Conventional wisdom says that liquefied natural gas (LNG) is a “can’t lose” proposition.
After all, natural gas is plentiful. And liquefying it for transport – to countries that are willing to pay through the nose for it – seems like a no-brainer.
Everyone wants in on the game, too.
When I spoke about natural gas at a conference in Vancouver recently, those at the event showed a level of interest in LNG that bordered on obsession.
[ad#Google Adsense 336×280-IA]If you’ve been following the story as closely as I have, however, you know that LNG’s prospects aren’t nearly as rosy as everyone thinks. Here’s why.
The Tightrope Walk of Doom
During the most recent winter season in Asia, LNG prices topped $20 per million British thermal units (mmbtu), causing suppliers to salivate at the prospects for the rest of the year.
Fast forward to today, though, and prices have sunk to $10 per mmbtu.
That’s a 50% haircut, thanks to slack demand during the summer and new facilities coming on line.
Now traders are parking LNG on tankers, sitting idle at ports in the hope of a rebound in prices.
What U.S. investors are failing to realize is that LNG is already up and running in the rest of the world – and pricing trends are pointing lower over time, not higher.
Granted, weather events can boost prices. As evidenced by the 50% drop in prices during the summer season, however, weather can send LNG prices crashing just as easily.
Making matters worse, the trend is towards more LNG production in the coming years, not less. Exxon Mobil (XOM), for instance, just started up a new LNG facility in Papua, New Guinea – which will further add to supply.
And if one weather event can cause a near 50% drop in prices, an oversupply situation could seriously dent profits in the future.
Especially with LNG’s major buyers beginning to bow out…
Will Prices Take Another Hit?
South Korea and Japan are two major Asian buyers of LNG. Yet their LNG addiction is waning…
Consider, South Korea stockpiled LNG while its nuclear plants were offline as a result of a safety scandal. The country has since restarted the nuclear plants, though, which reduces demand for LNG.
Japan has been the primary driver of the demand for LNG since the Fukushima disaster shut down its nuclear facilities. Yet it has also brought many reactors back on line, and a cooler-than-expected summer has led to less demand, as well.
As a result, many LNG traders are being hit with losses.
LNG contracts are usually at fixed prices for the majority of supply, about 80% in most cases. But the remaining 20% is bought and sold by these countries on the spot market – and that’s what determines day-to-day prices for traders and those wishing to buy on the open market.
It’s the spot market that should really worry investors in LNG companies.
The thinking that LNG is somehow less vulnerable to price shocks than any other commodity is misplaced, and uncertainty will be part and parcel of this “new” market, as well.
Now, much like the dry natural gas sector, there will be little in the way of supply shortages as many new facilities come on line in the next few years.
So the key will be to focus on producers, which are able to lock up long-term supply contracts at higher prices.
For now, companies that have already secured (and are delivering) the product, some of which was locked in at higher prices from last year, are in the driver’s seat. British Petroleum (BP) is one such company.
Bottom line: The future issues may not lie on the supply side for LNG, which is where most of the attention is focused, but on the demand side. That may have been overstated, and the recent price move is a good indication that this business is far from a slam dunk.
And “the chase” continues,
Karim Rahemtulla
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Source: Wall Street Daily