Woodside's Flame Burns Bright

It was interesting to see some of the coverage of the opening of the new Chinese LNG import facility at Dapeng. Australian Prime Minister John Howard and Chinese Premier Wen Jiabao opened the enormous asset. The first of $25 billion of LNG shipments from the North-West Shelf arrived for the opening ceremony, and remember it has to be a pretty significant Chinese economic event for Premier Wen to turn up.

It's also interesting that you are seeing very similar talk from the Chinese about LNG to what we have seen in iron ore, and I feel that unfortunately for the Chinese, LNG prices are heading the same way as iron prices '” upwards.

Dapeng in its current form is on track to process more than 3.7 million tonnes of LNG this year, and already in their five-year plan, the Chinese see production ramping up to 12.7 million tonnes a year. This is just from one plant in one small area of China.

Across the delta from Dapeng, there are plans for a plant at Zhuahi, capable of handling 10 million tonnes a year. This province of Guandong alone is the home to 92 million people, so these massive plants are for the region’s needs. If it were a country, Guandong would be the world’s 16th-largest economy. By 2010 in the five-year plan, Guandong province will have increased capacity to handle another 19 million tonnes of LNG a year. It's worth remembering these are the plans of only a single province. China has plans for more than 16 new coastal LNG receiving terminals with up to 45 million tonnes per annum (MTPA) in import capacity. Although clearly not all will go to plan, it does show the importance of LNG for China going forward.

Here are just a few of the LNG plants planned by 2010 in China.

Remember much of China's gas reserves are in remote western areas, a long way from the growth areas on the coast. It's difficult to justify 3000–4000-kilometre pipelines costing $US3–4 billion to build, and get no real economic return from owning the pipelines. Therefore, I believe it is unlikely that domestic Chinese gas reserves will ever satisfy any great percentage of the country’s domestic energy demands.

The usual tricks

The Chinese are again trying to talk down the LNG price, saying potential new supply can come from Russia, the Middle East, and South Asia, and so prices would be coming back in the medium-term. However, even a Guandong government official recently agreed prices weren't coming back to the prices set in the Guandong deal four years ago.

The reality is that the Chinese are not the only buyers of LNG and the global LNG market will continue to grow rapidly regardless of what games the Chinese try to play. As strange as it sounds, countries like Spain are now significant customers of Woodside. Spain cannot risk relying on one area for gas supply, and I believe the uncertainty surrounding Russian gas supplies in recent months will only further strengthen global LNG demand from new areas such as Australia and Papua New Guinea.

Some might say Australia has locked in poor prices for 20 years, but in my view it was clearly a key to break into the Chinese market, and let’s not forget how much lower commodity prices were four years ago; since then, iron ore prices have gone up 175%, crude oil 195%, copper 361%, and zinc 302%. So while Woodside and the North-West Shelf partners are being criticised for selling the LNG too cheaply, the environment four years ago was clearly very different for commodities.

The Chinese also know that they have to lower their reliance on coal-fired power stations in an attempt to reduce their terrible pollution problems. LNG and nuclear energy are the obvious solutions. LNG is truly a clean energy solution, and although people can talk about alternative "clean energy" solutions such as solar, the reality is that LNG is the best medium- term clean energy solution that will have far less controversy surrounding it near term than nuclear power.

That is not criticising uranium as an alternative energy source, but in much the same way as uranium prices have played some catch up after the enormous run in the oil price in recent years, you can tell the LNG-crude oil pairs trade is about to narrow significantly in coming years.

Australia initially had a fledgling LNG industry in the late 1980s and needed long-term supply agreements with the Japanese, so did not have any form of pricing power. Times have changed. Woodside chief executive Don Voelte, in almost every presentation, says that when long-term LNG contracts expire they will be renewed at significantly higher prices or not at all. He said recently that Woodside would do no more deals with the Chinese except at market rates, and they would be nowhere near the rate of the initial Guandong contract.

A familiar advantage

Australian iron ore has an enormous comparative advantage in freight differentials into the Asian markets (only one week’s shipping from Karratha to Dapeng). I believe Australian LNG has a similar comparative freight advantage to Australian iron ore, and I like the way Don Voelte is playing hardball. Woodside has unique assets for an Australian resource company, and it will be a big change for it to be paid the rates it should be receiving for those assets.

In three years Woodside will be an LNG stock, not an oil stock, and while the abacus pushers at big broker firms concentrate on how the oil price is affecting short-term earnings per share they are missing the point. By 2015 Woodside could be the second-largest LNG company in the world after its 35% shareholder Shell, which has huge Russian developments such as Sakhalin Island.

So why I am not worried about LNG over-supply? Because most of the data you see in near-term global LNG demand forecasts assumes very little demand from the US, where environmental concerns might make it difficult to build the necessary import terminals. However, once Americans realise that Canada won't be able to supply them with as much gas as they have had for many years, it will be panic stations all around and there will be a frenzy of building LNG receiving terminals. You can also see that the US gas market is getting tighter and tighter, with Andarko Petroleum announcing a three-way $US20 billion merger deal last week. These mega mergers aren't going ahead because these companies think US gas prices are going down near term.

I also find it interesting that the South Korean shipyards, which build the specialist LNG tankers for $US350 million a pop, are reporting full order books for the next five years.

If you think America’s LNG demand is never going to happen, look at the link below for the first new LNG receiving terminal in Louisiana being built by Sempra Energy. This will be up and running in 2008, with capacity of 1.6 billion cubic feet of gas per day, but it is the first step in persuading Americans about why they should be involved in LNG.

Louisiana LNG terminal link

Woodside has bounced 15% off the recent lows of the trading correction, yet even at current prices it remains a strong long-term buy. It remains a core member of our Magnificent Seven recommended list, and will remain a long-term outperformer of the index. I would love to see BHP Billiton take out Shell and bid for Woodside and, as I've written before, merge BHP's petroleum assets with Woodside's LNG assets and spin it off as the most politically stable oil and gas stock in the world.

Such a spin-off would be a top 10 Australian company by market cap, and would command a premium for its scale, political stability, and long-term growth profile. It would also attract a premium because it would have all the attributes superannuants seek. Anyhow, that's just my idea, and a stand alone Woodside remains a strong investment.

While the May/June trading correction was deeper in terms of decline from absolute top to absolute bottom than the October 2005 trading correction, I just can't get out of my head how similar both of them are.

If the October 2005 trading correction is any guide '” and you know I think it’s an excellent one, albeit a slightly small scale one '” then what you can expect is for the ASX 200 to retest the old highs around 5400 over the next few months, and then pause for another consolidation phase.

I'm not sure that can happen so quickly, but if the history of Australian trading corrections is any guide, it can happen.

There's plenty of pessimism and caution around at the moment, but the ASX 200 has recovered 350 points off its lows, and leading companies such as BHP are now trading closer to their highs than lows. With macro-economic and interest rate fears easing, and a strong reporting, dividend, and capital management season coming from the vast bulk of large-cap Australia, I suspect the market as a whole could surprise on the upside in the short-term, and new-year money and dividend reinvestment will be forced into the market.