Citing only unnamed people familiar with the matter, Bloomberg reported on July 6 that Apache (NYSE:APA) may sell its 13% stake in Australia's Wheatstone liquefied natural gas, or LNG, project. LNG demand is poised for growth in Asia, so would such a sale be a good move for Apache?
Apache is cutting up credit cards
According to Bloomberg, Apache's desire to reduce debt is behind the planned sale of the Wheatstone stake. This possible divestiture would follow Apache's exit from operations in Argentina, the sale of its deepwater assets in the Gulf of Mexico, and the closeout of an Egyptian business stake.
Apache reported almost $9.7 billion in long-term debt as of March 31, with an interest expense for the latest quarter of $124 million. Based on that, the company would see a 5% annual return from any Wheatstone sale proceeds used for debt reduction. But is this enough to make such a sale worthwhile?
A fuzzy outlook for returns
LNG is becoming a hot commodity in Asia. Lack of pipeline infrastructure, China's growing smog problem, and Japan's exit from nuclear power all conspire to make LNG an attractive energy source for the region. So, Apache could be giving up on a great opportunity. On the other hand, the returns Apache would receive from its investment in the Australian LNG project are far from clear.
The Wheatstone Project is a joint venture, with Australian subsidiaries of Chevron (NYSE:CVX) holding an interest of about 64%, Kuwait Foreign Petroleum Exploration holding a 13% stake, Apache holding another 13%, a subsidiary of Tokyo Electric Power with 8%, and Kyushu Electric Power holding the rest.
Construction started on the project in December 2011. The facilities will include an onshore gas plant and a liquefaction plant with two processing trains providing a capacity of about 8.9 million tons per annum, or MTPA, of LNG. Natural gas from Chevron's Wheatstone and Iago fields will provide 80% of the gas for the plants, with the other 20% supplied from the Julimar and Brunello fields held by Apache and Kuwait Foreign Petroleum Exploration. Chevron has buying commitments for about 85% of its share of LNG from the project.
Because there are several variables that affect the economics of liquefaction plants, the returns from Wheatstone are difficult to predict. The International Energy Agency, or IEA, created a model based on the feedstock gas cost, the sale price, and the initial cost of capacity for such facilities.
The $27 billion project has a planned capacity of 8.9 MPTA, for a cost of capacity of about $3,000 per ton. Since this includes the cost of the gas plant, the actual cost of LNG capacity would be somewhat less. But even compared to Chevron's nearby Gorgon project, this is high. Gorgon also includes both a liquefaction facility and a domestic gas plant on which Chevron expects to spend $30 billion. With an LNG capacity of 15.6 MTPA, the initial cost of capacity is less than $2,000 per ton for the entire Gorgon project, including the gas plant.
Based on the IEA's model, using recent Australian gas prices of about $5 per million BTU as the feedstock price, and assuming a cost of capacity of only $2,000 per ton for Wheatstone, the sale price would have to be about $14 per million BTU in Asia for the Wheatstone project to see an acceptable 15% return on capital. But natural gas prices in Asia have been plummeting lately because of oversupply from new liquefaction plants in the area. In the winter, prices were as high as $20 per million BTU, but were only $12 per million BTU in June.
At $20, the Wheatstone project would have great returns, but at $12, they're marginal at best. So, fluctuating prices for LNG in Asia combined with a high initial cost for capacity add up to hazy returns for the Wheatstone project.
A Foolish look forward
What all this boils down to is that the Wheatstone project isn't for everyone. Like any such project, it has great potential, but it involves economic risk as well. Chevron, with its low debt-to-equity ratio, is more suited to handle those risks right now.
Apache, on the other hand, will be doing the right thing if it exits the Wheatstone project. The company can use the proceeds to pay down its high debt at a known return, as opposed to keeping that capital tied up in a project that could go either way.