New Kid on the Block

Upgrades & Downgrades

By Jack O'Connell 2017-04-28 11:37:36

(Article originally published in March/April 2017 edition.)

The wonders of the shale revolution never cease, and early next year the U.S. will become for the first time in its history a net exporter of natural gas. It’s already exporting a million barrels of oil a day and more than a million barrels of natural gas liquids (LPG) a day. Throw in distillates like diesel and gasoline and you get another million and a half barrels a day.

That’s nearly four million barrels a day of product and a big reason why the U.S. is fast becoming a force to be reckoned with on the global energy scene. Of course it’s always been an energy power- house, but most of that energy stayed at home. And for years it was dependent on OPEC and others for half its oil supplies. Now all that has changed, and it’s all because of what Michael Kasbar, who graces this edition’s cover, calls “the single biggest energy innovation of the last 100 years” – fracking.

Fracking has made the U.S. one of the world’s lowest-cost oil and gas producers and competitive with Middle East production. The vast amount of new reserves unlocked by fracking and its sister technology, horizontal drilling, ensure that the U.S. will be a major player on the global energy front for years to come.

Now it’s LNG’s turn to take center stage, and the prospects couldn’t be brighter. According to the Energy Information Administration and others, the U.S. is poised to become the world’s biggest producer – and exporter – of LNG sometime in the next ten years, passing Qatar and Australia in the process. But forecasts, as you savvy readers know, have a way of not always panning out, so what’s a smart investor to do?

ALL ABOUT CHENIERE

In late February 2016, the LNG carrier Asia Vision departed from Cheniere Energy’s Sabine Pass, Louisiana facility, an historic moment that marked the first LNG cargo to be exported from the continental U.S. in over 50 years. The shipment opened a new chapter in the global energy trade with the U.S. expected to become one of the top three global LNG suppliers by 2020.

The Asia Vision loaded up at Sabine Pass Train 1. Later in 2016 Sabine Pass Train 2 came on line, and early this year Cheniere (NYSE: LNG) loaded its first shipment of LNG from Train 3. Each train is capable of producing about 4.5 million tons a year (the global LNG market is approximately 250 million tons) when fully operational. Two more trains are scheduled for startup at the Sabine Pass facility –Train 4 later this year and Train 5 in 2019.

Why are they called “trains”? I was afraid you’d ask that. I’m no chemist but apparently the process of liquefying and chilling the gas down to a temperature of minus 260o Fahrenheit involves a series of steps or stages, laid out in one long “train.” A typical train consists of a compression area, propane condenser area, methane area and ethane area connected by an intricate series of pumps, valves and pipes. For more information, go to cheniere.com.

THE U.S. HAS JOINED THE RANKS OF LNG EXPORTERS AND INVESTORS ARE CHEERING. TIME TO BUY CHENIERE?

Cheniere is also building two additional trains at its new Corpus Christi facility, both scheduled for startup in 2019. If all seven trains are built, the company will have total capacity of 31.5 million tons per year by 2020 or roughly half of all U.S. LNG production and about 10 percent of global output.

It’s a tall order, but investors are enthusiastic. The company notched its first profit in last year’s fourth quarter – despite a loss for the year – and revenues topped $1 billion for the first time. Half of those revenues came in the fourth quarter when the company achieved almost full production from Trains 1 and 2, so the potential is huge as additional trains ramp up and reach capacity.

Wells Fargo Securities initiated coverage of Cheniere and its MLP stock, Cheniere Energy Partners (NYSE: CQP), earlier this year with an Outperform rating and a “valuation range” of $56-61 per share for LNG (currently trading at $45) and $33-35 per unit of CQP (currently trading at $32). The MLP is the safer bet since it carries a dividend of $0.425/unit or roughly five percent. LNG is will be an ongoing challenge, but so far so good.

Analyst Michael Webber says in his report that “we believe the Cheniere complex (as a whole) is uniquely positioned as a LNG market leader and should increasingly benefit from improving long-term U.S. LNG export dynamics, growth opportunities in new markets, and narrowing risk premiums on its existing, visible long- term cash flow streams. Effectively, we view CQP as the warehouse of undervalued, investment grade, fixed-fee revenue streams and believe Cheniere (LNG) is an attractive sum-of-the-parts play that carries significant option value via its Cheniere Marketing volumes and additional project buildouts.”

Webber believes the company must pay off its more expensive debt and strengthen its balance sheet now that it has achieved an investment-grade rating (BBB-). He also says it can make significant profits from its nascent shipping operation (Cheniere Marketing), which over time could become one of the world’s largest charterers of LNG vessels.

