"Australia will be hit especially hard with the oil rout"

[InsvestoBoy]

My whole portfolio is kind of setup to sell little chunks of my winners and allocate them into unloved asset classes.

So last week I was thinking of maybe getting long some energy stocks to get some inflation beta happening in the portfolio, kind of as a hedge against the nonstop rocking performance of my long duration and gold trades (which both do really well in declining real interest rate environments) and any geopolitical shocks with Iran.

So I use Barchart to pull up the cash WTI and divide it by cash AUDUSD and end up with this chart:


Now let's see what kind of beta our biggest energy stocks have to this:

WPL


STO


ORG


ORG has a little divergence there because there was a takeover offer or something around 2009 I remember.

I'm thinking to myself, if I want I can just buy little baskets of the top 3 and earn some nice dividends to boot instead of buying an oil futs ETF like USO (on the US exchange) and paying for contango, which drains returns. I don't like OOO because it's currency hedged and I like to manage my own currency exposure, and in general commodity ETFs on the ASX suck.

So I start browsing the sites for WPL, STO, ORG and I realise none of them are even oilers! They all sell LNG. Of the big stocks on the ASX, it's only really BHP that actually produces and sells oil.

Since I wanted some copper exposure as well (for other reasons) I was thinking maybe I'll just buy BHP so I never pulled the trigger on the WPL/STO/ORG basket.

Anyway, today I was browsing through Anas Alhajji's twitter feed and saw this thread:



about the impact of the Saudi/Russia oil fight on LNG exporters with oil linked pricing and even insignificant Australia got a mention in tweet 3:

"All LNG companies operating in Australia will be hit especially hard with the oil rout".

Anas is a pretty sharp oil dude, he used to be a regular on MacroVoices Energy Week and I would always perk up when he talked.

Anyway, possibly an interesting thing to discuss so I thought I'd throw up a thread with some charts.

I know @Smurf1976 probably has something interesting to add.

 

[Austwide]

insignificant Australia?

Australia is the 2nd or even the largest exporter of LNG in the world.
Volumes may drop of a bit as China is one of our 3 main importers

 

[aus_trader]

Interesting information, which probably explains why the oil/gas asx stocks were down by a lot.

There may be some beneficiaries of lower oil prices as well such as the airlines, but they are grappling with another problem which is Corona.

Transport companies may also have a big reduction in expenses, it's a pity that 'Toll Holdings' is no longer listed on asx after takeover from Japan Post Co. Perhaps NZ listed company Mainfreight Limited (NZE: MFT).

We could be the other beneficiaries, when we get cheaper Petrol prices at the pump, which may go as low as a dollar/litre or lower in the near future if Crude Oil price stagnates around the US$30 mark.

 

[Dona Ferentes]

Interesting information, which probably explains why the oil/gas asx stocks were down by a lot.

Transport companies may also have a big reduction in expenses, it's a pity that 'Toll Holdings' is no longer listed on asx after takeover from Japan Post Co. Perhaps NZ listed company Mainfreight Limited (NZE: MFT).
... other beneficiaries.

Lindsay LAU

 

[InsvestoBoy]

insignificant Australia?

Australia is the 2nd or even the largest exporter of LNG in the world.
Volumes may drop of a bit as China is one of our 3 main importers

As a country on the world stage we are completely insignificant.

"Australia is the 2nd or even largest exporter of LNG in the world" makes it sound like there is a company called Australia which exports a lot of LNG. Nope, it's giant - actually significant - multinational companies which do the exporting, take the profits, and Australia gets not a lot out of it. This is nothing like Qatargas which is a state owned entity.

Aramco market cap: 105B USD
Exxon market cap: 183B USD
Chevron market cap: 159B USD
Shell market cap: 120B USD

Woodside market cap: 19B AUD

Insignificant.

 

[aus_trader]

Lindsay LAU

Yeah, I forgot "You are passing another Fox". Lindsay Fox that is

 

[Dona Ferentes]

Yeah, I forgot "You are passing another Fox". Lindsay Fox that is

do not take overturning vehicles

 

[aus_trader]

do not take overturning vehicles

Bit twisted, but I like it

 

[Dona Ferentes]

also K & S Corporation

K&S Corporation Limited (KSC) is an Australian provider of transport & logistic solutions, contract management, warehousing & distribution and fuel distribution to clients in Australia and New Zealand.

 

[Dona Ferentes]

Bit twisted, but I like it

I do the Sydney - Canberra run too often.

 

[Smurf1976]

I know @Smurf1976 probably has something interesting to add.

