We're running out of gas! Small caps to the rescue

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This was published 11 years ago

We're running out of gas! Small caps to the rescue

By Richard Hemming

New South Wales is poised to run out of gas in the next year or so (just think about that for a second) as the big producers of this world export vast quantities.

It is the gas shortages on both the east and west coasts of Australia that are prompting manufacturers, led recently by Brickworks managing director Lindsay Partridge, to complain about domestic gas shortages and price rises.

These rises haven't been caused by Australia's carbon tax in their view, but by increasing liquefied natural gas (LNG) exports from Western Australia and the Gladstone projects in Queensland.

The big hope for both investors and, more pertinently, for heavy users of energy such as Brickworks, is that sources of LNG can come from the so-called “unconventional” techniques because it is getting harder to find oil and gas the conventional way, where a reserve of liquid and gas exists in porous rocks, known as reservoirs.

2013 is a game-changing year

While many experts Radar has spoken to call 2013 the “game-changing” year for Australian shale oil and gas production, there is consensus that the biggest market in the world has already been won over.

The United States is now producing more gas than it needs, and 10 million barrels of oil a day, compared with its domestic needs of 18 million barrels. Domestic production has increased by 2 million barrels a day in the past five years. There is industry speculation that the US could become a net exporter in the next decade. This would be amazing.

An important outcome of this increasing supply is that there may not be a big rise in the oil price for some time. At the moment it's just below US$100 a barrel.

Because of this it is important to invest in companies that have a production profile that is growing, or in those that have very low costs, and preferably both.

Opportunities to profit for the realists

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Radar contends that there are great opportunities for investors in companies that have operations in the Cooper Basin, which is north of the Arckaringa Basin, on the border of Queensland and South Australia. We are thinking of companies like Beach Energy (BTP), Drillsearch (DLS) and Senex (SXY) as better risk reward exposures to Australian unconventional potential.

Radar expands upon the opportunities in our latest issue, but briefly, one of the reasons why the Cooper Basin is lucrative for the oil and gas producer is that there is a big production facility called Moomba, which is owned by Santos. The facility is only about 60 per cent utilised so there is more than enough capacity for the oil and gas producers out there to use it. Plus they have access to pipelines to the major cities for cheap transportation.

Chevron and BG have already taken positions, and other multinational giants in the sector such as Total, Shell, Statoil and Hess are all watching the Cooper Basin activity closely because they would like to access any new substantial oil and gas resources opened up by unconventional means.

If ongoing testing is encouraging, all Cooper Basin stocks could become takeover targets.

There is also less political pressure, because the fracking is done in the middle of Australia and at depth – so there is no danger of an aquifer being disturbed.

So Radar does see opportunities for investors at the Small Cap end, but it is also clear that this “hope” for oil and gas from unconventional techniques has boiled over in some cases.

Beware of the hype

Linc Energy's (LNC) shares have doubled this year and at $2.55 giving it a market cap of $1.3 billion. Much, if not all, of that rise was due to an announcement to the market in mid-January.

The announcement was based on an exploration study estimating that the amount of shale oil in the Arckaringa Basin in South Australia was between 3.5 billion and 233 billion barrels. That is a big call for a completely unknown area, and also considering that Australian onshore exploration has historically found vast quantities of gas, rather than oil.

Despite having a section on Linc's website titled “Analyst Reports”, none appear for the past 12 months. The last one was in August 2010 by the now defunct broker Austock.

Seasoned investors in the sector say that it is too difficult to value the “blue sky” potential of these companies, although by virtue of share prices, some have.

Linc does have conventional oil and gas assets. It trumpets that late last year it was producing more than 6000 barrels a day, but even this amount goes nowhere near justifying its market cap.

Linc's share price is heavily based on the potential offered by unconventional oil exploration, which hasn't been proven anywhere near their leases.

Click here to access the fortnightly newsletter Under the Radar Report: Small Caps, edited by Richard Hemming. Visit here for more Under the Radar articles.

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