In its fourth quarter conference call, Cheniere CEO Jack Fusco described 2016 as a “year of transition” and 2017 as a “year of opportunity” as the company moves forward from construction to operations. “We have big plans,” he added. Financing those plans will be an ongoing challenge, but so far so good.

Right now Cheniere is the only game in town, but there will soon be others. Next up is Dominion Resources (NYSE: D), the Richmond, Virginia-based utility whose $3.8 billion Cove Point LNG Terminal on Maryland’s Chesapeake Bay is scheduled for startup later this year. Though much smaller than Cheniere’s Sabine Pass facility, its location on the U.S. East Coast puts it closer to key markets in Europe and parts of Asia. Dominion’s stock, currently trading in the high $70s, offers an attractive four percent yield.

In addition to Cheniere and Dominion, two other LNG export facilities are currently permitted and under construction: Sempra Energy’s Cameron LNG terminal, located in Hackberry, Louisiana, is scheduled to bring three trains online in 2018 while Freeport LNG’s terminal in Freeport, Texas has three trains under construction. The first two are scheduled to begin service in 2019 and the third in 2020.

All told, eleven permits have been issued by the U.S. Federal Energy Regulatory Commission for LNG export facilities, but only four are currently under construction.

ESTABLISHED PLAYERS

While the upside in all these companies is great, so are the risks. Who is to say that the global LNG market won’t become overcrowded with too much capacity and not enough demand? What if there’s a trade war between the U.S. and China and China decides to curtail all imports of U.S. LNG? Farfetched? Maybe, but we live in a brave new world where competing national interests could wreak havoc with established patterns of commerce and trade.

For those of you with queasy stomachs, the safe approach is to stick with those companies who have been playing this game for a long time. At the top of the list is Royal Dutch Shell (NYSE: RDS/A), which is divesting its Canadian oil sands assets to pay for the British Gas acquisition and focus on its growing LNG portfolio. Shell has LNG liquefaction facilities all over the globe. Its trading and ship- ping arm was a pioneer in transporting LNG and today operates one of the world’s largest LNG fleets.

ExxonMobil (NYSE: XOM) is another safe choice. The world’s largest independent oil and gas company is pursuing an aggressive acquisition strategy to boost its presence in the burgeoning LNG and petrochemicals markets, which – according to Cowen & Company analyst Sam Margolin – the company sees as “the two largest growth markets within the petroleum complex.” Margolin has an Outperform rating on both Shell and ExxonMobil with price targets of $66 and $100, respectively.

He also has an Outperform rating on Chevron (NYSE: CVX) as well despite the company’s well-publicized cost overruns at its Australian LNG operations. But no matter. Chevron’s expanding Permian Basin operations in Texas and growing presence in Kazakhstan are more than making up for losses elsewhere. Margolin’s target price? $122. Chevron currently trades at $113 and, like Shell and ExxonMobil, offers an attractive and reliable dividend.

LNG EXPORTERS*

(1)          Qatar (32%)

(2)          Australia (12%)

(3)          Malaysia (10%)

(4)          Nigeria (8%)

(5)          Indonesia (7%)

LNG IMPORTERS*

(1)          Japan (34%)

(2)          S. Korea (13%)

(3)          China (8%)

(4)          India (6%)

(5)          Taiwan (6%)

* 2015 Market Share Source: IHS, IGU.

U.S. HULLS FOR U.S. EXPORTS?

No discussion of U.S. LNG would be complete without mention of using U.S.-flagged ships to transport it. And Congressman John Garamendi (D-CA) has introduced a bill that would do just that. The “Energizing American Maritime Act” would require that up to 30 percent of U.S. exports of crude oil and LNG be carried on U.S.-flagged bottoms.

“The state of the American maritime industry is in crisis-level decline,” said Garamendi in introducing the bill. “After World War II, our oceangoing fleet of U.S.-flagged ships numbered 1,200. To- day, it’s fewer than 80. This isn’t just an economic concern – it’s also a national security risk. We can’t rely on foreign-flagged vessels to pro- vide the necessary movement of strategic materials in a time of war. Requiring even a minority of strategic energy asset exports to be carried on U.S.-flagged ships will compel us to rebuild the technical skill to man these vessels – and with that comes good, high-paying maritime jobs.”

Garamendi is the Ranking Member of the House Subcommittee on the Coast Guard and Marine Transportation, and he knows full well that the U.S. currently has zero LNG carriers and no large crude oil carriers. That’s right, none. If his bill passes there will be no ships available to make it happen.

And that’s the point, isn’t it? The bill is really a symbolic act to call attention to the sorry state of U.S. maritime and hopefully kick-start the long overdue effort to rebuild the U.S.-flagged fleet and bring it into the 21st century. In the meantime, America’s strategic energy assets will continue to be transported by foreign-flagged ships.

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