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AFR Article 7 January 2008


Coal- seam gas comes of age




What it really, truly demonstrates is there's a quality of resource
in Queenslande
SANTOS CHIEF EXECUTIVE DAVID KNOX

Formerly disregarded or underestimated, the sector has been transformed
into a multibillion-dollar growth industry, writes
Paul Garvey.

The coal-seam gas sector provided one of the main bright spots in 2008, attracting billions of dollars in international investment and sparking swift consolidation activity, a trend likely to continue this year.
Viewed by some as a quirky niche area, the occasionally ridiculed and comprehensively underestimated energy source has been transformed into a bona fide multibillion-dollar growth sector, sought after by some of the biggest names in international energy. In 2008, ConocoPhillips, Petronas, BG Group and Royal Dutch Shell collectively invested the best part of $20 billion to gain a foothold in Australia's budding industry.
Along the way, those who backed Australian coal-seam gas explorers such as Queensland Gas Company, Arrow Energy and Sunshine Gas, and diversified players such as Santos, Origin Energy and AGL Energy, have had the value of their portfolios protected by the almost universal surge in the value of equities exposed to coal-seam gas.
"We weren't surprised by it, but the momentum has stayed up very high," Santos chief ~xecutive David Knox says.
He saw the potential early and helped engineer one of the fIrst mega-deals in the sector, the $US2.5 billion sale of a 40 per cent stake in Santos's Gladstone coal-seam gas¬fed liquefied natural gas project.
"What it really, truly demonstrates is there's a quality of resource in Queensland, and that the international companies have recognised that quality," Knox says.
"They have an advantage in that they've been in the data rooms, and they operate large LNG fIelds already. They can bring that experience and swim around in the data room and decide for themselves how similar is this to what we know and how credible it is."
The rush of investment suggests Queensland's coal-seam gas reserves have proved to be very credible.

Industry executives who spoke to The Australian Financial Review in + the final months oflast year shared FB.4014

the view that this year was likely to be one of increased development in the sector by international gas majors as they moved to increase collaboration on projects and consolidation of players.
Like all good overnight success stories, the sudden explosion of interest is in fact the product of years of hard work.

The potential of Australia's reserves was recognised in the early 1990s.

Coal-seam gas - extracted for power generation from coal seams too deep for conventional mining ¬had already developed into a recognised industry in the United States.

But in Australia it couldn't shake the tag of a quirky niche industry.

"From a resource perspective, there's always been a reasonable amount of interest, particularly

from some of the US companies, but the thing that's always been the stumbling block has been the market," Arrow Energy chief executive Shaun Scott says. Last year he secured a $774 million coal¬seam gas joint venture with Shell.

The abundant, cheap energy sources that supply the comparatively tiny population along Australia's east coast did not make a compelling case for large¬scale investment. But that changed after the realisation that Australia's fIelds could support exports of liquefied natural gas, allowing companies to tap the 3 billion-strong Asian market.

LNG works by cooling gas to such an extreme point that it condenses into a liquid, allowing for the molecules to be easily shipped to export markets.

Though a coal-seam gas-fed LNG plant has never been built, the weight of investment last year from companies experienced in LNG suggests it is feasible.
The first sign of the coming wave of investment was the deal last February between pioneering explorer QGC and British LNG

giant BG Group. Within months, BG had signalled its strong interest in Australian coal-seam gas by beginning discussions with Origin Energy, which at that stage was valued almost exclusively for its utilities business.
BG's approach to Origin was compelling: the British suitor was offering a 60 per cent premium in cash.

But the union was scuttled when Origin saw that valuations in the sector had changed, confIrmed by Santos's $US2.6 billion sale of a 40 per cent interest in its fields to Malaysian giant Petronas.

"It would be fair to say, if you step back and take a macro view of the scale of what's happened in the coal-seam gas sector, I think it's surprised everyone about how fast it's moved," AGL chief executive Michael Fraser says.

"It certainly surprised everyone when BG showed the level of interest in QGC initially, and then when they originally made their approach to Origin. That really got the elephants rumbling, the major international oil players.
"In that regard, I don't think there's anyone in the industry who, ifthey were speaking honestly, would say they expected to see things happen so quickly - and priced so aggressively - as they were in that short time frame. ' ,
A spurned BG responded by launching a hostile $13.6 billion offer for Origin, but not before Origin had begun an international hunt for ajoint-venture partner.

It was that hunt that led ConocoPhillips to secure its slice of Queensland, when it bought a 50 per cent share in Origin's projects, in a deal that will ultimately be worth around $10 billion.

BG canned its bid soon after, turning its attentions instead to buying out its existing partner, QGC.
AGL's sale of its major shareholding in QGC into the BG bid means it is cashed up for a
buying spree of early-stage coal¬seam gas explorers operating in NSW.

It paid AJ Lucas and Molopo Australia about $370 million for a lease covering the Gloucester Basin, and a week out from Christmas announced a $170 million takeover of Sydney Gas.

The pace of investment has continued despite the precipitous drop in the oil price, from $US 150 a barrel to less than $40.

Arrow's Scott doesn't believe the drop will harm the sector's progress.
Instead, the souring economic environment will help ease project development costs during the next three years of studies and construction.

''The reality is we're looking at what the oil price will be in three years' time, and what it will be in the 20 years after that. The forward curve is still about $80 a barrel," he says.
Collaboration and, potentially, consolidation between the various LNG proponents this year is shaping as the key second act of the coal-seam boom.
The various parties are already working together on basic common infrastructure around the proposed LNG sites, but larger-scale co¬operation may be just around the corner.
That could throw up some interesting political moves, particularly given the history between Origin and BG.
For Origin chief executive Grant King, the past will quickly be forgotten ifthere is money to be made by joining forces.

"The history won't matter; there's no impediment to pursuing those benefIts," he says. "It's all about the trade-off of economic benefIts of co¬operation versus the cost of delay. We would be very open to discussing co¬operative development with two other major projects."

Each group will use 2009 to gain as much distance on their competitors as they can to ensure they have the strongest bargaining position possible if and when the project consolidation begins, Scott says.
"Everyone's trying to make sure their own stand-alone project is as strong as can be, to the extent that you can enter into any discussions from a very strong position.

"From a resource perspective, from a market perspective, there's no reason every project can't happen; from a logistics perspective and execution perspective, that's where the real challenge exists."