Shale-gas is igniting

Australia’s shale-gas rush has reached ignition point, with Santos leading the race.

PORTFOLIO POINT: A string of shale-gas discoveries and developments are under way across Australia, potentially providing a good cash flow to investors in the right companies.

The rush to develop a shale-gas industry in Australia, and revolutionise the country’s entire energy sector, has accelerated with more successful tests in South Australia and WA along with plans to start first commercial production of the unconventional gas in a matter of weeks.

Santos, the leading oil and gas producer in the Cooper Basin of northern SA, quietly confirmed its intention to lead the shale-gas race by announcing a significant discovery of the previously ignored gas in its original conventional gasfield, Moomba Big Lake.

Gas flows from tapping beds of tightly-packed shale rock, that were first drilled in the 1960s but never tested, have been so strong from the Moomba No.191 well that it is being connected to the nearby pipeline system.

By October, Santos customers in Adelaide, and other east coast markets, will be the first in Australia to cook with gas from the new source, signalling Australia’s official entry into a business which has revolutionised the US energy sector – for better and worse.

In WA, an equally significant test occurred last week when another oil company, AWE, recorded near-commercial gas flows from testing its Senecio No.2 well near Dongara in a big geological structure known as the Perth Basin.

Success for Santos and AWE means they now join Beach Energy and Senex Energy in successfully testing for shale gas, with other explorers close behind, including Icon Energy, Drillsearch, Buru Energy, Norwest Energy and New Standard Energy.

Like all revolutions, shale gas will produce as many winners as losers, while also generating environmental controversy because of the rock fracturing (fraccing) required to liberate gas trapped in shales and other types of tight rock.

The potential for environmental protests of the same sort which have dogged the coal-seam gas industry is limited in the shale gas industry because shale gas is generally found much deeper (below the water table), and in thinly-populated areas.

For investors, that means keeping an eye on the shale leaders in areas such as the Cooper, Perth and Canning Basins, where conditions are believed to be best for discoveries and developments, with the Cooper explorers in the best position to generate early revenue from shale gas production.

Picking winners in the shale gas race has not been easy, so far, as can be seen by looking back at the last story I wrote about the industry on March 5. Since then not much has happened in the overall oil and gas sector, with the oil price slipping from around $US125 a barrel to $US112/bbl.

The lower oil price coincided with the mid-year equities sell-off across global markets, meaning that only one of the six stocks named has risen, just. Norwest is up from 5.8c to 6.8c.

With equity markets showing greater stability, though for how long is anybody’s guess, coupled with the successful flows (and flaring) of shale gas in SA and WA, the ground work is being laid for greater scrutiny of an embryonic, but deeply significant, new industry.

Interest will be heightened by plans to drill at least 30 shale-specific wells over the next 18 months, and for some to join Santos in connecting their discoveries to existing pipelines.

While early movers will prove to be shale gas winners, gas customers will also win because they will have access to a new source of energy which will, over time, drive down energy prices across the country in the same way shale gas has in the US, where gas prices have crashed by 80%.

Gas (and oil) production from shale has been so prolific that it has not only slashed US gas prices but also boosted confidence that the country could achieve its goal of energy independence.

Losers from shale gas include late arrivals at the party, in much the same way BHP Billiton overpaid for US shale gas assets, only to be forced to book big balance sheet write-offs. Rival energy sources, including coal and renewables such as wind and solar, could face stiff competition.

Directly transferring the US experience to Australia might be unwise because other countries have struggled to find the same volumes of gas (and oil) as American explorers have in thick and rich beds of shale.

But, what happened last week was a reminder that Australia’s geology, as predicted by the US Energy Department, shows striking similarities to that of the US, with gas-rich shales located in the same broad structures as conventional gas.

Differences will determine the pace at which Australia’s shale gas industry develops, especially the easy access to pipeline systems in the US – a reason why the Cooper Basin and Perth Basin explorers have the best opportunity to sell what they discover.

Santos, which has kept its shale gas search under wraps for the past few years, made its dramatic entry with the release of its annual profit announcement. As well as reporting a 27% increase in sales revenue, and a 20% increase in net profit, the company casually announced the Moomba No.191 success, and plans to accelerate its shale gas hunt.

“It’s only now that we’ve really got our eye in and we’ll really chase hard,” the company’s manger of eastern Australian business, James Baulderstone, said in a media interview. “There’s no doubt we will spend more than we originally were planning over the last few years.”

The reason shale gas exploration takes longer than conventional gas exploration is that vertical wells, those drilled directly into a target, will only ever produce limited flows of gas because any “fraccing” is limited to the immediate area around the drill pipe.

Horizontal drilling, in which a drill pipe is “turned” underground to follow the shale bed, increases exposure to the trapped gas and generates much stronger gas flows. Few Australian tests have yet included horizontal drilling.

Over the next 18 months the news flow from the shale gas industry will expand sharply as the number of wells drilled increases, horizontal drilling techniques increase access to gas deposits, and a number of companies start producing gas from shale.

The Santos drilling program, which started quietly as long ago as 2006 with early fraccing and coring in old conventional gas wells, now includes “shale specific” wells, to be followed next year by horizontal drilling. “Multiple horizontal wells” will be drilled from next year, with full-scale shale gas production from 2015.

Beach, which has exposure to a number of shale gas projects, including being a minority shareholder in the successful Santos well, Moomba No.191, is planning to drill two vertical shale-specific wells in the current quarter and two more in the December quarter. It will also drill its first horizontal shale test well, with another three vertical and three horizontal wells planned in the first half of next year.

Senex is planning as 12-well program in its unconventional gas search. AWE has a three-well program pencilled in for the Perth Basin, and Norwest Energy is currently running trials on its Arrowsmith shale-gas well.

Major oil producers, and customers, are slowly signing up for the Australian phase of an industry which is spreading worldwide, and which promises to significantly change the global energy business.

In Australia, the US oil major ConocoPhillips is a partner in the Canning Basin gas hunt with New Standard Energy in north-west WA, while the big aluminium producer (and major gas consumer) Alcoa, is partnering Buru Energy’s Canning Basin search, along with the Japanese trading house, Mitsubishi. BG Group, one of the LNG-project developers in Queensland, has formed an exploration alliance with Drillsearch on its Cooper Basin tenements.

Right now, with exploration news building and first commercial production just weeks away, it is difficult to identify shale gas winners. For Santos, shale gas is an interesting but small addition to its overall portfolio. For Beach and AWE it could be a significant additional source of revenue. For smaller explorers, success could be a company-making experience.

Best exposure to the emerging shale gas industry is probably through investing in a mix of participants: Santos for size and stability; Beach, AWE and Senex for possible strong growth; and Drillsearch, Icon and Norwest for the potential of rapid growth.

Whatever the preferred entry, shale gas is an industry which has arrived in Australia and it will change the country’s energy sector.