BG sets an LNG defence in train

The announcement from BG Group overnight that China National Offshore Oil Corporation will substantially increase its involvement in BG's Curtis Island export LNG facility in Queensland jars with the view that the US shale gas revolution will strand the hundreds of billions of dollars of investment being pumped into export LNG projects in Queensland and offshore Western Australia.

BG announced CNOOC had signed a heads of agreement under which it will pay $US1.93 billion to lift its interest in the first of the two trains BG is building at Curtis Island from 10 per cent to 50 per cent. It will also increase its existing interests in BG's onshore coal seam gas resources from five per cent to 25 per cent and take up a 25 per cent working interest in additional tenements.

The partners will also add another two LNG ships to the two they are already building in China and CNOOC will have an option to acquire a 25 per cent stake in any potential expansions trains at the BG facility.

Significantly, CNOOC has also increased the amount of gas it has contracted to buy from the project from the 3.6 mtpa it signed up to in 2010 to 8.6 mtpa.

Last year the Origin Energy-led APLNG consortium announced that China's Sinopec had increased its committed purchases from 4.3 mtpa to 7.6 mtpa in a 20-year deal, underwriting a go ahead for a second train. Sinopec also lifted its equity stake in APLNG from 15 per cent to 25 per cent. The APLNG consortium includes ConocoPhillips and Japan's Kansai Electric.

The other big Curtis Island project, the Santos-led consortium that includes Malaysia's Petronas, France's Total and Korea's KOGAS, also demonstrates that mix of equity stakes and 20-year binding off-take agreements, as did the sale earlier this year by Woodside of an effective 14.7 per cent interest in its Browse development off WA to Mitsui and Mitsubishi.

The concern about the economics of the vast investments in export LNG – more than $200 billion, with more than $80 billion of that being ploughed into the Curtis Island projects – relates primarily to the transformation occurring within the US energy sector, where the surge in shale gas production is creating energy self-sufficiency and, indeed, a surplus of energy that has driven down energy costs in the US.

That has and will increasingly have dramatic implications for the competitiveness of US industry, wider geopolitical implications and global energy markets (On the cusp of a new US prosperity, October 31). Already energy coal that has been displaced by shale gas is flowing into the global market and competing with traditional seaborne coal producers, including Australia's.

It has, however, yet to disrupt the market for LNG, mainly because there are no export terminals in the US, historically an importer of energy. There is, however, a terminal in Louisiana that is being converted into an export facility which will provide a conduit for some US gas to be sold into the Asia Pacific market.

The glut in shale gas, which saw the US Henry Hub domestic gas price plummet from around $US6 per mi/BTU to under $US2 per mi/BTU (it has since recovered to be just under $US3.50 per mi/BTU) provides an obvious incentive for that gas to find its way into the markets the Australian LNG projects are targeting.

At current domestic gas prices the US gas would be more than competitive with the Australian producers, even after taking into account the costs of liquefaction and transport.

If the market for US-sourced LNG, however, were to really open up it would have an impact on US domestic gas prices – the producers would have an incentive to sell into the international market and therefore the domestic gas supply-demand equation would change.

There is a political dimension to the prospect of rising domestic gas prices – the US is well aware that the shale gas phenomenon has the potential to transform its competitiveness – but also a basic economic one. Effectively a rise in LNG exports will lead to a rise in domestic gas prices and the incentive to export will be diminished once the liquefaction and transport costs are factored in.

That doesn't mean that shale and other unconventional gas flowing from the US and elsewhere (China and Europe both have potentially very large unconventional gas resources and Africa is potentially another major source of LNG) won't impact the market or the price of LNG.

The Queensland LNG plants do, however, have what appear to be quite robust economics.

Origin has said it needs an oil price of only $US35 a barrel in real terms over the life of its project to cover its costs and debt-servicing obligations. An average real oil price of $US50 a barrel would recover its weighted average cost of capital.

The sheer cost and complexity of LNG facilities and the lead time for bringing them in to production – BG's plan hopes to be making its first shipments in 2014 and the Origin and Santos projects are scheduled to start producing in 2015, about seven years after their first steps towards commercialising their Queensland coal seam gas resources via liquefaction – means that it will take years for large-scale competitors to emerge.

In the meantime the Australian producers, and the Qataris and other natural gas producers, have been securing long-term contracts with the key players in the major growth markets, especially China, and binding them closer with significant equity holdings in the projects and, in the case of the Curtis Island projects, the upstream resources that support them.

Similar multi-dimensional partnerships with the Japanese steel mills and trading houses were pivotal to the development of the Pilbara iron ore province in WA and the Queensland export coal sector. That provides some protection against new entrants.

The Australian-based producers will also face the same equation and incentives as the US shale gas producers, with the ability to shift their gas between export markets and the domestic market depending on the relative prices once the processing and transport costs are taken into account.

With now new coal-fired generation likely to be built in this country gas will be an increasingly important – and more expensive – source of energy.

The export LNG projects are, of course, predicated on scenarios that envisage surging demand for energy, and for cleaner energy, in China and other Asian economies.

If that longer term demand curve doesn't develop, and a permanent over-supply of cheap gas floods the market, the projects will be stressed. Those sorts of potential outcomes, while highly unlikely, are however inherent in the high-risk, high-reward nature of the natural resources sector.