Cheniere Making Big Gambles With Other People’s Money

Popular wisdom has it that traders and modern investors alike are a short-sighted bunch. The focus is always on the next quarter's earnings, the feeling is, which punishes companies with long term, strategic plans. Those that hold this view say that this obsession with short term profitability discourages investment and distorts the market. There may be some truth to that in certain sectors, manufacturing for example, but in energy the opposite is true. Markets are remarkably patient with companies engaged in the right business, even if immediate results aren't forthcoming.

Take Cheniere Energy (LNG) for example. A quick glance at the chart since the beginning of 2012 tells you that the market just loves LNG.

The stock climbed steadily for two years, quadrupling in price from the beginning of 2013 until falling energy prices caught up with it in September of this year. The case for Cheniere is fairly clear. They are, as the ticker symbol would suggest, involved in the liquefied natural gas business, so, with the enormous boom in gas production in the US over the last 5 years, it is little wonder that the stock has done well. The only problem is that there is one thing missing from the picture. Cheniere is a public company and has been for a long time, but has never made any money.

The story is a fascinating one for sure; it could even be described as inspiring. The company started out with a plan to import natural gas to the U.S. and its Sabine Pass facility was originally built for that purpose. Then, when the massive reserves of natural gas in the U.S. were unlocked by advances in drilling technology, America went from undersupply of gas to massive oversupply seemingly overnight. Undaunted, founder and CEO Charif Souki simply responded to the changing conditions and adapted the plant for export. Now, with natural gas significantly cheaper in the U.S. than on the global market and with supply still increasing that looks like a stroke of genius.

Once again, though, there is one problem…no profit. To facilitate the change and continue to operate, Cheniere borrowed initially. So much so that the company now has over $9 Billion in debt and a debt to equity ratio approaching 400, even as cash flow remains negative. Then, this week we are told that Cheniere is issuing more stock to finance a second export terminal.

Far be it for me or anybody else to discourage optimism or ambition in a company, but as it stands I would rather that optimism and ambition be financed with other people's money. LNG is priced as if the future is not just rosy, but guaranteed and that is not the case.

Any further drop in energy prices will quickly impact production and the spread between U.S. and global pricing would narrow. In that case, while liquefied gas could still be exported, the pricing power that investors in Cheniere envisage would quickly disappear. There is also one other risk that could endanger more than just pricing. The current political climate in the U.S. favors allowing the free market to control the price of natural gas and whether or not it is exported, but that could change. If it does, the very premise on which Cheniere's prospects are based could be in danger.

Gas, as with all energy, has a role in national security and geopolitics. Right now Putin's Russia is seen as an enemy and releasing a flood of cheap natural gas on the market and thereby reducing their economic power seems like a great idea. To make an investment predicated on the constancy of politicians, however, particularly on the global stage, is the ultimate folly. Alliances shift faster than playground friendships and, as the U.S. attitude to various Middle Eastern countries has amply demonstrated, today's enemy can easily become tomorrow's friend.

In short, the flexibility and innovation shown by Cheniere is admirable as an example of how capitalism should work. It is, however, a company saddled with huge debt that is taking an enormous gamble on both energy prices and geopolitics, but is priced as if already successful. It may be short-sighted of me and a reflection of my trading background, but I regard making money as the first duty of a company. Cheniere has failed in that to date and, unless things all go their way, could well continue to do so. Until that very real risk is priced into the stock, short LNG may be a better position than long.