US LNG Export Is Beginning – One Sector Is A Clear Winner

By Larry Smith

http://seekingalpha.com/article/3668186-lng-export-is-beginning-one-sector-is-a-clear-winner

Nov. 9, 2015

Summary

LNG exports from the U.S. are about to begin and will grow rapidly in the next few years.

The new LNG facilities will create a huge demand for natural gas, although it is unclear just how much will be needed.

Prices are falling and production is increasing, which is hurting LNG prices.

Pipeline operators may be the biggest winner.

If everything goes as planned, Cheniere (NYSEMKT:LNG) will begin LNG exports from the United States before the end of 2015. This milestone will be just the beginning of what appear to be a massive build-out of LNG facilities. Between now and 2020, 12 liquefaction trains are expected to come online. The following plants are currently under construction.

  • Cheniere      Energy’s six-train Sabine Pass plant in      Cameron Parish, La., is the most advanced project. LNG is developing up to      six natural gas liquefaction trains, each with an expected nominal production      capacity of approximately 4.5 mtpa (million tonnes per annum) of LNG, at      the Sabine Pass LNG terminal adjacent to the existing regasification      facilities. As of last week, trains 1 and 2 were 95% complete, trains 3      and 4 were 74% done, train 5 began construction in June, and train 6 was      still waiting for contracts to take product.
  • Cheniere      Energy Corpus Christie – Plans are      in place for five trains, construction began in May on train 1 and 2, a      final investment decision will be made soon for train 3. Train four and      five are still under consideration.
  • Cameron      LNG, in Louisiana, is slated to be      a three-train LNG export terminal capable of exporting 1.7 bcf/d of LNG,      much of which is contracted to its partners. Construction began in October      2014.with commercial operation expected to begin in 2018. Cameron LNG is a      subsidiary of Sempra Energy (NYSE:SRE).
  • Freeport      LNG’s and Corpus Christi LNG terminals      in Texas have capacities of 1.8 bcf/d and 2.14 bcf/d, respectively.      Construction on the Freeport LNG terminal began in November, 2014, with      commercial operations expected to begin in 2018.
  • Dominion’s (NYSE:D)      single-train Cove Point project at Lusby, Md., began construction in October      2014 and operations are expected to begin in 2017.

The projects named above are the few that have received DOE approval for export to both Free Trade and Non-Free Trade countries. However, over two-dozen other projects are waiting approval from the DOE. A complete list of pending projects can be found here. In total, these projects have requested approval to export over 43 Bcf/d.

Although not all the projected demand for LNG will materialize, the growth in LNG will be a welcome site for natural gas producers and pipeline operators as they have seen production boom and prices fall. As you can see below, the shale gas revolution has unearthed enormous supplies of natural gas, which has driven prices to rock bottom. Note on the charts below, as shale gas started to boom in 2008, natural gas prices started to fall.

LNG importers and exporters.

In 2014, LNG trade reached 241.1 MT (Million tonnes), up 4.4 MT from 2013. 19 countries exported LNG in 2014, up from 17 in 2013. Importing countries rose to 29. The chart below from 2012 shows some of the various importing and exporting countries.

As you can see, Qatar has been the world leader in LNG export, but that may not continue, as over 150 Bcm of additional LNG liquefaction capacity is under construction, with half of that in Australia.

It should be noted that the chart above is from 2012 and since then, Japan has put back on-line some nuclear facilities and South Korea has begun production at some new nuclear facilities, thus reducing their demand since 2012.

Future demand

A few years ago it was thought LNG trade was going to explode, however, the picture now is not quite so clear. The majority of LNG contracts base their pricing for LNG on the price of oil. With oil prices falling rapidly, the price for LNG has also fallen. Building an LNG facility is a very costly endeavor which requires a premium LNG price to make building the plant worthwhile.

In Australia, seven LNG facilities are being built at a cost of $150 billion. In the U.S., the Cheniere LNG facility will cost $12 billion and the Cameron LNG facility will cost $10 billion. Keep in mind, both of the those developments had the advantage of being able to use some existing facilities that had been built anticipating LNG imports. The chart below from Wood Mackenzie shows the escalating cost of building LNG facilities,

While the cost for building liquefaction facilities has risen, the price for LNG has fallen. As mentioned previously, part of the price fall is related to how LNG contracts are written. In most cases, the price of LNG is indexed to the price of oil. As oil prices fall, so do LNG prices. The U.S. is one of the few countries that does not price LNG that way, the U.S. uses current Henry Hub pricing and then adds, essentially, a toll.

