Why is Stokes on the gas train?

The media mogul has made an unexpected move into LNG.

Summary: Diversification in investing is always key, and so is recognising an opportunity. Media mogul Kerry Stokes, majority owner in the Seven Group, has accomplished both by swooping on oil and gas producer Nexus Energy. His key motivation is to leverage Nexus’ gas production on the east coast of Australia and to monetise the company’s holding in another promising project.
Key take-out: The entry of Stokes into the gas business is an encouraging pointer to opportunities in the sector, particularly from stocks with gas in the ground.
Key beneficiaries: General investors. Category: Commodities.

Why has the media and industrial equipment billionaire, Kerry Stokes, taken a plunge into liquefied natural gas?

The official answer provided by his son Ryan to the media earlier in the week is that the Stokes family empire is looking for a ‘third arm’. Citing the Wesfarmers' conglomerate model as a structure to be admired the Stokes camp has suggested that someday the diversified Seven group might also become a major Australian conglomerate and a move into commodities fits a longer-term agenda.

Which is all very well … but a more immediate answer is that he has spotted an undervalued opportunity in the financially distressed Nexus Energy that will eventually generate a handsome profit for the Seven Group, in which he is the major shareholder.

A rider to that answer is that Seven can provide the firepower, estimated to be around $400 million, to make the plunge into Nexus and help repair the business.

Not many investors have either the cash or the high-level advice Stokes is getting from his in-house energy expert, Don Voelte, a former chief executive of Woodside Petroleum and a man who has made earlier fortunes in his time as an independent oil industry consultant in the US.

But what most investors can do is analyse the Seven/Nexus deal to appreciate that the oil and gas sector is not homogenous. It is made up of many moving parts, with some moving in opposite directions.

In effect, Stokes is playing a gas game not an oil game. That’s what other investors can also play by focussing on stocks with exposure to gas reserves capable of being developed and delivered to the energy hungry markets along Australia’s east coast.

The Cooper Basin of South Australia is the prime starting position for retail investors, because that’s where you will find stocks such as Santos, Beach, Drillsearch and Senex. These companies have gas in the ground, more waiting to be developed, and much more waiting to be discovered as technology enables access to tightly packed reservoirs.

Getting into gas is precisely what Stokes is doing by rescuing Nexus with a financial package that will leave him with a series of profit-making stages and/or exit points (see Santos’ cash pipeline).

The first stage is to get Nexus’ sole cash-generating asset, the Longtom gasfield off the Gippsland coast of Victoria, back to full production to meet a revised gas sales agreement with Santos, which markets the gas in eastern Australia.

Production at Longtom was halted on February 21 when an electrical fault forced the shutdown of the facility. The shutdown occurred at what can only be described as a dreadful time for the company given its high debt levels and failure to attract high-priced bids for its 15% stake in the big Crux gasfield off WA’s Kimberley coast.

For Stokes, and the funds he has at his disposal via Seven, the first win is Longtom. It is a gasfield feeding into an under-supplied gas market along the east coast where prices are highly likely to rise substantially as the gas deficit widens, thanks to lack of new developments and demand from three Queensland LNG projects.

In time there is a risk that industrial and residential gas customers in Sydney and Melbourne will be paying a gas price based on LNG prices which, essentially, means paying a price determined by what gas buyers in Tokyo are prepared to pay.

Once Longtom is back online and Nexus has repaired its balance sheet by retiring an alarming assortment of debts that include bonds, notes and conventional bank debt, the focus can shift to generating value in Crux, a potentially world-class gasfield – but one without a firm development timetable.

In theory, and based on previous dealing in the Crux ownership structure, the 15% Nexus owns could be worth more than $500 million if someone is prepared to pay that amount. This is a critical consideration given the opening remarks in this story about the oil price possibly falling in the future. (See Oil: The big drop ahead)

Monetising the 15% in Crux, and possibly in another remote gas project off the WA coast called Echuca Shoals, will be a priority for Seven and Voelte.

Voelte might be able to generate value by enticing the majority owner of Crux, Royal Dutch Shell, to add Nexus’s 15% to its existing 82%, or by enticing another minority shareholder, Japan’s Osaka Gas, to lift its 3% to 18%.

Deal-making skills will be critical with Crux because Shell is trimming back its higher-risk projects and selling down its exposure to high-cost Australia.

An Asian-based buyer for all of Crux is a more likely outcome and a deal which is well within the skillset of Voelte, who has an intimate understanding of LNG. He correctly predicted the gas-shortfall crisis about to hit Queensland’s coal-seam fed projects and the slow start-up of US LNG exports, which are being delayed by complex government regulations.

So, for Stokes, the value generation points with his entrepreneurial entry into oil and gas start with Longtom and the ability to extract higher gas prices from east coast customers, and then move along to monetising the minority Crux stake.

For investors, the entry of Stokes into the gas business is an encouraging pointer to opportunities in the sector, particularly from stocks with gas in the ground that can be delivered to east coast markets.

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