With the east coast liquefied natural gas (LNG) exporters hauled into Canberra and told to claw back some of their designated export sales to supply the hard-pressed domestic market, it’s time to take a look at the sector – given that markets don’t like government intervention.

LNG remains a huge success story for Australia, with LNG exports almost 2.5 times the volume of national domestic gas production in FY17, according to independent energy consultancy EnergyQuest. FY17 marked a major shift in the petroleum industry, as the LNG investment boom moved deeper into its production phase.

Much scrutiny has fallen recently on the three coal seam gas (CSG)-to-LNG export plants at Gladstone, where $70 billion has been spent to develop an export industry. The three projects are:

• Australia Pacific LNG (APLNG), a joint venture of ConocoPhillips, Origin Energy and Sinopec);
• Queensland Curtis LNG (QCLNG), a joint venture of the Shell-owned QGC, China National Offshore Oil Corporation and Tokyo Gas; and
• Gladstone LNG (GLNG), a joint venture between Santos, Petronas of Malaysia, Korea Gas Corporation and French oil and gas heavyweight Total.

The $18.5 billion GLNG project is the only one of the three Gladstone projects to use third-party gas to fulfil export contracts, and is thus most at risk from the Federal Government’s new Australian Domestic Gas Supply Mechanism: previously the partners had said that GLNG only had enough gas to fill its export contracts, and would struggle to supply the domestic market.

After arm-twisting in Canberra, GLNG has agreed to divert a further 30 PJ of gas to the domestic market in 2018 and again in 2019. Santos had earlier decided to deliver up to 72 PJ of gas over four years into the south-east market through a swap agreement and sale of 15 PJ to the Pelican Point power station in Adelaide.

How has that affected the investment outlook for Santos, the operator and 30% stakeholder in GLNG?

Santos (STO, $4.00)
Market capitalisation: $8.3 billion
1-year total return: +10.7%
3-year total return: –28.7%
5-year total return: –15%
FY18 consensus estimated dividend yield: No dividend expected
Analysts’ consensus price target: $3.91

Source: ASX

The stock market is looking past the GLNG response to government intervention, focusing on Santos’ excellent interim result and the company’s progress in cutting its costs and restoring its balance sheet to health: Santos still bears the scars of collapse in oil prices in 2014-15.

However, profit for the June half (before one-off items) jumped to $US156 million ($198 million), from the year-earlier $US5 million loss, easily beating most analyst expectations. The company reported a bottom-line interim loss of $US506 million ($642 million), but that was expected after the company took a $US870 million ($1.1 billion) on the GLNG project – the third such impairment, which takes the total of after-tax write-downs on the Gladstone project to $US2.2 billion ($2.8 billion).

GLNG is yet to ramp up to full production, because of low Asian LNG prices and high costs to source needed gas from the tight east coast market. Now some of that gas has to go back the other way – to domestic users – but at the moment the market appears to be much more interested in the better outlook for the Cooper Basin assets – which were actually written up – and the progress on repairing the balance sheet. Dividend payments probably won’t be resumed until FY20, and in the meantime the market views Santos as fully priced. And it’s fair to say that the long-term outlook for the thrice-written-down GLNG project does not look wholly rosy.

Woodside Petroleum (WPL, $28.70)
Market capitalisation: $24.2 billion
1-year total return: +2.9%
3-year total return: –6.2%
5-year total return: +2.6%
FY18 consensus estimated dividend yield: 4.3% fully franked
Analysts’ consensus price target: $30.32

Source: ASX

Western Australian-based energy giant Woodside is not involved in the east coast gas market – except perhaps as a potential internal “exporter” to it – which it has been keen to do in the past. Woodside has been in talks aimed at solving eastern Australia’s gas shortage, but in its own patch, on the north-west shelf, it has been going gangbusters.

The company gets most of its earnings from LNG through output from the North West Shelf project, which has been operating since 1984, and the Pluto LNG plant, which began producing in 2012. Woodside has the US$34bn Wheatstone LNG project, being developed by its partner Chevron, ready to commence this year, and its own Greater Enfield oil project. The company is poised to boost its LNG capacity in the coming years, increasing output at its Pluto project, and flagging plans to potentially use its facilities as a hub for undeveloped gas fields in the region. Woodside has guided for a modest slide in production this year before it climbs about 15% through 2020. Eventual production appears likely from its Senegal and Myanmar exploration and development efforts, and longer-term, it will have the Browse and Scarborough fields coming onstream.

The company says growing demand from emerging economies in Asia will soak up the current oversupply in LNG markets, and again open a window for new LNG developments. Between 2022 and 2026 Woodside will increase spending on new projects to develop existing assets to meet forecast LNG supply shortfalls, but will still have a strong base of production generating cash.

