Oil search versus Australian LNG (Marc Lerner)
Oil Search is a company which we have recently bought a small stake in for our clients. It is an oil and
gas producer listed in Australia and their main project is a new liquefied natural gas (LNG) project in
Papua New Guinea called PNG LNG, on which they are partnered with Exxon Mobil amongst others.
Whilst we have been somewhat negative towards many of the new Australian LNG projects such as
those Origin Energy is involved in, the key difference can be seen in the below graph:
As can be seen, the break-even cost of PNG LNG is estimated to be just over $8 per mmbtu (million
British thermal units – a measure of volume of LNG). Most of the new projects in Australia are to the
right and have costs of $11-12 (the ones to the left are largely legacy projects that have been running
for years at a very low cost but are not expanding production).
Many of these expensive new projects are, we think, very likely to come under pricing pressure as the
US begins to export its far cheaper gas into Asia, whilst at the same time China’s demand for energy is
likely to be sluggish at best as the economy slows from its current credit fuelled construction boom
model. For example, Origin’s Australia Pacific LNG (APLNG) – based in Queensland – is estimated to
have costs of just under $12 per mmbtu. Origin (a far more widely held stock than Oil Search in
Australia) owns 37.5% of the project, and it is about two fifths of the net assets on Origin’s balance
sheet. In the medium to long term significantly cheaper supply from the US, which is continuing to
approve LNG exports and where prices are approximately $4-$5 due to lower production costs is
likely to keep Asian prices down (even after adding costs of approximately $3 for transportation to
Asia from the US and Canada) to the detriment of the more expensive Australian projects such as
Australia Pacific LNG. Although the LNG is sold under long-term supply contracts with prices linked to
oil, these can be and are often renegotiated in the face of falling prices.
This is not to say there are no risks to Oil Search – we have only bought a small holding precisely
because it is a risky investment. The company is ramping up its production just as China is beginning
to slow its rampant and uneconomic growth, and in the face of a truly severe China correction oil
could fall to levels where even Oil Search’s oil-linked contracts become unprofitable as the gas is sold
at prices below its costs. On top of this, there are ever-present political risks in Papua New Guinea.
However, it stands out compared to other more popular and well-known Australian companies like
Origin and Woodside (who own Pluto LNG, which has costs of about $11 with contracts that are
renegotiated every five years) with new LNG projects that are under far more immediate pricing risk
because of a high Australian cost structure and overruns which PNG LNG largely avoided.