BG - Juggling Political Risk Is Earning Double Digit Production Growth

A certain level of political risk is endemic to the oil and gas sector but BG Group probably wins first prize with its exploration licence from the Palestine National Authority. Drilling offshore of Gaza, BG found a substantial gas field two years ago, enough to supply power to the beleaguered state and potential for a significant export business.

Unfortunately, the obvious buyer for Palestinian gas is Israel and tensions between the two have brought exploration activity to a halt. BG’s interest extends across the border into Israel, where offshore exploration has also yielded gas finds, and a rival Israeli exploration company has been going to court to try to stop local power companies negotiating to buy gas from Gaza.

This irritation at the fringes of a much bigger Middle East conflict exposes the big issue for BG and its interest in gas, the fuel of the moment. Because it is clean, free of Opec influence and emits lower levels of greenhouse gases, demand for natural gas is growing fifty percent faster than oil and twice the rate of coal.

There is a problem though in that gas needs a market. Oil has intrinsic value; it can be stored, traded or shipped anywhere in the world, but gas is worthless unless you have a customer at the end of a pipeline. Until someone is willing to finance a power station in Gaza or Israel agrees to buy gas from Palestine, the Gaza field might as well be in the Antarctic.

This does not trouble BG though because, in the end, it knows that self-interest will lead energy-hungry Israel to sign up for Palestinian gas. And BG has lots more irons in the fire. Frank Chapman, the chief executive of the company, argues that his company has a better understanding of the gas market than his big rivals, ExxonMobil, Shell and BP.

“Our major competitors start from a legacy of oil exploration: you acquire a licence and you drill a well. If you find oil, great. If you find gas, not so great because then you have to find a market,” says Chapman.

He argues that, from its beginnings in the nineteenth century selling town gas, BG has always understood that it was, above all, a marketing business. And since the demerger from the old British Gas, BG Group has been assembling the pieces of a complex geographic and political jigsaw puzzle, linking potential markets to sources of supply and vice-versa.

One of BG’s larger money spinners is the export of liquefied natural gas (LNG) to the US from Trinidad and Tobago, where BG is a major shareholder in Atlantic LNG alongside BP. New gas discoveries and increasing US demand have stimulated a one billion dollar investment in tripling the Trinidad LNG plant’s capacity.

The long reach of American energy demand extends to Egypt, where BG has found more than ten trillion cubic feet of gas over the past five years, drilling offshore of Alexandria. Two marketing ventures have been established. The Nile Valley Gas Company has a twenty five year franchise to market gas in Upper Egypt to businesses as well as consumers and BG has a thirty seven percent share of the business, which will eventually extend the gas transmission network as far south as Aswan. Shorter term, BG is developing an LNG export business with the potential to ship gas to North America and to Europe, probably southern Italy, where the company is seeking permits to build a re-gasification terminal.

The huge US market, long established and with extensive if inadequate infrastructure, can absorb more gas than BG could ever ship but the price is volatile. Immature markets in less developed countries offer the potential of monopoly scale returns but much higher risk.

In Argentina, BG controls the Buenos Aires gas company, Metrogas, with a forty eight percent shareholding. Some GBP 130 million was invested and BG has recovered GBP 86 million but the remaining stake has been almost written off. Last quarter, Metrogas not surprisingly had a large bad debt charge and the Government wants to renegotiate the licence.

Brazil looks more interesting, in particular Sao Paolo, where BG owns sixty percent of Comgas, the local gas utility. With a hinterland of twenty four million people and substantial industrial demand for fuel, BG has a ready market, and in Bolivia, BG has found some seven trillion cubic feet of gas. A pipeline connecting Bolivia to Sao Paolo is up and running and BG is wrangling with Petrobras the operator of the pipeline to get more of its own gas into Sao Paolo. As ever, the game is about joining up the dots on the map.

Since the demerger, BG has been a stunning share price performer. The only disappointment was provided by the British Chancellor: the supplementary oil and gas tax will hit BG hard as the North Sea still accounts for two thirds of production.

However, investors recognise that BG is still the best energy growth story around. While Shell, BP and ExxonMobil struggle to generate more than a miserly one to two per cent volume growth, BG has been raising its output in double digits and Chapman reckons that the high output growth should continue.

Such growth inspires envy among leading oil companies fearful of turning into dull utilities, and takeover speculation has dogged the shares. But BG is just too expensive a target, say oil and gas analysts, rated at substantial premiums to BP and Shell.

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