One of the hottest topics of 2022 is liquefied natural gas - better known by its abbreviation "LNG". The war in Ukraine, which resulted in Putin cutting off natural gas exports to Europe, the general supply issues of fossil fuels, and Asia's hunger for cleaner energy sources make LNG one of the best places to be. The IEA just came out explaining why we should expect much higher LNG demand in Europe. Meanwhile, China is selling its excess LNG supply at sky-high prices to Europeans waiting for American LNG.
In this article, we're going to discuss this topic in greater detail, as well as three companies that I believe offer great opportunities to invest in natural gas/LNG. All of them operate at different stages of the PNG supply chain. In other words, I will give you something for a longer-term portfolio as well as investments you can trade more actively if that's what you're into.
But first, let's look at the bigger picture.
On a side note, if you want a complete breakdown of why Europe is in the mess it is now, I wrote a detailed article incorporating macro and geopolitical aspects in August, which I recommend readers take a look at. I cannot cover all of it in this article, as it would get way too long.
What we're dealing with is a fantastic bull case for United States natural gas producers and exporters. The United States is the world's largest producer, producing almost more than Russia and Iran combined.
LNG is liquefied natural gas. In order to export natural gas, the United States needs to liquefy it as it cannot use pipelines when exporting gas to Europe, Asia, and Africa.
Hence, on top of accelerating natural gas production thanks to the shale revolution, the US needed export facilities where natural gas can be turned into LNG and loaded onto ships.
In the past few years, investments in this area have accelerated, boosting the country's LNG export capacity from almost zero to almost 12 billion cubic feet per day. That was prior to the fire at Freeport LNG.
Even if we ignore geopolitical issues, for now, LNG has a huge long-term bull case. LNG (natural gas) is a fossil fuel, but it's one of the cleanest, most reliable, and most affordable (under normal circumstances) energy sources in the world. Especially Asia will be a huge buyer in the future as countries like China try to move away from coal. In 2040, roughly 70% of demand is expected to come from Asia.
The problem is that demand will outgrow supply by a mile as the somewhat abstract outlook from Shell on the right side of the overview below shows.
Based on this context, Europe needs to compete with Asia for valuable LNG. This competition just got worse as Putin reduced natural gas flows to Europe, making the continent rely on its inventories and whatever it can get from its remaining suppliers. On a side note, the situation is now even worse than the chart below suggests as Nord Stream 1 gas flows are zero due to the sabotage of the pipelines.
What we are now seeing is that Europe was not prepared for Russia's move. Europe was asleep at the wheel as it became dependent on Russia, neglecting diversification. Hence, it doesn't even have the infrastructure to receive LNG imports - even if the US and others had the needed capacity to export.
According to Bloomberg (note that FSRUs are infrastructure to turn LNG into natural gas):
But demand for the terminals is so intense in Europe that it could make it less affordable for emerging nations to use FSRUs for their own needs. "The risk is real that underutilized facilities in other regions of the world could be relocated to Europe, existing charter terms permitting," Ramesh said.
"Both FSRUs and LNG are in high demand," Fearnly's Fett said. "Europe is sourcing FSRUs and trying to secure cargoes, while other countries are finding it expensive. It is a combination of high LNG prices and a struggle to find infrastructure."
As a result, Europe is now cutting its gas usage to prepare for what could be a very dark winter (literally).
The IEA estimates that inventories could fall below 5% in February if Russia continues to refrain from exporting natural gas.
Hence, Europe's hunger for LNG is only growing faster. This is how bad it could become, according to the IEA:
Despite anemic demand, Europe's search for alternative sources heightens global competition for liquefied natural gas. The IEA forecasts Europe's LNG imports will increase by over 60 billion cubic meters this year, or more than double the amount of global LNG export capacity additions.
"The outlook for gas markets remain clouded, not least because of Russia's reckless and unpredictable conduct," said Sadamori. "But all the signs point to markets remaining very tight well into 2023."