Ultimately the end uses of energy can be divided into a few key categories:

Electricity
Transport
Industry
Commercial
Residential

Note there that "industry" or "residential" means the direct use of fuels in factories or homes and does not include their use of electricity.

Now looking at those the reality is that there's considerable short term flexibility in the electricity and industrial sector to switch between fuels based on price. In the long term that also applies to the commercial and residential sector when equipment wears out and is replaced etc. It's really only the transport sector which is really stuck - can't run a plane on coal for example.

LNG projects are capital intensive when compared to oil in that it's not just producing the resource but the liquefaction, shipping, storage and regasification is all rather expensive when compared to the comparatively cheap and low tech process of storing oil in a simple tank at ambient temperature and pressure. Oil's a lot easier to handle than gas and has no need for all that costly infrastructure.

LNG contracts are thus commonly set with reference to the oil price since an electricity utility, and they are the largest LNG buyers, isn't going to spend all that money on infrastructure without some assurance that they're actually going to get cheaper fuel by doing so.

So for contract LNG it's commonly set with reference to oil as a benchmark. For spots sales well they're still competing with other fuels especially oil.

A lot of industrial boilers, power generation etc can switch between fuels seamlessly. That is, they can do it without even a drop in output during the change, production continues completely uninterrupted. As such they will go for whatever's cheapest - that's gas under normal circumstances but if it wasn't then they'd be switching to oil real quick.

Not all power generation or industry has that capability but enough does to create a situation where the ability to substitute one for the other is significant in practice.

A key factor with gas is that it's a local commodity as such rather than a global one. If there's no or very limited ability to import / export from a gas system then the local price won't reflect any international price for example. The USA is the most obvious example there - exports aren't zero but capacity is very limited and the domestic price has in recent years remained below the international prices for that reason.

So looking at market pricing of the various things which "oil" companies listed on the ASX produce:

Crude oil = self-explanatory and it's directly tied to the oil price.

Condensate = this is a by-product of gas production which is sold to oil refineries as feedstock for the production of petrol etc. It is counted as "oil" for statistical purposes globally and its price also follows the oil price despite its association with gas. Anything referring to total oil reserves etc will commonly refer to "crude + condensate" for this reason. Consider it to be oil in practice for financial purposes.

LPG (propane and butane) are a gas at ambient temperature and pressure but the hint's in the name - Liquefied Petroleum Gas and that's exactly what it is. LPG is not LNG, it is not natural gas, and LPG is closely tied to oil in terms of most end uses and price. Some LPG is also produced at oil refineries. So whilst it doesn't always strictly track the oil price and is not oil as such, it mostly does and most publishers of statistics, either government or private, do include LPG as "oil" for that reason.

Ethane is a minor component of natural gas. It's either stripped out and sold separately (as a gas not a liquid) to petrochemical producers or in small amounts it's left in the natural gas supply to consumers if there's no local petrochemical producer wanting it. In a few cases it is used as fuel in its pure form at specific facilities. Financially it's not a major market in most parts of the world - it tends to be either sold as though it were natural gas or sold under contract to a specific end user.

Natural gas (methane) or LNG is as per the name. Comments as above about its linkage to the oil price.

Electricity - OP mentioned Origin and they do generate electricity, the market price of which is its own market although fuel costs are a key influence.

Retail - Origin is also a retailer of gas and electricity to consumers as well as a physical distributor and retailer of LPG. These markets and the profit derived from them don't have a lot to do with the underlying commodity prices since it's the retail margin that's of significance. Companies involved in this area often venture into other retailing as well - most common example is selling internet services but there's also a few who've tried selling house insurance and other things totally unrelated to energy. They're simply a retailer in that role, a middleman basically.

Bottom line is that the Australian gas producers are "substantially" exposed to the oil price apart from any hedging etc they've entered into. Not fully but substantially and with Origin being less exposed than the rest due to its power generation and retailing operations which form a substantial part of the business.

Even those who don't themselves produce LNG, they only sell gas domestically, are still selling into a market where price is heavily influenced by what the LNG producers are willing to pay for gas. As the oil price has come down, we've likewise seen gas prices drop in the Australian domestic market indeed for the east coast they're down more than half from where they were a year or so ago.

