Another day, another LNG cost blowout

<p>Santos has again come to market with news that its LNG development activities are seeing huge cost blowouts. This time, the increased cost is attributed […]</p>

Santos has again come to market with news that its LNG development activities are seeing huge cost blowouts. This time, the increased cost is attributed to the PNG (Papua New Guinea) LNG project in which Santos has a 13.5% share along with other partners ExxonMobil, Oil Search, Nippon Oil and state owned entities. The project will now cost a whopping US$19bn in capital costs alone and since its 70% complete, Santos has little choice but to front up its share of extra costs to the tune of US$450m, cross its fingers and hope for the best.

To put things into context, Santos only generated A$283m in underlying earnings during the first half of the year, so the extra capital costs are significant. The PNG LNG cost blowout is not in isolation, in fact it follows an announcement in June from Santos in which costs were also revised upwards at its Gladstone LNG Project. The excuse in June from Santos was that a further US$2.5bn of capital expenditure was being brought forward, not increased. The market didn’t see it that way. Either way, Gladstone LNG is expected to cost US$18.5bn and that is the most recent estimate. With a 30% interest in Gladstone and 13.5% in PNG LNG – 2012 has been an expensive year for Santos’ LNG growth ambitions.

The company says it has the ability to meet its funding commitments and stands to benefit when the projects actually hit production, but such comments are predictable. The jury is still out as to when the increased capital costs to develop LNG actually starts to payoff. The market for LNG looks promising now but success in not guaranteed.

Bottom line: International groups partnering with Australian companies into these projects are starting to feel the high cost environment. This all comes at a time when domestic gas earnings, as illustrated by Origin, are actually coming under pressure. The difficulty and cost in developing new LNG facilities highlights the attractiveness of Woodside (WPL) – a proven developer and operator – which remains our key preference in the energy space. The market will now start to speculate around Santos’ existing debt facilities and what would happen if further costs materialise between now and completion. Shale gas ambitions are not without capital cost risks either.

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