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How to Profit from Chinese LNG Demand

On April 30, a U.S. House congressional committee passed a bill that would streamline the approval process for exporting liquefied natural gas from the United States. Sponsored by Rep. Cory Gardner (R-CO), the bill would require the Department of Energy to make a decision on LNG export applications within 90 days after the close of the public comment period.

The bill has a long way to go before becoming law, but its ultimate fate may not be that important. It appears that the Obama administration is keen to allow LNG exports to move forward, albeit in a gradual way, to countries without which the U.S. has a free-trade agreement.  The Department of Energy has approved seven LNG export projects, with a combined capacity of around 13 billion cubic feet per day, or 96 million metric tons of LNG per year (mmtpa).

This amounts to more capacity than the world’s largest LNG exporter – Qatar – currently has (77 mmtpa), so if all of those terminals moved forward the U.S. would become one of the world’s top producers.

But that doesn’t mean that all of these projects will be constructed, and even if they are, there is no guarantee that they will be profitable.

LNG is Risky

There is a lot of exuberance regarding the potential of LNG. The reason for the excitement is the remarkable arbitrage opportunity – natural gas prices sit below $5 per million Btu (MMBtu) in the United States, while in Asia, spot cargoes can fetch well over $16/MMBtu. After factoring $4-$5/MMBtu in liquefaction and transit costs, companies can make a tidy profit by sending natural gas from North America to Asia.

But there is a chance that the price gap won’t last. Natural gas prices in the U.S. have already doubled in less than two years – they were below $2/MMBtu as recently as 2012. And coal-fired power plants continue to shut down, increasing demand for natural gas to be burned within the United States. This likely means that over the long-term, U.S. natural gas prices rise a bit more, perhaps to the $6/MMBTu range.

More importantly, prices in Asia could be abnormally high. The surge in demand from Japan after Fukushima sent prices skyward. Japan accounts for 37% of global LNG demand and the sudden closure of 49 gigawatts worth of power resulted in a quick tightening of the LNG market. That may change however. The government of Prime Minister Shinzo Abe strongly supports a restart of the nation’s nuclear power plants, with some estimates projecting that 14 reactors could come back online later this year. More nuclear means less LNG coming into Japan, putting downward pressure on LNG prices.

Moreover, a surge in LNG supply could be coming online over the next two to three years. In addition to the potential capacity from the U.S., Australia plans on adding 62 million tonnes of liquefaction capacity by 2017, tripling its current supply. Australia would serve the hungry Asian market, and as it ramps up, prices will come down.

The Chinese Bull

On the other hand, there is a bullish case for LNG, and it all comes down to China. Japan has always been the biggest player in the LNG market, and while its LNG demand will remain very robust no matter what it decides to do with its reactors, demand growth will come from China.

China’s last decade and a half of rapid economic expansion has allowed it to become the top consumer of an endless list of commodities and products – copper, gold, steel, concrete, coal, cars, and on and on. But it has been a laggard when it comes to natural gas. The Politburo hopes to change that as it seeks to clean up the terrible air pollution problem plaguing Chinese cities. That means that LNG consumption is set to take off in the coming years and will be the biggest driver of growth in the global LNG market.

China’s consumption of natural gas is growing at an average annual rate of 22%, hitting 16.4 billion cubic feet in 2013. According to its 12th Five Year Plan, China hopes to hit 22.2 bcf in 2015, a target it is on track to reach. Although China has a massive endowment of shale gas, it has struggled to develop its reserves in any significant way, owing to poor infrastructure, water scarcity, complex geology, and price controls. China hopes to develop a mere 100 bcf of natural gas in 2015. By comparison, the U.S. produced 9,380 bcf in 2012.

So, in order to feed its demand, China will rely much more heavily on imported LNG. Total LNG imports climbed 27% in 2013 to 18 mmtpa. And the rapid growth in LNG demand is not expected to slow down. By 2025, LNG demand could hit 65 mmtpa, more than triple today’s levels.

To put it in context, over the next ten years, China’s additional demand alone will be like adding another half of a Japan to the LNG market.

Who Benefits?

If China does not live up to the hype, there is a possibility that the world will be oversupplied with all the new projects coming online. But, if China’s growth does meet expectations, who will be there to feed Chinese demand?

Australia is the best positioned both geographically and because it has several projects already under construction while other countries are in the planning phases. There are seven LNG export terminals under construction in Australia that will be up and running to meet Chinese demand over the next decade. Chevron Corporation (NYSE: CVX) is a big player for investors to look at. It is a leading partner in the Gorgon LNG facility (47% stake), one of the world’s largest LNG export terminals. Located on the northwest coast of Australia, the Gorgon facility will be able to export 15.6 mmtpa when it is completed in 2015. Royal Dutch Shell (NYSE: RDS.A) is also a participant in the project (25%).

Chevron is also the lead on the Wheatstone project with a 64% controlling interest. Another massive facility, it will be able to export 8.9 mmtpa when it is completed in 2016.

Outside of Australia, but still near China is the PNG LNG facility located in Papua New Guinea. ExxonMobil (NYSE: XOM) runs this $19 billion operation, which will eventually be able to export 6.9 mmtpa. ExxonMobil announced that its first production is up and running ahead of schedule as of April 2014.

These are large companies, so Cheniere Energy (NYSE: LNG) offers more of a pure play on LNG. With a ticker symbol like that, you know the company is all in. It was the first to receive DOE license approvals to export out of its Sabine Pass facility on the U.S. Gulf Coast, and has first mover advantage. It has lined up contracts for deliveries to BG, Total, and Kogas. With access to cheap natural gas – for the time being – the company thinks it will make hand over fist with its straightforward arbitrage business plan. However, this one could be risky. Some analysts think its stock is highly overpriced, and the company is betting its future on rosy assumptions about natural gas prices.

Another interesting company to look at would be Veresen (TSE: VSN), an even smaller company that is hoping to export LNG from the west coast of North America. It plans on exporting Canadian natural gas out of the Jordan Cove export terminal in Oregon. This will bypass a 7% LNG export tax in British Columbia. The Jordan Cove facility received a green light from DOE earlier this year. With a market cap of only $3.3 billion, Veresen is trying to develop a multibillion dollar project that will send 6 mmtpa to Asia by 2018. It’s a risky bet, but Veresen is positioning itself to be the first mover on the West Coast of either the U.S. or Canada, a much more favorable location to ship to Asia than the Gulf of Mexico.  

In this “golden age of gas,” a phrase coined by the IEA, global LNG trade is set to take off. Just as China has gobbled up all sorts of commodities in the past, it is finally going to be entering the LNG market in a big way. The only question is by how much and which countries and companies will be there to profit from China’s demand.

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