That is also putting downward pressure on electricity prices at the wholesale level in most states. Comparing 2018-19 financial year with 2019-20 year to date:

Queensland = $94.41 / MWh last year, $72.53 so far this year

NSW = $97.93 / $84.32

Victoria = $119.02 / $97.27

Tasmania = $90.65 / $60.68

SA = $126.12 / $82.90

There are other factors also but the drop in the gas price is definitely a contributing aspect. Whilst most electricity does not come from gas in Australia, for the above states collectively it's in the 8 - 9 % range over the year, reality is that if you're generating from coal or solar or whatever and want to maintain volume well then you need to under cut gas or oil otherwise you'll be pushed out of the market on price alone. The lower the gas price goes, the lower your price for power from coal or hydro needs to be if you want to stay in business. Etc. Only time that doesn't apply is when demand's high to the point that everything has to run - that happens but not constantly.

There's also an international aspect there. The electricity companies generally don't say much publicly but there are some which do in practice have exposure to international prices in regard to contracts for supply within Australia.

Australian domestic (east coast) gas pricing has been running around the $5 - $6 per GJ mark in recent weeks, equivalent to oil at AUD $30 - $36, but it's pushing to the bottom end of that range now. Gas will under normal circumstances always be at a discount to oil unless there's some very definite scarcity issue etc in a particular region.

 

[Junior]

Comparing 2018-19 financial year with 2019-20 year to date:

Queensland = $94.41 / MWh last year, $72.53 so far this year

NSW = $97.93 / $84.32

Victoria = $119.02 / $97.27

Tasmania = $90.65 / $60.68

SA = $126.12 / $82.90

Looking at Victoria for example, we saw all retailers hike electricity prices again in the past 6 months. Does this means the likes of AGL are benefiting from falling oil/LNG prices? Will they pass on any of these savings to retail customers?

 

[fiftyeight]

I do love catching knives, but damn this sector is complicated, like most I once you get in to the nitty gritty.


WPL managed ok in 2016



Apart from 2021, debt maturity is 5 years away



Not sure how to verify, but WPL also tell me their operating costs of $3.9 per boe is world class.

I am sure if push came to shove they can reduce capex on expansion projects if needed.

Seems WPL are well placed to weather the storm and then do well when/if markets return to more normal times.

 

[Smurf1976]

Looking at Victoria for example, we saw all retailers hike electricity prices again in the past 6 months. Does this means the likes of AGL are benefiting from falling oil/LNG prices? Will they pass on any of these savings to retail customers?

Looking at AGL's operations in Victoria specifically:

(Note - skip to the last paragraph if you just want the answer without the engineering and technical detail).

AGL operates the Loy Yang coal mine. The coal is of high moisture content and thus has no exportable market value and does not track any traded commodity price. Its cost is what it costs AGL to mine it plus royalties paid to government. Since it's an open cut mine on a huge scale, the cost per tonne isn't much at all - it's a low cost operation due to that scale and that the coal is just below the surface.



Photo by Smurf . For scale, dimensions of the mine are approximately 2.3km wide and extending 4.5km from the front to the back. It's a bit hard to appreciate that scale from the photo. As you can see, the coal is straight under the ground so it's very cheap to mine.

There's also very little transport cost for the coal since it all goes via conveyor belt, no trucks or trains involved, with two thirds of it going into AGL's Loy Yang A power station just to the right of the photo. Most of the other third is sold to Alinta who burns it in another power station, Loy Yang B, located literally right next to Loy Yang A so no real transport cost there either.

Electrical capacity of Loy Yang A is 2210 MW and for Alinta's Loy Yang B it is 1120 MW hence the roughly two thirds / one third split in coal use. Very minor amounts are sold to others for various uses - that's the only bit that goes on a truck etc.

So at this facility AGL is generating power at essentially a fixed cost not influenced by any external market. Likewise Alinta will have basically fixed costs of operation.

AGL also operates several medium size hydro facilities in Victoria. They're a far smaller hydro operator than Snowy Hydro (NSW) or Hydro Tasmania (Tas), which are fully owned by the Australian and Tasmanian governments respectively, but as an operator of hydro plant but they're still of significance. AGL's hydro capacity in Victoria is about 640 MW in total.

AGL also operates the Somerton gas turbine power station in Melbourne. It's a relatively small operation and used as a peaking facility in practice. Capacity is 160 MW.

What AGL does not do in Vic however is produce gas, their production of that being literally zero in Vic. Nor do they currently own any gas pipelines etc. For that they are retailer and that's it - buy gas from someone else, use pipelines owned by others, sell it to consumers and run a bit through their own power station at Somerton.

So there's an internal hedge with electricity but not with gas. The higher the wholesale electricity price, the greater the profit from coal and hydro generation but on the other hand, retail margin gets squeezed. If price goes down then profit increases at the retail level but diminishes on the generation side.