The other factor is a growing oversupply of LNG caused by new supply and weak demand. According to Wood Mackenzie, some 130 tonnes a year of new supply could hit the market over the next five years. Most of this supply would be from Australia and the U.S. Because of the oversupply, short-term pricing has dropped in Japan from $20 a MMBTU in early 2014 to the current $6.70 a MMBTU.

Like most commodities, LNG demand has been waning. Demand for LNG in China, which had been growing double digits, fell 3% in the first half of 2015. It is estimated Asian LNG imports fell 8.5% in the first half of 2015 from the same time last year, as the region’s economies slow.

Despite all the current gloom and doom, there are still those that forecast huge future LNG demand. Total, the French energy giant, believes LNG will grow 7% a year through 2020.

Energy Insights agrees that in the short-term the LNG market will be over supplied but long term demand will grow beyond supply, without continued construction. Here is how they describe it.

“Longer term however, LNG markets have a much more positive outlook. Demand is expected to grow on average between 4-6% p.a. until 2030, with our base case expectation at 4.5% p.a. between 2015 and 2020. Given this long-term demand outlook, the market needs to take FIDs on a further ~20mtpa of capacity in the next ~2.5 years to bring it to market by 2023, and a further 45mtpa by the end of the decade so it’s ready for 2025. Otherwise from 2023, we quietly enter a very tight global LNG market.”

In the current environment of slowing LNG demand and growing LNG supply, I believe very few of the over two-dozen pending requests for LNG export facilities get built. The companies that do proceed will need to have sufficient funding and a long-term view of the energy market. I also believe the companies with existing facilities, originally built for import, will have the advantage of lower development costs. Using that criteria, here are the plants I believe get built.

Exxon Mobil (XOM) Golden Pass – Exxon Mobil has an existing import facility located in Texas, near Sabine Pass. The existing Golden Pass LNG Import Terminal, is a joint venture formed by affiliates of Qatar Petroleum (70%), Exxon Mobil (17.6%) and ConocoPhillips (NYSE:COP) (12.4%). The export facility will be a 70% Qatar Petroleum and 30% Exxon Mobil partnership. DOE approval for shipments to Free Trade countries has been received, with approval for shipments to Non-Free Trade countries pending. Golden Pass has already begun early solicitation for contractors and they expect LNG operations to begin in 2020. The plant would cost $10 billion and would have approximately 15.6 million tons of LNG export capacity. XOM and Qatar Petroleum are partners on a LNG facility in Qatar and likely have many partners to sell the LNG to.

Kinder Morgan (KMI) Elba Island – In July, Kinder Morgan bought out Shell’s (NYSE:RDS.A) interest in the Elba Liquefaction Company and now owns 100% of the company. The plant’s 350 million cubic foot per day of capacity is contracted to Shell for 20-years. The Elba Island facility was originally built for import, but will now be modified for export. Permitting continues for the proposed Project, which consists of 10 small-scale liquefaction units purchased from Shell. They will be integrated with the existing Elba Island facility and enable rapid construction compared to traditional large-scale plants. The next step in the regulatory approval process is for the Federal Energy Regulatory Commission to issue a draft environmental assessment. KMI pipelines will feed the plant. KMI expects a 2017 in-service date. With Shell ready to take the natural gas for 20-years at an attractive rate for KMI, this plant gets built.

Lake Charles LNG - Energy Transfer Equity (NYSE:ETE) and Energy Transfer Partners (NYSE:ETP) have received all necessary approvals for the project, including DOE approval for shipments to Free Trade and Non-Free Trade countries. BG Group, which is currently being acquired by Shell, has contracted for the LNG shipments. The three train facility will cost $12.3 billion and will be producing 2 Bcf/d of LNG. A final investment decision will be made by all parties in mid-2016 with first shipments in mid-2020.

I am sure there may be others, but I believe these three are the most likely to be built. Keep in mind, LNG facilities take years to build, so investment decisions have to be made with an eye to where the market is headed, not where it is today.

