How to Profit From Liquefied Natural Gas

November 21st, 2013
in contributors

Investing Daily Article of the Week

by Chad Fraser, Investing Daily

Back in 2005, the notion that the U.S. could one day become a significant natural gas exporter seemed far-fetched, at best. That year, the country’s marketed gas production stood at 18.9 trillion cubic feet, according to the Energy Information Administration (EIA), well short of total domestic gas consumption of 22.0 trillion cubic feet.

If anything, the trend looked to be headed the other way: 2005’s production figure was down from 20.6 trillion cubic feet in 2001, while demand was little changed.

But by 2012, the picture was dramatically different, with production soaring to 25.3 trillion cubic feet, just short of demand, at 25.5 trillion cubic feet. The country could become a net gas exporter as soon as 2016.

Follow up:

Shale Gas Rewrites the Energy Story

The main driver behind the increase in overall gas output is the sharp rise in the production of gas from shale rock formations. That, in turn, has resulted from the emergence of technologies such as horizontal drilling and hydraulic fracturing as economically viable means of extraction.

The U.S. currently holds a large lead in shale gas production: according to the EIA, shale gas accounted for 39% of all natural gas produced in the country last year, compared to 15% of Canada’s production and just 1% of China’s gas output.

EIA industry economist Aloulou Fawzi said in an October 23 USAToday article,

There’s no commercially viable shale gas production outside the U.S. and Canada.

The EIA expects U.S. shale gas output to rise 44% between 2011 and 2040.

What Is Liquefied Natural Gas?

Before we go any further, let’s take a step back and look at what exactly LNG is and how it plays into America’s hopes of becoming a major gas exporter.

LNG is simply natural gas that has been cooled to below -261 degrees Fahrenheit (-162 degree Celsius). At that point, it becomes a liquid and takes up much less space, which helps facilitate shipping and storage.

The difference in size between natural gas and LNG is massive, with the conversion process reducing it to less than 0.2% of its initial volume. Put another way, a container of a given size could transport either one unit of natural gas or about 600 units of LNG.

Producing natural gas in the U.S. and shipping it across the ocean requires purification, or removal of impurities, like sulfur, as well as natural gas liquids (NGLs), such as butane, propane and ethane, which can be sold separately. The natural gas must also be cooled, converted to a liquid and shipped on special tanker ships with double hulls to prevent leaks and spills. When the LNG reaches its destination, it’s converted back into a gas.

The LNG Market by the Numbers

The U.S. LNG export market will be driven by the differentials between the cost of production in the U.S. and LNG prices in other regions, particularly Europe and Asia.

Here’s an illustration based on figures from Robert Rapier, Investing Daily’s resident energy investing expert. From 2010 to 2012, the spot price of Henry Hub natural gas averaged $3.72 per million British thermal units (MMBtu).

Meanwhile, the price of LNG in Japan over the same period averaged $14.13/MMBtu, a differential of $10.41/MMBtu. In Europe, prices averaged $9.84/MMBtu, for a differential of $6.12/MMBtu. Japan has been a particularly strong LNG market since it shut down its nuclear power plants in the wake of the Fukushima disaster in 2011.

The key factor for investors, then, is how much it will cost to deliver the gas from the U.S. into these markets.

Here at Investing Daily, we’ve been following the American LNG story since its early days, particularly in our MLP Profits and Energy Strategist advisories. Rapier is an investment strategist for both.

He wrote in a September 26 Energy Strategist article,

“I have seen enough independent estimates to convince me that total LNG costs from U.S. wellhead to foreign city gate are less than $5/MMBtu, plus the price of the natural gas. If we take $5/MMBtu as a rough ballpark estimate (which I believe to be conservative), we can see why the LNG export market is developing."

Then he added,

“If we add the average 2010 to 2012 price of U.S. natural gas to the cost to liquefy and ship, natural gas producers could have put gas into Japan at a cost of $8.72/MMBtu, $5.41/MMBtu less than the average price of LNG in Japan during that timeframe. The European market wasn’t nearly as lucrative, but LNG could have still been landed in Europe for $1.12/MMBtu less than the going rate.”

Any increase in natural gas exports is also likely to push up gas prices here in the U.S. In his article, Rapier identified a number of companies poised to benefit from both U.S. LNG exports and higher prices at home, including No. 1 gas producer ExxonMobil (NYSE: XOM)—though he doesn’t feel gas prices will have much impact on the earnings of this massive integrated oil and gas producer.

He writes,

“Look rather to drillers that produce a lot of gas as a percentage of total production. Chesapeake Energy (NYSE: CHK)Devon Energy (NYSE: DVN) and Anadarko Petroleum (NYSE: APC) should all do well as natural gas prices increase.”

Rapier also sees shipping companies as likely winners, as well as gas infrastructure providers.

Cheniere Leads the Permitting Race

Even so, there are still risks and challenges for companies aiming to export LNG from the U.S. For one, gas must be converted to LNG at terminals that are costly to build.

In addition, as Rapier points out, new projects must receive approval from both the Department of Energy (DOE) and the Federal Energy Regulatory Commission (FERC). To date, the DOE has approved four projects and has 20 more applications awaiting a decision, but only Cheniere Energy (NYSE: LNG) has received the go-ahead from both agencies.

In 2007, the company created the Cheniere Energy Partners (NYSE: CQP) master limited partnership (MLP) to own assets such as the Sabine Pass LNG export terminal (the facility that has now received DOE and FERC approval) under construction on the Louisiana/Texas border, as well as another LNG terminal in Corpus Christi. The company has already signed up a number of customers in Asia and Europe. Startup is targeted for 2015 or 2016.

Author's Note: (MLPs are tax-advantaged investments that typically offer investors above-average income. We recommend a number of high-yielding MLPs in our MLP Profits advisory.)

Rapier sees Cheniere’s first-mover status as a significant plus.

He writes,

“Cheniere is in the driver’s seat at this point. There is a risk in the longer term that as more LNG export capacity comes online around the globe, the large price differentials that have made the LNG trade seem so profitable will inevitably shrink."

He also adds,

“Likewise, major pipeline projects on the drawing board could pose formidable competition for some of the LNG proposals. This will especially affect latecomers to the process, whereas Cheniere’s head start should give it probably a few years with limited competition and strong profitability.”

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