A New Era for an Old Technology
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In 1923, two German coal researchers figured out how to convert coal into gasoline and other hydrocarbons. Franz Fischer and Hans Tropsch gasified coal into so called synthesis gas and then converted the constituent carbon monoxide and hydrogen into hydrocarbons. The original Fischer Tropsch (FT) process for coal required heat (up to 350C) and an iron catalyst. Turns out, any carbon source can theoretically be used as a feedstock and natural gas proves to be a good one. Natural gas contains few pollutants, requires lower temperatures for the FT process and is dirt cheap. Given the price differential between natural gas and oil, the FT process is attracting renewed interest.
So How to Cash in on Fischer Tropsch?
Sasol (NYSE: SSL) of South Africa arguably has the most experience with the FT process of all major oil companies traded. During the apartheid era, Sasol supplied South Africa with a variety of petroleum products courtesy of FT. Initially, Sasol used coal as feedstock, but along the way learned something about using natural gas, too. Today, Sasol exports its expertise around the world. The most visible project is the Oryx gas to liquid (GTL) plant in Qatar. Currently, this plant produces over 33,000 bpd of petroleum products from natural gas. The fiscal year 2012 saw record production and profits from this endeavor. Canada and the US may be the next site of a Sasol GTL plant. Sasol is closing in on a deal to build a GTL plant in western Canada that could produce 96,000 bpd. Sasol’s plant in Calcasieu Parish, Louisiana will be the site of a $10 billion GTL plant, assuming feasibility studies support such an investment.
Sasol could use the business. It’s quarterly earnings growth declined 20% yoy, and its net earnings dropped slightly from last year. The company sells at a five year expected PEG of 4.27. It has planned a pipeline expansion requiring financing through a $1 billion debt offering paying 4.5%. Standard and Poors rated the debt BBB. Further, a planned joint project with Chevron (NYSE: CVX) for a GTL plant in Nigeria fell through forcing a write off of those efforts. The stock has lagged the S&P 500 for the past several months and currently trades at about 9.5 times earnings. The current dividend yields 4.5%. However, I wonder how well that dividend will hold up if earnings continue to languish.
Not to be outdone, Royal Dutch Shell (NYSE: RDS-A) also opened the Pearl GTL plant in Qatar using natural gas and the FT process. The project cost $19 billion rather than the original $5 billion estimate and has been a drain on Shell’s capital. Full production is “nearly there” and can’t come soon enough. Shell has a fully operational GTL plant in Malaysia and is exploring an additional plant off the US Gulf coast. Shell's stock has lagged the S&P 500 over the past year, no surprise given the delays and costs of the Pearl GTL project. The Class A shares (RDS-A) offer a 4.4% dividend while RDS-B shares offer 5%. Be advised, revenues and dividends have declined since Q4 2011. On the other hand, the company currently sells at a PE of 7.9 and recently announced a stock buyback plan. Some say the company is oversold. I think the company needs to deliver some improved earnings before looking attractive as an investment.
Good Things Come in Small Packages
Sasol and Shell build large GTL plants that incurred significant cost overruns. What if someone built a small GTL plant? That’s what Calumet (NASDAQ: CLMT) is doing. The company currently plans to build a 1000 bpd plant in its Karns City, Pennsylvania facility. The idea is for Calumet to supply its own petroleum raw materials for refining through a small scale GTL plant using cheap Marcellus shale gas as feedstock. The FT process can be tweaked to produce petroleum with whatever characteristics Calumet may want for its refining purposes. Clever, if you ask me.
Even if the feasibility study shoots down these plans, I still think Calumet makes a better investment than Sasol or Shell. In a nutshell, Calumet sells at a PE of 9.4, a five year PEG of 0.63, enjoys a Return on Equity of over 26%, has limited debt and pays a dividend of 8.3%. Earnings and revenues this past quarter were substantially improved over last year’s numbers. Calumet has acquired two refineries and a specialty lubricants manufacturer over the past year, further enhancing its position as a specialty hydrocarbons company. The purchase of a refinery in Wisconsin alone increases Calumet’s refining capacity by 50%. However, Calumet is a small player and is vulnerable to changes in the commodities market. The company operates six plants and if any one of them shuts down, it would significantly impact earnings.
Foolish Final Thoughts
Big FT plants producing petroleum from natural gas incur substantial costs and risks. Dealing with countries like China and Nigeria can produce headaches rather than profits. However, given the price differential between the natural gas feedstock and final product, companies can still profit despite these start-up expenses. Of the three companies presented here, I like Calumet most. Its operations are entirely in the US, avoiding problems dealing with foreign governments, and right now has earnings momentum. Tapping into FT technology and cheap Marcellus shale gas looks like a sharp move for Calumet to secure its own source of petroleum, enhance future earnings and boost dividends to its investors.
dylan588 has a long position in Calumet Specialty Products Partners. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Chevron and Sasol. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!