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Follow the Contracts to LNG Glory

By David Dittman on December 9, 2011

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Editor’s Note: In this special edition of The Energy Letter, My colleague David Dittman, editor of Australian Edge, shares his take on the best way for investors to profit from the many LNG (liquefied natural gas) export projects under way in the Land Down Under.

A September 2011 International Energy Agency (IEA) report speculates that we’re on the verge of a “golden age” for natural gas. In this scenario, use of the clean-burning fuel would climb 50 percent from 2010 levels account for more than 25 percent of global energy demand by 2035.

This golden age is predicated on a more ambitious forecast for gas use in china, less reliance on nuclear power, greater production of unconventional gas and lower gas prices. Mainland China continues to confound pundits who forecast a hard landing for the economy; events in Japan have cooled the ardor for nuclear power worldwide; and large-scale gas production and distribution projects continue to advance, even amid depressed prices for natural gas in the US.

Global demand under this scenario is 600 billion cubic meters higher than under the IEA’s base case articulated in its 2010 World Energy Outlook.

Emerging markets will lead demand growth, with China forecasted to consume as much gas as the entire EU by 2035. Middle Eastern demand will grow to match china’s demand over the next few decades, while India will consume four times as much as China.

Natural gas extracted from shale and other unconventional plays will account for about 40 percent of the 1.8 trillion cubic meters required to satisfy this new demand, with most of this production coming from North America, China and Australia.

Australia is close to the epicenter of global demand growth, prompting many major oil companies to build export terminals for liquefied natural gas (LNG)

What is LNG? When natural gas is cooled to minus 260 degrees Fahrenheit at a liquefaction facility, it condenses into a liquid that’s roughly 1/600th its original volume. In this form, large amounts of natural gas can be safely transported overseas in specially designed ships. Re-gasification terminals warm the LNG to return it to its gaseous state before pipelines transmit the product to end users.

Australia is home to almost half the world’s LNG projects under development. Green-lighted projects worth USD174 billion would increase Australia’s nameplate export capacity by about 87.5 million metric tons per annum (mmtpa), making the country the world’s top LNG producer.

With this many projects focused on Asian LNG demand in the works, overbuilding is a distinct risk. LNG projects also have longer construction-time cycles than typical exploration and production (E&P) projects. This means that the impact of cost inflation is regularly underestimated, and contingency plans for unforeseen crises often fall short of the mark.

Overruns for seven major projects completed since 2005, including the first phase of the Pluto project in western Australia’s Carnarvon Basin, have averaged 35 percent. That’s enough to overwhelm the low- to mid-single digit average rates of return on Australian LNG projects. E&P companies with strong balance sheets are best-positioned to deal with these variables.

A better way to profit from the Australian LNG boom is to focus on companies that provide services to project operators such as Australia-based midsized E&Ps Woodside Petroleum (ASX: WPL, OTC: WOPEF) and Santos (ASX: STO, OTC: STOSF), as well as Japan-based Inpex Corp (Tokyo: 1605, OTC: IPXHY) and Income Portfolio stalwart Chevron Corp (NYSE: CVX).


WorleyParsons (ASX: WOR, OTC: WYGPF) provides professional services to the resources and energy sectors and the complex-process industries. WorleyParsons operates in four primary business segments: hydrocarbons, power, minerals and metals, and infrastructure and environment. The company conducted early-stage analyses of Chevron’s 8.9 mmtpa, two-train Wheatstone project in western Australia’s Pilbara region. The firm recently won an AUD235 million contract to provide construction management services for the entire endeavor.

WorleyParsons recovered from a weak first half to grow its fiscal 2011 profit by 25 percent to AUD364.2 million. Revenue grew 12 percent to AUD5.6 billion, while operating cash flow increased 5 percent to AUD294 million. Earnings per share were AUD1.215, and the company declared dividends of AUD0.86 per share—a full-year payout ratio of 70.8 percent. WorleyParsons, which in 2011 boosted its dividend 13.9 percent, is a buy under USD29.

Canada-based ShawCor’s (TSX: SCL/A, OTC: SAWLF) Bredero Shaw unit is the world’s largest applicator of pipeline coatings for the oil and gas industry for both onshore and offshore pipelines.

In November 2011, ShawCor signed deals with Chevron worth USD170 million to provide pipeline coatings and related products and services for Wheatstone’s flowlines and to supply coatings for the project’s gas supply trunkline. The company also signed a letter of intent for a USD400 million arrangement to provide coatings for the Ichthys Gas Field Development Project in northern Australia. The company also won a USD45 million pipecoating contract for the Barzan project in Qatar.

ShawCor’s stock yields a modest 1.3 percent. But the dividend rate—currently CAD0.08 per share per quarter— has grown 6.8 percent over the past year, 7.6 percent over the past three years and 18.5 percent since 2006. The company has little debt and about CAD60 million in cash on hand. Buy ShawCor under USD30 for reliable dividend growth.

Origin Energy (ASX: ORG, OTC: OGFGF) is Australia’s largest integrated energy company, with extensive E&P efforts focused on gas. The firm also has one of the country’s largest, most flexible power generation portfolios and an energy retailing operation with 4.5 million customers.

Through its 42.5 percent stake in the USD20 billion Australia Pacific LNG project, Origin Energy holds a share in the country’s largest proved- plus-probable coal-seam gas (CSG) reserves. Along with ConocoPhilips (NYSE: COP), which owns 42.5 percent, and China Petroleum & Chemical Corp (NYSE: SNP), which owns a 15 percent share, Origin is developing one of Australia’s largest CSG-to-LNG export projects, with initial capacity of 9 mmtpa. Origin Energy will build and operate the project’s gas fields and its main transmission pipeline.

During its full-year 2011 results announcement, Origin forecast underlying EBITDA (earnings before interest, tax, depreciation and amortization) growth of 35 percent for fiscal 2012 and underlying profit growth of 30 percent. Management reaffirmed this guidance during its Oct. 24 annual general meeting.

Origin is well-placed to fund ongoing capital expenditure requirements— including the Australia Pacific LNG project—while preserving the strength of its balance sheet. In recent months, the company raised AUD2.3 billion through a pro rata entitlement offer to existing shareholders; secured AUD2.1 billion and USD350 million three- to five- year bank facilities; raised EUR500 million (AUD680 million) through a hybrid issue; completed the private placement of a 10-year, USD500 million note in the US; and executed a AUD800 million subordinated note offering with a 2071 maturity.

Funding for growth is assured via AUD4.6 billion of undrawn debt facilities and cash as of Sept. 30, 2011. Origin’s underlying business also generated AUD1.3 billion of free cash flow in fiscal 2011. A solid E&P operation, paired with a quality utility business, provides a foundation for stable cash flow and dividend growth. Origin Energy is a buy up to USD15.

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