From the excellent CS team today:
In Aesop’s fable, The Father and His Two Daughters, a father asks his two married daughters what they wish for. One, married to a gardener, wishes only for rain. The other, married to a tile-maker, wishes only for sun. The father of course is stuck in the middle, with the moral being that you can’t please everyone. So it is that the metaphorical father of Australia, PM Malcolm Turnbull, has announced the Domestic Gas Security Mechanism, which will provide the government the power to impose export controls on companies when there is a shortage domestically. This is clearly a momentous decision for the gas industry, an industry we firmly believe is currently broken. Whilst we believe action was firmly needed to fix the market, there is far more information needed on this all to form a firmer view.
■ The need to be a net contributor to the domestic market The release states that, whilst good progress has been made, the requirement for all the LNG projects to be net contributors has not been met. The net exporters (GLNG) will be required to outline how they fill that net take from the domestic market and they will be “ordered” to limit exports to ensure local supply. The other projects (QCLNG and APLNG) will be licensed to export according to their forecasts – i.e. don’t tell any porkies about your production, also an important step.
■ What is meant by export prices? The release talks about ensuring domestic buyers pay prices that “fairly reflect international export prices”. The key to this whole debate, from a stock perspective, is what this means. Is that a contract price or a spot price? Is it a delivered price or is it a netback to Gladstone price? If the price is a contract netback to Gladstone then GLNG JV partners will be financially ambivalent to selling domestically – indeed the overcontracted buyers (Petronas and Kogas) will benefit from not having to resell as many cargoes at a loss. However, as we discussed last week, even at only US$60/bbl oil and a 75c A$ the netback to Gladstone would be ~A$10/GJ (they don’t have the sunk take or pay on a pipeline like QCLNG). This is still very expensive gas delivered south to industrial customers.
■ How will it work mechanically? We think now, more than ever, the role of the intermediary will be needed to mechanically make this all work. We don’t fully understand on what basis AEMO will make their recommendations to the Minister for Resources. If the weather forecast says it is cold tomorrow, will they stop a cargo that week? Will they just take development plans as gospel and for how long will the impose the mechanism. Buyers need a duration of certainty (on price and volume) to make their capital decisions. Equally as important, how mechanistically will whatever gas GLNG diverts make it to industrial customers? Someone needs to step up and play the role of the intermediary. It is slightly unclear whether the former incumbents there have a social license to do so, though. We still think a public tender would provide a lot of answers.
■ How do the companies react? This is a tough question in terms of both share price reaction and corporate strategy. The natural reaction may be for the market to punish Santos. At face value, though, if all GLNG has to do is sell at export netback, then they are FCF ambivalent. In terms of strategy, a seeming contentment with export parity sets a high benchmark price for domestic gas (if you are semi-constructive on oil). We have written before that Santos’ perhaps now redundant strategy of capital preservation is at loggerheads with the need for more gas. If you have greater certainty of higher prices, and a political imperative to produce more, does the drillbit get a bit more of a workout? In theory this could be value accretive.
