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Playing Devil's Advocate with Golar LNG ?3
09:16 30-Oct-18
Preface
Although almost all of my liquid investments are still in individual stocks and their derivatives, my return on capital didn't really take off until I put a significant portion of my analytical effort into macro analysis - factors that are non-specific to a specific company. Over the last decade as a full-time investor, this focus has proven to be of tremendous value both for identifying new opportunities and risks that would otherwise go unnoticed. Golar LNG is one of the many stocks I cover in my long service as part of my belief that the the reshaping of energy markets presents perhaps the greatest investing opportunity of this generation. Although I am bullish on GLNG for the near-term, this article will focus on why I think the market may be under-appreciating the long-term risk it embodies. Furthermore, I will assume that readers are already familiar with bull case, though one update distributed via my service earlier today may be worthwhile:
As I see it, risks associated with Golar LNG fall into 4 main categories: Geopolitical, Shipping, LNG-specific, and Stock Market.Two pieces of news this morning make it look increasingly likely that Golar will get the go-ahead on the Tortue project. The first is BP's earnings call, where we heard the following at 19 and 22 minutes into the Q & A, respectively:
in terms of LNG and FIDs, I wonder if you could give an update on Tortue LNG. What's still missing? Will BP be the sole off-taker has the development plan be approved and what when exactly do expect to take FID?
In terms of the Tortue project, the project entered its feed in April 2018. And we're still targeting FID by the end of '18 and first gas in 2022. The project was targeting first phase of about 2.5 million tonnes per annum. And then we've got a further 2 phase to test it up to a further 10 million tonnes per annum. We've got nothing left to update on that. We still expect FID this year. And I'm sure Bernard will have some more to talk about that in December at the Investor Day in Oman.Furthermore, a Chinese firm has just confirmed a contract for a platform at the site. This makes it seem quite likely that the Final Investment Decision from BP will go Golar's way.
Geopolitical
Geopolitical risk is highlighted by the fact that the field developer, Perenco, still has not made a decision to start operation of additional trains despite mounting demand for natural gas. This is almost certainly related to finances, politics and infrastructure in Cameroon, whose credit history was stable and gradually improving until a recent downgrade in outlook from Moody's. If we were to (somewhat improperly) translate that to a risk of corporate default, it would nominally equate to over 30%. While I think that overstates the risk, it does have relevance as a quantified measure that might impress would-be investors, and get them to remember retroactive tax troubles that Vodafone has faced in India, or the summary cancellation of AES business in Bulgaria. Golar's incarnations would be much less able to withstand such events than either of these companies.
Similarly, the Tortue project referenced above relies on agreement between Mauritania and Senegal. Plans for the completion and commencement of operations of the Sergipe power plant, in Brazil, will have to survive the electoral upheaval that has just taken place there. While I have no particular reason to believe that either of these projects will not proceed, the fact remains that developing in such environments represents a significantly elevated level of risk.
Shipping
When it comes to energy my outlook for the long-term is guided by estimations on ERoEI. Though the concept it simple, its implementation is complex and unstandardized. Normally such effects would translate directly into pricing, but by contrast to Europe, and increasingly, much of the rest of the developing world, the Americas have long avoided pricing pollution appropriately. This has lead to a fragmented global natural gas market, which LNG seeks to overcome. The recent result is a frothy and reactionary shipping market. Much of the bull case relies on extrapolating current pricing, even though the length of that dynamic is debatable as new ship supply and fuel issues are set to intensify in 2020.
Over the long-term, though studies by the University of Texas at Austin put natural gas as the cheapest form of generation, with simple turbine generation coming in at $820/kW, and combined cycle at $1020, that cost more than doubles to $2080 when adding carbon capture capabilities. By comparison, utility solar is always competitive at $1100 and wind not so far behind at $1520. No other solutions even come close. In America, this gives natural gas a potentially bright future, depending on local and federal policy, but that won't help Golar. Asia is more likely to take a holistic approach, especially if Trump's solar tariffs continue to dampen external panel demand. Schlumberger's most recent report also indicates potential for Asian development. Even to the extent that external sources are used, Russia and Australia would be the logically preferred sources.
