Gas boom builds steam

PORTFOLIO POINT: The stage is set for the third wave of Australia’s natural gas boom, shale gas. Here’s how investors can join in.

High oil prices are back in the headlines. And no wonder: earlier this week the European Union imposed a long-threatened embargo on Iran. In turn, Iran is now threatening to block all oil shipments moving through the Persian Gulf. As the world watches these events Australian investors should be watching what is fast becoming the third wave of Australia’s natural gas boom, one that is perfect at this stage for retail investors with an appetite for risk.

Shale gas, which has already revolutionised the US energy sector, has now drawn in at least a dozen ASX-listed explorers and four major foreign explorers.

Leading local stocks in the hunt for shale-gas include:

• Beach Energy (BPT), which has already outlined a world-class two trillion cubic feet (2tcf) gas reserve in its Cooper Basin tenements, and is highly likely to discover more.
• Drillsearch (DLS), which has attracted a major joint venture partner to its Cooper Basin tenements, BG Group, the old British Gas, which is also a leader in coal seam gas.
• Buru Energy (BRU), which has attracted Japan’s Mitsubishi into a $150 million oil and gas search in the Canning Basin of northern WA.
• New Standard Energy (NSE), which has attracted US oil major ConocoPhillips into a $110 million search on its Canning Basin tenements.
• Senex Energy (SXY), which holds a large tenement position in the Cooper Basin and has reported intersecting gas-rich shale in its first well (Vintage Crop).
• AWE (AWE) which is leading the hunt in the shale-rich Perth Basin and waiting on environmental approval to test a well (Arrowsmith No.2) which has shown encouraging signs of being gas rich.

Other ASX companies already active in the shale-gas hunt (and there are more joining) include: Cooper Energy (COE), Icon Energy (ICN), Norwest Energy (NWE), Somerton Energy (SNE), and the original Cooper Basin explorer, Santos (STO).

Major foreign players, apart from Mitsubishi, ConocoPhillips, and BG, include the US mid-tier oil producer Hess Corporation, which has secured extensive tenement exposure over the remote Beetaloo Basin in the Northern Territory, and unveiled a $55 million exploration program.

What’s happening in the hunt for shale gas is a rerun of the early days of Australia’s second gas-wave when a stampede of explorers moved into the coal-seam gas industry, with most later selling for fat profits to international oil companies that are now developing multi-billion dollar LNG export projects.

Australia’s first gas-wave, which is also almost totally dominated by the oil majors, started 30 years ago with the North-West Shelf project and now incorporates a series of multi-billion dollar LNG developments on the northwest coast.

Understanding the three waves of Australia’s fast-evolving gas sector is important, as are these three critical points:

• The same issue that originally launched Australia’s LNG export industry – trouble in the Middle East – is at work now with Asia’s hunt for secure energy supplies highly likely to underwrite the shale phase of this three-stage gas boom.
• Shale gas is different to coal-seam gas in that it is generally located below the water table, and often at great depth, which means most environmental issues can be managed safely. (See below.)

• It’s all gas. All forms of natural gas, conventional and unconventional (coal seam and shale) are essentially methane, with some other gases such as ethane, propane and butane used for a diversity of purposes. Methane is the important pipeline gas. Ethane is used in the chemical industry. Propane and butane are sold as liquefied petroleum gas (LPG).

A spot of history first. Back in 1979, when Woodside Petroleum and its partners in the North-West Shelf joint venture were considering the high-cost, high-risk, investment of up to $6 billion in Australia’s first LNG project, it was the second oil-price shock of that decade, caused by the Iranian revolution, that provided the essential incentive to undertake the development.

Central to the final investment decision was a series of contracts from Japanese power utilities, which feared the long-term loss of oil from the Gulf region. The North-West Shelf became phase one of the Australian gas-export boom.

Queensland’s coal-seam gas industry, which started with a number of small explorers, reached critical mass in 2007 when the oil price soared to more than $US130 a barrel, largely because of tight control of supplies by members of the Organisation of Petroleum Exporting Countries (OPEC), but also because of growing Chinese oil demand.

