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The big pricing threat facing Woodside Petroleum

It is often suggested by consumer groups that if buyers are not happy with a product or price they should ‘vote with their wallet’ and take their business elsewhere. Now that is exactly what some of the world’s largest LNG buyers are threatening to do to Australia’s huge natural gas projects.

Woodside Petroleum (ASX: WPL) is reported to be under increasing pressure from two of its major buyers, Tokyo Gas and Kansai Electric, to factor in the expected boom in US shale gas into pricing of its long-term contracts when they come up for renewal in 2015, according to The Australian.

Significant increases in estimates of shale oil and gas reserves by the US Energy Information Administration (EIA) and the threat of competition from US gas exports have added to the pricing pressure on Australia’s gas producers just at the time the country’s biggest LNG projects are about to come online. These include the huge GLNG project being conducted by Santos (ASX: STO), and the $24 billion APLNG joint venture whose partners include Origin Energy (ASX: ORG) and ConocoPhillips (NYSE: COP).

LNG pricing is closely tied to movements in the price of oil in what is termed ‘slope’ pricing. It is a well-known point of contention for many large gas buyers, particularly those out of Asia because of the growing supply of LNG compared to oil.

Estimates by Ernst & Young suggest that US shale gas could be sold to buyers in Asia at US$12 to US$13 per million BTU (British Thermal Units) after transport costs. This could be US$3-4 less than the price of Australian LNG making it a bargaining chip for buyers.

Foolish takeaway

With production costs for US shale gas around 33% lower than in Australia a substantial increase in supply would give big buyers more options and more purchasing power. Fortunately, investors are insulated somewhat by the long lead times to develop significant LNG projects and growing international demand to help absorb the increases in supply.

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Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article.

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