Woodside vs. Santos – any upside for SMSFs?

Financial journalist and commentator on 3AW and Sky Business
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Although the stubborn altitude of the Australian dollar has begun to temper some of the more optimistic forecasts, there is little doubt that Australia is in the throes of a liquefied natural gas (LNG) boom.

A 2012 report commissioned by the Australian Petroleum Production and Exploration Association (APPEA) predicted Australia would be the largest LNG exporter within eight years. That’s not bad for an industry that shipped its first product in 1989.

By 2016, said the report, investments in LNG will add 2.2 percentage points to Australia’s gross domestic product growth.

The gas boom involves $220 billion worth of investment, on both seaboards of Australia, involving conventional gas off Western Australia and the Northern Territory, and coal seam gas in Queensland.

Australia has known gas reserves are likely to last the next 100 years, and is adding new discoveries to this resource regularly.

At present, there are 14 gas liquefaction plants under construction around the globe – eight of them in Australia.

The driver is energy needs in Asia, and the fact that LNG is a cheap and clean alternative to coal. When Australia’s eight projects underway are completed, Australia will be supplying 10% of China’s gas needs, 30% of Japan’s needs, and 30% of Korea’s needs.

The value of LNG exports is expected to grow from around $10 billion a year now to more than $40 billion.

High dollar and cost concerns

That said, there are legitimate concerns that the high A$ and an alarming rise in Australia’s infrastructure and employment costs – and all of the associated imposts of doing business in this country, including the productivity/industrial relations imbroglio, the carbon tax and dealing with three tiers of government – could bite into all  these optimistic numbers.

For example – and most notably – Australia’s single biggest resources project, the Chevron-led Gorgon LNG project based on Barrow Island off Western Australia, has suffered a cost blow-out of about 40%, with the estimated project cost ballooning from $US37 billion when it got the go-ahead in September 2009 to a revised estimate of US$52 billion.

Similarly, the Woodside Petroleum-led Browse joint venture off Broome – a $40 billion project – is weighing up the cost difference between a floating processing plant versus one located on the coast near Broome (a potentiality that has met with local opposition, but which is desired by the WA government on employment grounds).

Likewise, the four coal seam gas-sourced LNG projects on the drawing board in Gladstone in Queensland – three of which are being built – may not all go ahead, with the final project, the Arrow Energy project, yet to begin construction as it goes through the process leading to a final investment decision.

Clearly, there are several pressing short-term problems facing the gas industry. Santos chief executive David Knox warned late last year that $150 billion of LNG plant proposals waiting in the wings were at risk unless the industry’s productivity improved.

Of interest for SMSFs

However, the gas industry’s fundamentals are well-established and its long-term export prospects are very healthy – leading to the kind of long-term earnings flows that certainly interest an SMSF.

Woodside Petroleum is Australia’s premier pure oil and gas stock (remember, BHP has a petroleum business), producing LNG, natural gas, condensate, crude oil and LPG. Just this week, Woodside reported that production and revenue both surged by about 30% in 2012 to new records, mostly due to its massive Pluto LNG operations in Western Australia, which the company describes as a “game-changer.”

The strength of the Pluto project has enabled Woodside to pick up some big growth opportunities, such as recently-announced exploration agreements in Israel and Myanmar. In particular, the recent deal it struck in picking up a 30% stake in the world-class Leviathan gas field off Israel has been hailed around the petroleum industry as a savvy deal.

Having successfully operated LNG projects for nearly 25 years, Woodside – although a relatively small global player in the industry – has been consistently able to punch above its weight, although it must be said that about 95% of revenue still comes from Australia (with the North-West Shelf joint venture generating the lion’s share.)

Market expectations project Woodside to pay a fully franked dividend yield of somewhere between 3.5% – 4.4% in FY13, or 4.25% – 5.35% to an SMSF in accumulation mode. Clearly an outcome near the higher end of that range would be more suitable to an SMSF investor, but this is one of those cases in which yield is not the only consideration. Woodside is the kind of cornerstone stock that a long-term portfolio should have, giving it exposure to a major investment theme – energy supply to the faster-growing economies of Asia.

LNG latecomer

Santos has perennially played second fiddle to Woodside in the Australian hydrocarbon world, mostly because it took a long time to move away from its long-established Cooper Basin gas base and position itself for the future. However, the company remains Australia’s largest domestic gas supplier. While its Cooper Basin home field plugs away – indeed it appears rejuvenated – Santos has branched out into all the other major Australian basins, and also produces gas in Indonesia, Vietnam and Bangladesh.

Santos is a latecomer to the LNG world compared to Woodside. It got into the business through the position it built up over the 2000s in coal seam gas (CSG) in Queensland: Santos produces about one-quarter of the country’s CSG, and has manoeuvred itself into the box seat to be the major supplier to two of the LNG export projects based on a CSG source, namely the PNG LNG project (42% owned by operator ExxonMobil, and 17.7% owned by Santos) and the Gladstone LNG project (in which Santos is the largest stakeholder, partnered by Petronas of Malaysia. Total of France and KOGAS of Korea, the latter being the largest buyer of LNG in the world.) Exports are expected to commence in 2015.

When LNG deliveries from PNG LNG begin in 2014, signed-up customers include China Petroleum and Chemical Corporation (Sinopec), Osaka Gas Company Limited, The Tokyo Electric Power Company Inc., and Chinese Petroleum Corporation – a blue-chip energy customer list.

PNG LNG and Gladstone LNG look great projects on paper. But Santos at this stage is a potential producer, from an unusual source. That alone stamps it as a higher-risk, lower-quality LNG investment than Woodside at present.

That is not to say that Santos is a dud: it has a good gas growth story to tell, too. But at Santos’ FY 13 forecast fully franked yield of about 2.6% on consensus expectation – equivalent to 3.1% for an SMSF in accumulation mode – Woodside has a more rewarding yield proposition for SMSF investors.

Next week we will examine Origin versus AGL.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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