Key points
- As Australian gas projects worth more than $180 billion move into production in the next three years, supply fears are rising.
- Positioning portfolios to capitalise on the move towards a lower-emission world and higher demand for LNG and renewable energy makes sense in the long-term.
- On balance, try taking a global rather than local-only approach to energy investments, focusing that exposure on LNG and renewable sources, using professional managers, and waiting for better value.
Few sectors have such contrasting short- and long-term fortunes as liquefied natural gas (LNG).
As Australian gas projects worth more than $180 billion move into production in the next three years, fears are rising of sharply lower LNG prices and falling share prices of LNG suppliers. The bears say LNG will follow iron ore and coal lower as supply spikes and demand eases.
The supply problem
New LNG supply cannot be easily turned off. Giant gas projects cost tens of billions of dollars and take years to build. Lower LNG prices will hurt incremental or new gas projects, but those committed to years ago, close to production, and benefiting from long-term contracts at higher prices, have to push ahead.
On any measure, the new LNG supply wave, led by Australian producers, is massive. The Queensland Curtis LNG project, which shipped first cargo in January, and the Australia Pacific LNG and Gladstone LNG projects, due in 2015, add 25 million tonnes of annual production capacity, according to the Australian Petroleum Production & Exploration Association (APPEA).
The Wheatstone and Gorgon projects, and the Browse floating LNG project (if it goes ahead as scheduled) add another 27.4 million tonnes in the next few years, according to APPEA. For perspective, BG Group estimates LNG deliveries in 2014 were 243 tonnes. Clearly, the new projects will add huge supply to the global LNG market in the next few years.
Gas prices have fallen sharply in the last few years. The Henry Hub Natural Gas spot price of US$2.61 per million of British Thermal Units (Btu) in late May compares with US$12.69 in mid-2008. Spot and future gas prices are seen as the primary price setter for the US LNG market.
I am not as convinced as some commentators about a lasting supply glut in LNG. Fears of sustained LNG oversupply might underestimate new LNG projects in the US states being shelved as the lower oil price affects the boom in shale oil and its by-product, oil shale gas.
Moreover, as energy becomes more like a consumption item than a utility – users can change their energy mix faster than ever these days – any supply glut could be resolved sooner than expected as lower prices boost demand for LNG over other energy sources.
Longer-term case for LNG
Energy remains one of the great long-term investment themes. Positioning portfolios to capitalise on the move towards a lower-emission world and higher demand for LNG and renewable energy makes sense.
An extra 3.1 billion middle-class consumers by 2030, two-thirds of whom will be Asian, on OECD projections, is a big long-term driver of demand for LNG.
Rising income will put a rocket under energy consumption in emerging markets. Then there is the rise of the Asian super-city. Nearly half of global economic growth between 2010 and 2025 will come from 440 cities in emerging markets, predicts a new book, No Ordinary Disruption. These new cities will need a much stronger focus on LNG and renewable energy to avoid the entrenched pollution problems in many Asian mega-cities such as Beijing.
As the market focuses on long-term Asian LNG consumption, the US could drive higher demand, not only supply. The US Supreme Court is reviewing a challenge to the US Environment Protection Agency’s Mercury and Air Toxics Standards (MATS). A decision on this case, two decades in the making, is expected after June.
Whatever the outcome, the Obama administration is quickening the move towards a lower emission environment in the US. The move worldwide to lower emissions is good for cleaner energy sources such as LNG and bad for traditional fossil fuels such as coal.
The push to reduce global energy poverty is another demand driver for LNG. About 1.3 billion people, mostly in sub-Saharan Africa or developing Asia, cannot access electricity and 2.6 billion are without clean-cooking facilities, International Energy Agency (IEA) data shows.
Renewable energy sources such as solar power are expected to play a bigger role in bringing power, better living standards and economic possibilities to billions of poor people. LNG, too, should benefit as emerging countries increase demand for cleaner energy.
Taken together, these trends suggest more uncertainty in the short term for LNG and a solid long-term outlook. The likely opportunity is buying energy stocks when sentiment deteriorates even further this year as the market grapples with unpresented new energy supply from Australia.
How to pounce
The starting point is to look overseas for energy stocks. There is a long tail of mid-cap and small-cap companies, mostly explorers, once beyond Woodside Petroleum, Santos, Origin Energy and Oil Search. This can result in investors paying a “scarcity premium” for Australian energy stocks compared with offshore markets that have bigger oil and gas sectors.
The same is true of renewable energy. Australian-listed renewable-energy companies are mostly too small and speculative for conservative investors. Much larger, profitable renewable-energy companies can be found in offshore markets such as the Nasdaq Composite Exchange.
When choosing stocks, consider offshore energy companies that provide a mix of energy exposures: Royal Dutch Shell, BP Plc and ExxonMobil, for example.
Also, focus on companies that have volume rather than price risk: the large established producers that will benefit as LNG production volumes rise and, compared with explorers, are far less reliant on short-term energy prices.
Another strategy is buying companies that benefit from LNG logistics: for example, providers of gas pipelines or LNG ships. Shell, for example, is among the world’s largest LNG shipping operators. In Australia, APA Group is the largest owner of natural-gas infrastructure, but looks fully valued at its current valuation.
Consider investing through managed funds and use the services of professional managers, given the complexities of global energy investing. The award-winning Australian Ethical International Equities Trust has a strong bias towards renewable-energy companies and positions in Nasdaq-listed solar-equipment providers First Solar Inc, SunPower Corporation and JA Sola, and three of the world’s largest wind-turbine makers: Danish company Vestas, Spanish provider Gamesa, and Germany’s Nordex.
The Pengana Global Resources Fund is overweight the global energy sector, with about 31% held in oil and gas companies at April 2015 — more than double its exposure to the precious or bulk metal sectors.
On balance, taking a global rather than local-only approach to energy investments, focusing that exposure on LNG and renewable sources, using professional managers, and waiting for better value as the market grapples with abundant new supply seems a prudent strategy for long-term investors.
Prospective investors need at least a 3 to 5-year horizon as the LNG supply/demand dynamic will take time to play out and it could be several years before significantly higher prices accompanying higher production volumes. Energy will be a great investment for investors with a multi-year or multi-decade focus and LNG will continue to lift its share of the global energy mix. But it is too soon to buy.
– Tony Featherstone is a former managing editor of BRW and Shares magazines.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.