Gas gets expensive

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The news that BG Group had experienced a cost over run of 36% for its 2014 QCLNG project in Queensland has Macquarie tracking the
consequences for listed Australian stocks. BG stressed that much of the cost over run was country specific influences rather than sector
specific conditions. Macquarie concludes that this is likely to influence Santos and Origin at some point:

The key drivers behind BG’s cost pressures were: the strength of the AUD (accounting for ~45% of the cost increase), project specific scope changes (less than 10% of the cost over-run) and in-country inflationary pressures including the “over-heated local market” and the growing cost of compliance with increasingly “onerous environmental regulations” which made up ~50% of the added cost. It is this final driver of higher costs that is most directly relevant to STO and ORG.

Macquarie comments that the market should be expecting such cost pressures, which it should, especially with speculation about the Gorgon and Pluto projects. But Macquarie is sitting on the fence by maintaining outperform ratings on Origin and Santos. As ever, it is a question of how much of the bad news is factored into the price. The earnings multiples are 15 times for Origin and 20 times for Santos, so one would have to conclude that the market is not that well prepared for bad news, especially with the changes to global gas production, which will have to affect LNG supply at some point:

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Origin – maintain Outperform rating & A$18/sh target: Given the considerable upstream overlap between QCLNG and APLNG, BG’s\ overrun announcement is perhaps most directly relevant to ORG. What’s more, the cost pressures at QCLNG will do little to support ORG’s case for leniency from the credit ratings agencies as it looks to preserve its BBB+ credit rating over the APLNG development period. Santos – maintain Outperform rating & A$17.75/sh target: The majority of BG’s inflation was seen in the upstream – here we note that GLNG now has three 3rd party gas supply agreements which act to reduce the project’s upstream exposure. Also, unlike ORG, STO’s contracting strategy in the upstream (where Flour is working on a fixed unit price basis) offers STO at least a degree of price protection.

Macquarie