US administration gaining confidence

08/04/2009 - 22:00

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THE jury is out on whether global stock markets have bottomed or whether there is a further downward leg to be endured.

US administration gaining confidence

THE jury is out on whether global stock markets have bottomed or whether there is a further downward leg to be endured.

Briefcase has no idea which way the market will go. There are plenty of pundits in the dead cat bounce school but too many market participants who believe we have bottomed out. In the short term, the ASX All Ords Index appears to have upside to 4,200, but needs to hold 3,300 to have a chance at this, since there is still an unmet downside target at around 2,750 points.

Investors need to remember that the market looks out to earnings expectations in a nine to 12-month timeframe and it will climb a wall of fear, while underlying economic conditions remain bleak.

The Obama administration appears to be getting the hang of things. One is left to wonder how a McCain-Palin administration would have performed had they been elected.

The latest moves on the US auto industry by Washington shows that this administration is maturing and has more confidence in its judgement. Imagine how the US stock market would have reacted just six months ago to news of the president suggesting that the administration was not going to bail out the US's dysfunctional auto industry, and it was instead looking to use existing insolvency laws to sort the problem? It's a sign of just how far we have come that the market only fell 3 per cent and not 6 per cent on this news.

The oil price is likely to trade below $US53/bbl until July or August, when declines in non-OPEC production and ongoing OPEC restrictions should begin to reduce levels of oil inventories. What is very interesting from an investment viewpoint is that the current weak oil price is going to restrict forward supply over a two to five-year time frame, as oilfield projects are deferred or cancelled. This will ensure that the oil price rises dramatically beyond 2010, when supply is unable to match rising demand.

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Briefcase has recently railed against the current system of executive remuneration, criticising its short-term focus and levels of reward, which do not adequately reflect the access an executive position can offer to productive assets, owned by the shareholders.

Bonus payments and incentives to executives should be made in the light of long-term outperformance, not on the basis of quarterly sales. In the case of Origin and AGL, management can stand on its long-term record. Other companies should take a leaf out of the AGL & Origin books to set reward systems in place.

Unlike the shareholders of most top 200 ASX-listed companies, shareholders of Origin Energy and AGL Ltd have every good reason to look favourably on bonus reward payments to the executives who have steered their companies through the past two tumultuous years. The share prices of these two companies belie the current conditions, which has resulted in the halving (or worse) in value of many former blue chip stocks.

The outperformance of Origin and AGL did not come about by chance. These companies have ended up with balance sheets bulging with cash just at a time when utility and energy asset prices generally are plunging. Origin and AGL are not cheap by comparison with the rest of the market, but they are incredibly well placed for growth and they don't have to rely on the kindness of strangers to move forward.

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Last week, Briefcase addressed about 140 delegates at a conference in Brisbane that looked at progress towards development of coal seam gas (CSG) into liquid natural gas (LNG) in Queensland. Some interesting and controversial conclusions can be drawn.

Firstly, Briefcase believes that eastern Australia will experience a surplus of natural gas at least until 2015. Development of CSG fields will ensure plentiful supply of gas at a price of $3-$4 per thousand cubic feet (Mcf) for at least the next five years. Power production will play an important role in the medium-term market for CSG, but large volumes of gas required for LNG projects will overhang the market until the LNG facilities are built post 2015.

All of the four or five proposed LNG plants for Gladstone are likely to be delayed from their current schedules, resulting in a glut of domestic natural gas, and lower prices than may have been expected. Project operators should work together to reduce capital costs, but industry experience indicates that this is unlikely to eventuate.

Arrow Energy and LNG Ltd have front running with an excellent project location, but funding partner and LNG shipping company Golar has no natural customer constituency. Golar plans to tap spot markets, which may be a tall order in an LNG market that will be oversupplied until 2015.

Only those CSG companies with access to an LNG facility will be able to achieve higher margins for their gas. Other CSM players hoping to sell gas to LNG producers may be disappointed. LNG operators will be keen to capture as much of the margin as possible by processing their own gas, leaving the stragglers facing the option of selling gas into a glutted local market, at least until late next decade, when delayed LNG plants begin to soak up local gas production.

This gas bubble will have a negative influence on conventional gas players in the Cooper, Gippsland and Otway Basins, where prices will remain weak. This is particularly bad news for BHP, Mosaic, ExxonMobil, Nexus, AWE, Santos and Woodside, which understandably is trying to sell its Otway gas interests, while Beach has its CSG assets on the block.

Asian LNG buyers are having difficulty understanding the concept of probable gas reserves. In the past, sales contracts have been underpinned by proven, conventional gas. There is some education to be done to inform the market about security of CSG supply and ultimately of LNG supply, especially since Queensland's CSG-LNG push is a world first. Dealing with CSG developments and certification of reserves requires different standards from those applied to the conventional oil and gas industry.

Globally there are an estimated 40 million tonnes a year of uncontracted LNG coming onto the market from new projects in Qatar over the next two years. This low-cost LNG supply is likely to flow towards spot markets in India, Europe and ultimately to North America. A flood of LNG into the US on spot sales will compete with local suppliers to keep gas prices low in North America until at least 2011.

High cost shale gas and CSG in the US will find the going very tough and many companies and projects will fail. Companies with gas production from the Texas Gulf Coast are unlikely to see gas prices return to over $US7/Mcf any time soon. There are many Australian companies with gas production in the US, all of which will find margins squeezed, most notably, Petsec.

Post 2015, there is a large market gap for LNG opening up with some market watchers calculating about 95mt/year of uncontracted demand by 2020 in Asia alone. This market expansion will account for excess Qatari production and open opportunities for expanding production from Darwin, Gladstone, PNG and other projects in WA, such as Gorgon, Wheatstone and Pluto 2.

n Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au

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