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Treasure Chest: Woodside’s Longer Term Risk

Treasure Chest | Sep 12 2017

Pressure on LNG prices put Woodside’s returns at risk when contracts are negotiated at a time of peak oversupply.

– India renegotiating LNG pricing
– Early Pluto contracts up for renegotiation in 2019
– Woodside may not be as low risk as assumed

 

By Greg Peel

The issue of LNG pricing has long been an issue for buyers and sellers in the global gas market. Traditionally, the price of exported LNG has been indexed to the prevailing price of oil. However, while the price of oil has had its ups and downs since the GFC, the price of gas has remained at low levels due to ever increasing shale production.

This means the spot price of gas is always lower than the indexed price of LNG, even after accounting for the premium to cover the cost of liquefaction for export, and sometimes materially so. Why, then, would importers of LNG pay oil indexed prices when they are that much higher than spot?

The reason is security. Buyers need to know they have a secure energy supply and thus are prepared to pay up for long term offtake contracts with suppliers. Typically such offtake contracts are negotiated before the construction and ramp-up of an LNG facility is complete, given sellers need to be secure in the knowledge their significant investment will be worth it. A buyer looking to exploit prevailing spot markets may miss out, and a seller offering spot prices may find themselves burning cash.

But as more and more gas is pumped out of the earth and ocean floor, and more and more LNG export facilities come on line, it is difficult to argue the case for ongoing elevated pricing.

Indian Takers

Goldman Sachs today notes press reports are suggesting India’s Petronet may have successfully renegotiated terms with ExxonMobil with regard its 20-year offtake agreement from the Gorgon LNG plant in Western Australia. Petronet has agreed to increase its offtake volume by 67%, but only in exchange for a lower oil-linked pricing equation and better terms on shipping.

We see this outcome, if finalised, as reflective of an oversupplied, buyers’ market in which buyers want lower prices and suppliers want to reduce spot LNG exposure through medium/long term volume placement,” says Goldman. The result may well be one of tempting others in the region to more aggressively seek similarly reduced terms, particularly those on contracts at significantly higher prices, the analysts suggest.

Goldman Sachs already believes the most recently completed Australian LNG facilities (not including PNG LNG) are likely to produce returns below the cost of capital over their life cycle. A renegotiation of pricing will only make this worse. There are nevertheless some projects that can yet achieve a clear positive from debottlenecking (improving production efficiency), Goldman notes, including PNG LNG and Woodside Petroleum’s ((WPL)) Pluto LNG.

Woodside’s Risk

Offtake contracts typically mitigate price risk in the LNG market, Citi notes. However, in the great Australian LNG boom of the past decade, resulting in the more recent start-ups of the likes of Gorgon and the various Queensland CSG LNG facilities, Woodside’s Pluto in WA was an early mover. This means original offtake contracts will be coming up for repricing as soon as April, 2019.

Pluto production is 70-90% contracted but this means only some 20% is protected from price weakness from 2019 on, when all the new projects are hitting their straps and LNG hits peak oversupply. (And that’s without considering the push by American producers to allow more export of abundant shale gas as LNG).

To make matters worse, Woodside has recently signed a 20-year deal to buy American LNG from Corpus Christi in Texas at what Citi describes as an “expensive” price.

Citi has remodelled its Woodside earnings forecasts to include losses from the Corpus Christi deal, which results in a -10% reduction over 2020-22, and has assumed a reduced oil-linked pricing mechanism from 2019, which takes off another -20%. Citi’s 2019 earnings forecasts are now -39% below market consensus.

This leads to a dividend yield forecast in the same period of only 3.4%. FNArena database consensus forecasts suggest 4.0% in 2017 and 4.3% in 2018 (at the current exchange rate).

Citi is quick to acknowledge this potential earnings risk is several years away, and perhaps the ultimate impact could be significantly less than Citi is currently forecasting. Maybe Woodside can negotiate a better deal. Maybe the company will just trade exceptionally well. Maybe the gas price will recover.

And maybe not. Either way, Citi believes the market is being misled into perceiving Woodside as a low risk investment.

Citi retains a Sell rating and has a twelve month price target of $27.16. This is not the lowest target among the eight stockbrokers in the FNArena database. Credit Suisse (Underperform) has $25.60.

As is typically the case with a resources company, broker valuations, and therefore targets, cover a wide range. This is due to divergent views on the many variables involved in that valuation, from the oil price to currency to demand/supply assumptions. Morgan Stanley (Overweight) is the high marker on $36.65.

In total there are two Buy, four Hold and two Sell (or equivalent) ratings, for a consensus target of $30.00.

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