Surprise Winners of the Natural Gas Boom

By Daniel Ferry - July 20, 2012 | Tickers: GLOG, GLNG, RDS-B, TGP, WPRT | 0 Comments

• Email
• Print

The rise of hydraulic fracturing has unlocked vast new reserves of natural gas, and despite environmental concerns, American natural gas is set to become an increasingly important source of energy. A lot of excitement surrounds innovative companies like Westport Innovations (NASDAQ: WPRT) using natural gas to power vehicles as well as boring old electricity utilities building natural gas-powered plants. Such investments in demand capacity, however, will take years to reach fruition. In the meantime, America is producing more natural gas than it can use, leading to rock-bottom prices. Look across the Pacific, however, and natural gas prices can be as much as ten times higher. Why the discrepancy in an increasingly globalized world? Oil, after all, fetches about the same price the world over.

The answer is that natural gas is unusually difficult to ship overseas. It requires vast, expensive liquefaction plants to chill the hydrocarbon to -260 Fº (producing liquid natural gas, or LNG). Then, LNG must travel on purpose-built ships to safely contain that super-cooled liquid, and regasification plants must be at the other end to safely heat the LNG back into a gaseous state. The expertise and deep pockets needed to create and operate these facilities and vessels creates huge barriers to entry that have slowed the creation of LNG transportation capacity.

Wherever there is a bottleneck in the meeting of a demand, the companies that control movement through that bottleneck have incredible pricing power. Golar LNG (NASDAQ: GLNG), a pure play LNG shipper that has developed a proprietary process to retrofit LNG tankers as off-shore regasification terminals, has seen its operating income quadruple since 2009 as day rates for its vessels have increased from around $40,000 to an expected average of nearly $150,000 through 2012. Of course, after a price run-up of over 300% over the last three years, the stock now sports a P/E of 63 and a P/B of 4.6. Teekay LNG Partners (NYSE: TGP) is not a pure LNG play, as crude oil tankers and LPG carriers make up over a third of its fleet, and as such it is about half as expensive as Golar. However, it still looks fairly pricey compared to the shipping industry and its own long-term average. With such a sky-high valuation, aren't LNG shippers bound to fall back to earth? Not any time soon.

LNG tankers are complex ships to build: they can cost around $200 million to order, and can take more than two years to construct. Because of their complexity, buyers shy away from inexperienced shipyards like those in China, and most LNG tankers are built only in a select few shipyards in South Korea and Northern Europe, where they compete for spots in the production queue with drill ships and deepwater oil rigs. The natural gas production boom caught many shipyards napping, and only two new vessels will be brought online in 2012 and 22 new vessels in 2013: with an existing global fleet of only 374, this is an annual growth rate of about 3%.

Eight of these vessels will be going to GasLog (NYSE: GLOG), a company with long experience in ship management which, following an IPO in March, is rapidly expanding into ship ownership. It is representative of the overall market for LNG tankers in that has forward-contracted all its vessels at stellar rates, and new ships will be making significantly longer voyages than the existing fleet—from gas-producing regions in the US, Middle East, and Africa to meet rising demand in the Asia-Pacific region instead of taking the shorter route to Europe. A longer trip means that ships will be engaged for longer periods, resulting in a net reduction of transportation capacity, so the 3% annual growth of the tanker fleet will barely be enough to accommodate the IEA's estimate that global demand for natural gas will grow by 2.7% annually through 2017. This should keep pricing power for incumbent shippers high.

And afterward? Coincidentally, 2017 is the year that Royal Dutch Shell (NYSE: RDS-B), a global leader in LNG production, will bring the $10 billion Prelude online. Prelude will be both the largest vessel in the world and the first attempt to commercially harvest natural gas from under the seafloor from a floating rig. Shell believes that offshore natural gas could become as important and revolutionary a development in the global energy markets as offshore oil drilling has been. If this comes to pass, demand for marine LNG transportation will stay strong for decades. Prelude, likely to become the design standard for floating LNG if successful, is designed to pump LNG directly onto tankers like those that Golar and Teekay operate now.

Downside risk is high in the LNG market. Predictions about natural gas demand and LNG export have been proven terribly wrong before, and new innovations in renewables or safe nuclear could transform the market yet again. There's political risk, too—a bill has already gone before the US Congress to limit LNG exports in a misguided attempt to keep domestic natural gas prices low. But for those who can stomach it, a position in a company controlling a chokepoint on demand for what is quickly becoming a critical globally-traded commodity could provide the triple digit returns to make it worth the risk.

• Email
• Print
• Feedback