Hence why most generating companies have at least some involvement in retail and vice versa. It's an internal hedge so far as the volumes match and especially so if production costs can be locked in (eg you own the coal mine or it's solar, hydro etc with no resource costs).

It's important to note that in this sense the wholesale and retail side are separate as such. Dispatch of generation depends on prices offered to the market - AGL can't simply decide that they'll generate all that they sell via their retail division. They can try to do that if they want to, that is they could offer generation to the market at prices which results in physical dispatch equal to their retail sales, but they cannot simply decree that it will occur since AEMO (the Australian Energy Market Operator) will dispatch on the basis of price offered not the reasons behind it.

For example right at this moment physical supply into Victoria is coming from plant owned by AGL, Alinta, Energy Australia and an assortment of wind farms owned by numerous companies. Meanwhile Origin certainly has retail customers in Victoria but isn't generating anything of significance. So in practice AGL etc are generating surplus to their own sales and Origin is simply buying from the market. Nothing wrong with that and nothing unusual about it - point being it's not a direct link between generation and retail even though a company might aim to get that outcome in a broad sense over the long term.

Note that under a different combination of wind speed and load it could be a very different situation. Origin does generate in Victoria - but right at this moment others are beating them on price and with low demand Origin's plant isn't being run due to that. It's the market in action there.

On the gas supply side, they would have hedging arrangements in place in practice and that's where it gets complex. In the long term it could be expected that the price AGL are paying for gas reflects the market price. Short term though, it could be substantially different if the contract was entered into when market expectations differed from present reality. That aspect can make seemingly simple wholesale versus retail price comparisons somewhat more compelx.

For both gas and electricity there are also network costs to consider - that's pipelines and power lines basically. Companies like AGL or Origin don't own them and the cost of using those networks is effectively a fixed cost. Whilst that is ultimately passed through to consumers and all retailers are incurring the same costs, where it can become more complex is with contract dates and notions of "fixed" prices to consumers during that period which typically won't end on the same date that network prices are changed. Not a problem for minor changes in network prices but would be a risk if there was a major change.

So the overall answer to the question is that long term, if wholesale prices are going down and retail prices are going up more than any increase in network charges then yes an integrated generator and retailer ("gentailer") such as AGL would increase profit. Short term however that may not necessarily be the case due to hedging arrangements etc.

 

[Smurf1976]

WPL also tell me their operating costs of $3.9 per boe is world class.

If that's really their cost then they're at the lower end certainly.

There'd be some who'd be more than happy if they could get their costs down to a multiple of that amount.

 

[aus_trader]

If that's really their cost then they're at the lower end certainly.

There'd be some who'd be more than happy if they could get their costs down to a multiple of that amount.

The companies that are on the edge of existence due to the huge dive in Oil prices are the US shale Oil producers. There is no way they can remain profitable at current crude prices of ~US$30 per barrel. In fact their cost of producing a barrel by fracking procedures will be way higher than that, so they'll be losing money as we speak ! Most will stop production or go bust unless Oil price heads back up...

 

[fiftyeight]

If that's really their cost then they're at the lower end certainly.

There'd be some who'd be more than happy if they could get their costs down to a multiple of that amount.

Yeah I assumed I didnt fully understand boe

 

[fiftyeight]

The companies that are on the edge of existence due to the huge dive in Oil prices are the US shale Oil producers. There is no way they can remain profitable at current crude prices of ~US$30 per barrel. In fact their cost of producing a barrel by fracking procedures will be way higher than that, so they'll be losing money as we speak ! Most will stop production or go bust unless Oil price heads back up...

As the oil prices squeeze companies and states relying on oil prices, there must be an increased risk of disrupting the already shaky geo-political games being played in that part of the world.

It does not take a big leap of imagination to imagine the states hurting economically or their proxies to start damaging infrastructure of competitors and prices of oil to ultimately recover.

If things really got wild, gas producers in Oz could surely charge a premium for secure supply and lock in advantageous prices.

Maybe more likely, as I am starting to look at WPL, I am just looking for a potential upside to justify my current bias.

 

[aus_trader]

Maybe more likely, as I am starting to look at WPL, I am just looking for a potential upside to justify my current bias.

Unlike the high cost US shale Oil producers, WPL should be OK in terms of survival. I recently sold out of it in the spec portfolio, hoping to buy back close to the bottom. When it'll hit the bottom is a good guess, down again today...

 

[InsvestoBoy]

@Smurf1976 just wanted to say a huge thanks for your amazing, in-depth knowledge and posting here.

I'm just letting your writing percolate in my brain for a bit.

So good mate.