High oil prices and Asian demand for LNG gave Australia phase two of the oil boom, which has also seen a number of conventional, multi-billion dollar gas projects launched on the north and west coast thanks to Asia countries seeking reliable and secure energy supplies.

However, for most Australia retail investors the first two phases of the LNG gas export industry has effectively become a closed shop because control has passed from a string of local juniors to global oil giants such a Shell, Chevron, BG, and ConocoPhillips.

If early hints of substantial gas deposits are proven by exploration then the world’s oil majors will move into the sector, just as they did with phase one and phase two.

There is another reason for the next few years being the best time to take a position in the shale gas exploration sector – too much success will destroy the gas price, as it has done in the US where a gas glut (from shale) has driven the gas price down from more than $US13 per million British Thermal Units to less than $US3 in five years.

Australia’s shale gas industry will evolve differently to the US because of the much smaller domestic energy market, and the lack of an extensive gas gathering and distribution pipeline system.

Analysts at the stockbroking firm Bell Potter told clients in a pre-Christmas note that the current stage of the shale gas industry “reminds us of the early days of the coal-seam gas industry, before any major merger and acquisition activity occurred”.

Bell Potter also did a good job is identifying the three key issues for investors to consider in what is the highest risk (highest reward!) phase of any exploration program.

Geology. Australia has a number of basins (areas of sedimentary rock rich in organic material that can first generate oil and gas and then trap it). An important point is that “shales ain’t shales” and not all basins will contain the appropriate geological conditions.

Technical know-how. This is a new industry for Australia, and requires specialist drilling and gas extraction technology. Most of that will come from the US but it will be many years before local drill crews have enough of the correct equipment and know how to use it.

Economics. Finding gas in shale is the first trick in a complex equation. Developing access to local markets will be the heavy lift in Australia because of the limited pipeline infrastructure and limited local demand. Bell Potter reckons that commercial factors will see “the bulk of future Australian shale gas '¦ exported as LNG”.

Boiled down, investors thinking about joining the shale gas rush need to pick their targets carefully, meaning that in the early stages it will be the Cooper Basin explorers that have the greatest chance of success.

The best of the Cooper players are Beach, Drillsearch, Santos, Icon and Senex. All have access to pipelines serving major east coast cities, and have the potential to feed gas into Queensland’s coal seam LNG projects. BG has almost certainly joined the Cooper Basin shale hunt because it is concerned about future coal-seam supplies, either because of flow rates or possible environmental challenges.

In the Perth Basin, the pick of the players is AWE, with Norwest also worth a spot of research. The appeal of this location is two passing pipelines linking WA’s south-west with the conventional gasfields off the north-west coast. Domestic gas prices in Perth are high because much WA’s gas exported to catch high international fuel prices.

In the Otway Basin between South Australia and Victoria, Somerton and Cooper are the explorers to watch. Proximity to Melbourne and Adelaide offers marketing potential.

In the Canning Basin, Buru and New Standard are the leading players. This vast region not only has the potential for the biggest discoveries, but is also the most remote. Most possible development options are LNG-based for export markets, which is why Mitsubishi and ConocoPhillips have become involved.

There is one important factor missing from the limited advice from the handful of stockbrokers following this early stage of the shale gas rush, which EurekaReport first covered in some detail almost two years ago (see Shale of the century) is an important timing factor because if Australian explorers follow their US colleagues, success could destroy the gas market.

The next five-to-10 years will be the exploration, discovery, and share boom phase. It is the period of maximum risk, but also maximum reward.

If success comes, the M&A phase will give shale gas investors second wind, as it did for coal seam gas.

After that comes the capital intensive project development phase which sees most small companies acquired, clearing the way for the global gas players.

Today, shale gas is on the first step of an escalator. Oil market conditions caused by troubles in the Middle East, new technology developed in the US and geology that bears similarities to the US, mean Australian gas is poised for its third boom in the past 30 years.