Set your sights on gas giants

With Australia's production of LNG increasing rapidly as prices rise, David Potts examines the stocks on offer to predict which will give the most bang for your buck.

With Australia's production of LNG increasing rapidly as prices rise, David Potts examines the stocks on offer to predict which will give the most bang for your buck.

Petrol prices are on the way up and converting the car to gas won't help because its price is rising too.

Well, it had better: otherwise the $175 billion being spent developing new deposits of gas everywhere from the North West Shelf to coal seams along the east coast will go straight down the, er, pipeline.

At the risk of sounding indelicate, Australia's production of gas is expected to quadruple in 10 years.

Oil passed $100 a barrel even before the jitters over Iran's nuclear intentions and in an energy crisis gas prices will be on the boil too.

Gas is closely connected to the price of oil, partly the result of being produced almost as a by-product but more because each can replace the other as a fuel.

One thing's for sure: Liquefied natural gas is Australia's next big thing and has the lion's share of projects in the once-in-a-lifetime investment boom that is under way.

Gas will not be as dependent on China as our other mining exports are. The biggest buyer of our North West Shelf LNG, for instance, is Japan, which is likely to become an even bigger customer as it moves from nuclear to gas and other energy sources in the wake of the meltdown at Fukushima.

So what's the best way to get a bang, as it were, out of a buck from gas?

The good oil

The trick is to get both the stock and the price right, which is easier said than done - but here goes.

Gas stocks cover the whole spectrum, from explorers through producers to energy retailers. Unlike oil, there's no benchmark price or, for that matter, a spot market to speak of.

Gas contracts go for 20 years or 30 years, so the spot price doesn't mean much. Unless, that is, you signed a contract at a ridiculously cheap price, just as China did when the North West Shelf consortium was desperate for sales.

Then there's the US, where, strange to say, gas prices have been falling despite the oil price soaring above $100 a barrel. That suggests a serious gas glut but those who know these things, by which I mean not me, say it's due to an explosion - oops, wrong word, perhaps - of production thanks to the development of shale gas.

Gas is a cheaper alternative to oil and more environmentally friendly, though it might be best not to get into that.

Although it's clean and emits far less carbon dioxide than oil does, extracting it can wreak havoc on neighbouring farms and presumably our food. Did you see those kitchen taps on television spewing gas when they're turned on? And it's not as if gas is a renewable source of energy - it's a fossil fuel, after all.

Liquefying gas to form LNG, which takes up 1/600th of the volume - making it easy to be shipped - has been a godsend for Australia. So far it's only been used for the export of natural, which is basically methane, as distinct from shale or coal seam gas.

Fingers crossed, Australia will be producing more gas just as its price is rising, a bonanza matched only by the booms in iron ore and coal.

As it is, exports of LNG are already worth about one-third of those of iron ore, and that's with only two plants operating - the North West Shelf and Darwin.

The point is that the biggest and most lucrative markets for LNG are right on our doorstep.

Although the gas price in the US is only about $2.50 a gigajoule, the price is $14 in Japan, our biggest market. Even in recession-bound Europe, the gas price is closer to $9.

Also in our favour is that in Asia it's tied to the oil price, and you know where that is going.

"We're lucky we have the gas resources here and close to Asia," a leading energy analyst, Gordon Ramsay, at UBS says.

He says an "unbelievably huge transformation" is under way and he points out that the aptly named $15 billion Gorgon project in 2015-16 will produce in its first six months almost as much as the North West Shelf is now.

The trouble is, the gas boom might be too huge. "I worry about labour shortages in four areas: heavy lift crane operators, welders, electricians and pipe fitters," Ramsay says. "These projects are coming on stream at the same time."

The market worries too. The key gas stocks have been marked down because it frets that the new projects won't be on time or on budget.

In the pipeline

This is most obvious with the premier LNG stock, Woodside Petroleum (WPL), which put the North West Shelf on the map but owns just one-sixth of the consortium of producers.

Woodside itself has the oil giant Shell owning slightly less than 25 per cent of its shares.

Far from making a takeover bid, as normally follows in the energy industry, Shell turns out to be a seller and has promised not to do anything before November, creating what brokers call a stock overhang.

"It will get out at some point but it's not too much of an issue," the director of fund manager and shares tip sheet Fat Prophets, Angus Geddes, says.

Rather, the share price's problem lies with Pluto. Not the former planet but the almost-as-distant Karratha, where Woodside has been spending $15 billion to develop a new gas field for LNG production.

"It's been marked down on cost blowouts associated with Pluto," Geddes says. "But once that kicks into production, the stock will be re-rated."

Pluto is scheduled to start this month but when it might hit full production is anybody's guess.

Mind you, the return on Pluto is also lower than hoped - after all, it has cost 24 per cent more than expected and been delayed by a year.

This is strictly a long-term stock, though perhaps not as extended as a gas contract. If it can expand Pluto and bring on the environmentally challenged Browse and Sunrise fields, watch the price go.

By the same token, Woodside is conspicuously absent from the booming coal seam and shale gas developments in Queensland.