Woodside unveiled a stellar 49% increase in first-half profit, paying an interim dividend of US49 cents, up 44% from US34 cents a year ago. As a fully franked dividend payer – the company aims to pay out 80% of net profit – and on analysts’ views on the scope for a share price rise, Woodside looks very attractive.

OilSearch (OSH, $7.01)
Market capitalisation: $10.7 billion
1-year total return: –1.6%
3-year total return: –5.8%
5-year total return: –0.03%
FY18 consensus estimated dividend yield: 1.3%, unfranked
Analysts’ consensus price target: $7.32

Source: ASX

The Papua New Guinea-based Oil Search is also happily aloof from the Australian east coast gas market debacle, and is poised to push the launch button on the long-mooted expansion of its flagship PNG LNG asset. Expansion of PNG LNG will be the factor that drives the share price for Oil Search, and over the coming months the market will be hoping to see the proposed Elk-Antelope natural gas field development (known as Papua LNG) brought officially into the fold.

Progress at PNG LNG generated a 405% lift in Oil Search’s first-half profit to $US129.1 million ($163.1 million), with the interim dividend also up fourfold, from 1 US cent to 4 cents. The company lifted the bottom end of its production guidance range from 28.5 million barrels of oil equivalent (mmboe) to 30.5 mmboe, with costs at now US$8–$US10/boe.

The PNG government is now out of the stock, having sold its 10% stake gradually, to help fund its share of future growth in LNG in PNG, and that removes any perceived overhang. Oil Search’s dividend can be expected to rise steadily in coming years: for the moment, its yield is not that exciting, at 1.3% unfranked. But even with LNG market weakness through 2017-2018 expected to dampen sentiment somewhat, longer-term, analysts seem to like the look of where OSH is heading.

Origin Energy (ORG, $7.23)
Market capitalisation: $12.7 billion
1-year total return: +30.7%
3-year total return: –15.4%
5-year total return: –3.7%
FY18 consensus estimated dividend yield: no dividend expected – but consensus FY19 yield = 4.4% unfranked (32 cents)
Analysts’ consensus price target: $8.25

Source: ASX

A good story looks to be evolving at Origin Energy, despite its full-year FY17 loss widening from $628 million to $2.2 billion, and no dividend, as the company made large write downs ($3.1 billion in total) against its Australia Pacific LNG project and conventional oil and gas assets. But on an underlying basis, profit was up 49% to $2.53 billion, driven by its electricity and gas retail business.

And Origin gave a better-than-expected growth forecast for its energy markets division, which includes its retail operations, with earnings to rise by between 14%–21% in FY18, underpinned by higher electricity prices and increased generation from its Eraring power station. That would see the energy markets division on track for $1.7 billion–$1.8 billion in operating earnings – an outlook that will not please Canberra, of course, which is trying to lower household power bills.

Origin Energy has struck a deal to sell its conventional oil and gas arm, Lattice Energy, to Beach Energy for $1.6 billion – most of its oil and gas assets in the Cooper Basin, offshore Victoria, New Zealand and Western Australia. Origin will use the proceeds to pay down debt. It will keep its interest in the Ironbark CSG project in Queensland and the Beetaloo Basin shale gas deposit in the Northern Territory, as well as its 37.5% stake in APLNG.

There is a very good reason why Origin kept Beetaloo. The company calls the Beetaloo deposit an “elephant,” and it could be a multi-billion-dollar gas resource, several times the size of the North West Shelf: however, it is presently stymied by the NT government’s moratorium on ‘fracking.’ If developed, it could solve the eastern states gas market dilemma virtually on its own. The NT government has an ongoing scientific inquiry, which was driven by community concerns about risks to land and water resources.

Again, analysts like the look of Origin’s prospects. And if you’re hurting from higher electricity bills, why not hedge with a stock that benefits from the situation?

Beach Energy (BPT, 84.7 cents)
Market capitalisation: $1.6 billion
1-year total return: +25.2%
3-year total return: –13.1%
5-year total return: –6.8%
FY18 consensus estimated dividend yield: 2.4%, fully franked
Analysts’ consensus price target: 66.9 cents

Source: ASX

With Origin Energy getting out of its conventional oil and gas assets, it’s worth looking at the company that bought them – Beach Energy.

To say that Beach is significantly enhancing its scale is an under-statement: at a stroke, the deal will almost triple the size of Beach’s oil and gas reserves, boost the company’s production this financial year by 150% and establish Beach as a major supplier of gas to domestic markets. Beach is currently worth just more than $1.5 billion so the acquisition, which will be funded by debt and a capital raising, will double the size of the company.

As part of the sale, Origin has secured access to a significant portion of Lattice’s future east coast gas production under long-term gas supply agreements. Origin retains access to future Lattice east coast gas production and LPG (liquefied petroleum gas), which will help it continue to supply domestic customers.

Beach is also a fully franked dividend payer, but analysts think that the Origin deal has pushed it past fair value – the shares have risen from 55 cents in June to 85 cents.

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