Hi Commodore, its in the subscriber section from yesterdays...

Hi Commodore, its in the subscriber section from yesterdays edition. this is the article

Venture into the Wild West ... buy Woodside and Karoon Gas

With the current focus in liquefied natural gas (LNG) being on Gladstone and the significant operations that are due to come into production by 2015, we thought we should spend some time reinforcing Australia’s existing LNG hub over in the west via the Carnarvon Basin, North West Shelf (NWS) joint venture (JV), and Darwin LNG. While we are big supporters of Gladstone via Arrow Energy (AOE), Santos (STO) etc, but let’s have a look at the existing Australian LNG industry as it will be rerated in the green world we are heading into.

Along with the two current operations there are a number of new projects at various stages located in the following regions; the Carnarvon Basin, the Browse Basin and the Timor Sea.

As a result, there is market concern surrounding the potential LNG supply glut that could eventuate by 2015 should all these planned projects come to fruition on time and at their forecast capacity.

This will not be the case, because the projects will not progress to the Final Investment Decision (FID) unless they have secured off-take partners with a 20-year supply contract. Second, the amount of planned capex for projects in PNG, Gladstone and Australia’s Western States is so enormous that consolidation is inevitable, as we’ve discussed before here.

Third, as the US Clean Energy and Security Act passing through Congress shows us, the world needs alternate fuels, particularly those that are more environmentally acceptable, and the demand for such fuels is only going to increase into perpetuity as traditional resources fall into decline and are financially penalised, namely oil.

The other point worth noting is that while we can put a big figure on total production for planned LNG projects, the figure is diluted significantly as a vast majority of these projects will only be in stage one of a three to four-stage process when the anticipated supply glut is due to hit in 2015. The end result is that the current forecast supply/demand dynamic could alter quite considerably before then.

The two key LNG exposures in the Australian market are most notably Woodside Petroleum (WPL) from a production perspective, and Karoon Gas (KAR) from an exciting development play. However, there are a number of new production projects in each of the three Western LNG regions; the Carnarvon Basin, Browse and Timor Sea.
Carnarvon Basin

The North West Shelf is Australia’s earliest LNG producing region. The operation commenced with production from North Rankin field in 1989 and involved a six company syndicate with Woodside as the operating partner. The other five members are BP, Shell, Chevron, Exxon, BHP, Mitsui & Mitsubishi (MiMi). CNOOC was also bought into part of the operation in 2008 as an off-take partner when first shipments commenced to China.

The operation has four active fields in conjunction to North Rankin, these being Angel, Perseus, Goodwyn and Echo Yodel. Current production is 16 mt pa of LNG, plus domestic gas supply, with no current plans for further expansion. It is an interesting time for the NWS with a number of supply contracts that were signed in 1989 on 20-year terms recently rolled, at what will be significantly better prices.

There are three other projects of notable significance that are currently being developed in the Carnarvon Basin region, these being Pluto, Gorgon and Wheatstone.

Pluto is 90% owned by WPL and is a significant growth project for their operations. WPL plan to build two trains which will produce 4.3 mt each. Train 1 is due for completion in 2010, with a supply contract signed with Japanese partners Tokyo Electric and Kansai Electric. Infrastructure required includes a new pipeline to Pluto operations, which are close to their existing NWS facilities. WPL expects to complete Train 2 well in advance of 2015, with FID expected next year. There is a concept in place to build a third train, however trains 1 and 2 are the key focus at this point in time.

Gorgon involves a syndicate of three companies: Chevron (50%), Shell (25%) and Exxon (25%). The production target is for 15 mt pa of LNG via the build of 3 x 5 mt trains, with first train in operation by 2015. The estimated cost is $50 billion, so in order for the operation to be financial it will need to operate at the full production rate, it can’t just stop building at two trains. The reason for the increased cost is that they are building a completely new facility at Barrow Island, which is just off the coast from the NWS production facilities. Currently Gorgon has an environmental impact statement (EIS) approved; however they are still waiting on FID, with off-take partners still to be confirmed.

Wheatstone is 100% owned by Chevron and has a LNG production target of 8 mt pa via 2 x 4 mt trains. The project is still a concept, with timing unclear for their first LNG production. The progression of the project may well depend on how everything unfolds in the East and other Western operations. Gorgon is such a huge project, we would expect it would delay Chevron’s development of Wheatstone as supply levels may make project development uneconomical.
Browse

The Browse basin has come into focus recently through the exciting drilling activity by KAR at their Poseidon well. Poseidon is the first of a three-well drilling program and current results suggest a multi Tcf reserve at the site. Conoco Phillips, who operates the current Darwin LNG operation, is KAR’s farm-in partner and it sees significant upside potential for Poseidon. Conoco and KAR have sourced a new rig to drill Kontiki-1, a similar 7Tcf target to Poseidon, to be followed by an appraisal well Poseidon-2. They then have options to drill up to six additional wells on Poseidon/Kontiki depending on upcoming results.

Poseidon is very exciting for Conoco in that the reserve size could be big enough to supply a second and third train at the Darwin LNG operation. Darwin LNG falls in the Timor region however it is pertinent to detail the operation just to outline the significance of KAR’s tenements in the Browse. Darwin LNG currently consists of one train producing 3.24 mt pa. The project is a JV involving Conoco, Inpex, STO, ENI, Tokyo Gas and Tokyo Electric.

The operation has approvals in place for the development of a second train, however to date they have not been able to secure the reserves to supply the train and thus complete FID. In Poseidon they may well have the reserves, hence Conoco’s excitement. A lot of work still needs to be done before Poseidon, or KAR’s other tenements, can be banked on to supply an additional train over a 20-year period, which would require circa 7Tcf of gas, however initial results are very encouraging.

