When natural gas is cooled to minus 260 degrees Fahrenheit at a liquefaction facility, the fuel condenses to roughly 1/600th of its original volume, facilitating overseas transport in specially designed ships.
Regasification terminals heat the liquefied natural gas (LNG) to restore the delivered volumes to a gaseous state before pipelines transmit the product to end users.
This network of LNG carriers and import and export terminals effectively releases natural gas from the geographical constraints of the pipeline network, enabling producers to deliver their output to overseas end markets.
In recent years, investors have become obsessed with the wide price differential between US and Asian natural-gas prices and the potential for meaningful LNG exports to provide a much-needed release valve for the oversupplied North American market.
However, the start-up of Exxon Mobil Corp (NYSE: XOM) and Oil Search’s (ASX: OSH, OTC: OISHY) LNG export project in Papua New Guinea, coupled with lower-than-expected Chinese demand growth and a mild winter in Northeast Asia, has led to a regional oversupply in the spot market.
Over the next two years, the start-up of other massive LNG export facilities in Australia and on the US Gulf Coast will exacerbate this emergent oversupply, intensifying competition among suppliers and redirect flexible volumes from Qatar and other producers back to Europe, the market of last resort.
At the same time, most long-term LNG supply contracts with Asian buyers allow for regular price resets based on movements in the Japanese crude cocktail, or the monthly average price of a basket of imported crude oils.
Second-quarter results for LNG buyers and sellers that operate primarily in the Asia-Pacific region should reflect the full effect of the severe downdraft in crude-oil prices; the price reset mechanism included in these oil-indexed supply agreements usually occurs on a three- to six-month lag.
With the global LNG market shifting into an oversupply after a period of tightness, we’ve updated our macro outlook for this niche business and revisited opportunities on the supply side to identify the best bets for investors seeking exposure to this theme.
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Elliott and Roger on Jul. 28, 2015
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