WHEN Santos chief executive David Knox fronted investors at the end of last year, a key message was that his big expansion into LNG was doubling the company’s exposure to international oil prices and soon 70 per cent of revenue would be linked to oil prices. This is now not looking like such a good thing. It is illustrative of the local energy sector’s growing exposure to oil prices as Australia nears completion of an extraordinary liquefied natural gas construction boom that should see the nation become the world’s biggest exporter of the fuel from 2018. And since 2011, the nation’s biggest energy producer, BHP Billiton, has spent more than $US30 billion increasing its exposure to US shale oil and gas. Unfortunately, the game has changed just as shareholders and tax collectors were getting ready to reap the benefit. Forecasters across the board are now lowering expectations on oil prices for the foreseeable future in the wake of OPEC powerhouse Saudi Arabia’s landmark decision last week not to support prices. This has been starkly illustrated by $30bn wiped off the market value of the energy sector since the November 27 OPEC decision. Promised dividend rebasing and buybacks from BHP Billiton, Oil Search, Origin and Santos now look less likely, with some Santos and Origin shareholders even worried that they could be asked to bail the companies out themselves. “The market is not just pricing in lower earnings, it is also concerned around the balance sheet position of those two companies, and the potential risks of emergency equity raisings,” says Deutsche Bank analyst John Hirjee, who thinks these fears are unfounded. The effects of a prolonged slump will be widespread for an energy sector that has been chasing growing exposure to LNG and oil-linked pricing. Cashflow for Woodside, Oil Search, BHP, Santos, and Origin will be slashed, big writedowns will be on the table, new LNG projects such as Woodside’s Browse will be rendered uneconomic, oil majors will have less money and appetite to expand existing LNG projects such as Gorgon, and Chevron is unlikely to keep funding its central Australian chase for shale gas with Beach Energy. What it will not do is shut down any of the LNG projects or prevent any under construction from starting up. While the pricing will be affected, operating costs are low once the expensive-to-build LNG plants are up and running. On top of this, most contracts have a floor, thought to kick in at about $US60 a barrel, meaning extreme price falls will not be directly passed on. And apart from 35 per cent of Chevron’s volume from the $US54bn Gorgon project, all the LNG is contracted to reliable buyers. Another positive is that in the longer term, the lower LNG prices should hamper Australian LNG’s biggest potential threat, North America, which is not signing oil-linked contracts. “LNG prices from oil-linked contracts are now appearing more cost-competitive against US projects,” Citi analyst Dale Koenders said of the recent oil price slump. He said the cost of shipping cheap US shale gas to Asia was about the same as Australian oil-linked LNG prices at a Brent oil price around $US70, which was where it was trading late last week. On top of this, US LNG contracts pass on supply risk to the customer, as opposed to Australian contracts, where the producer carries the risk if a plant goes down. “Hence at a similar price, we see oil-linked contracts from conventional projects having a slight advantage over US exports,” Mr Koenders said. BHP has been responsible for the lion’s share of the share market’s oil-inspired losses, accounting for $16bn of lost market value because of its exposure to US oil production. This is something of an irony given it is easy to paint the actions of the Saudis as a more restrained version of the iron ore strategy employed by BHP and Rio Tinto. That is, they are maximising production as the world’s lowest cost major producer and putting pressure on higher cost newcomers. In oil, that’s the US shale players. But Saudi Arabia could be seen as more restrained, because if the Saudis were playing as hard as BHP and Rio are in iron ore, they would bring on the 1 million barrels a day of low-cost sustainable spare oil production capacity they are thought to have. But the Saudis have more to worry about than just keeping market share, with geopolitical effects of lower oil prices, future reserve life, balancing their own budget and their relationship with the US to weigh up. BHP has already written down the value of its $US5bn Fayetteville acquisition by $US2.8bn because of low US gas prices. But according to Deutsche Bank, falling oil prices may even make it more appealing to shift Texas drill rigs in the frontier Permian region that are targeting oil back to the gas-only Fayetteville ground, which BHP is trying to sell. Speaking days before OPEC’s decision, BHP chief Andrew Mackenzie restated a target of making the US onshore oil business deliver positive free cashflow by financial 2016. But Deutsche analyst Paul Young says this will not be the case if the US oil price holds near current levels of $US65 a barrel. Indeed, at the current price of oil he said the company would not be delivering free cashflow until financial 2018. But Mr Young stressed that BHP’s progressive dividend would not be at risk. “Operating cashflow would more than cover the dividend and approved capital expenditure if commodity prices fall another 10 per cent,” he said. For BHP’s mining rival Rio Tinto, which has no oil operations, collapsing energy prices are nothing but good news. theaustralian.au/business/mining-energy/lng-projects-at-risk-as-oil-linked-prices-fall/story-e6frg9df-1227146498980
Posted on: Sat, 06 Dec 2014 14:00:26 +0000
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