Still, Ramsay says it's going cheap at anything less than $40 and most analysts agree. A senior equities analyst at Morningstar, Mark Taylor, says $60 is more like it. Woodside was $36.30 on Friday.

As such a huge exporter of minerals, it's easy to forget that BHP Billiton (BHP) is also Australia's biggest energy company and is Woodside's only Australian partner in the North West Shelf.

And it's moving heavily into gas.

What's got the market fired up, so to speak, is its push into shale gas in the US after spending $20 billion, with another $50 billion to come, buying Petrohawk.

Curiously, just as Woodside has no unconventional gas ventures anywhere, BHP has stayed away from them in Australia.

Because the US push is a potential game-changer for BHP, the market is naturally nervous about it.

"It paid a good" - as in high - "price and it's late to the party," Geddes says. "But it has to have a presence [there]."

That makes the stock a potential buying opportunity, though you would want to be sure China, its major market, doesn't fall into a heap any time soon.

But then, if it did, "we'll all be rooned," said Hanrahan, as the poem goes. Besides, China wants to use more gas.

Fuel for thought

All gas pipelines lead to Moomba, which is owned by Santos (STO).

It supplies almost one-quarter of eastern Australia's natural gas from the Cooper Basin in South Australia and the nearby Carnarvon Basin.

While several other companies are also drilling away in the Cooper Basin, Santos "is in the unique position of controlling the infrastructure", Ramsay says. "It's at Moomba where the gas pipelines go to Queensland and NSW."

Santos is building the world's first large-scale commercial project to convert coal seam gas to LNG at Gladstone in Queensland and is active in Papua New Guinea, south-east Asia and north Africa.

Best of all, it's a potential takeover target. And if you hadn't noticed, gas prices are rising along the east coast.

Ramsay values the stock, which closed at $13.68, at $17.55.

And not to be overlooked is Santos's Cooper Basin partner AGL Energy (AGK).

Considering Oil Search (OSH) has a crucial LNG joint venture with energy giant ExxonMobil in Papua New Guinea - where there were two prime ministers for a while, like we had in a way, too - it's hardly surprising its share price has been going nowhere.

"As we get closer to the plant being commissioned, Oil Search will get re-rated," Geddes says. "It's just a matter of time."

Oil Search has gained 12 per cent so far this year, despite an expensive drilling program.

And while Woodside's earnings will leap next year thanks to Pluto, the spoils for Oil Search (and Santos) aren't due until 2014-15.

The stock is valued at $7.83 by research group and fund manager Lincoln. RBS Morgans has a target price of $8.20, compared with Friday's close of $7.30.

With a foot in both camps, selling gas and electricity, Origin Energy (ORG) is a big winner from rising energy costs. Origin can deliver gas from the well to your home.

Its main challenge is getting higher gas prices to flow through to power prices - but no doubt it'll manage.

"It's a top company with very little debt and, I would say, the best management team of any resource company in Australia," says analyst Peter Strachan, of tip sheet StockAnalysis, who values the stock, which closed at $13.49, between $16 and $17.

Somewhat more speculative, Beach Energy (BPT) was in and out of coal seam gas well before the rest of us knew what that was, let alone before it became an environmental issue, the fracturing process used to extract it thought to contaminate water and cause salt to rise to the surface.

Beach Energy has ventures all over the place and the market is worried about how it will finance an extra $116 million of investment this year.

The smaller gas explorers have already been caught up in the market's euphoria for energy stocks.

"They've run quite hard," the chief executive of Lincoln, Elio D'Amato, says. "You need to wait for a comeback in price, or plunge in now and ride the momentum, but make sure you use a stop-loss."

For a real punt, you could look at shale gas explorers New Standard Energy (NSE) and its Canning Basin neighbour, Buru Energy (BRU), both up almost 60 per cent since the start of the year.

They have big energy partners and are rated buys by Fat Prophets and StockAnalysis.

Or there's Cooper Energy (COE), which, having just gone through an arm wrestle for control, has jumped 50 per cent to 52? so far this year and should get to 67?, Strachan says.

Drilling down

A canny way to ride the gas boom without a lot of the risk is to buy stocks in the tugboats that service the offshore rigs.

These include Mermaid Marine Australia (MRM), Miclyn Express Offshore (MIO) and Neptune Marine Services (NMS).

The most undervalued of these are Mermaid (worth $3.70) and Miclyn (worth $2.27), D'Amato says.

Or how about the drill-owning companies such as WorleyParsons (WOR), the biggest listed engineer and project manager? Another is Ausdrill (ASL), which last week won a $13 million contract to supply drill rigs for extracting coal seam gas in Queensland.

Other drill suppliers are Boart Longyear (BLY), Imdex (IMD), Monadelphous (MND) and Swick Mining Services (SWK).

Off the North West Shelf

The largest engineering project since the Snowy Mountains scheme

World's third-biggest LNG project

Accounts for 1 per cent of GDP

Pays more than $1 billion a year in royalties and taxes

Only one-third of estimated 934 billion cubic metres of reserves produced so far

Supplies about 40 per cent of Australia's oil and gas

Source: The Investing Times

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles