America De-energised

While we groan about petrol prices, spare a thought for our American cousins. They may be still paying far less than us for petrol, but natural gas is quite another matter: many US households will soon be paying four times more than we do. The impact of natural gas selling at more than $12 per 1000 cubic feet '” more than double last September's price '” will crimp not just Christmas retail sales, but almost all sections of the US economy: fertilisers, textiles, petro-chemicals and food processing have all been hit by prices that are five times the 10-year average. It is a bracing change. In 2002, oil and gas represented 30% of Dow Chemicals’ input costs. This year they are 43%.

But as the US Department of Energy (DoE) sends out warnings to utility companies, there is a spring in the step of energy entrepreneurs '” including a dozen Australian listed energy companies. BHP may have lost its Typhoon platform for a day or two, drilling costs may be up and rigs hard to book, but for those with reserves or prospects, this is bonanza territory. We are not just talking about a brief energy spike: the DoE warns that prices will rise further, that the futures market is pricing gas at $12–14 for January and $10 through 2006. It's fair to say that natural gas, the fuel for 24% of the US power industry, 60% of US home heating, much of food processing and almost all the petro-chemical industry, may moderate, but never see $2–3 again.

Even before the two hurricanes ploughed into the US hydrocarbon heartland, the official view bordered on grim. After strong rises through 2004, gas peaked at $9 and even before Katrina’s disruption the DoE was expecting further rises. The heatwave that fuelled the hurricanes had kept Gulf region air-conditioners on full throttle, diverting to power generators gas that would normally have been sequestered for winter and set up a risk of winter shortfalls.

With 80% of Gulf infrastructure still shut down, there is a scramble for supplementary LNG from Russia, or whoever can supply, and it's a seller’s market. Gazprom, Russia’s biggest gas company, landed a cargo of LNG two weeks ago at the unprecedented price of $9.50, which raises the immediate question of what this would do to Australian LNG if cargoes currently committed by forward orders could be diverted to the spot market. Japanese buyers are apparently offering $12 or more '” if they can find shipments. But they are hard to come by. Repairs and maintenance worldwide mean that 20–24 shipments are absent from Australia, Nigeria and Egypt.

It may be premature to call this a global supply crisis, but the seeds of a regional energy crisis are surely there. World energy markets are no longer confined by distance and geography and nowhere is this clearer than North America, where population and economic growth remain firm, nuclear energy is politically shackled and hydro-electric generation opportunities are mostly fully exploited.

If this does become a true crisis, the cracks will open not so much in the US as across the northern border. Canada sends half its gas production south, supplying 16% of US gas. This comes largely from its Alberta fields, a vast prairie landscape east of the Rockies and south of the Canadian arctic. Big as the western sedimentary basin is, it has been producing for 50 years and output from 60,000 wells peaked in 2000.

The other issue confronting US supply is Mexico. It has a shortage of gas and imports about 5% of US output. Its proven reserves are about 14 trillion cubic feet, or 7.6 years’ supply, with the US filling its shortfall. Certainly, Mexico has plans to accelerate exploration and a series of large finds in the Gulf in the past two to three years provide some respite, but for the mid term it's not an encouraging picture. Mexico is now leaning on the US and the US is leaning on Canada.

Of course, sheer urgency of demand alone does not a good investment make. The downside of this market is that, by definition, easy gas targets are growing scarce and/or more distant. Just as the bulk of US coal production has switched from the declining Appalachian fields to the mid-West, so too gas explorers are switching their focus from the Gulf to Wyoming, Montana and Utah.

One possibility in the mix is that gas gradually prices itself out of the market. Coal looks cheap even after jumping about 90% in the past two years from a long-term average of $5–6 a tonne to the current $10. Already, big US coal operators such as Rio’s Kennecott are capturing some of this new $10 price, and as contracts roll forward UBS expects $9–10 will be the new level for the foreseeable future. This is still way below world spot prices of $60–80, so with coal the US is in the reverse position. It has the world's largest reserves of a resource that is now much cheaper than gas for energy output.

But there is a catch, perhaps the greatest Catch-22 the world has seen. If the US swings back to coal and scraps plans for hundreds of gas-fired power stations, there will not only be a lot more mercury, sulphur and nitrous oxide to remove, but the certainty of more greenhouse gases, which, in turn, could worsen the weather. Next year and in the following cyclone seasons, the surface temperature of the Gulf will at times equal or surpass the 30C of early September. That's too warm for comfort in the local swimming pool. It is hurricane fuel.

So this presents an invidious choice for the many; it offers windfall opportunities for the few. Most need not go past BHP and Woodside, but the informed '” as long as they really are '” have a range of smaller Australian gas explorers to choose from. Some are targeting coal-bed methane, others “tight” gas in the Rockies. Norwest is drilling onshore in coal territory in Tennessee and West Virginia. It is also spreading its risks with activity on India, Britain and Australia. Petsec is a Gulf gas specialist and, luckily, avoided hurricane damage. The reward for focus has been a big lift in profits and 80% margins. These now look like doubling as it achieves gas prices four times the Australian price.

These small to mid-sized operators may be only for the risk-tolerant, but the broader point requires no special brain power. It's enough for BHP and Woodside shareholders to know the world price for LNG is now in new territory.

Richard Campbell is a stockbroker with Bell Potter Securities