Shale set to blaze

PORTFOLIO POINT: Shale gas is a global energy game-changer, and the exploration phase underway in Australia will last for at least five years (and perhaps a decade).

Picking winners in the resources sector on the Australian stockmarket over the past three months has not been easy, but investors who follow emerging shale gas explorers have fared better than expected, with the promise of more to come.

Since March 5, the collective value of six shale gas explorers identified as worth following in a Minefield column on Eureka Report has risen by a modest 2.5%.

Small as that increase may seem, it is better than the 5% fall posted by the top 200 stocks, or the 10.7% fall in the energy index which incorporates all oil and gas stocks.

The lion’s share of the rise posted by the six shale gas stocks came from Buru Energy (BRU), which rose by 36%, from $2.33 to recent trades around $3.17. Norwest Energy (NWE) was the other stock to rise, by a modest 3% to 6c. Three of the other four – Beach (BPT), Senex (SXY) and AWE (AWE) – fell, while New Standard (NSE) was steady.

All six remain stocks to watch as the Australian shale gas hunt (and its associated search in other so-called “tight rocks”) warms up, with important drilling and downhole testing scheduled for the next six-to-12 months.

Many variables affect the stocks mentioned, but a common thread linking them is participation in the hunt for unconventional gas in Australia, a commodity which promises to revolutionise our energy industry, as it has done in the US.

A second issue connecting the six stocks is their focus on deeply embedded, gas-rich shale (and gas in other types of “tight” rocks), which is significantly different from the shallow, coal seam gas that has generated widespread negative publicity, and which might have been a factor in the failure of Dart Energy to float its international operations on the Singapore stock exchange earlier this week.

Understanding the difference between coal seam gas and shale gas is a first step for would-be investors in the shale sector. Other important points include:

• Recognising the importance of liquids, such as oil and condensate (a light crude oil) in some shale gas deposits, which can significantly enhance their value.
• Picking the right location for discovery, with close proximity to infrastructure (such as pipelines) and a big, nearby, energy-hungry market.
• Knowing that Australia’s shale gas window is just opening, while also appreciating that the window can slam shut if explorers are too successful (as they have been in the US, which is “enjoying” a gas glut).

The size of that glut, and how quickly it can arrive, was highlighted in a presentation by Beach chief executive Reg Nelson at a conference last week in Broken Hill.

He showed how in the year 2000, the US Energy Information Administration forecast a gas market out to the year 2020 dominated by conventional gas, with minor contributions from shale gas and other tight gas.

A combination of new technologies (horizontal drilling and rock-fracturing, or 'fracking') has turned that forecast upside-down, with shale gas already accounting for 23% of total US gas production, and forecast to hit 49% in 2035. Other tight gas has a 26% market share, falling to 21% in 2035 when the combination will account for 70% of gas output, which begs the following question: when does the unconventional become conventional?

The six shale gas stocks mentioned in March have the advantage of being early movers in what is essentially the early-stage “land grab” phase of a boom-in-waiting.

• Beach has been the sector leader so far, having already “booked” or added to its gas inventory a massive 2 trillion cubic feet in provisional reserves from its first two shale-specific holes in its Cooper Basin tenements in South Australia. The company is confident of finding much more gas. Senex is working in the same region of central Australia.

• Buru is the junior leading the hunt in the Canning Basin of WA. The company has made a conventional oil discovery, which is starting to generate cash flow, and has formed alliances with major companies (Mitsubishi and Alcoa) to fund much of its work for oil and gas in a variety of settings. New Standard is working in the same region and has a close working and cross-shareholding relationship with Buru.

• AWE and Norwest are the leaders in the Perth Basin. Prime targets for shale gas testing have been identified and a special rig is expected to be on site later this month.

Some of the shale gas discovered by Buru, Beach and the others contains a liquids boost, or is sitting atop an existing pipeline system, and all of the gas is located in areas with low population density, which will minimise land-use disputes. The companies are also exploring far below the water table, minimising potential water pollution issues.