Adding to that, because of economic woes and high commodity prices (i.e., LNG prices), China is shifting to coal. As a result, China is now selling excess LNG to Europe as it benefits from lower LNG demand and higher imports from Russia.
As reported by the Wall Street Journal:
The economic slowdown in China, a Trump-era trade deal and Europe's desperate hunt for natural gas are creating a windfall for some Chinese energy companies. The unusual alignment is helping Europe stock up for the winter.
With demand down, Chinese companies that signed long-term contracts to buy U.S. liquefied natural gas are selling the excess and making hundreds of millions of dollars per cargo. Buyers include Europe, Japan and South Korea. Just 19 LNG vessels from the U.S. docked in China in the first eight months of the year, compared with 133 for the same period last year.
In other words, Europe is now buying overpriced LNG from China as it sanctions Russian imports. I'm not making the point that Europe shouldn't sanction Russia, but the situation has become a total cluster****.
The good news is that there are investments that benefit from the long-term LNG bull case. Note that these investments do not need Europe to suffer. Even *if* Russia restarts exports after the war, the long-term LNG bull case is high as supply won't be nearly enough to satisfy demand as we discussed.
So, here are three picks that I like.
It's no surprise that the company whose ticker is "LNG" is involved in the LNG sector. Houston-based Cheniere is an energy infrastructure company engaged in LNG-related businesses. The company provides LNG to integrated energy companies, utilities, and energy trading companies around the world.
As the complex overview below shows, the company owns some of the world's largest LNG terminals where natural gas is turned into LNG before it is shipped to customers overseas.
Since 2016, the company has provided 2,300 cargoes to 37 different nations. 11% of global LNG is produced by Cheniere in 2022. 70% of its cargo delivered in 2022 went to Europe.
The bull market has resulted in sky-high growth. In November of 2021, the company expected to do between $5.8 and $6.3 billion in adjusted EBITDA. The company now expects that number to be at least $9.8 billion. Distributable cash flow is expected to rise to at least $6.9 billion, which is 16.5% of the company's $41.8 billion market cap.
The company is trading at 7.2x 2023E EBITDA of $9.2 billion using its $41.8 billion market cap, $21.6 billion in expected net debt, and $2.4 billion in minority interest. I believe that is a very fair valuation, providing the company with at least 30% more upside. Also, note that the net debt load is quickly coming down as free cash flow is accelerating. The net leverage ratio is now expected to remain below 3.0x EBITDA, which is good news for financial stability.
It also helps that Cheniere is getting more important. At the end of last month, the news came out that Cheniere would add a third dock, making it the first exporter with three docks.
The company's Sabine Pass facility is poised to become the first US LNG terminal with three operational loading docks. Houston-based Cheniere already made a small piece of history earlier this month when three LNG tankers - Aristarchos, Castillo de Merida and Maria Energy - were docked side-by-side.
Although Sabine Pass's new berth is still in the commissioning phase and needs approval from federal regulators before it can go into commercial service, its equipment can be tested and load LNG cargoes that are then sold on the global spot market.
Unlike Cheniere, EQT doesn't produce LNG. It produces natural gas, selling it to companies that use it for various things including the production and export of LNG.
In this case, EQT isn't just another natural gas producer. With a market cap of $15.4 billion and more than 1,800 core net drilling locations, Pittsburgh, PA, located EQT is the nation's largest natural gas driller.
The company is so large that it would be the 12th-largest producer in the world if it were a country. EQT produces 6% of total US natural gas production through its Appalachian assets, resulting in 4.0 billion cubic feet per day.
As I wrote in August:
What's interesting is that the company sees a new "era" for natural gas - at least under current conditions. The chart below shows three different periods of natural gas prices. Pre-2008, natural gas prices were higher as companies hadn't accelerated shale production. That changed after the Great Financial Crisis. It was backed by a rapid expansion of infrastructure, allowing the gas supply to explode. The result was cheap gas for more than a decade. It's one of the reasons why inflation was subdued during these years as natural gas is one of the most important commodities in the world.
After 2020, growth was restrained, demand accelerated, and prices jumped.
