High prices work miracles – in time – because they make it profitable to exploit resources previously ignored because of high costs. It’s important to remember that, in the current investment environment of hysteria over oil prices.
There was little interest in mining the immense reserves in the Canadian tar sands – till oil quadrupled from its $10-a-barrel low. Deposits deep beneath the sea were largely ignored in the past – now the Sugar Loaf fields of Rio de Janeiro, under 6 kms of Atlantic waters and a thick layer of hot salt, could turn Brazil into a bigger petro-power than Russia.
Nowhere is the transformation from rubbish to riches more dramatic than in the realm of natural gas.
Oil producers are now keen to capture and sell the waste gases traditionally flared off at their wellheads. Gas deposits that were ignored because they couldn’t be pipelined to markets are being liquefied at considerable expense for shipping thousands of kilometres.
But perhaps the most dramatic development is the upsurge of interest in tapping gas from coalfields — rather than the traditional source, oilfields.
Once a deadly threat, now a treasure
Coal deposits contain varying quantities of almost-pure methane, which is the main constituent of natural gas.
That ‘fire-damp’ has always been a deadly threat to coal miners, causing explosions. But where it can be recovered, coal seam gas (CSG) – also called coal-bed methane (CBM) – is a valuable substitute for natural gas. It already accounts for a tenth of gas supply in the US, and in Australia’s coal-rich Queensland state, a quarter.
Boreholes can be drilled down to tap gas found in:
• Coal deposits so gassy that they have been too dangerous to mine;
• Deposits that have not been worked for other geological reasons;
• Worked-out and abandoned coal mines.
Currently the focus of greatest excitement over methane is Australia, beneath which lies almost one-tenth of the world’s coal reserves.
A bidding war drawing international oil/gas giants is under way for ownership of that nation’s resources of coal seam gas (CSG).
They are particularly attractive. They are vast in scope. They’re located in a country with stable government and business environment. And they offer proximity to Asia’s high-growth energy markets, which already take two-thirds of global shipments of liquefied natural gas (LNG).
The world’s first plants for liquefying coal seam gas are now under construction on the Queensland coast. They will draw gas by pipeline 400-odd km from inland coalfields, converting it into some 11 million tons of gas a year for shipment to Asian buyers.
To put that figure into perspective, it’s more than half as much liquefied natural gas as Australia already exports, and equivalent to 5% of current global shipments of LNG.
Motivated by rising prices and paucity of cheap onshore natural gas reserves, Australia has moved aggressively into exploitation of the gas in its coalfields.
Production of CSG has expanded ten-fold over the past seven years. Australia, claims EnergyQuest CEO Graeme Bethune, has moved from being “a rank beginner to a world leader” in CSG recovery technology.
The major players
Origin Energy, (ASX:ORG), which supplies gas and electricity to more than 3 million homes and businesses. It produces about a quarter of Australia’s CSG and owns more than a third of its proved and probable reserves.
BG Group, the leading international natural gas specialist, has made a $13bn bid for this company. Its directors have rejected the bid, but the markets expect BG to come back with a better one for such a prize.
Analysts reckon that the bid valued Origin’s proved, probable and possible (PPP) reserves at about one Aussie dollar a gigajoule. (A gigajoule is an industry-standard measure for gas). Gas currently sells for AU$3 to AU$3.50 a GJ to the local market, but export prices for liquefied gas have been averaging more than AU$7.
Analysts reckon that the BG bid was far too low in comparison to the price paid by Petronas for its stake in Santos (see below).
Freezing gas for shipment to Asian markets
If BG pursues its takeover effort and succeeds, it will be able to beef up its liquefied gas export plans, which are based on its building an $8bn liquefaction plant at Gladstone, on the Queensland coast, and a 20-year contract to supply three million tons of LNG to Singapore from 2012.
However Origin shares now look more like a speculative play than a long-term investment.
Santos (STO) is the second largest CSG company in both production and reserves. It also plans to build a plant at Gladstone to liquefy gas recovered from its inland coalfields to produce initially 3 million tons of LNG annually for export.
Petronas, the Malaysian oil giant that operates the world’s largest gas liquefaction plant, recently bought a 40% interest in the Santos project for $2.5bn.
The price it paid, which works out at AU$1.65 per gigajoule of PPP reserves, is believed to be the reason Origin’s board rejected BG’s lower-priced offer.
Because of the size and diversity of its international interests – encompassing natural gas, LNG and oil, in Asia, Egypt and the US as well as at home – this isn’t a well-focused play on Australian CSG, although its charts do look attractive.
Queensland Gas (QGC), the No.3 producer, was the BG Group’s entry into Australian coal seam gas – it paid $700 million for 10% of the company’s shares and participation in ownership of up to 30% in the company’s Surat Basin reserves, 50% of the planned pipeline to Gladstone, and 70% of liquefaction facilities.
For an investment of $8bn, the partners plan to produce three to four million tons of liquefied CSG a year from gas brought 380 kms by pipeline. The scale could be doubled if BG succeeds in buying control of Origin’s resources.
This looks to me as the most interesting buy.
Many Australians in the CSG sector
Arrow Energy (AOE), the fourth biggest producer, hopes to be the first to bring on stream an LNG plant near Gladstone, by 2010, with a planned capacity of 2.6 million tons a year.
This month Shell spent nearly $800 million for 30% of the company’s CSG resources, 10% of its international assets – which include sites in China, India, Indonesia and Vietnam – and a five-year option to acquire up to 50% of future projects.
There are about 20 other companies now active in Australia’s CSG sector, either producing or soon to start, including Sapex (SXP), whose large coal deposits in South Australia are about to be explored for gas; Metgasco (MEL), which owns the largest certified CSG reserves in New South Wales; Sunshine Gas (SHG), which plans a small-scale liquefaction plant on the Queensland coast; and Molopo (MPO), a small-cap exploration and production firm specializing in CSG.
Low recovery and processing costs, the abundance of resources in politically secure locations, and the generally favourable longer-term outlook for natural gas, suggest that coal seam gas in general, and Australian CSG in particular, offer interesting potential investments.
• By Martin Spring in On Target, a private newsletter on global strategy