Is it Time to Invest in Liquefied Natural Gas?

During 2013 (up-to-date), shares of Cheniere Energy (NYSEMKT: LNG), among the few future U.S liquefied natural gas exporters, jumped by almost 119%. Despite the sharp rise in the company’s stock, it has yet to turn an operating profit in past quarters. Most of the company’s valuation is based on future expectations for growth in revenues from exporting LNG. But will exporting liquefied natural gas become such a lucrative business in the near future? Here are four reasons why exporting LNG might not result in a positive return on investment.

1. The natural gas market is cooling down

The prices of natural gas have remained low in the past couple of years compared with previous years. This trend may continue in the coming years as shale gas becomes more available. The low natural gas price is likely, in turn, to pressure down the price of LNG. This downward trend may also reduce the profit margins of Cheniere Energy and other U.S LNG exporters.

2. Competition to export in the U.S rising

Cheniere Energy was the first company to receive a license from US Department of Energy back in 2011. The company was the only one with such a license, because the DOE hasn’t approved any additional licenses during 2011 and 2012. Since May of  2013, the DOE has started to approve additional LNG projects to other companies: The DOE has  recently approved Venture Global LNG to export 670,000 Mcf/d of gas from its terminal in Louisiana.

Therefore, the higher number of LNG exporters is likely to increase the competition, which, in turn may adversely affect the revenues and profit margin of Cheniere Energy.

The main problem is the uncertainty around the future LNG market, which could result in a different valuation than the market currently expects. This brings to the third problem, the competition outside the U.S.

3. Competition from aboard is also rising

The main disadvantage U.S exports have is the high distance to the main imports of LNG such as China and Japan. The widening[l3]  of the Panama Canal will help get through it bigger LNG tankers, which will cut down the transport costs. But LNG projects around the world continue to develop and increase the competition. The U.S faces strong competition from Australia that is likely to export to the Asia-Pacific region. Among the companies that have increased their LNG operations in Australia are Chevron (NYSE: CVX) and ConocoPhillips.

Chevron has a joint venture with Apache Energy and several other companies to produce and sell LNG from the Wheatstone Project located in Western Australia. This venture will supply from its two LNG trains a combined 8.9 million tonnes per year. Chevron has recently signed an agreement to sell 0.9 million tonnes of LNG per year for 20 years to Tohoku Electric Power.

ConocoPhillips  (NYSE:COP) has been in the LNG business since 1969. The company continues to expand its operations including in Australia. It is part of a joint venture in the Australia Pacific LNG, which is expected to start in 2015 and to sell 4.3 million tonnes per year.

Australia isn’t the only up and rising LNG exporter. Israel’s LNG is also expected to rise in the coming years. Off the shores of Israel huge caches of natural gas were found in the past couple of years and are expected to start exporting to Asia. One company that is part of the exploration partnership in Noble Energy The Company has 20% in the biggest natural gas cache. The current expectations are that Israel will export natural gas to India.

Other big players include Qatar and Malaysia that were leading the way in LNG exports in recent years.

Besides the growing competition in the LNG market, the main problem LNG investors faces is long wait they will have to wait until the export business will kick off.

4. High investment costs with long return period

The high capital expenditure of Cheniere Energy has increased its financial risk – its debt-to-equity ratio rose to 19 as of the third quarter. The company  continues to finance its projects by issuing loans: It has recently announced a $1 billion Senior Secured Notes due by 2022 for its Sabine Pass Liquefaction project. Furthermore, Cheniere Energy expects to start exporting LNG from train 1 of its Sabine Pass Liquefaction project by 2015. The combination between high debt and long return period puts the company at risk. The high risk might not payoff considering the factors listed above. Therefore, I remain dubious about investing in a company such as Cheniere Energy.

Take away

The liquefied natural gas market is likely to become the next big thing in the energy market but it might also suffer from low profit margins on account of high competition. Therefore, I remain skeptic about the high valuation of Cheniere Energy and the potential return on investment in LNG.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.