It also helps that the company is becoming a cash cow as it has hedged just half of its 2023 production volumes. Its operations are breakeven at a gas price of just $2.30 Henry Hub.
[...] if NYMEX retraced to approximately $3 per MMBtu in 2023, we would still expect to generate approximately $1.6 billion of free cash flow next year or a 10% free cash flow yield. Conversely, if natural gas averaged $7 per MMBtu level, we would expect to generate almost $6 billion of free cash flow in 2023 or nearly a 40% free cash flow yield.
Hence, even if NYMEX prices remain at $7 on a long-term basis, the company can do $37 billion in cumulative free cash flow between 2022 and 2027, that's more than twice its current market cap.
Moreover, in August, I wrote that the company has a fair value of at least $60 per share. I am sticking to that target.
Based on these numbers, I would give the company a fair value of $60-$65 per share. The problem is getting there. I do not recommend trading this stock. Long-term investments make more sense given that we're dealing with a long-term bull case that will further develop in the years (and decades) ahead.
The third pick is a wild card and a great addition as it sheds light on another aspect of the LNG thesis.
This company manufactures and operates marine infrastructure for the liquefaction and re-gasification of LNG. So-called floating natural gas liquefying systems ("FLNG") and floating storage re-gasification units ("FSRU") are crucial as they make LNG exports possible.
FLNGs are positioned close to production areas, making it possible to use seawater for the liquefaction process. This also reduces the need for pipelines, speeding up the process to produce LNG.
FSRUs can be used to allow nations without the proper infrastructure to receive LNG shipments. Right now, that's a huge issue in Europe - mainly in Germany.
Golar operates one FLNG ship called Hilli, with a capacity of 2.4 million metric tons per year. According to Seeking Alpha author Ricardo Fernandez:
The Hilli is based in Cameroon under contract to Perenco and SNH (national oil firm). The contract has a US$67m base lease plus variable payments based on the price of TTF and Brent as well as production levels. This unit earns US$3.1m for every dollar Brent is over US$60 and US$3.5m for every dollar TTF is over US$1.6mmBTU on an annual basis according to the 2Q22 results. Golar keeps about 87% of the EBITDA as each train has varying ownership stakes.
Next year, the company is expected to add another FLNG unit with a 20-year contract with BP (BP).
The company also owns a stake in New Fortress Energy and the Cool Company, which adds hydrogen and LNG shipping to the company's income stream.
Golar LNG is currently trading at 9.2x 2023E EBITDA of $410 million, based on a $3.8 billion enterprise value - $2.8 billion of this is the market value of its equity.
This valuation is fair, and I believe the company has room to grow to at least $50 over the next 1-2 years.
LNG and natural gas are two of the hottest (and related) topics this year. Normally, that's not a bullish thing as it's better to invest in sectors that are flying under the radar. However, the LNG bull case has legs. This year, LNG companies benefit from Europe's desperate need to get their hands on every drop of LNG available for export. Russia is using the leverage it has over Europe's economy, which temporarily benefits China.
It's also a problem that the US does not have the capacity yet to replace Russia as Europe's largest natural gas supplier. The addition of new terminals will take a few years, which benefits companies with existing export capabilities.
Moreover, on a long-term basis, the LNG bull case remains very strong. Asia is rapidly transitioning to natural gas as it lowers pollution while it still needs reliable energy. That's where natural gas is superior to any renewable energy source.
In this article, I discussed the fundamental bull case and presented three stocks in different areas of the LNG industry. Cheniere will benefit from high export demand for decades to come. I believe this company will turn into a high-yielding dividend stock as well. EQT is America's largest producer of natural gas with a low breakeven price and healthy balance sheet. Golar LNG benefits from missing global infrastructure and its ability to accelerate (regional) LNG production.
**On a side note, please let me know in the comment section if you like articles that cover more than one stock. If there's enough demand, we can build on this and add the top investments in each industry and work on different strategies.**
(Dis)agree? Let me know in the comments!
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.