Love On A Beach

This story features ORIGIN ENERGY LIMITED. For more info SHARE ANALYSIS: ORG

– Beach Energy has announced shale reserves of 300tcf in the Cooper
– Broker interest is piqued, but not obsessive
– Prices, costs, technology and the long timeframe are all hurdles

By Greg Peel

Three hundred trillion cubic feet. That's the volume of “gas in place” suggested from test drilling at Beach Energy's ((BPT)) acreage in the remote Cooper Basin, known as PEL 218. It's a figure that has Beach executives grinning from ear to ear, has the market rather excited, and has energy sector analysts sitting up to take notice.

How much gas is that? Well if you recall the last milk crate you snaffled from outside a 7eleven, that's about one cubic foot. Now imagine snaffling 300,000,000,000,000 of them. It would be one hell of an an LP collection. That amount of gas is one hundred times Beach Energy's current “proven and probable” reserve base. And if accurate, PEL 218 alone would be enough, Macquarie calculates, to meet Australia's current east coast gas demands for 90 years.

Now we'll all be cooking with gas! 

The 300tcf figure was revealed last week at Beach's Investor Day gathering in Melbourne. Beach's stock price obviously skyrocketed on the news. Well, actually no, it didn't. It didn't go anywhere.

The market already knew Beach was sitting on an interesting and highly prospective “unconventional” gas source in the Cooper. Unconventional meaning shale gas and “tight sand” gas. It knew that shale gas is now the Next Big Thing in America, where those with more open minds are looking to the day crude oil supplies run out and/or reliance on enemy supply can be much diminished. But it also knows man might land on Mars before Cooper Basin shale gas is grilling lamb chops in suburban Sydney.

Chevron is the most recent global Big Oil conglomerate to announce the go ahead on yet another gargantuan LNG project offshore from Western Australia, in the form of its Wheatstone asset. The project lines up against the massive Gorgon project, Woodside's ((WPL)) Pluto and other assets, and many more projects in the region including the long established North West Shelf Operation. Over in Queensland, Santos ((STO)) and Origin Energy ((ORG)) are trying to win the race with their enormous coal seam methane LNG projects, so they can match the progress of Oil Search's ((OSH)) PNG LNG project, while other companies are also trying hard and everyone is sticking holes all over the east coast, from prime pasture to inner city suburbs.

Australia's first CSM LNG production is targetted for 2013-14. Over in America, shale LNG production is foreseen by 2015 or perhaps a little earlier, and now everyone is getting in on the act. Including BHP Billiton ((BHP)). Aside from hoping to sell natural gas domestically in the US to a market dominated by crude oil consumption, US shale hopefuls are also looking to export LNG to the burgeoning markets of Asia. Asia is exactly where Australia's west and east coast gas production is intended for too, given Australia's population is way too small and too far away from gas resources to be a viable sales destination alone. And if it felt like, Qatar could alone supply Asia tomorrow.

The price of Brent crude oil bottomed out in late 2008 at around US$40/bbl before rebounding to US$125/bbl in early 2011. The price of Henry Hub natural gas bottomed out at under US$3/mmbtu but not until mid 2009. It quickly bounced to US$6 but is now back under US$4. This is a US domestic price, and does not necessarily reflect long term gas offtake pricing which works on a moving ratio of the oil price. However, the bottom line is all gas prices remain weak for the simple reason there's a lot of it about.

It is in this climate that Beach has announced that it, too, can lay its hands on bucket loads of gas. The sheer size of the resource means that energy analysts must admit a potentially world class asset and agree that further development is warranted. But beyond that, can we really have any idea whether Beach's unconventional Cooper resources could be economical?

For starters, UBS notes the amount of gas Beach could actually recover from the Cooper will likely be in the range of 10% to 30% of reserves based on established US experience. JP Morgan suggests a tighter 15% to 25%. Already that 300tcf number has to be trimmed.

Then there's the fact that as far as Basins go, they don't come much more remote than the Cooper. Santos made its name in the Cooper, and Beach's existing cashflow businesses include conventional Cooper oil production. But even here Citi notes production is limited by trucking capacity, at least until the reopening of the Tantanna pipeline. The Cooper is so far away from anything – the coast, infrastructure, human life – that already it is understood unconventional gas production will come at an elevated cost. 

Then we consider that Australia does not yet have any shale gas production. It doesn't have any CSM LNG production yet either, but development has been underway for some time now and everything's just about in place. While not dissimilar to CSM extraction, shale gas extraction is nevertheless different and requires different equipment and skills, neither of which exist in Australia. Production equipment will have to be imported, and probably won't be cheap. And then it has to make out to a place people in the remotest Outback call The Outback.

America well and truly has the jump on Australia when it comes to shale and although there are some pretty remote places in the US, none of them are far from a town or a railway line. Specific equipment and infrastructure exists and already economies of scale are kicking in.

At its Investor Day, Beach outlined an intended initial $200m spend on further Cooper shale development. That's a lot of money for a company with only a $1.2bn market cap ($600m at the bottom of the GFC). It's nevertheless a lot of money energy analysts feel is probably worth investing at this time given the sheer size of the potential resource, but we're talking a very long, long-term project and a lot of things have to fall into place to make Cooper shale viable.

Firstly, the gas price has to rise, particularly on the east coast of Australia, where every backyard is a potential source of CSM. Secondly, the margin on the production of the gas achieved at the price which must rise must rise, from levels suggested at current pricing. This means cost inflation has to be controlled, and the way things are going the opposite is looking more likely. There is a great gas rush going on in the world which will be going on for many years yet, and there'll only be so much equipment and so many experts and workers to go around.

So while analysts don't disagree Cooper shale is worth throwing a bit more money at, and are happy to suggest the world gas price will probably rise over time (driven by Asian consumption, the rising cost of crude oil), they struggle to see the overall economics of the venture if, as Citi puts it, “costs remain significantly higher than in the highly competitive US market”.

The result is that brokers are not ascribing much value to Cooper shale in their models at present, which is why Beach's share price did not rocket on the news of 300 trillion milk crates full of gas. The Cooper is not, however, Beach's only asset, with other promising acreages on the books in other far flung locations such as Tanzania and Egypt. Indeed, Beach can boast “several potential company-making opportunities,” Citi suggests, but “most of these are long-dated and require proof of concept (exploration success, proof of technology, proof of cost control etc) before we could include respective value in our price target."

JP Morgan is impressed by all of Beach's assets, but wonders if the company may not spread itself a bit too thin in chasing its wealth of opportunities.

“Will improved efficiencies, technology and higher future Australian gas prices help unlock this gas?” asks UBS. 

Will man first land on Mars?

Perhaps Macquarie has the right idea, given the sci-fi that's creeping in. Ultimately economical or not, Beach is “on the threshold of a rich vein of news flow”. On that basis, says Macquarie, the company is likely to receive significant attention in the months ahead.

Five brokers in the FNArena database currently cover beach Energy. One (Macquarie) rates the stock a Buy while the others are all on Hold. Their average target price is $1.18 which is only a tad above where the price has been this week.

As a side note: To date neighbouring Santos has shown no interest in Cooper shale whatsoever. BHP chose shale gas as its next diversification asset (after failing on potash) but went to America to find it.
 

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