Look out for an LNG supply glut
Summary: The threat of worldwide LNG over-supply could depress prices, in a similar way to the iron ore glut. One US short-seller called LNG “a disaster waiting to happen”, as project development surges in the US and Australia. Locally there are several facilities in different stages of production, and oil companies continue to talk up expansion plans. Meanwhile, BHP Billiton spin-off South32 lived up to its reputation as a love/hate stock on its debut. |
Key take-out: The forecast of supply exceeding demand points to falling or stagnant LNG prices for some time, but LNG producers' sales contracts generally contain clauses that enshrine floor and ceiling prices. |
Key beneficiaries: General investors. Category: Oil and gas. |
Australia is close to overtaking Qatar as the world's biggest producer of liquefied natural gas (LNG), but for investors that achievement could be a double-edged sword.
Shareholders in Woodside Petroleum, the local company most exposed to LNG, will get a clearer picture of the industry when it holds a “strategy day” tomorrow with comments from that event applicable to other stocks with LNG interests such as Santos, Oil Search and Origin.
High on the list of questions for Woodside management will be the outlook for LNG at a time of low oil prices, project development plans, exploration spending, development of a new LNG-trading business, and progress on renegotiating the terms of expiring sales contracts.
But, whatever happens at the Woodside meeting there is another issue brewing in the background which threatens to swamp any good news and that's the threat of worldwide LNG over-supply which could have the same price-depressing effect as the iron ore glut.
Different in many ways, there are connections between LNG and iron ore with those links masked only by time.
Both LNG and iron ore have enjoyed a period of massive production expansion to meet surging demand, especially in China and other fast-growing Asia countries.
Iron ore miners, because their industry is less technically complex, were quickest off the mark with new mines as they chased a price of $US160 a tonne – four times the long-term average iron ore price.
LNG project developers moved to catch an oil price of $US135 a barrel which was used as the basis for calculating the price of their gas contracts.
Whereas an iron ore mine can be brought into production in a handful of years an LNG project can take a decade or more, and cost 10 times as much.
That's why iron ore supply reached flood conditions last year and LNG supply could reach flood conditions in the next few years.
No-one with an eye on investment markets should need to be told that over-supply and slowing Chinese demand has killed the iron ore price, and that the same forces have killed the oil price.
What comes next is the more interesting question and that's why tomorrow's investor briefings at Woodside are important for shareholders in that company, and for investors exposed to the wider LNG sector.
Warning signals about the outlook for LNG have been flashing more brightly over the past few months thanks to the close connection between the price of oil and the price of gas – in whatever form it traded, either through a pipeline or when liquefied.
Jim Chanos, a highly successful US-based short-seller who made his name shorting Enron Corporation and correctly predicted a fall in Chinese property prices, told an investment conference in Las Vegas earlier this month that LNG was “a disaster waiting to happen”.
He also claimed he was short-selling big LNG producers such as Chevron, Royal Dutch Shell and its takeover target, BG Group.
All short-sellers have a gloomy investment view, it's how they see the world. What makes Chanos's opinion interesting is that it appears to be supported by some facts, including the Australian LNG rush, which is being matched by a surge in US LNG project development.
Australia's LNG position is that there are three well-established facilities in production, three more just starting, two nearing completion and another classified as Australasian given its location in Papua New Guinea but with Australian interest through Santos.
The three in production are the North West Shelf with an annual capacity of 16.3 million tonnes of LNG a year, Darwin LNG at 3.6m/t and Woodside's Pluto project at 4.3m/t.
The PNG LNG project has a capacity of 6.9m/t and the three new Queensland projects converting coal-seam gas into LNG have a combined capacity of 25.4m/t.
Following close behind is the giant Gorgon project on WA's Barrow Island at 15.6m/t and the smaller but nearby Wheatstone project at 8.9m/t.
To put all those numbers into perspective the Australian Government's Department of Industry forecasts that the value of Australian LNG exports will rise over the next five years from $16.3 billion to $52.2 billion, a compound annual growth rate of 21.4 per cent.
In pecking order terms that means LNG will rocket past coal to second spot as Australia's most valuable export with iron ore still No.1 in 2020 at $90.1 billion.
What worries people like Chanos is that Australia is not alone in rushing to be a big LNG producer because of the fuel's properties of being relatively clean burning (less polluting than coal or oil) and safer than nuclear power – fulfilling a role as a “halfway” source of power on the way to renewable energy from wind and solar.
Four LNG plants with a collective capacity of 62 million tonnes are currently under construction in the US with more planned – and Australian oil companies continue to trundle out expansion plans.
Yesterday, at the annual conference of the oil industry's top lobby group, APPEA, Woodside's chief executive, Peter Coleman, talked up plans for the Browse floating LNG development and Santos revealed it was pushing ahead with a floating LNG project on gas deposits in the northern waters of the Bonaparte Gulf.
Those expansion plans were offset by a warning from the local boss of US oil giant Chevron that the Australian LNG industry was losing its competitive edge. Roy Krzywosinski told The Australian Financial Review ahead of his talk at APPEA today that Australia could “no longer rely on strong commodity prices”.
The size of the emerging supply/demand LNG imbalance was detailed in the Department of Industry's publication, Resources and Energy Quarterly, which added the 121 million tonnes of Australian and US production to LNG from African and Russian projects to reveal that global capacity will reach 423 million tonnes by 2020 while import demand will lag at 368 million tonnes.
In theory, that forecast of supply exceeding demand points to a fall in LNG prices or, at best, stagnant prices for some time.
What might save LNG producers is that their sales contracts generally contain clauses which enshrine floor and ceiling prices to protect customers and suppliers from sudden shifts in the price of oil.
Investment banks will be well represented at Woodside's investor day, not just to get an update from the company but also to gauge the effects of the oil price on other LNG-exposed companies.
Citi listed “clarity on LNG contracts” as the top point on a list of issues it will watch during Woodside's presentations, especially given the potential for a dispute with a low-priced Chinese contract. The bank also expects guidance will highlight the strong LNG price and “price protection” from low oil prices.
UBS in its Woodside investor day preview expects a focus on cost cutting, the proposed Browse LNG project, an update on assets acquired from Apache Oil and LNG pricing.
Macquarie Bank will be looking for comments on a proposed toll-treating deal with Hess Corporation which is trying to develop its Equus gas discovery and Woodside's domestic gas sales strategy.
South32 makes its debut
South32, the BHP Billiton spin-off, lived up to its reputation as a love/hate stock when it debuted on Monday at a discount to its forecast price and then clawed back lost ground yesterday and today.
Early sellers were always expected because some BHP Billiton shareholders who received their one-for-one entitlement in South32 were never going to be happy with the higher risk profile of the new company.
What worries investors more comfortable with the collection of tier-one bulk commodity assets in BHP Billiton is South32's heavy exposure to aluminium, coal and manganese, along with an expectation of modest dividends during a period of low metal prices.
From an opening trade on Monday at $2.13, South32 sagged to a low of $2.01 before recovery to close its first day at $2.05. Yesterday, after the release of a flurry of optimistic broker notes the trend flipped around with the stock rising quickly to $2.34, and then up again in early trade today to $2.36 before easing back to around $2.26.
Brokers and investment banks, like South32 shareholders, have mixed views of the company. Macquarie Bank has the lowest 12-month price target for the stock at $2.40. JP Morgan is tops at $2.95, with Citi and Credit Suisse sitting at $2.50.