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A Non-Obvious Investment in Natural Gas

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Investing in a company before the crowd sees value in its products or services not only makes you look like a genius, but can generate steady returns and help to anchor your portfolio for years. Just ask Warren Buffett. When investing in the natural gas industry it may be easy to narrowly consider rig and well owners or liquid natural gas (LNG) operators, but in a market with historically low prices it might be difficult to realize any profits. Why not consider investing in companies that will benefit from the race to unload bulging domestic reserves? Asking this question will lead you to the non-obvious investment opportunity in LNG carriers. 

The Federal Energy Regulatory Commission (FERC) recently approved three LNG export terminals and is considering up to four more, which has lead to the prediction that the U.S. will become a net exporter of LNG in 2016. That will require an armada of specialized carriers capable of keeping natural gas condensed at temperatures below -260 F.

<img src="/media/images/user_6293/lngcapricorn_large.jpg" />

This beast is the 936-foot LNG Capricorn. As new ships are built with regasification capabilities they become floating pipelines – and it’s easy to see why.

Go with Golar

The first two companies to consider in LNG carriers are Golar LNG Ltd (NASDAQ: GLNG) and its limited partnership Golar LNG Partners LP (NASDAQ: GMLP). The two entities may only own 13 ships, but Golar has over 40 years of experience in LNG (ordered its first carrier in 1970). The company also has several first-mover advantages. In 2002 they became the first in the industry to build a Floating Storage and Regasification Unit (FSRU), which can inject natural gas directly into power grids; thus removing the need for costly import terminals. In 2004 Golar studied converting one of its vessels into a Floating Power Generation Plant (FPGP), which may one day be used to quell energy shortages in developing countries or those affected by natural disasters.

Golar LNG Ltd has been steadily reducing its debt over the last five years, which has come mainly in the form of capital lease obligations. Despite long-term debt remaining relatively constant near $700 million the debt to assets ratio has fallen from nearly 75% in 2007 to around 50% in 2011.

<img src="/media/images/user_6293/golar_debt2assets_large.PNG" />

Golar may have some room to run with a 3.35% dividend and sitting in the middle of its 52-week range. The company should continue to reduce debt as orders for LNG pick up. This should also be true for Golar LNG Partners LP, although the LP had to acquire its parent company’s two FSRU carriers in October 2011 to keep dividend distributions steady and hasn’t been able to shed debt as easily.

Everything is okay at Teekay

The next company owns the third largest fleet of LNG carriers (27), which are complemented with 5 liquid petroleum gas (LPG) carriers and 11 oil tankers. Teekay LNG Partners L.P. (NYSE: TGP) flaunts a 6.3% dividend and has operational advantages provided by its parent Teekay Corp. (NYSE: TK). Similar to Golar, Teekay LNG has been cutting debt levels and increasing orders over the last several years. Although it is trading near a 52-week high there is room to run with the world’s growing appetite for LNG, which is expected to grow by 50% by 2030.

<img src="/media/images/user_6293/tgp_debt2assets_large.png" />

A stealthy investment?

StealthGas, Inc. (NASDAQ: GASS) has enjoyed quite a run in the last 6 months, but still trades at 39% of book value. The company owns a fleet of 28 LNG and 6 LPG carriers. You may wonder why the company trades at such a low book ratio?

<img src="/media/images/user_6293/gass_debt2assets_large.png" />

A look at the company’s past five years shows little growth and an inability to reduce debt, which may be cause for concern. Still, the significant bargain has not scared away all investors as 336 of 352 CAPS players have the stock weighted as an outperform.

Growing profits with ethylene

As the LNG industry builds capacity, competition for contracts will become fierce. Companies that continue to be first-movers, such as Golar, stand to benefit the most. So while the industry is caught up in the growing trend of exporting LNG to high-value markets, privately-held Synfuels International (company website) through its GasRich Transport technology is quietly planning for the next big trend: liquid ethylene transportation.

Depending on the market, ethylene, an important precursor in the chemical industry, sells for $800 - $1,600 per metric tonne.  That makes it far more valuable than natural gas, which sells for $100 to $650 per metric tonne. Why is there such a large range in prices? Ethylene can be made from naptha (an oil derivative) or ethane (a component of natural gas). Those building block molecules track the price of their respective commodity, which increases globally for oil and varies for natural gas.

Despite the growing amount of natural gas methane outnumbers ethane 9:1 (wt/wt) in the mixture. As a result of the ethane shortage ethylene will only continue to rise in price. That’s why Synfuels created the industry’s only methane to ethylene cracker – ensuring a steady supply of cheap ethylene.  They also created technologies surrounding the transportation of ethylene that are compatible with current LNG terminals and carriers after minor improvements. Watch this video to see how it works.

What’s the point? By filling one 138,000 cubic meter tanker a month with 75% ethylene a company could generate an annual return of $500 million (assuming an average price of $1,200 per metric tonne of ethylene) with US natural gas. One day some of the companies above may be using Synfuels’ technology to increase the value of their cargo by billions of dollars per year.

Foolish bottom line

The LNG carriers listed above may be trading near 52-week highs, but I believe they still offer value to investors and access to a quickly expanding industry. They represent non-obvious investments in the natural gas industry and a way to play historically low prices. As Golar and Synfuels International demonstrate, it is important to keep an eye on new technologies and first-movers. If these companies continue to shed debt and therefore create value, then investors will continue to see great returns.

Did you enjoy this article? Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and biopharmaceuticals @BlacknGoldFool.

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