Staying Competitive in LNG

 | Apr 23, 2013 | 6:00 PM EDT
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Chevron (CVX) announced it has found more natural gas in Australia. It is Chevron's 21st discovery. Australia is swimming in natural gas. The only way to export the product is to transform it into liquefied natural gas (LNG) and ship it to foreign markets.

Now, Russia's Rosneft has announced plans to produce 100 billion cubic meters of gas per year by 2020. It will also team with Exxon Mobil (XOM) to build a $15 billion LNG export plant in Russia's far east by 2018. Royal Dutch Shell (RDS.A) is constructing a massive offshore floating platform to produce massive amounts of LNG in situ. The concept of floating LNG production is called FLNG and Shell is not the only player. Petrobras (PBR), ConocoPhillips (COP), GDF Suez and other producers are engaged in front-end engineering for additional FLNG facilities.

According to the International Gas Union (IGU), more projects are reaching final investment decisions. In 2011, Peru became the 18th exporter of LNG. This is in addition to the 240 million tons per year already exported by Qatar, Malaysia, Indonesia, Australia, Nigeria, Trinidad, Algeria, Russia, Oman, Brunei, Egypt, UAE, Equatorial Guinea, Norway and others.

LNG Demand Constrained

For a country to accept LNG imports, costly LNG import and regasification facilities must be available. Japan is one of the few countries that needs LNG and has LNG import facilities in place. It is not clear that Japan can absorb all the LNG contemplated. In 2011, Japan imported a third of the world's exports. Because of the Fukushima nuclear meltdown, Japan continues to import LNG. But there is a limit, particularly at current prices.

South Korea is the world's second-largest importer. Then the U.K., Spain, China, India, Taiwan, France, Italy and 16 other countries. Some of the importing countries also export. This includes the United Arab Emirates and the U.S. Unconventional gas production in North America, China and Europe continues to rise, leaving LNG volumes previously destined for those markets redirected elsewhere.

The world market for LNG is small and limited. The barrier to entry is the heavy capital expenditures required for the production end and the additional capex required for the receiving end. In addition, the receiving-end facility must be collocated near a seaport, which also has an existing pipeline infrastructure. The capex is in addition to operating and production costs. If all planned production facilities are built, it appears the LNG market will be flooded. Excess supplies and constrained demand suggest lower prices for delivered LNG are looming. Cost leaders -- not price leaders -- will be the winners.

As natural gas prices float higher, any cost leadership advantage U.S. LNG producers thought they had will evaporate. As a result, it seems improbable investors will allow additional capex to support LNG exports from U.S. ports. Pacific-facing Alaska may be an exception.

Domestic LNG Production

The only reason Cheniere (LNG), Cheniere Energy Partners (CQP) and Dominion Resources (D) are building LNG export facilities is to recover their stranded assets. They already own LNG import facilities that became stranded when massive amounts of shale gas were discovered. By using the same facility and equipment to reverse the flow of natural gas, Cheniere and Dominion can recover the mothballed assets. Any margin they capture will help recover investments in new and additional capex.

Cheniere's core contracts should be fine, but any plans they may have to cash in on highly lucrative LNG spot markets should be questioned. There will be spot markets, but they may not be at current prices. The same can be said for Dominion's Cove Point proposed LNG export facility. The base contracts are solid, but surplus capacity is constrained by the realities of a new market.

It is difficult to see how U.S. producers can compete in world LNG markets. Competitors have a critical advantage over U.S. suppliers: They are the world's cost leaders. Specifically, their feedstock costs are not indexed against inflating Henry Hub or NYMEX NG prices.

From a U.S. perspective, the LNG story is more sizzle than steak. While others ask where's the beef, speculators have already exited.

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