Over the past few weeks, a series of events has revived interest in the Australian shale-gas hunt. First was a comment from the Resources Minister, Martin Ferguson, at the annual conference of the Australian Petroleum Production and Exploration Association in Adelaide, who said that shale gas could “double the country’s gas resource”.

David Knox, chief executive of Santos, was more cautious, noting that there was a future potential for an Australian gas glut, saying that: “North America is a different market to us, but it’s a really fine example of what could, over the longer term, happen in Australia”.

Last week, Nelson chimed in with his Broken Hill presentation, in which he explained the technical aspects of his company’s work in the Cooper Basin of central Australia, the region most likely to produce the first commercial shale gas.

In a table headed “Shale gas option – key technical attributes” (see above slide), Nelson listed four key parameters for gas in the ground: shale thickness, lateral continuity (width), organic content (from the gas formation process) and maturity (whether the gas forming process is complete).

Similarly, Eric Streitberg of Buru is encouraged by the thickness of the shale beds being explored in WA’s Canning Basin, measuring in part several kilometres of potential gas-bearing rocks that have never been targeted for detailed exploration.

Minister Ferguson, in his talk at the APPEA conference, acknowledged that exploration for shale gas had just started in Australia. Indeed, just recently industry analysts doubled the value of anticipated shale gas exploration in Australia over the next three years.

For investors, the “newness” of shale gas exploration requires an understanding of what is effectively a new branch of the petroleum industry which did not exist a decade ago, but which is causing sweeping changes across the world (as predicted two years ago in the definitive analysis of shale gas by a US academic).

Back in May 2010, Amy Myers Jaffe, a fellow in energy studies at Rice University’s James A Baker institute, wrote in the Wall Street Journal that “shale gas will revolutionise the (oil) industry, and change the world in coming decades”.

It was a big call, but everything that Jaffe forecast has fallen into place, including:

• Changing global geopolitics;
• A slowing in the transition to renewable energy; and
• Preventing the formation of new energy cartels such as OPEC.

The first geopolitical change was the takeover of the assets of the Spanish oil giant, Repsol, in Argentina. The Argentinian government was keen to get control of Repsol’s shale gas discoveries, making it the world’s first act of shale-gas nationalisation – a trend to watch in the future.

Abundant shale gas in the US and the first discoveries in Europe, China and South America are driving down energy prices, making renewables less competitive without increased government subsidies.

“The shale boom also is likely to upend the economics of renewable energy,” Jaffe wrote. “It may be a lot harder to persuade people to adopt green power that needs heavy subsidies when there’s cheap, plentiful fuel out there that’s a lot cleaner than coal, even if gas isn’t as politically popular as wind and solar.”

While shale gas is still in its infancy in Australia, relative to the game-changing events which are revitalising the US economy, this new energy source could eventually have the same “boom/bust” impact on the Australian economy.

That is, we could see an initial boom, as explorers chase resources, followed by a bust which, ironically, will deliver a boon to gas users in the form of cheaper power.

Knowing the timing of the unstoppable process now getting underway is impossible, but it would be reasonable to assume that the excitement of the exploration and discovery phase will last for at least five years, and perhaps a decade.

Maturity will come as production rises and producers seek ways to “monetise” their discoveries, either by selling pipeline gas into major populations centres, or by seeking export opportunities via LNG developments.

If sufficient markets cannot be found, and that’s a near-certainty given predictions that Australia could contain as much unconventional gas as the US, then a glut will follow and energy prices will crash, triggering an interesting political debate about the size of subsidies required by renewables.

If, as has happened in the US, the Australian gas price falls sharply over the next decade, it will drag down the price of all forms of energy, including coal and renewables.

As Jaffe wrote: “We’ve always known the potential of shale, we just didn’t have the technology to get it at a low enough cost.”

Now we do, and that’s why shale gas is a global game-changer.