Investing in natural gas

Natural gas is often described as environmentally friendly although it is a non-renewable fossil fuel just like oil or coal. This is because burning natural gas, which is mainly methane, creates far lower atmospheric emissions than oil or coal. Consequently, using natural gas instead of oil or coal is an environmental plus, says Adrian Herbert in his article for the Eco Investor magazine.

There are further advantages in using natural gas. In Australia we have much larger reserves of natural gas than oil and international markets do not determine prices. In addition, natural gas is much cheaper to transport within Australia than either oil or coal because it is supplied directly to most users by long distance low-pressure pipelines and local reticulation networks. Of course this infrastructure requires substantial investment but pipelines already link production sites with most major population areas.

The Federal and state governments recognise the advantages of natural gas and encourage its use.

About 3.4 million Australian households and 105,000 commercial and industrial customers are now linked to natural gas through 75,000 km of underground pipes and there is potential for this number to be significantly increased.

Overall production of energy from Australian natural gas including exports has increased strongly over more than 30 years. According to the Australian Bureau of Agricultural and Resources Economics (ABARE), in 1973-74 the figure was 172 petajoules (PJ) compared to 858 PJ from crude oil and condensate and 1,464 PJ from black coal. In 2001-02, the last year for which statistics are available, the figures were natural gas 1,355 PJ, crude and condensate 1,336 PJ and black coal 7,282 PJ.

The 2001-02 figures for natural gas and black coal showed increases over the preceding year but that for crude oil and condensates showed a decline, from 1,432 PJ to 1,336 PJ.

ABARE projects that without any major government policy changes, natural gas consumption will grow by around 3.4 per cent a year over the next 20 years increasing its contribution to primary energy consumption from 18 per cent to 24 per cent.

This will mean that even with a four-fold increase in coal seam methane production, which is currently being used to supplement natural gas supplies, eastern Australian markets will need supplies from new sources in the relatively near future. Some new sources are expected to come on stream as soon as next year but ABARE still predicts that by 2019-20 almost all of eastern Australia ’s gas reserves will be gone or running out with only an estimated three years’ worth of production remaining. ABARE notes that this is a conservative estimate based on current known reserves and new discoveries could change the picture significantly, but it stresses that natural gas is very much a finite resource.

Worldwide, the market for liquefied natural gas (LNG) is growing but so too is production capacity and there is actually a possibility of over supply in some markets in the short term. But projections for world energy demand, and the likelihood of oil prices continuing to rise, suggest that any over supply situation will be quickly self correcting as LNG will increasingly be used for new purposes, for example for powering motor vehicles. At present only 0.5 per cent of vehicles around the world are powered by natural gas although conversion from petrol power is relatively simple.

The environmental advantages of using natural gas instead of coal and oil are illustrated by figures from the US National Energy Information Center (NEIC) in Washington. NEIC notes that 23 per cent of US primary energy consumption is supplied by coal but it produces 37 per cent of carbon dioxide emissions. Carbon dioxide is a significant greenhouse gas. The percentages for petrol are 39 per cent usage and 42 per cent contribution to carbon dioxide emissions, and for natural gas 24 per cent usage and 21 per cent contribution to carbon dioxide emissions.

Focusing on vehicles alone, which are recognised as a major cause of photochemical smog, use of natural gas can greatly reduce emissions and their toxicity. In the US, the natural gas industry claims that replacing diesel and petrol with natural gas would reduce vehicle carbon monoxide emissions by more than 90 per cent, carbon dioxide by about 25 per cent and nitrogen oxide by more than 35 per cent.

As it is mainly methane, use of natural gas inevitably results in some emissions of methane which is itself a significant greenhouse gas.

On balance, however, use of natural gas as a replacement for other fossil fuels is seen as a strong plus for the environment.

So what is the investment track record of natural gas and how can individual investors invest in the sector? ASX listed companies operate in the various tiers of the industry: production, distribution and retailing. Here are profiles of some major companies grouped as far as possible in their predominant sector:

Production

*Woodside Petroleum (ASX-WPL) is Australia’s largest ASX-listed oil and gas exploration and production company and has a market capitalisation of $22.853 billion, a current share price of $34.28 ($13.69 five years ago) and a dividend yield of 1.95 per cent as of late September.

Woodside operates the North West Shelf Venture offshore from Karratha in Western Australia, Australia’s largest resource project. It also operates numerous joint ventures in Australia, Africa and the US.

The company has total probable reserves of more than 1.3 billion barrels of oil equivalent and produces the equivalent of nearly 60 million barrels of oil a year. Woodside recently contracted to export LNG to the Chinese province of Guangdong for the next 25 years, a deal expected to be worth $20-$25 billion.

*Santos (ASX-STO) operates the Cooper Basin in South Australia and is Australia’s largest onshore gas producer. Santos has a market capitalisation of about $6.753 billion, a current share price of $11.41 ($6.30 five years ago) and dividend yield of 3.16 per cent.

Santos has a large Australian and international exploration portfolio. Overseas exploration areas are in Indonesia and the US and it is pursuing new exploration opportunities in North Africa, Central Asia and the Middle East.

Significant development projects include the Bayu-Undan Liquids and LNG projects in the Australia Timor-Leste Joint Petroleum Development Area, the Mutineer-Exeter oil fields and John Brookes gas field developments in the Carnarvon Basin off Western Australia, the Oyong oil and gas field and Maleo gas field off East Java, and the Casino gas development off the coast of Victoria.

