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Energy Firms See a Bonanza in Australia

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Energy Firms See a Bonanza in Australia

Once a Byproduct, a Form of Gas 
Could Become a Big Export Darling
By BILL LINDSAY
June 10, 2008

SYDNEY, Australia — With three global energy companies looking to make massive bets on Australia’s latest commodity darling, coal-seam gas, the outlook for the industry has never been brighter.

While debate persists about how to value the resource, recent deal prices suggest the fuel, known as CSG and already a significant energy source in Australia, will become a major export earner.

“It’s moved from something that was only of interest to Australian minnows to something that’s of international interest,” says Graham Bethune, chief executive of Energy Quest, a consulting group based in Adelaide.

Australian Reserves

While BG Group of the United Kingdom is recovering after a A$13.62 billion (US$13.11 billion) takeover offer was rebuffed by Australia’s largest CSG producer, Origin Energy, two companies have snared CSG reserves by buying stakes in projects controlled by Australian companies. Malaysia’s state-owned Petroliam Nasional, or Petronas, did a deal with Santos, while Royal Dutch Shellcompleted one with Arrow Energy.

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The gas, comprised largely of methane trapped under pressure when organic matter forms into coal, has gone from a byproduct to accounting for about 12% of Australia’s gas consumption.

Although major U.S. energy companies includingConocoPhillips and Enron spent hundreds of millions drilling for CSG in Queensland in the early 1990s, they had little success using U.S. extraction techniques.

Large quantities of CSG have been used in the U.S. for more than 25 years, but the industry took off in Australia in the last decade, helped by new technology and state-mandated targets for use of cleaner gas in electricity generation.

While the technology to convert CSG into liquefied natural gas, or LNG, hasn’t been commercially proven, at least four groups have plans to build multibillion-dollar LNG plants at the port of Gladstone, in Queensland state, to ship the fuel overseas.

‘Difficult to Assess’

By bidding for Origin, BG was hoping to secure additional gas supplies for an A$8 billion LNG plant it plans to bring on stream in 2013.

In rejecting BG’s sweetened approach after a month of talks on May 30, Origin Chief Executive Grant King said the price paid in the Petronas deal implied that his company’s CSG reserves would be worth about A$16 billion. Origin also said its “3P” gas reserves — proven, probable and possible — had more than doubled, highlighting the difficulty in accurately valuing the fuel.

“Since the resource potential of these assets is changing so rapidly, it is difficult to assess what the buyer is actually paying for and what the ultimate value of this resource actually is,” Macquarie analyst Andrew Blakely wrote last week.

With Origin’s domestic and New Zealand electricity generation, transmission and retailing businesses accounting for about 80% of its earnings, J.P. Morgan estimated BG would need to pay around A$23 billion to match the price Petronas paid Santos.

While the BG approach at A$15.50 a share was a 48% premium to Origin’s price before talks began, its shares remain above the offer level, closing Friday at A$15.60. (Australian markets were closed Monday.)

Origin’s response to BG prompted J.P. Morgan and ABN Amro to upgrade its stock to a “buy” from a “hold” and increase their target prices. ABN Amro raised its 12-month target to A$17.50 from A$14.70. J.P. Morgan set a target of A$18 — 15% above Friday’s close.

Growing Production

With high oil prices also boosting energy stocks, shares in Santos are up 80% since late February. Niche CSG producers such as Queensland Gas have seen their shares skyrocket as well. Shares of Queensland Gas, which signed a deal to supply gas to BG in February, briefly traded below 50 Australian cents in mid-June 2006. On May 29, they reached an intraday high of A$6.39 before slipping. On Friday, they closed at A$5.04.

Energy Quest says that national CSG production, primarily from two Queensland basins, grew 38% from a year earlier in the first quarter of 2008. On Australia’s east coast, where CSG comprises almost a quarter of gas production, prices are generally between A$3 and A$3.50 per gigajoule, “but the amounts the companies would be hoping to get from exports are significantly higher than that,” Mr. Bethune says.

A gigajoule of gas is enough to produce a bit less than 280 kilowatt-hours of electricity.

According to Energy Quest, Australian LNG export prices averaged A$7.29 a gigajoule for the January-March quarter.

Analysts believe Petronas’s US$2.51 billion investment in a Santos LNG project has created a new pricing paradigm for CSG and made exporting the gas appear more viable. Petronas is one of the world’s three largest LNG producers.

Teaming Up

On May 29, Petronas bought a 40% stake in the Santos project. This secured one-third of Santos’s CSG reserves and teamed up Petronas with the Adelaide-based producer in developing a 450-kilometer gas pipeline to Gladstone and a US$7.7 billion LNG plant.

“This transaction has established a new benchmark for the value of Eastern Australian gas resources and appears to be driven by the view that LNG is increasingly linked to oil prices in the Asia Pacific market,” said UBS energy analyst Gordon Ramsay in a May 30 note. The deal with Petronas valued Santos’s 3P reserves of CSG at A$1.65 a gigajoule.

Further complicating the issue of valuation, Shell also entered the fray June 2, with a A$776 million investment in the CSG assets of Arrow Energy, which hopes to develop an LNG plant near Gladstone, by 2010.

Shares of Arrow rose sharply after it bought CSG producer CH4 Gas in late 2006. They were about 60 Australian cents in September 2006; on the day the Shell deal was announced, the stock hit an intraday high of A$4.11. On Friday, it closed at A$3.75.

Merrill Lynch calculated the Shell deal valued Arrow’s 3P reserves at A$0.70 a gigajoule. It said the deal “takes some of the heat out of the implied valuations for Origin and demonstrates that Santos achieved an excellent sale price.”

Write to Bill Lindsay at [email protected]

http://online.wsj.com/article/SB121304692355458603.html

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