Benefits for producers

According to the Energy Information Agency, natural gas demand in the U.S. will average 76.2 Bcf/d (billion cubic feet per day) in 2015 and 76.4 Bcf/d in 2016, compared to an estimated 73.1 Bcf/d in 2014. There is little doubt, that with the addition of LNG exports, natural gas demand will increase. Wood Mackenzie is now estimating there will be an increase in demand year-to-year of 5%. It projects an increase from today’s level of 76 Bcf a day to about 110 Bcf a day by 2025, that’s an increase of 40%. Not all of that is LNG export, some is exports to Mexico and some is increase power demand. But, LNG will be a key player in the growth of natural gas.

If natural gas demand is going to grow 40%, then a lot more natural gas will need to be produced. In addition, if 40% more natural gas is needed, it seems reasonable that natural gas prices will rise. More production and higher prices should be good news for producers. In a rising price environment, all natural gas producers should benefit, but a couple names may benefit more. The names provided are not recommendations, they are just names I believe will benefit by the increase in demand for natural gas, brought on to a large degree, by LNG exports.

Southwestern Energy (NYSE:SWN) Southwestern is the third largest natural gas producers in the U.S. SWN’s 2015 natural gas production guidance is 973 to 982 Bcfe (Billion cubic feet equivalent), which is 27% growth compared to 2014 production of 768 Bcfe. SWN has reserves of 10.7 Tcfe. SWN is predominantly a natural gas company and as such they would stand to gain from increased demand and higher pricing.

Chesapeake (NYSE:CHK) – CHK is a company that seemingly has been dealing with balance sheet issues for a long time. However, they still have some great acreage and despite a move to increase their liquids production, dry gas is still their main product. CHK is the second largest producer of natural gas in the U.S. Any move higher in gas prices is very beneficial for CHK, as they have the ability to increase production if they desire.

Exxon Mobil – The largest producer of natural gas in the U.S. is Exxon Mobil. Would they benefit from higher gas prices, yes they would. But, they are so big that I don’t see it moving the needle that much. However, they have stated on conference calls that they have the ability to quickly increase production if market conditions warrant such a move. In addition, assuming their Golden Pass facility gets built, they may have the ability to process and market their own natural gas into LNG, thus maximizing profits.

Benefits for pipeline operators

If more natural gas is going to be produced and if LNG plants need to be fed natural gas, then more natural gas will flow through pipelines. When it comes to pipeline operators, I see one big winner and that company is Kinder Morgan.

Kinder Morgan moves about a third of all the gas that is consumed in the U.S. More natural gas movement around the country will increase the flow of gas on the KMI pipes. Kinder Morgan has signed on to be two of the four pipelines that will move the natural gas the last few miles to the Cheniere Sabine Pass plant. The four pipelines are Cheniere’s own Creole Trail Pipeline, Kinder Morgan’s Natural Gas Pipeline, Williams’s (NYSE:WPZ) planned Gulf Trace project and Kinder Morgan’s Louisiana Pipeline.

Kinder Morgan has also signed an agreement with Cheniere for their Corpus Christie LNG Facility. The press release from Kinder Morgan reads as follows.

Kinder Morgan, Inc. today announced that Kinder Morgan Texas Pipeline, Kinder Morgan Tejas Pipeline and Tennessee Gas Pipeline Company have entered into 15-year firm transportation agreements and a multi-year storage agreement with Cheniere Energy, Inc. through its subsidiary, Corpus Christi Liquefaction, LLC. Under the agreements, KMI will provide 550,000 dekatherms per day (Dth/d) of firm natural gas transportation service, as well as 3 billion cubic feet (Bcf) of natural gas storage capacity to serve the LNG export facility being developed near Corpus Christi. The project is being designed and permitted for up to three trains, with aggregate design production capacity of approximately 13.5 million tonnes per annum (mtpa) of LNG. The natural gas transportation service can be increased to 800,000 Dth/d upon the completion of certain conditions in the Kinder Morgan Texas Pipeline agreement.”

Boardwalk Pipeline Partners (NYSE:BWP) and Enterprise Product Partners (NYSE:EPD) also have natural gas lines servicing Cheniere, but not to the degree KMI does.

