Despite the prospects of entering a golden age for natural gas, investors are looking decidedly less excited about LNG.
Australia is set to take over Qatar as the biggest exporter of LNG within the next decade or so.
And yet, some of medium-sized companies going big on this resource, such as Santos and Woodside, are trading below core net asset value, points out Neil Beveridge from Bernstein Research — who says this is not just macro bearishness on resources stocks:
Increasingly, LNG projects are perceived as more value destructive than value accretive. On the basis of current valuations, it appears that investors have reached the conclusion that LNG projects are more of a liability than an asset.
The reason: most LNG projects see big cost blowouts, as this table of projects completed since 2005 suggests:
Although project over-runs are endemic in the oil and gas industry,the reason why LNG projects in particular seem to be moreimpacted than most is down to the relatively long construction cycles. Typically an LNG project has a 4-5 year construction timescale, which is longer than most E&P projects. ‘Contingencies’ included to deal with the ‘known unknown’s’ are typically too low and the impact of cost inflation throughout the duration of the project has systemically been underestimated.
The problem is that Australia appears to be the world’s marginal supplier of LNG – much like the Canadian oil sands projects are for world oil markets.
Although long term LNG contract prices have become firmly linked to oil, the rate of return for new LNG projects in Australia is typically close to 12-13%. This means that a 30% cost over-run will effectively turn an LNG project with a positive NPV (at the time of sanction) into a project which is value dilutive with a return below the cost of capital.
As Beveridge notes, the currency costs haven’t helped much, in Australia or Denmark, for that matter.
The labour costs are another factor. Having to compete with big miners for staff is one thing, compounded by the fact that two of the big LNG projects under construction, Pluto and Gorgon, are based in north-western Australia – a region so unappealing that McDonalds’ employees get fly-in-fly-out, or ‘FIFO’, included in their package and even the locals don’t have much nice to say about it.
Anyway, better to get exposure to the down-under LNG boom via the construction companies, says Beveridge: