The Battle Over the Future of Shale Gas Exports
Pierre is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Nothing like a good old fight between major corporations.
Remember Mitt Romney's famous words during the last presidential campaign? "Corporations are people too, my friend." Well, rest assured I'm not here to discuss the degree of humanity of corporations. But maybe Romney was on to something: Corporations do sometimes embody the zeitgeist of their time and place. What could at first be dismissed by some as nothing more than a petty clash between corporations over conflicting business interests might, in fact, be hiding a much deeper issue beneath the surface. The issue at stake could even be the future of the United States.
Ok, after this John Le Carré intro, let me rewind for a second and introduce you to the fighters. Picture in your head a boxing ring. In the right-hand corner, Dow Chemical (NYSE: DOW). Three weeks ago, Dow pulled out of a limited partnership with Freeport LNG, a Texas export terminal that is asking for federal permission to cool shale gas into Liquefied Natural Gas (LNG,) so that it could transport it overseas and sell it in foreign markets. Dow is vehemently opposed to the project because it believes that LNG exports will lead to lower natural gas supply at home, therefore higher prices, which in turn would compromise its future construction of domestic chemical plants and hurt its bottom line.
In the other corner, the Mike Tyson of all corporations, the heavyweight champion of the S&P 500, the one and only ExxonMobil (NYSE: XOM). What does Exxon want? In plain English, it wants unlimited U.S. natural gas exports. The Texas-based multinational insists that exporting shale gas to overseas markets will create so much profit for American companies that it will outweigh all of the negatives of a potential price increase at home. Exxon's views on the matter are now backed by the Department of Energy, which published a report in December that concluded that LNG exports would offset the costs from higher domestic energy prices, and benefit the US economy overall.
What is at stake for America?
Dow's financial position has been in a bit of a jam lately. Profit margins have declined. Its EPS is now 75% lower than 2008 levels, and the stock price has gone nowhere since early 2010. The company was in the process of restructuring and moving its business to Asia on a massive scale in order to improve its bottom line, but then the horizontal hydrofracking, or fracking, revolution came as fresh summer rain to the chemical giant. Greater natural gas supply means cheaper energy and lower production costs. Dow sees its future in using the shale gas boom to boost domestic projects, not for exports that would raise domestic natural gas prices. Thus, the company is very much in sync with a majority of Americans, who also believe that the main use of the shale gas boom should be to provide the U.S. with inexpensive energy that would be a catalyst to a job-creating manufacturing revival at home.
Fair enough, but let's listen to what Exxon has to say.
Its position is based on pragmatism and free markets theory. It goes like this: the shale gas revolution was so sudden, and increased inventories at such a high speed, that natural gas prices collapsed, losing over 85% of their value between 2008 and 2012. The Henry Hub spot price bottomed around $1.80 per million BTU in May 2012, the lowest price in its recorded history in inflation adjusted dollars- though it is now back to $3.40 per million BTU. But after the boom comes the bust, and while America was rejoicing in shale gas heaven, nobody paused to notice a major flaw: How could these prices last forever when those who were putting all the money, and taking all the risks to make it possible -the investors- were also the ones who would be the least benefited by low gas prices caused by this overcapacity?
I believe this is the point that Exxon is trying to raise. Natural gas prices fell so much, that the whole situation became a boon for consumers such as Dow, but a bane for gas companies. It's continued throughout 2012.
Do American shale gas exports have a future?
Unlike crude oil, the natural gas market is not globalized. Natural gas is an extremely difficult and pricey commodity to export. This explains why natural gas prices have plummeted in the US, while in Europe it sells for $10; in Japan for $17; and across Asia for up to $20. Shale gas resources elsewhere in the world have not yet been developed to the same extent as in the US, thereby creating a sustainable arbitrage opportunity for major American energy corporations such as Exxon and Chevron (NYSE: CVX).
The indicative sign of the increasing interest in American shale gas exports is the recent active project sponsorship by major oil companies through equity ownership. I've already mentioned Exxon Mobil's position on the issue and what profits it could draw from LNG exports. Chevron is also going down the same path. As a company, it is cash rich, boasting as much as $21 billion in cash and equivalents. It is therefore likely to use some of its cash for productive asset acquisitions, in line with its recent purchase of 246,000 net acres in the Delaware Basin in New Mexico from Chesapeake Energy.
Last December, Chevron also joined Kitimat LNG project on Canada's West Coast in a joint venture with Apache to operate the LNG plant and the associated pipeline. The significant purchase price (officially undisclosed but most experts place it at around $1.4 billion) for a 50% interest in the project indicates that the operation has a very good chance of moving forward. Kitimat LNG has already received all significant environmental approvals, and a 20-year export license from the Canadian federal government. Early site work is under way, and the 290-mile Pacific Trail Pipeline will provide a direct connection to Spectra Energy's transmission pipeline system.
For now, only American exploration and production (E&P) companies possess enough capital and technological know-how to develop shale gas on a massive scale. Every foreign government that is serious about expanding its local shale gas industry will have to ask American energy multinational corporations such as Exxon and Chevron to get involved at some stage. This is why these companies are trying to get a head start in the global shale gas race and benefit from this arbitrage opportunity while they can.
But a good business always attracts competition. China's shale gas reserves are the largest in the world, and it's just a matter of time before they figure out fracking for themselves. If the Chinese pull it off, most LNG exports in Asia will be shipped from China and then from Australia. Pitted against these forces, natural gas prices will fall worldwide, and US shale exports will become uneconomical. This won't greatly affect American energy corporations either way, because they operate on a global scale. But when gas prices go south again, it will be a good moment to be bullish on chemical companies like Dow, because cheaper natural gas prices will allow them to substantially reduce their operating expenses and improve their profit margins.
PierreDV has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of Apache and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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!