Why Woodside, Santos and Origin should be worried

Australia's major gas players are soon to find a lot more competition knocking on the door to Asia and with Australian costs on the higher end of the scale, they ought to be nervous.

Within the International Energy Agency’s World Energy Outlook are a few charts that suggest Woodside, Santos and Origin will find themselves with a lot more competition in the future in selling gas to Asia.

In case you were hiding under a rock, the United States now finds itself with a glut of gas thanks to breakthroughs in extracting gas and oil from shale rock formations. The end result is that the price of gas in that country has plummeted from $9 per mmBTU to now trade at about $3.50.

Companies like BHP-Billiton and Exxon-Mobil, who paid top dollar for small US shale gas companies, are now finding themselves in a state of shock as they scramble to find a way to recover the value of their investments. 

The problem for these companies is that in spite of all the talk of a gas boom in the US, gas demand is only expected to grow relatively slowly over the next two decades, at about 0.5 per cent per annum according to the IEA.

IEA forecast of gas demand under New Policies Scenario

Source: International Energy Agency (2012)

So in an effort to recover some of the money they’ve sunk into shale, China and India naturally capture the eye of BHP, Exxon etc. Not only are these markets growing rapidly but they also pay an incredible amount more than the $3.50 on offer in the US for gas.

The IEA chart below illustrates the premium that’s available to US shale gas producers from liquefying and exporting their gas to Japan (which is a proxy for the prices in Asia more generally). Right now the pure profit is $6.10 – more than twice the entire revenue (let alone profit) these producers are getting for their gas. This is expected to narrow to 2020 but it’s a lot more attractive than the cut-throat market in the US.

Indicative economics of LNG exports from the United States

Source: International Energy Agency (2012)

To date Australian LNG developers have had a cosy competitive environment for Asian customers. Indonesia and Malaysia’s gas supplies are dwindling. Russia and most of the Middle East, which have plenty of gas, are viewed with deep suspicion in terms of their reliability. This has then left Qatar, which has studiously refused to compete on price and has been happy to let Australia take a slice of the Asian market.

But private sector US suppliers aren’t likely to be as nice as Qatar. What’s more Asian customers will probably see US companies as suppliers with equivalent reliability and trustworthiness to that of Australia.

While the United States is almost irrationally concerned about energy supply security and there is strong resistance to allowing the export of gas overseas, companies like Exxon Mobil and other oil companies know how to influence things in Washington. 

In addition, what should also worry Australian gas exporters is that the US has vastly lower construction costs, particularly in the Gulf of Mexico states, than Australia.

The chart below prepared by Deutsche Bank’s John Hirjee illustrates the cost of the US gas liquefaction plant currently underway in red - Sabine Pass - relative to a range of other LNG projects constructed in the past and currently planned. Sabine Pass is about half the capital cost of Australian projects planned for Gladstone (QCLNG, GLNG, APLNG), and a third of the cost of several WA and NT projects (Wheatstone, Pluto-1, Gorgon, Sunrise, Prelude).

Gas liquefaction plant capital cost intensity

Source: Deutsche Bank (2012)

Lastly, for those engaged in coal seam methane in Australia there is an additional competitive disadvantage – these projects are purely gas and contain no oil. A number of US shale gas projects on the other hand have oil which is a premium product that acts to virtually cross-subsidise the extraction of gas. This chart from the IEA illustrates that the break-even price for gas from shale can be as low as zero if significant liquids are available and prices for oil by-products remain high.

Relationship between gas break-even price and liquid content of shale resource.

Source: International Energy Agency (2012)

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