They
will be followed
by Canada, where
Shell recently approved
the LNG Canada
project. The
facility will be
Canada's largest
infrastructure
investment in
recent memory
and use a
modular LNG
train design
with proven
technology built
in Asian yards
which have
recent
experience
delivering LNG
modules on
budget and on
schedule. The
cost to deliver
LNG into Asia is
expected to be
structurally
advantaged
compared to a
greenfield
development on
the US Gulf
coast. My guess
is that applies
to the west
coast of Africa
as well.
Construction
should begin
immediately, but
that still means
initial LNG
shipments won't
start until the
middle of the
next decade.
Developments
like this are
being driven by
a global push to
reduce
pollution. Only
America is purposefully
going in the opposite
direction. In
Europe, the IEA
predicts
wind will become
the dominant
energy source by
2027. Estimates
on the energy
used to liquefy
natural gas come
in around 25% of
the energy being
harvested. That
means that even
in Europe and
Africa pipelines
seem likely
remain the
preferred modus
operandi, with
LNG remaining a
niche market
that will mostly
be relegated to
spot balancing
of supply.
To its credit, management has said that its priorities are first
FLNG, then FSRU, and only then shipping. My
best-case hope
is that the GMLP
Partnership will
follow those
same priorities
by monetizing
much of the
fleet through
asset sales.
Long-term
contracts would
be second-best,
but they would
not be long
enough to fully
sustain Golar
LNG's
multi-decade
development
plans and
expenditures.
In this way,
GMLP may turn
out to be a
better
investment than
GLNG through a
flattening of
the equity
structure just
as happened with
my coverage of
CQH.
LNG-specific
Another risk is natural gas' ties to oil production. The ERoEI
on natural gas is even more poorly established
than the figures for other sources because of these ties. It is
generally placed in the 5-7 to 1 range, whereas oil is more like
20:1, though both are declining as easy sources are sucked dry.
This creates something of a Catch 22 for natural gas, and LNG in
particular.
On one hand, oil will remain a major
part of the global economy until widespread alternatives to
plastics and other petrochemicals and its supply will reduce the
demand for alternatives. Even the recent U.N. report may underestimate
how much that needs to change, but to the extent that fossil fuels
become even more out
of favor, natural gas will see lack of demand. If the shift
is one-sided against oil, natural gas production would still
become more expensive. While this doesn't impact Golar's current
projects it does have relevance to its power generation and
upstream aspirations.
Let's say I'm wrong, though, and LNG does become a dominant
source of global supply. The more widespread its use, the greater
the risk of incidents
of either terrorist or accidental origin. Although most
comparisons of LNG tanks to atomic bombs are inappropriate,
there is no getting around the fact the amount of energy in
question is immense and does have catastrophic potential. A major
disaster is a possibility that increases over time and with
broader use, and the effects would be likely to ripple through the
entire industry.
Stock Market
That would be reflected in the market most of all, and particularly in Golar stocks. Both are thinly traded, with GMLP managing less than a half million shares per day, and GLNG doing well under 2M. The usual warnings about volatility and reasonable position sizes definitely apply. A relevant factor is that Golar's contract brings in $3M per year, recognized monthly, for every dollar that Brent is above $60, up to a cap of $102 per barrel, but the recent rally in oil has been fizzling faster than many expected. The contract is smart, but quarterly comparisons may prove challenging and produce dramatic volatility in an equity with very limited volume.
Furthermore, Golar's development plans are long-term and very
capital intensive at a time when rates are rising, making funding
progressively more difficult. Despite this Golar LNG has just invested
$24.75M in Avenir LNG Ltd., which is a startup focusing on
delivery and storage to pockets of stranded demand. The
investment is part of a larger $182M initial funding round and
Avenir "contemplates a public listing on the Oslo Over-The-Counter
market during 2018." Mention of the OTC market listing alone is
enough to make me cringe, and the nicest thing I can say about
this is that Golar has always been aggressive in its development,
and that it is in a market
where that may be appropriate, though the timing less so. In an
economic downturn, not only will energy demand decline, but the
companies that I've covered which have access to much better funding
and can grow
more reliably will be more in favor.