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Australian Coal-Gas Sparks a Deal Boom


FEBRUARY 26, 2009

A heated contest for a small Australian energy firm is highlighting the appeal of a hot new play for Big Oil — gas trapped in the coal seams of north-eastern Australia.

BG Group PLC, the British oil and gas company, and Royal Dutch Shell PLC’s Australian partner Arrow Energy Ltd. are competing for Pure Energy Resources Ltd., an Australian player in coalbed methane. Pure’s board last week recommended BG’s 995 million Australian dollars (US$646.7 million) cash offer to shareholders.

It’s the latest in a series of big-money tussles for unconventional gas assets in the northeastern Australian state of Queensland. International oil majors have funneled more than $12 billion into the sector over the last year, partnering with small local players in a flurry of dealmaking. “It’s a Klondike mentality,” says Jason Kenney, an oil and gas analyst at ING Bank.

[Arrow Energy and methane gas deals]Bloomberg News

An Arrow Energy employee tests the methane gas levels in Dalby, Australia.

Australia isn’t the only place where oil and gas companies are drilling into depleted coalfields to access the natural gas trapped there. Coal bed methane, also known as coal seam gas, now accounts for nearly 10% of the gas produced in the U.S. There has been a huge upsurge in drilling activity in Wyoming, New Mexico and Colorado in recent years.

Some analysts have wondered about the wisdom of big investments in unconventional fuels at a time when the worldwide recession has damped demand for energy and the plunging price of crude is squeezing oil companies’ balance sheets.

For these bidders, though, the strategic rationale is clear. Coalbed methane projects can take years to reach peak output, but once they do, they keep producing for 25 years or more.

“These assets will begin to generate revenue beyond this economic cycle and for decades thereafter,” says Mr. Kenney. “And the bulk of the production comes much further down the line, when prices will presumably be much more buoyant.”

Australia has become one of the biggest draws in the sector. Coalbed methane helped drive a tenfold increase in the value of oil and gas deals in Australia last year to $16.6 billion, up from $1.7 billion in 2007, according to PriceWaterhouseCoopers. Globally, the biggest oil and gas deal of the year was ConocoPhillips‘s $5.85 billion coalbed methane joint venture with Origin Energy Ltd., PWC said.

The rise of this unusual resource underscores the increasing appeal of unconventional oil and gas. Shale gas, oil sands and coal seam gas were long too difficult and costly to produce, but advances in technology and rising energy prices made them viable. The fact they are often in safe, investor-friendly havens like Australia and Canada and close to lucrative end markets has only enhanced their allure.

Coal seam gas is also seen as a greener alternative to other fossil fuels. It contains relatively little carbon dioxide and sulfur, so it’s more clean-burning than coal, oil or conventional gas.

In Queensland, methane was long produced by local companies to feed single power stations. Low gas prices and a limited domestic market held back development.

That changed with the advent of technology to produce liquefied natural gas or LNG, which can be exported on tankers like crude oil. Energy firms came to realize the potential of Queensland’s coal seam gas as a feedstock for LNG, which could be exported from Australia to the high-value markets of northeast Asia.

A Rich Seam of Deals

There has been a steady flow of deals in Australia’s coal seam gas sector over the last year:

April 2008: BG Group makes $12 billion bid for Origin Energy. Origin rejects it.

May: Malaysia’s state-owned Petronas buys a 40% stake in Santos’s LNG project for $2.5 billion.

June: Royal Dutch Shell pays $739 million for an interest in Arrow Energy’s coal seam gas projects.

September: ConocoPhillips forms $5.9 billion joint venture with Origin to develop its coal seam gas assets. Conoco will kick in another $2 billion later for an LNG plant.

November: BG buys Queensland Gas for $3.4 billion.

February 2009: Pure Energy recommends shareholders accept BG’s sweetened offer of $646.7 million, which beat an Arrow Energy offer.

Sources: Reuters; WSJ Research

Big energy companies began to pour into the region. Last year, BG acquired Queensland Gas Co., Malaysia’s state-owned Petroliam Nasional, or Petronas, bought a stake in Australian independent Santos Ltd., Shell partnered with Arrow and ConocoPhillips with Origin. These assets will feed into five LNG plants being proposed for the area around Gladstone, a port in Queensland, all of which are slated for start-up between 2012 and 2015.

The sector got a big boost earlier this month when Golar LNG Ltd., a Norwegian LNG shipper, agreed to buy all the gas to be produced by LNG Ltd., a small Australian company that’s building one of the five proposed plants in Gladstone.

Some observers wonder if Gladstone can support all five. “Doubts have been raised as to whether all five projects will go ahead, especially with the shortage of skilled labor,” says Paul Rheinberg, regional manager for Australiasia at energy consultancy IHS.

There are concerns about the huge development costs. Coal seam gas production presents big technical challenges: gas is held in place by water pressure, and only starts flowing once the water has been pumped out. Unlike conventional wells, once you start producing gas from coal seams you generally can’t switch it off. Production has to be built up over time, flow rates can be unpredictable, and output can vary widely from one patch of coal to another.

“If you put yourself in a buyer’s shoes, it’s worrying,” says Frank Harris, an LNG analyst at energy consultancy Wood Mackenzie. Because of such concerns about LNG from coalbed methane, “there’s a finite appetite for it among north-east Asian buyers.”

BG has an advantage over other players in Gladstone because it’s able to offer Asian customers LNG from its many other liquefied gas developments around the world, says Mr. Harris.

Write to Guy Chazan at [email protected]

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