As the U.S. continues to grapple with an overabundance of natural gas and ultra-low domestic demand, the question remains about what to do with all that excess supply. One option that’s getting more support is exporting the fuel.
A variety of emerging market nations, especially in Asia, have turned to natural gas as a cheap way to power their economic growth. Global consumption of LNG is set to rise around 5% this year, and gas prices have fallen about 30% since the end of 2008, while both coal and oil have risen. However, unlike the U.S., these nations aren’t blessed with domestic sources of supply. The ideal solution for U.S. producers would be to open exports to these nations.
In “How to Play the Potential of LNG Exports,” I wrote about the first step in getting this gas to Asia. Natural gas needs to be cooled under pressure at minus-260 degrees and converted to a liquid in order to be transported overseas. These so-called liquefaction terminals and export facilities are vital steps in the process.
Private equity firm Blackstone’s (NYSE:BX) recent $2 billion investment to help Cheniere Energy Partners (NYSE:CQP) develop its Sabine Pass liquefaction project in Louisiana helps underscore the potential growth in natural gas exports.
However, these export terminals aren’t the only way to profit from LNG. Companies that physically ship the compressed gas overseas could be equally, if not more, rewarding for investors.
Surging Day Rates and a Dwindling Vessel Glut
Day rates for LNG tankers have been steadily rising over the last three years as a decade-long glut of vessels has begun to disappear. The cost to rent a LNG tanker for a day rose to $97,630 during 2011, up from $43,663 in 2010. However, as high-growth economies like China continue to demand more natural gas, some analysts expect future day rates to eclipse these amounts. A recent survey conducted by Bloomberg shows that median analyst estimates for LNG day rates will average $147,000 in 2012.
Those rates are certainly possible as the supply of LNG ships continues to be weak in the face of high demand. Currently, the global LNG tanker fleet totals only 347 vessels. Two new ships scheduled to be delivered in 2012, but that still won’t be enough.
Demand for LNG tanker services is expected to rise about 12% throughout the year. To meet that demand, analysts predict that carriers actually need to add around 5.5 million cubic feet of capacity. That’s essentially equal to 25% of the U.K.’s daily winter usage.
Given the strong uptrend in LNG demand (China alone will imports 42% more LNG this year), the tanker fleet will need to grow by an additional 100 ships by 2020. Given that an LNG tanker costs around $210 million to build, that’s a tall order.
Several vessels are currently in construction and set for delivery between 2013 and 2014, but these ships still won’t alleviate any near-term increases in day-rate pricing. That’s why tanker companies could be the best way for investors to profit from LNG’s current growth trajectories: The lack of shipping capacity will act as a leveraged play on exports. Morgan Stanley (NYSE:MS) highlights that this environment will be “an opportunity for a lot of LNG ship owners to generate premium returns.”
In addition, shares of the LNG tanker firms are relatively cheap due to guilt by association. As day rates for oil tankers and bulk dry ships have been falling due to overcapacity issues, many LNG shippers have felt the burn as well. The broad-based Guggenheim Shipping ETF (NYSE:SEA), which tracks a variety of subsectors of the global shipping industry, sits well below its 52-week high. However, the growth projections for LNG, coupled with the lack of capacity, makes these firms a value among the sector.
Charting a Course
Given the profit potential in LNG tanker stocks, investors may want to add some exposure through a few broad-based shipping companies. For example, Overseas Shipholding (NYSE:OSG) has a 49.9% interest in four LNG carriers.
However, to get the maximum benefit, investors may want to bet on Golar LNG (NASDAQ:GLNG). The firm, which operates nine LNG tankers and is controlled by the Warren Buffet of shipping — John Fredriksen — recently saw its fourth-quarter net income surge to $17.2 million. This is up from $4.71 million a year earlier. Now, though, analysts expect Golar’s net income to jump to $195 million for 2012. Analysts also expect shares of this LNG shipper to rise about 7.5% throughout the year.
There’s plenty of reasons to be bullish on Golar. The shipper expects to see continued improving earnings until 2017 as the global supply of available vessels remains tight. In addition, Fredriksen cites long-term strength in emerging-market LNG growth to support Golar’s decision to invest nearly $400 million on two new LNG carriers. This bullish outlook and strong earnings has helped Golar reaffirm its 2.9% dividend, while many other shippers have been cutting payouts.
While shares of Golar aren’t as cheap as rival Teekay LNG Partners (NYSE:TGP), on a forward P/E basis, Golar’s excellent growth profile makes it worthwhile choice to play the LNG export market.