Besides the support for the Cheniere projects, KMI will likely develop its own LNG facility at Elba Island and has applied for permits to construct another LNG facility in Pascagoula, Mississippi. No other pipeline operator has anywhere near as much involvement in the LNG market. LNG expansion is extremely beneficial to KMI.

A potential winner could be Energy Transfer Equity once they complete their merger with Williams Companies (NYSE:WMB). The merger, once completed, will create. among other things, the largest natural gas transportation network in the country. However, regulators have not approved the merger yet and there is some thought that ETE will have to sell some of the pipeline network to appease regulators. As mentioned previously, ETE may construct an LNG facility in Lake Charles, Louisiana.

LNG Shipping

Once the natural gas is cooled into LNG, it has to be shipped. However, I have always felt that the shipping/tanker business to be one of the more dangerous sectors in investing. The shipping business always seems to be boom or bust, but mostly bust, as the shipping companies are prone to over building new cargo/tanker ships when business is good. Therefore, I am only going to mention one name and that is Golar LNG (NASDAQ:GLNG). Golar owns a number of LNG carriers, but also is starting to expand into floating LNG terminals. Floating LNG terminals offer possible cost savings over typical facilities. Depending on how the LNG market develops, floating LNG terminals could be a growth business. Rather than say anything more on the subject, I suggest anyone wanting to learn more about Golar, to read this article about Golar, which was written by Seeking Alpha contributor Bram de Haas. It is excellent.

Conclusion

Within the next few months, LNG export from the United States will begin from the Cheniere facility in Louisiana. What will follow that is somewhat unknown. For sure, several new facilities will get built, but without an increase in LNG pricing, it is unlikely that more than seven or eight plants get built. Oddly, it is the price of oil that holds the key to the future of LNG. If oil were to rise, world LNG prices would rise with it and thus make the building of a liquefaction export facility more justifiable.

Cheniere Energy is an interesting company in that it has not made a profit in 20-years. In addition, two famous investors have differing views on the company. Jim Chanos, a well-known short seller is short the stock, believing that LNG growth has stalled and pricing is weak. Carl Icahn owns over 10% of the company and has stated the company is misunderstood and that Cheniere’s contracts are “golden”. For me personally, Cheniere is a risky stock that I would not own, however, investors wiling to take on risk could end up with a big win.

All of the natural gas producers should enjoy some benefit from LNG export as the added demand is likely to raise prices. How much prices rise depends on how much demand is created. With U.S. natural gas production at high levels and with additional natural gas supply readily available, I believe the benefit for producers is likely limited.

To me, the biggest winners are the pipeline companies which will see an increase in flow through their pipes and the biggest winner from the pipeline group will be Kinder Morgan.

The map below shows the Kinder Morgan system, with everything in red, natural gas related. As you can see, their natural gas system is huge and located near all the production areas.

Energy Transfer Equity could also be a big winner, if they are not forced to sell major portions of their natural gas pipeline network. In addition, I think it will be interesting to see if Shell, which is buying BG will proceed with the Lake Charles project. I mention this, because Shell’s last quarter saw a loss in the billions. During the quarterly conference call several answers to questions implied that no final decision has been made on whether to proceed or not.

In replying to a question about the North American gas market, Shell management said this.

“So the reality is that we manage the company differently. We manage the company on the fundamentals of the market and on the reality of the day, and if you look at the fundamentals, be it oil or gas, the point is that industry will not invest trillions of dollars if the price, if the cost is such that you can’t make a profit.”

And, more interestingly was this remark, that Shell has not seen all the details on BG contracts. Here is the question and answer.

And then maybe one more on just something you said a second ago, which was just there’s some confidential information that isn’t flowing between yourself and BG yet. Would that include the terms of your LNG contracts? Thanks.

Simon P. Henry – Chief Financial Officer & Executive Director

Thanks, Rob. Probably I better take them all here. The last one is easy. Yes, it does because we can’t talk about LNG commercial contracts until we are one company. ”

So it will be interesting to see what decision Shell makes, once all the details of the contracts are revealed, and what the LNG market looks like at that time.

LNG export is beginning, but what the LNG export picture looks like 5-years from now is still murky. The one thing I know for sure, is there will be demand for more natural gas, and more natural gas will flow through pipelines. In my opinion, the safest investment is in the pipeline companies that have a significant natural gas network. Best of luck to all.