‘Key decisions’ on how to address Australia’s soaring energy bills will be made during a national cabinet meeting on Friday, with price caps on gas - and possibly coal - expected to be implemented.

Federal energy minister Chris Bowen says any measures would aim to ease cost-of-living pressures for Australians, which have been exacerbated by the war in Ukraine.

“We’re obviously not contemplating these measures for fun. We’re contemplating these measures to lower energy prices. That’s why we’ve looked very, very carefully at all the options and ideas,” Mr Bowen said ahead of a meeting between energy ministers on Thursday.

One of those options is an expected price cap on the wholesale domestic gas price, reported to be between $11 and $13 per gigajoule, and may include a requirement for guaranteed domestic supply from producers.

Gas price controls ‘immaterial’ for E&P producers

Mark Taylor, an equity analyst at Morningstar says the expected gas price cap wouldn’t be materially detrimental for Australian exploration and production (E&P) companies covered by Morningstar.

The fair value estimate of no-moat rated Woodside (ASX:WDS), Santos (ASX:STO), and Beach Energy (ASX:BPT) remain unchanged.

“These companies have largely contracted domestic gas sales and on average at prices struck considerably below the cap level,” Taylor said.

“We understand they have deliberately avoided gouging the market in an attempt stave off this exact type of government intervention.”

Taylor noted two factors in relation to the price caps and whether they would have a material impact on producers:

  1. The percentage of revenue exposed to any price caps
  2. How the caps will impact margins

Percentage of gas exposure

Taylor says the domestic gas exposure for Woodside is comparatively small with total exposure approximately 20% of the overall gas production.

Even after the merger with BHP Petroleum, adding more LNG assets, only around 7% of Woodside’s overall sales revenue is derived from Australian domestic gas sales.

Like Woodside, the impacts of the price caps will also be minimal on Santos says Taylor, with domestic gas revenue less than 20% in total.

Taylor notes that Beach Energy has the highest domestic market exposure of the Australian listed energy and petroleum (E&P) producers covered by Morningstar, with domestic gas comprising of more than 40% of its revenue. However, Taylor says the company has a strong balance sheet and resilient cash flow positive operations.

Margins

The next consideration is margins, Taylor says, noting producers with higher exposure to the domestic energy market face tighter margins.

“Margins are tighter for domestic gas businesses than for export, meaning the profit contribution per gigajoule from them is less,” he said.

Beach Energy has a lower profit margin than Santos and Woodside due to its larger domestic gas exposure.

“Taking the lower domestic gas margins into account, in terms of profit contribution, we estimate domestic gas represents less than 5% of Woodside’s total, less than 15% of Santos’ total and just over of a quarter of Beach Energy’s total,” said Taylor.

Given Morningstar’s domestic gas price forecasts are ‘considerably below’ $11 to $13 per gigajoule, Taylor said the expected gas price cap of $11 to $13 per gigajoule doesn’t impact Morningstar’s fair value estimate on these companies.

Risks posed by the price caps

Taylor acknowledges that whilst the companies under Morningstar coverage aren’t expected to be impacted by the price caps there are still risks worth considering.

Current forecasts for domestic gas price achievement for Woodside, Santos, and Beach Energy fall below the expected government cap, and as such, Taylor says all three would be largely unaffected by caps.

However, if prices achievable were to rise above the level of the price cap there would be an impact. During the second quarter of 2022, Taylor notes Woodside’s average price achievement did rise to near the lower end of the proposed cap.

“This followed the merger with BHP Petroleum which brought Bass Strait gas onto the books,” Taylor said.

“But we would see this level of price achievement and activity largely as a one-off and 3Q22 prices had already fallen substantially.”

Another risk Taylor noted was a possible requirement for guaranteed domestic supply from producers, which could see companies forego higher margins in the export market to ensure domestic supply.

“But we don’t see this being anything other than a periodic issue,” he said.

“High prices and perceived shortages are likely to increase the chances for new developments, potentially lowering regulatory hurdles.”

Undervalued gas producers 

Woodside, Santos and Beach Energy are currently trading below levels considered fair valueaccording to Morningstar. Woodside and Santos are both currently trading within four-star territory whilst Beach Energy is rated five stars.  

Energy has been the worst performing sector on the ASX this week, with Woodside, Santos and Beach Energy losing4.5%, 3.9% and 9.1% respectively over the past five trading sessions.  

Woodside shares are currently trading at a 16% discount to Morningstar’s fair value estimate of $43.00. Santos is trading at a 37% discount to its fair value of $11.30 and Beach Energy shares are 45% below Morningstar’s fair value estimate of $3.00.