularly those in the US.|
|Key beneficiaries: General investors. Category: Commodities.|
Last night’s fall in the Australian dollar to its lowest level in more than three years against the US dollar will be welcomed by exporters, but the benefit might be short lived with the seeds of the next upward currency move already sown.
From next year exports of liquefied natural gas will start to surge as new projects on both sides of the country start production. LNG is expected to quickly overtake coal as the country’s second-biggest single export, potentially challenging iron ore for the top spot.
The dawning of Australia’s LNG-era is occurring at the same time as the previous resource-sector leader, mining, stages a comeback with one of the world’s leading investment banks, Citigroup, making a dramatic switch from neutral to bullish for the first time in three years.
Noting concern about the future demand for commodities in China, the bank said the change of view reflected better “bottom up” fundamentals, particularly from the major miners. “We would rather be too early than too late in making this call,” Citigroup said.
Adding a mining revival to the rise of LNG will add to pressure on the Australia dollar even as the Reserve Bank tries to talk it down further.
The gas pipeline
What’s driving LNG are the massive investments in Queensland’s coal-seam gas deposits and conventional gas in Western Australia and the Northern Territory, which caused one leading investment bank to call Australia in a pre-Christmas research report an emerging “energy superpower”. Woodside Petroleum today announced that it had inked a deal for an LNG project in Canada with the government of British Columbia.
While not a new title, what the Morgan Stanley analysis did was remind investors that the surge in resource-sector capital investment over the past decade, even if it has peaked, will have cash-flow consequences.
The bank did not dub rising LNG exports as a return of the resources boom, or an extension of the resources curse. But if its predictions on the effect of Australia becoming the world’s biggest single supplier of LNG to global markets are correct, then that’s what it will mean
The key to the Morgan Stanley forecast is the effect LNG exports are expected to have on Australia’s current account deficit (the value of exports versus the value of imports) with the potential for LNG, when added to other resource exports, wiping out a deficit which has been a feature of the economy for the past 40 years.
If correct, and Australia shifts from a current account deficit to a current account surplus, the implications are profound and could include the retirement of some of the country’s huge external debts, and confirmation of the Australian dollar’s status as a AAA-rated currency.
Not everyone believes the wave of LNG exports from new projects such as Gorgon and Wheatstone in WA, Ichthys in the NT, and at least two projects centred on Gladstone in Queensland, will have such a profound or rapid effect on the country, or the currency.
Most recent commentary on the LNG industry has focussed on the problems it is causing, from potentially creating a gas shortage for East Coast domestic consumers, to being the major culprit in an explosion of construction costs across the country.
High capital costs have led to the mothballing of several LNG proposals, including the onshore phase of the Browse project in WA championed by Woodside.
However, it is significant that Browse is not dead, but is likely to return using new subsea completion and floating production technology based on a giant barge similar to one already being built for the Prelude project of Royal Dutch Shell off the WA coast.
If Prelude is the technology breakthrough that the oil and gas industry believes it to be, a flotilla of floating LNG (FLNG) projects will appear over the next 20 years off the West and North coasts.
Competing gas giants
Overcoming the problem of the world’s highest capital costs is one challenge for the LNG sector. Another is the problem of rising competition from rival LNG projects, including a number based on surplus gas being produced in the US thanks to its shale gas revolution.
Some critics have suggested that Australian LNG will not be able to compete on price for what is becoming the world’s preferred fossil fuel, displacing oil and coal, because it is cleaner burning which means reduced levels of lower carbon dioxide pollution.
Over time Australian LNG could indeed face stiff competition, but that’s years into the future. Actually, it might never occur, because gas prices are rising in the US as that country increasingly switches its domestic power demands to gas, which will have the effect of eroding what was once a significant cost advantage.
The point about Australian LNG, which Morgan Stanley identified, is that the projects here are either in production, or soon to start, and while a debate has started over whether LNG should be priced as an oil equivalent (or at a lower level) the fact is that it will be produced and it will be sold, even if it a discount to oil.
Last year, LNG passed gold on the value-list of exports, rising by 15.3% from $13.7 billion to $15.8 billion. The value of thermal (electricity producing) and metallurgical (steel-making) coal increased in value by 6%.
Iron ore, the runaway export-leading commodity, surged higher by 43% to $82 billion, and even if the price contracts it could stay around that value as volumes rise.
From a currency perspective the rising volumes and value of LNG, coupled with the dramatic expansion of the iron ore industry, appear likely to act as a counterweight to the forces dragging the dollar lower.
Rising unemployment, which could trigger another downward leg in official interest rates, might deliver a fresh fall in the currency this year. But from next year, as the wave of new LNG projects flip from their capital construction phase to their cash generating sales phase, there will be renewed pressure driving the dollar higher.
A glimpse of the potential upward pressure on the dollar from Australia’s emerging status as an energy superpower is contained in the Credit Suisse report “Wild Ideas Down Under for 2014”, which we publish in today’s edition.
One of the wild ideas is for the Australian dollar to reverse its current downward trend, rising back above its 2011 high of $US1.10.
Credit Suisse acknowledges that its official forecast is for an exchange rate of US87 cents by the end of 2014, with US80c as the long-term forecast.
For the reversion to an exchange rate as high as $US1.10 a number of events need to occur, such as a continuation of quantitative easing (money printing) in the US, rising (not falling) Australian interest rates and stronger Chinese growth.
Not on the Credit Suisse list of events that could drive the Australian dollar higher is a surge in export revenue from LNG production, which is the key factor in Morgan Stanley’s optimistic outlook for Australian ending 40 years of current account deficits, an event which will unquestionably have an effect on the exchange rate.
Flattering as the title energy superpower sounds, it also represents the return of the doubled-edged sword which is the resource boom and its close relation, a resources curse, which means a sharply higher currency and damaged domestic economy.
The Credit Suisse wild idea of $US1.10 exchange rate is unlikely, but so too is a fall much further than where the dollar is today. There are real prospects of a rising exchange rate from next year as decades of current account deficits are repaired.