Other operations in the Browse include “Ichtys” and WPL’s development project. Ichtys is a proposed 8 mt pa JV between Inpex and Total. The project has a 12.8Tcf identified reserve which also includes 527m bbls of liquids. The project is nearing FID, with one of the main considerations being the 850 km long pipeline that will need to be built to transport the gas to LNG processing facilities in either Western Australia or the Northern Territory. The location of the Browse makes it possible for gas to be pumped to either WA facilities or Darwin. The Northern Territory government has been very proactive in securing the “Icthys” development, and it looks like the trains will be built in Darwin.

WPL’s development in the Browse has over 14Tcf of gas, and is in the concept selection stage with a decision due to be made in the second half of the current year. The project is 50% owned by WPL with other partners including BP, Chevron, Shell and BHP. The plan is to have a 15 mt pa facility, with first production by 2018. The location of the tenements is very similar to “Ichtys”, however it is likely that the gas will be pumped to either the Kimberley coast or the NWS. Given the field locations, the development costs are circa $26 billion, making it a very significant investment decision for the involved parties.
Timor Sea

The Timor Sea area consists of two main operations in Darwin LNG/Bayu-Undan and Greater Sunrise. As detailed above the Darwin LNG operation consists of an existing 3.24 mt train. The project has been approved for up to 10 mt pa of LNG; however gas supply is an issue, which is why KAR’s potential discovery in Poseidon is so exciting. As identified the JV includes Conoco (57%), ENI (11%), Santos (11%), Inpex (11%) and Tokyo Electric (10%). Bayu-Undan has been producing LNG since 2006 at Wickham Point, Darwin, via a 3.24 mt pa train. The gas is transported via a 500km subsea pipeline from the wells to the processing facility.

Greater Sunrise is located just North of Darwin and is 50% owned by WPL, with other partners including Conoco, Shell and Osaka Gas. They have an identified field with a reserve size of circa 5Tcf, which would at least equate to 2 mt pa train over 20 years. Due to the location of the fields there is a chance that they would look to construct a floating LNG terminal, which would be the first of its kind globally. The other option is to build a pipeline to Darwin. It is expected that they will have concept selection by the second half of this year, with EIS and FID expected over the course of the next 12 to 18 months. Best case scenario for first production is expected by 2018.
WPL and KAR are the way to play it

The potential for future LNG production in the West is significant. From today’s output of just over 19 mt pa via the NWS and Darwin operations, to potentially greater than 80 mt pa by 2020, should all operations be developed and implemented at planned rates. A greater than 400% increase in just over 10 years will obviously have a big impact on the forecast supply/demand equation, which is why a number of forecasters are sceptical on the longer term fundamentals for the LNG market, particularly when you throw Gladstone and PNG into the mix.

The key point that’s being overlooked is the severe weight of capital that is required to bring these operations into production. Quick estimates would be well north of $150 billion, when you consider that between Gorgon and WPL’s Browse operations you have a planned capex bill of $76 billion. When you then have to factor in Pluto, Ichtys, Greater Sunrise, Wheatstone and any expansion to Darwin LNG, you can see that the bill starts to get very high.

What’s important now is who is going to benefit first and where the near term upside is. For that you can look no further than WPL and the Pluto operation (keeping in mind that WPL’s growth options also include the Browse and Greater Sunrise). Here you have a development that will be producing at a rate of 4.3 mt pa by late 2010 when the world needs increased LNG supply, and are also very likely to have the second 4.3 mt LNG train in operation long before 2015 rolls around, which is when significant new supply is expected to flood the market, most notably via Gladstone and PNG.

Building a second train is contingent on having adequate reserves to support the venture. Pluto currently has 4.5Tcf of 2P reserves, which accounts for Train 1; however Train 2 would require a similar sized reserve in order to establish long term contracts.

There are thoughts that a tie up between Chevron’s Wheatstone and Pluto would be a quick fix to this problem. Chevron has their hands full with Gorgon and Wheatstone has approximately 6Tcf of 2P reserves sitting there, so a tie up with WPL would make the most sense.

From a consensus earnings basis the market has WPL making $3.46 a share by 2011, which would factor in 4.3 mt production of LNG from Train 1 at Pluto. That represents earnings growth of more than 110% from current forecast FY09 earnings of $1.64. At $3.46, WPL is on a price-earnings ratio (P/E) of 12.4 times, which is a significant discount to today’s 26.2 times. At today’s prices you are also getting a 2011 forecast dividend yield of 4.5%, given consensus has a 2011 payout of $1.95, which is very easy to fathom as cash flow per share is forecast to be $5.88. Either way at current levels WPL represents both a strong growth and value play given their exceptional strategic position.

On a more speculative note you have KAR, who have the potential to supply an existing operation in Darwin LNG, which is screaming for a new gas supply and is ready to hit the go button on the development of a new train, should the desired reserves be found. If you want to get really excited about KAR then you can see from our below valuation table that the unrisked upside is $84 a share, which is obviously getting a little carried away, however from a risk weighted perspective we have a target of $19.50. Our 12-month target is $9.47, which still represents value at current levels; however it is currently a longer-term play with the share price hovering up around $9.

Between WPL and KAR you have exceptional leverage to the LNG theme. You have a low-risk play in WPL, that is set to experience significant earnings growth via Pluto and you have the higher-risk play in KAR where the leverage is huge, as we wait for further updates and results surrounding Poseidon and their other tenements including Kontiki’s drilling program.

Either way the not so Wild West has a very exciting period ahead when it comes to new energy supply and it should not be overlooked as a result of the increased news flow surrounding Gladstone. Buy KAR and WPL and hold on for the green energy re-rating.

Go Australia.
Charlie Aitken
Director
Head of Institutional Dealing
Southern Cross Equities