Is Australian LNG a bubble?

Bubbles

The AFR has a solid report today on the slippery slope LNG is headed down:

US exports linked to the domestic American Henry Hub price – at least three years and billions of dollars of investments away – can’t come quickly enough for Asian buyers.

“Chubu Electric is positively seeking change in the energy market,” said Yuji Kakimi, managing executive of the large Japanese utility. Japan is short of energy due to the shutdown of nuclear plants following the Fukushima disaster.

Cheniere says it will be able to deliver gas to Asia at a cost of $US10.60 per million British thermal units from late 2015, at a Henry Hub price of $US4 per MMBTU. The prevailing price under oil-linked contracts in Asia is $US14-$US15.

This accords with my assessment of the delivery price of American LNG into Asia. This may sound a still decent price and it sure is if you have some legacy assets. But what if you just developed your LNG capacity in the past few years in Australia? This chart from the recent ANZ major projects report will cause dyspepsia:

Capture

 

Six of the seven recent boom LNG projects sit above $10 on the LNG cost curve, several above $12. The AFR goes on:

Trying unsuccessfully to referee the players out of their trenches are consultants such as Fereidun Fesharaki, chairman of FACTS Global Energy and a former Iranian representative at OPEC in the 1970s.

US exports will not be the “fantastic panacea” the Asian buyers are counting on, Mr Fesharaki told the LNG 17 conference in Houston last week. He expects crude oil prices to fall over the next two years due to slowing demand growth, and Henry Hub prices are rising again after a long slide.

“Whatever you do, you cannot land LNG in the East at a price of less than $US12,” Mr Fesharaki said.

Fesharaki goes on to predict no new projects in Australia. In a phrase, no shit. 

More to the point, what’s going to happen to the existing projects? They have long term supply contracts at oil-linked prices so should remain in operation, notwithstanding some renegotiation. But the return on these projects is not going to be anything like what was expected for either the firms, tax receipts or the economy.

I argued recently at Intelligent Investor that the iron ore boom was not a bubble. It was a demand shock and supply response overshooting in an inelastic market.

Australia’s LNG boom looks much more like a bubble to me: unrealistic extrapolations of demand, overly cheap finance, wildly inflating costs, a stampede for supply all adding up to wildly inflated asset values and, ultimately, poor returns on bubble pricing.

 

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Did you know the MB International Shares Fund has returned an average of 17.1% per annum and the Tactical Growth Fund an average of 10.4%? Register below to learn more:

Latest posts by Houses and Holes (see all)

Comments

  1. Yes, it’s a global bubble that Aussie investors have been caught in.

    Resource markets tend to work in this way, especially fossil fuels.

    Remember the OPEC price hikes in the 1970’s led to nations all over the world with more expensive oil, investing in infrastructure for extracting it? And massive investment in alternatives, and massive change in choices of cars? Then when the price of oil came down again, what happened to all these investments?

    Many ordinary investors might be getting fooled by the “we’re running out” mania. It is quite brave and contrarian to be an optimist and a cornucopian like me, but obviously I believe I am going to die having not had to eat my words in my lifetime, just as my fellow optimists (or perhaps I should say rationalists) in previous generations did.

    But there is a fossil fuels “pyramid”: the more expensive it is to extract, the more there is of it. The higher the price goes, the slower the price is going to increase. And there will always be volatility in the price in the short term, as one-off incidents happen (war, natural disaster, etc), speculators pile in, and then investors pile in to the new “supply” projects.

    Both these investors, and the resource doomsayers, are mistaking temporary upwards price volatility for “the beginning of the end”.

    • notsofastMEMBER

      To the Hugh Hendry’s out there who think global oil supply is not a very serious issue, I have one word.

      Manifa.

      • Thanks, I never heard of Hugh Hendry before, or Manifa.

        Hendry sounds like a pretty smart guy to me. And Manifa is no surprise to me. Global energy is all going pretty much how I expect it to.

  2. I am skeptical of natural gas prices staying that low in the USA,

    i believe they will start to increasing once more FID and exports start happening The difference wont be that much..

      • agreed. perhaps even lower. out of the well though US needs around 6 bucks to make a lot of shale players models add up.

      • notsofastMEMBER

        $6 per mcf will not get the shale gas drill rigs back out into the paddock. It might get a few more shale oil producers to connect up their wells so they can sell their associated gas rather than flare it but it won’t significantly add to gas supply. Bottom line in the US is $6 per mcf isn’t going to bring on a significant new source of gas to replace the gas that is depleting.

        It will take $8 per mcf plus to get some genuine interest in shale gas. Or put another way, shale gas producers can start to make some “real” money on the gas they produce, rather than using ever increasing cheap debt or sale of acerage to finance further drilling.

        So given the cost of new gas and the sharp drop off in the production from Shale Gas wells, I can’t see how there will be significant LNG export from the US. The US will need the gas at home. I suspect the talk of LNG export from the US is mainly just talk, talk to talk up the price of natural gas in the US sooner rather than later so its not such an advantage to US manufacturing.

        I am also skeptical of the “story” that Australia is a high cost place to build resource infrastructure. Over the last few years Australia has been beaten up a number of times over coal mines and iron ore mines which experienced significant cost blow outs. But now when we look overseas and see the likes of Minas Rio in Brazil going from $4 Billion to $8 Billion plus and projects in Africa being shelved because of significant and uncosted infrastructure requirements we see they had similar problems overseas The increasing cost of resource projects is a world wide phenomena, it is not unique to Australia. So I’m similarly skeptical of the story of “Australia being a high cost LNG producer” being told here. I take it with a grain of salt and think it is worth scratching the surface of some of these other “cheaper” projects to find what hides beneath.

        • Great questions you raise and I would love to see more analysis of these points.

          I agree the USA can use all its own natural gas – the fiscal and regulatory and institutional conditions in the South and parts of the heartland are so ideal for manufacturing. This is the major cause of the difference between them and Australia – the USA will use its own natural resources and export value-added (or substitute for imports) while Australia will continue to export raw natural resources and flick houses to each other.

          Hence the moniker “Houses and Holes”, which I think most apropos.

          • great replies,

            just been thinking about the 12 break even point. not sure why anyone would make an investment for 30 billion (wheatstone) with no head room. is it really a 14% IRR?