In his efforts to secure U.S. energy dominance, President Trump has just shot himself in the foot, bringing down prospects for the growing U.S. Liquefied Natural Gas industry.
China's latest proposed retaliatory trade measures, including a 25% tariff on LNG exports, have raised uncertainty around the already hard-to-get long-term offtake contracts between China and major U.S. LNG exporters. (Offtake contracts are frequently used to document market demand to lenders financing new infrastructure, such as export terminals.) However, China's retaliation comes at a price. China is becoming the largest importer of LNG, surpassing Japan, at a time when the U.S., Australia and Qatar are positioning themselves to provide 60% of the global supply.
If implemented, the 25% tariff could give exporters like Qatar, Australia and Russia an edge in securing competitive long-term offtake agreements with China and other Asian customers, even as a dozen U.S. companies seek to build new export terminals. This move is a major blow to the U.S. LNG industry. It comes at a time when Russia is planning to begin shipping gas to China through its newly-built 2,500-mile (4,000 kilometer) Gazprom-operated (OGZPY) , Power of Siberia pipeline by the end of 2019.
Cheniere and Tellurian
U.S. companies that stand to lose the most on this trade war are Cheniere Energy (LNG) and Tellurian Inc. (TELL) as well as a number of privately-owned LNG companies that have been looking to secure long-term offtake agreements with Asian buyers.
According to data compiled by Bloomberg, China accounted for 13% of the exports from Cheniere's Sabine Pass terminal in southern Louisiana. Cheniere recently entered into two LNG sale and purchase agreements with China National Petroleum Corp. (CEO) for the purchase of 1.2 million tons per annum of LNG over a 20-year period.
Both LNG and TELL are run by top tier management teams and they're uniquely positioned to leverage their geographic position in cheap, exportable, U.S. natural gas. Unfortunately, near-term macro uncertainty outweighs the long-term reward of owning the shares vis-à-vis other energy peers.
LNG shares have outperformed the Energy Select Sector SPDR ETF (XLE) by more than 1,200 basis points year-to-date, and volatility will likely increase on the back of this trade war. Rather than an outright short position on LNG stock on this volatile outlook, we prefer to be long LNG January 2019 straddles on a bet that implied volatility in LNG options will make the trade profitable.
As for TELL, the stock has substantially underperformed LNG over the last 12 months and this underperformance is likely to continue given TELL's early stage in terms of asset build up and executed contracts.
China Still Needs the Gas
According to a report by the International Energy Agency (IEA) last June, China is poised to become the world's biggest importer of natural gas. China alone will account for 37% of the growth in global demand over the next five years. According to the IEA, Chinese gas demand is forecast to grow by 60% between 2017-2012 as it aggressively moves to reduce its reliance on dirty coal to reduce pollution.
However, China still has a strong need for LNG, and U.S. gas at $2.75 per MMBTU is a sharp discount to the $10 for LNG that is being charged by others shipping to Asia. On top of this, China has margin requirements on the Yuan to support its currency, putting additional pressure on purchases of U.S. dollar-priced LNG.
According to the IEA, Australia will be the third largest LNG producer in the world by 2023, making its pricing and geographical position more competitive. By 2023, the U.S., Australia and Qatar will comprise 60% of the supply. With the voracious lion's share of the demand, China is ultimately a price taker. Australia's top LNG player is Woodside Petroleum (WOPEY) which we think is better positioned to capture market share versus U.S. LNG pure-play export peers given its diversified footprint.
