Heads in the Sand on LNG Economics?

Heads in the Sand on LNG Economics?

One of the issues attracting media and analyst commentary recently is the potential impact of American shale gas exports to the economics of Australia’s large LNG projects.

The theme of many of the comments is that there is no cause for alarm, at least for the time being. Some of the reasons advanced include: the reluctance of US policymakers to permit exports; the time taken to ramp up supply if the US does export; and the fact that LNG contracts tend to be linked to oil, rather than gas prices.

Our view is less sanguine. None of these arguments carries a lot of weight in our opinion, and we expect that the likely future pressure on energy prices, combined with the cost blowouts currently being reported for the big Australian LNG projects, combine to present a very real concern for Australia’s large energy companies.

Our main concern with the “no cause for alarm” arguments is that they are too narrowly framed, and don’t address the interconnected nature of world energy markets. Some of our particular issues include:

· Even if America does not export in volume, moving from being an importer to being self-sufficient means the energy that would otherwise have been imported is added to the supply looking for a home on global markets;
· It is rational for a nation with surplus energy to export the surplus. While American industry may prefer the low domestic energy prices that would result from restricting exports, this vested interest is unlikely to stand up indefinitely to objective scrutiny;
· It may well take many years to develop the infrastructure needed to deliver US energy into global markets. However, Australia’s large LNG projects are very expensive, long-term investments. Their economics rely on returns that will be earned many years into the future;
· America is not the only country in which advances in hydraulic fracturing technology will have an impact: China, Russia, Canada, and probably others, also have large reserves which can add to global supply;
· In the long run, different forms of energy are substitutes for one another. As gas becomes a larger part of the world energy picture it is unlikely that a large differential between gas and oil prices can be sustained long-term; and
· To the extent that a differential is sustained, is it plausible that Australia’s LNG customers will accept contracts tied to (high) oil prices, while gas prices in other markets are much lower ? The speed with which Asian customers have begun to approach US gas producers provides some indication.

As a high-cost producer, we think that Australia has very good grounds to be concerned for the return that may be earned on the tens of billions of dollars currently being invested in LNG.

MORE BY TimINVEST WITH MONTGOMERY

Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

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