Why I’m Buying this Solution to our Natural Gas Glut

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

We have a lot of gas, more than we know what to do with.  Several companies are exploring the opportunities that lie in exporting some of our windfall.  The only company that’s actually been approved to do so is Cheniere Energy’s (NYSEMKT: LNG) publicly traded subsidiary Cheniere Energy Partners (NYSEMKT: CQP) via their Sabine Pass project. 

The economics behind exporting gas are very compelling, but the process is not without its detractors.  Because I view exporting gas as an important future demand driver for this abundant resource, I want to be invested in its future success.  That’s why I’m looking to add Cheniere to my virtual “No Drip, No Mess” Portfolio.

Which Cheniere?

It’s important to know the difference between the two public companies in order to determine which one to invest in.  Cheniere Energy Inc. (to be known as LNG) is a corporation, while Cheniere Partners (to be known as CQP) is a Master Limited Partner.  LNG owns a 61% interest in the partnership as well as a 100% interest in their general partner, not to mention 100% interests in Creole Trail Pipeline, Corpus Christi Liquidation and Cheniere Marketing. 

It simply makes more sense to own the parent company at this point, so I’ll be adding shares of LNG to the portfolio.  Because they own the GP as well as 61% of CQP, they’ll benefit much more than unit holders will.  Further, because of the structure of the Blackstone (NYSE: BX) equity injection, over time public unit holders of CQP will see their stake reduced from 6.4% down to 4.6% by the end of 2016. 

The issuance of Class B units of CQP to Blackstone was a real watershed moment for the company, but it came at a cost.  In exchange for the $1.5 billion of equity, Blackstone was issued 100 units that accrete 3.5% quarterly until convertible into common unity.  This accretion will bring Blackstone’s equity stake from its current 32.6% up to 43.9% and transfer a larger percentage of the equity ownership away from public unit holders.  That’s not to say public unit holders won’t do very well, I just think that Blackstone’s investors, and more importantly LNG investors, will do better.

The Economics of Exportation

These are VERY expensive projects, and you don’t typically see a project of this size undertaken by such a small operator.  Exxon Mobil (NYSE: XOM), for example, is a joint venture partner with Qatar Petroleum on the Golden Pass Products project.  Exxon is the largest natural gas producer in the US, and they are seeking permission to export from this recently completed import terminal at a cost of nearly $10 billion.  That investment represents the net cash that the $425 billion behemoth has on their balance sheet.  CQP on the other had a total enterprise value of just $8.8 billion at the end of the last quarter.  At the risk of doubling their size, Cheniere is seeking an equally outsized reward. 

To understand the economics of exploration I think you need to see it to believe it; take a look at this chart from Cheniere:

<img src="/media/images/user_12784/cheniere_large.jpg" />

This spread between US shale gas and the prices of natural gas from around the world is what makes these projects from Cheniere so enticing.  They’ve already entered into long term, “take-or-pay” style contracts with several international energy companies.  They pay an annual fixed fee and then a fixed fee per MMBtu for a 20 year term.  These economics make for a very compelling investment.

Financials

At of the end of June LNG had no debt and about a quarter of a billion dollars of cash on the balance sheet. Until the copious cash flows from the export trains begin flowing back to LNG, they estimate to be about cash flow break-even.  However, it is likely that they’ll be spending just under $100 million on the Creole Trail Pipeline modifications as well as for development costs for the Corpus Christi Liquidation Project.   They do eventually plan to sell Creole Trail to CQP and could also eventually drop down Corpus Christi as well. 

For the next few years, LNG will be more about the news flow than it will be about the financials.  Once gas starts flowing out of Sabine Pass and cash flows into CQP, they'll quickly be making their way to LNG.  Management estimates that by the end of 2016 LNG will begin to pay a dividend to their shareholders.  That rate should be about $2 annualized or about 13% yield for investors who buy today.  There is significant long term upside after that from both Cheniere Marketing and the Corpus Christi Project, and when taken together the rewards far outweigh the risks.    

The Trade

Given that this is a long term story with plenty of near term risks, I plan on starting small and building a position over time.  Because LNG doesn’t pay a dividend yet I’m going to allocate capital from the “no mess” sides of the score card, meaning I’m just using capital that the portfolio has generated.  Specifically, I’ll be allocating 0.5% of my total capital, or $500, which works out to around 32 shares, and uses up about two thirds of the income that's currently available. 

Risks and Why I’d Sell

Some of the potential risks include the possibility that a wave of protectionism could hit and hurt the future of natural gas exports.  Future export markets could find that they have their own natural gas glut as new technologies or shale plays uncover more gas.  Finally, drilling for gas in the states could be derailed by new environmental laws. 

The list of potential risks is long and very real; however, I think that Cheneire will be successful in their quest to export gas.  Once that gas starts flowing, investors will be greatly rewarded.  I want to start to build a position well before that happens.


latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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