Distribution

*Australian Pipeline Trust (ASX-APA) is Australia’s largest natural gas pipeline operator and has interests in over 7,500 km of pipeline infrastructure in various parts of Australia.

It has a current market capitalisation of $985 million, a current share price of $3.53 ($2.30 five years ago) and dividend yield of 6.37 per cent.

*Alinta Infrastructure Holdings (ASX-AIH), an Australian infrastructure business with natural gas pipeline interests in the eastern states and WA, is scheduled to list on the ASX on October 4 following a successful IPO and capital raising. Shares in the IPO were issued at $3.20, $2 payable on application and $1.20 payable on 29 December 2006.

AIH will have a capitalization of $926 million, and is forecasting a distribution yield of 6.75 per cent for 2005 and 7.88 per cent for 2006.

*Diversified Energy and Utilities Trust (ASX-DUE) was listed in March this year. It holds interests in four businesses: Multinet, United Energy Distribution, Alinta Gas Networks and the Dampier-Bunbury Pipeline.

The trust has a current market capitalisation of $1.132 billion, a current share price of $2.67 (in May its units were trading at around $2.47) and a dividend yield of 6.74 per cent.

The company reported a total distribution of 22 cents per stapled unit in its first annual results to June, ahead of the 21.7 cent forecast before the IPO. This represented a yield of 9.6 per cent on the IPO price of $2.29 per stapled unit.

*Envestra (ASX-ENV) owns about 18,500 km of natural gas distribution networks and 1,110 km of transmission pipelines serving over 950,000 consumers in South Australia, Victoria, Queensland, NSW and the Northern Territory.

Envestra has a current market capitalisation of $939 million, current share price of $1.22 (84 cents five years ago) and dividend yield of 7.7 per cent.

Multi Sectoral

*Origin Energy (ASX-ORG) operates in most parts of the energy supply chain including gas and oil exploration and production, power generation and supplying gas and electricity to end users.

Origin has a market capitalisation of $5.67 billion, a current share price of $7.18 ($1.90 five years ago) and a dividend yield of 2.09 per cent.

Origin Energy’s proved plus probable reserves have been estimated at 2,220 PJ that represents more than 25 years supply at its current production rates. Approximately 85 per cent of these reserves are natural gas of which about 45 per cent are located in the South Australian and south-west Queensland portions of the Cooper Basin. Another 30 per cent of its natural gas reserves are in coal seam gas fields in central Queensland that makes it Australia’s largest producer of coal seam gas.

Over half of Origin Energy’s gas reserves are committed to long term take or pay contracts.

Origin has an exploration portfolio that includes onshore and offshore areas in the Bass, Otway, Perth and Bonaparte basins in Australia and the Taranaki basin in New Zealand.

Over recent years, Origin Energy has focused exploration on eastern Australia, close to the country’s largest gas markets. This paid off in 2001 with the discovery of new gas fields in the Otway basin off the coast of Victoria that are expected to supply gas from next year. Origin has also made new discoveries in Western Australia.

*Australian Gas Light (ASX-AGL) has long dominated the retail gas supply industry in NSW and, with its expansion into electricity retailing in recent years, is the country’s leading energy retailer.

AGL has a current market capitalisation of $6.734 billion; a current share price of $14.75 ($10.23 five years ago) and a dividend yield of 4.27 per cent. At the distribution and retail level, AGL owns the gas network that delivers gas to domestic users in the major cities in NSW and is also a joint venture partner with Actew in the ACT.

AGL also owns gas powered electricity generation plants in Victoria and South Australia that are used to generate power to meet peak loadings. It expects to develop similar plants in NSW in the future.

Although it is not currently involved in gas production, AGL recently reached agreement with Oil Search Limited to take a 10 per cent interest in the Papua New Guinea Gas Project which is expected to produce natural gas by 2009. AGL has reached a conditional $4.5 billion agreement to take 1,500 PJ of gas from the PNG Gas Project for 20 years from 2009. This prices the gas lower than the present average from AGL’s current suppliers.

AGL also has a 30 per cent interest in the Australian Pipeline Trust and is a member of a consortium that has a contract to develop the Australian section of the pipeline that will bring the Papua New Guinea gas to Australia.

*Alinta Ltd (ASX-ALN) is a WA based integrated energy business and a natural gas distributor and retailer. It has a capitalization of $2.8 billion. At the end of September its shares were trading at around $11 compared to $2.60 five years ago. Its dividend yield is around 4.4 per cent.

The Future

The natural gas industry appears an area of investment with an attractive upside from increasing demand and from an anticipated continuing rising world oil price. As an important source of domestic power and an export industry, natural gas can expect to be largely unaffected by any downturn in the Australian economy. This should ensure companies in the sector will be able to continue their record of providing consistently good dividends as well as achieving capital growth as long as Australian gas reserves remain productive, which is expected to be at least for the next fifteen years.

Beyond that, the survival of the industry will probably depend on new reserves close to Australia being brought on stream at competitive costs. But with Australian oil reserves expected to be exhausted within the same time frame and environmental pressures continuing to increase, the industry may be able to bear significant increases in the cost of gas supplies should Australian reserves run down.

Meanwhile the industry offers a wide range of options for all types of investors including those focused on capital gains and those more interested in secure dividends.

Reprinted with permission from Eco Investor magazine October 2005 edition. For further information visit www.ecoinvestor.com.au.