There are currently six liquefied natural gas (“LNG”) projects under construction in Australia. According to the International Energy Agency, all of these projects would lose money at the current oil price of USD47/barrel(“bbl”), and most would struggle even with oil at USD60/bbl. I suspect that oil would have to approach USD100/bbl again to provide an acceptable return on capital invested.

The outlook for the LNG is poor. Global LNG supply is rapidly increasing, while demand growth is slowing. This means that even if the oil price rises, LNG prices may not follow. Aside from a large increase in LNG supply from Australia; Canada and PNG will also add more supply. And the first LNG exports from the US are on the horizon.

New, large natural gas discoveries will also put pressure on prices over the longer term. Last month Italian gas company Eni announced the discovery of a “supergiant” gas field off the coast of Egypt. They plan to fast track development.

At a cost of AUD200 billion, these six LNG projects are Australia’s largest infrastructure investment. They were planned at a time when the oil price was heading to USD100bbl and the sky was the limit for commodity prices. There are also three more projects in the pipeline and three projects already in production.

LNG projects usually have long term contracts with end users. This is necessary to facilitate financing of such capital intensive projects. However, the contracts are linked to the oil price; Brent crude in the case of Asian markets. Brent is currently USD46 per barrel, down from USD99 per barrel a year ago. The same fall will have happened to contracted LNG prices. Spot LNG prices in Asian are currently in the USD7-8MMBtu (“million British Thermal Units”), down from around USD20MMBtu in early 2014. Even with the Australian dollar at USD0.71, these prices are low.

Most Australian projects use conventional natural gas as a feedstock. However most of these gas basins are located offshore, which adds a further layer of complexity and cost. The Queensland projects use coal seam gas (coal bed methane) as a feedstock. This has its own set of issues. In particular, uncertainty about reserves, and environmental resistance to the ever increasing number of wells.

Finally, an example of the financial state of play of the sector: Santos Limited (ASX:STO). The company has a 30% share of the Queensland GLNG project costing USD18.5 billion. This company has a market capitalisation of  AUD4.7 billion at the time of writing, and debt of AUD8.8 billion at June 30 2015. Its main sales income is from natural gas and LNG from two existing projects in Australia and PNG. Profit for the first half of 2015, after tax, was AUD37 million on revenue of AUD1.6 billion. Enough said.

Conclusion

Australian LNG is a risky investment space. It is also risky for some industry executives, just ask sacked Santos CEO David Knox. One of the reasons for project underperformance is that Australia is a very high cost economy. LNG projects in PNG, on the other hand, look much more viable.

 

The three main Australian players are Woodside Petroleum Limited (ASX:WPL), Origin Energy Limited (ASX:ORG), and Santos.

21 September 2015 Commodities