Has Australia built a $200 billion dud?

download

For the past 12 months I have argued that Australia’s LNG boom is looking rather like a bubble, built on 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. It is now facing off with a giant pin:

JAPAN has ratcheted up its attack on high Australian LNG prices — hailing US shale gas exports as a game changer that could slash prices by up to 30 per cent — and is inviting industry players to Tokyo next month as it looks to break the traditional LNG pricing model and encourage new supply.

An official from the industry ministry said yesterday buying US shale gas was like purchasing from a “supermarket” at true market prices. He said shale gas exports coupled with a coming “boom” in supply had the potential to turn LNG pricing in Asia on its head.

…Success by Japan, the world’s biggest LNG buyer, in pushing the changes to the LNG pricing structure could put a severe dent in Australia’s national income.

…”The price in the US is $US4. You add liquefication and transport — that’s $US3 each — and when in comes to Japan it’s going to be $US11 or $US12. That’s still 30 per cent cheaper than what we are paying now.”

Japan has been buoyed by the Obama administration’s decision to issue an export permit for shale gas from the Freeport LNG project in the US.

The Japanese government is confident this will soon be followed by permits for two other projects that Japan is involved in — Cameron and Cove Point — in bringing exports to 15 million tonnes per annum.

“That’s going to change the game,” Mr Kihara said.

“The first gas priced directly (in proportion to the US Henry Hub price) has already happened. Kansai Electric has already struck a deal with BP Singapore. Also, with US gas exports some utilities have already announced they will purchase by gas-linked pricing. Also, worldwide, there is going to be a boom in production — this will change the entire market situation.”

Australia’s LNG cost curve shows that a pricing shift anywhere near $11-12 will be calamitous for the Australian LNG boom:

Capture48

There are mitigating factors. Japan is clearly ramping the rhetoric ahead of its big conference and some significant portion of the LNG underpinning these projects has been forward sold on oil-linked contracts that should hold up. Most have price flexibility provisions but only in the 5-10% range not 30%.

Even so, contracts fall through. Chevron is still, for instance, looking for buyers for the output of Gorgon, which will be finished in early 2015.

Also, the Japanese have a different history to that of the Chinese and iron ore. They have traditionally taken a long term view of the market and have recognised the mutual benefits in exchanging price for security of supply across different commodities.  Having said that, Australia also had a history of behaving honorably in North Asia and not gouging customers, until the past ten years of exuberance.

Another, less reassuring, way of looking at is that the Japanese are very well-informed clients, and would not be embarking on this course lightly.

I don’t think we’ll see any of the big local projects fall over and, in the very long run US shale gas volumes will likely disappoint expectations, so returns for Australian projects should recover. But in the medium to long term I see pain.

At best we’re looking at more sharp terms of trade falls for the nation and deteriorating returns for the hasty companies involved. Expect a great deal more pressure in the form of internal devaluation as managements seek to bail out their rashness, and no new projects as this process plays out.

Fiscal stabilisation mechanism in the form of a big fat mining tax and SWF anyone?

David Llewellyn-Smith

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 founding 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.

Latest posts by David Llewellyn-Smith (see all)

Comments

  1. Does the chart for LNG break even costs factor in the production and sale of liquids from conventional fields? Thanks.

    • Yes, I was wondering that, What happens also when Japanese nuclear power stations come back online as there is a push to get more of them restarted. I don’t know how much gas is been used as a substitute but i am sure it’s a lot.

      I have also been wondering about if and when the Japanese develop their methane hydrate. Government sources say they should have this up and running within the next five years. On top of this Japan has been in a building frenzy with solar farms. The only bottle neck their been the power grid but I am sure it won’t be long before that changes.

      To me Australia does have a white elephant, and other countries are developing so many new ways to get energy. Norway is doing it’s Thorium thing and I am sure that will change the face of the planet in years to come.

  2. HnH I think that you have summed it up perfectly in the first paragraph as to the reasons why Australia is so out of touch with the rest of the world at this point in time.
    I think that we are going to see a lot of this happening “bail out their rashness” in the next 12 months or so and and it will cover more than LNG

  3. The Business Spectator interview with Peter Coleman on the weekend provided good industry perspective on this.

    Pretty sure Chevron has 65-70% committed sales from Gorgon, down from 80-85% following KOGAS pulling out.

  4. HnH,

    Correct me if I’m wrong, but isn’t the answer to; “Has Australia built a $200 billion white elephant?”, quite simply, “No”?

    For the most part, the gas in the existing investments is sold on an oil linked basis and the broad expectation is that the contracts will be honored.

    Isn’t the issue more that it will have prove to have been a short-term investment boom – because, given our cost structure – there won’t be nay new investment (except maybe Browse)?

    • Thanks HnH. Having been hosed by the rising gas price on one project – we’re nicely hedged by an exposure to the incoming spike in eastern seaboard gas prices – which is pretty dependent upon the above assumptions….

      IMO, this east coast gas price issue remains the elephant in the room. Manufacturing is going to get a belting and there is going to be a dramatic shift in the generation merit order back to coal. Large manufacturers may also head back to coal firing (many can), but the there will be a political/EPA fight there…

      I don’t think this had enough media exposure or analysis. For starters – it looks like gas reservation will do nothing for the main issue (price) as all the cheap sources are gone… But what are gas prices likely to do in the long term?

      3d – cheers for the link.

    • There has also been some difficulty for Australian buyers getting supply. For example, the NT Power and Water Corporation has had difficulties getting supply contracts out of the pipeline coming into Darwin. Others have expressed concern that we are sending too much of our energy reserves off shore in any event.

      Perhaps we could offer to take some of the gas of the hands of the Japanese?

  5. What makes the Japanese think the price of US shale gas will still be $4 once it starts getting exported to Asia? Doesn’t increased demand usually raise the price?

    • I think the US are also increasing supply rapidly though no?

      Bit of a fish out of water on this topic admittedly..

      • They may be, but usually the cheapest reserves are those developed first. So it would seem likely that the price must rise.

    • notsofastMEMBER

      I would suggest that is the main idea to exporting LNG from the US. To get a leaver on US natural gas prices. The cost of a few LNG plants will be cheap as a sunk cost when compared to the gains that can be obtained from having control of this leaver.

  6. Consider here the Gladstone LNG projects, where the elephant is nominally pale, as the selling price of the LNG will not cover the return on capital to build the plants.
    Where the elephant is distinctly white is that the supply of gas to the plants may not be there, at all, and at least without significant environmental damage to the regions where the gas is intended to be extracted.
    This is going to be a white knuckle ride for all involved.
    WW

  7. Well the good news is that a lot of the investment is not actually Australia’s money. It’s chevron, shell, inpex and bg. We are the lucky country. Fortunately for us they didn’t discover FLNG until later.