A New Opportunity in Energy Investing?
Morningstar.com
Wednesday December 8, 6:00 am ET
biz.yahoo.com
By Eric Chenoweth
Dear Analyst,
I've read much about liquefied natural gas (LNG) in the news recently. From what I can tell, LNG is bound to grow because it's the best solution for high natural gas prices in the United States. Unfortunately, I can't find many companies that focus on LNG. One stock I found, Cheniere LNG, is up about 800% over the past year. What do you think about investing in LNG? Are you aware of any other companies involved in LNG?
N.G.
You've raised some good points and asked some timely questions. Although the LNG business is not as new as some might think (Japan's been importing LNG for several decades now), rapid growth in global LNG shipments over the next decade may completely reshape the LNG industry. Before we delve into the pros and cons of investing in LNG, let's discuss the development of this industry a bit more.
Some Background on LNG
Because it's fairly expensive to transport overseas, natural gas is considered a stranded resource. Thus, natural gas prices vary regionally, depending on one's access to local reserves and infrastructure. The LNG industry, however, hopes to change natural gas from a stranded resource into a globally priced commodity. Specially designed tankers transport LNG (at super-cool temperatures) from liquefaction plants in resource-rich countries to regasification plants in gas-starved regions, profiting from geographic price differences. Thus, the wider the spread between natural gas prices in different parts of the world, the greater the profit potential for LNG.
Thanks to higher domestic natural gas prices, U.S. investors have reawakened to LNG's potential. I say reawakened because the original push to develop a domestic LNG industry happened more than 20 years ago during energy crisis of the 1970s. Most LNG facilities built during the first boom were mothballed until just recently, killed by cheap domestic natural gas prices. Despite the fact that the U.S. has regularly consumed more natural gas than it has produced over the past decade, imports from Canada had kept gas prices low--until two years ago.
With natural gas prices ranging from about $5-$8 per thousand cubic feet (mcf) in the U.S. compared with prices of $1 or less per mcf abroad, some investors are convinced that LNG is poised for explosive growth. However, we don't suggest leaping into the LNG business expecting quick profits. For LNG to succeed over the next decade, it will first need to clear some big hurdles. Liquefaction, tanker, and regasification capacity will all need to grow in sync. All three of these components will require sizeable capital investment to develop, as well as significant time to build. In addition to its huge capital requirements, LNG profits will depend on cooperation from volatile commodity prices. Investing purely in LNG is best left to speculators.
The Global LNG Industry
Most of the world's LNG trade occurs through long-term contracts. These long-dated commitments have emboldened liquefaction and regasification terminal operators to invest the large sums of money required to build and maintain their facilities. To date, one country--Japan--has driven LNG development. And, though LNG markets are expanding, Japan still consumes over half the world's LNG.
Given its enormous thirst for energy and its resource-barren land, Japan is clearly made for LNG. However, the economics of the LNG trade in North America and parts of Europe are quite different. Without long-term contracts backing up investment in new facilities, profits will depend on the emergence of spot markets for LNG. Investors must be willing to front large amounts of capital to projects before knowing if LNG spot markets will form and be favorable. Because the upfront cash cost is high and future cash flows are uncertain, today's LNG investor has little room for error.
LNG in the United States
Four regasification terminals exist in the U.S. today, and about 40 more have been proposed. Unfortunately, the projected natural gas demand for the U.S. will only support a handful of new terminals over the next 10 years. Because regasification profitability will largely hinge on capacity utilization, overbuilding is a threat to future profitability.
Who Wins? Who Loses?
Given the distribution of the world's natural gas reserves relative to consumption, it is highly likely that LNG will become a truly global commodity someday. So who's best positioned to profit? We think the upstream segment looks most promising. Those companies that produce and liquefy natural gas will be able to choose the highest bidder from a long list of consumers. Unfortunately, the lion's share of these upstream LNG profits will fall to companies owned by foreign governments, shutting out individual investors. But many of the world's major integrated energy companies will be able to get a sliver of the pie, too.
ExxonMobil (NYSE:XOM - News) has a 30% interest in an upstream LNG project with Qatar Petroleum. The project, expected to come online in 2009, will cost about $12 billion and produce about 2 billion cubic feet (bcf) of natural gas per day. Both Royal Dutch-Shell (NYSE:RD - News) (NYSE:SC - News) and Repsol (NYSE:REP - News) expect to hold 25% stakes in an upstream LNG project with National Iranian Oil Company. They hope to begin shipping LNG by 2010. Repsol also plans to develop LNG projects in Trinidad and Tobago and Algeria. Already up and running, BP (NYSE:BP - News) is currently the low-cost supplier of LNG to the U.S. through its operation in Trinidad. Meanwhile, Marathon Oil (NYSE:MRO - News) is positioned to sell LNG to the U.S. from West Africa.
On the flip side, the economics of the regasification business leave much to be desired. Like the upstream projects, these will require large amounts of capital to develop. However, the downstream business will be much less flexible. Where upstream facilities should run at full capacity nearly all the time, downstream facilities are more likely to carry excess capacity, hurting profitability. To reach America's coast from the Middle East, LNG is estimated to cost between $3 and $4 per mcf. While that may sound reasonable today, if prices retreat from their recent highs ($8 per mcf), it could leave little room for profits. Such a price depression could lead to long-term mothballing of facilities, much like what happened 20 years ago.
In general, we expect the regasification business will become the most commoditized, cyclical portion of the LNG industry. Thus, it will be the least attractive area for LNG investors. If a receiving terminal's local market experiences slumping natural gas prices, or overbuilding of capacity, it could spell doom for investors. Oddly enough, much of the recent market hype has centered on these types of companies.
Dominion Resources (NYSE:D - News), El Paso (NYSE:EP - News), Southern Union (NYSE:SUG - News), and Tractebel own existing downstream LNG assets in the United States. Potential newcomers (those with approved terminal plans in the U.S.) include Sempra Energy (NYSE:SRE - News), Cheniere Energy (AMEX:LNG - News), and ChevronTexaco (NYSE:CVX - News). Companies like McMoRan Exploration (NYSE:MMR - News) are still waiting for approval. In Britain, BG Group (NYSE:BRG - News) operates downstream LNG facilities. In general, we don't think many of these companies are particularly attractive investment candidates, and if we do, it's not because of LNG.
What Should You Do?
Rather than focusing your sights on LNG--an industry where, for some time, capital investment will be high and profits uncertain--we recommend seeking out the best energy companies trading at the cheapest prices. More likely than not, these firms will be in a position to profit when LNG finally has its day in the sun, with a fraction of the risks. |
