Hi, welcome to the oil drum report, where I’m going to teach how energy markets work. I’ll be passing on the tricks of the trade I’ve learned from more than 15 years of investing in energy at two of the world’s largest banks.

The inaugural episode of the oil drum report is about what else, gas!

You might think I’m joking around, but gas markets really are tightly linked with oil markets in many parts of the world, especially in North America. To clarify, when I talk about gas, what I really mean is liquified natural gas, or “LNG” for short.

The reason I’m kicking off the oil drum with a focus on LNG is that I strongly believe LNG is the most important energy investing theme of the next 10 years. At the oil drum report, we love focusing on big trends that play out over years not months. Big trends reward deep analysis by serving you an investment opportunity you can set and forget as it pays off year after year.

LNG is that opportunity.

To get you up to speed, I’ll start by explaining what LNG is, then take a look at the global supply and demand situation and finish off with my preferred ways to invest in the LNG trend.

So What is LNG?

LNG is short for Liquified Natural Gas. LNG is an engineering breakthrough where natural gas is drilled out of underground wells and sent to big “fridges” that cool the gas down until it becomes a liquid.

Once the gas is turned into a liquid, it’s loaded onto big LNG shipping vessels to travel to the market that needs it most.

The picture below is an old-school LNG ship, you can tell by the round domes. Newer vessels are made of many individual membranes and look more traditional.

Besides the ship, the only hardware needed to consume LNG anywhere in the world is a regasification facility. This is where the very cold, very liquid LNG is heated up slowly and expands back into its gaseous state to be sent through pipelines or trucks to where it’s needed locally.

Recently, the industry is moving towards floating regassification ships (called FSRU’s) to save on up front costs and for greater flexibility.

LNG technology is a game-changer for the gas market. Prior to LNG’s invention, natural gas could only travel as far as your pipeline or pressurized truck would take you. This limited gas’s ability to move from one continent to another, while oil has been moved globally for decades.

The lack of transportation options drove the world to become a market of dozens of local gas hubs, all with their own pricing, supply and demand.

With LNG’s help, natural gas will finally become a global fuel source.

Explain globalization of gas to me like I’m five

At its core, turning gas into a commodity that can be moved all over the world means gas prices around the world will converge. The only difference between the price of gas in New Delhi and New Jersey will be the cost of transporting LNG between them. This is how the oil market works and with LNG’s help, natural gas will too.

This price convergence creates a huge opportunity and is the key theme we want you to understand.

US Natural gas trades for only $5/mmbtu while gas is going for $40 in Asia and almost $80 in Europe, where a bad gas shortage is ongoing.

There are big differences in the production cost, supply and demand of natural gas, depending on where in the world you are.

Natural Gas Price in Europe and the US

LNG has now created an opportunity for a US producer to pull $5 gas out of the ground, pay $8 to ship it to Europe and bank $65 in profit.

Obviously, global LNG prices aren’t going to stay at $80/mmbtu or even $40 long term, but they will definitely end up higher than $5, creating a huge opportunity for anyone selling US gas to the world.

LNG produced in North America has a multi-year window to outcompete LNG from anywhere else. This significant cost advantage means demand for US natural gas is set to grow strongly for years to come.

LNG investors have a massive profit opportunity staring them in the face.

Now before we talk about the ways to invest in LNG it’s important to look into the supply and demand outlook. You don’t want a flood of new LNG capacity to crater the price before the US can squeeze out every last dollar of profit.

Before we get into our deep dive of LNG supply and demand I have a…

Spoiler Alert GIFs - Get the best GIF on GIPHY

The LNG market is TIGHT…

In the fourth quarter, LNG exports going from the US to Europe increased, but only with export cuts to Asia and elsewhere. This tells us one thing, LNG supply is effectively sold out.

The current spike in prices confirms the market is sold out in the short term, but the medium term is what we really care about. Luckily things look very good for at least the next 5 years, maybe longer.

On a longer timeline, the LNG market needs 48mtpa of additional capacity by 2025, 70mtpa by 2030 and 210mtpa by 2040 just to meet demand. LNG supply must grow 20%, 55% and 90% over the next 3,8,18 years just to remain balanced.

And this was before Russia invaded Ukraine and changed the game! We will talk more about this later.

Drilling down into the next few years shows us the market will remain very tight at least into 2025 and likely through the end of the decade.

The market needs to add 48mtpa of capacity to meet demand growth by 2025. The chart below shows planned capacity additions in 2021 are exactly that, 48mtpa.

Considering it takes at least 4 years from final investment decision to even partial startup, even if the industry makes plans to build way more than 48mtpa of capacity, the LNG market is going to remain super-tight through 2025/2026.

Announced FIDs (Final Investment Decisions) by Year and Capacity

However, a flood of new capacity is not coming and as it stands in 2022, LNG supply is going to struggle to meet demand through this decade.

LNG Demand (Bars) vs Supply (Line)

Ukraine Changed the Game for LNG

I spent all this time going through the supply and demand for LNG to drive home the point that the market was already very very tight before Russia decided to invade Ukraine.

Post invasion, LNG demand is likely now on a whole other level.

On March 3rd, Europe announced plans to cut Russian gas imports by 2/3rds THIS YEAR and completely cut off Russia by the end of the decade. Russia is the largest gas supplier to Europe sending 15 bcf/d.

Let’s put 15bcf/d in perspective…

15bcf/d is equal to 112mtpa of LNG annually. The global size of the LNG market today is only 374mtpa. So if Europe were to replace Russian gas with LNG, total world demand just grew by 30%!

A market that was already sold out just got even more sold out.

Granted we don’t believe Europe will use LNG to plug the entire Russia hole, but of the three supply options (local drilling, LNG imports or Nuclear) LNG is by far the most realistic.

Why Not Nuclear?

Nuclear is far more energy-efficient than LNG but the political realities of nuclear and construction timeline of 10 years or longer make it infeasible as an energy source in the medium term.

Why Not Drill Local Gas Wells?

Going back to drilling in Europe’s backyard doesn’t really jive with the whole ESG movement. Europe has been at the forefront of replacing fossil fuel sources with renewables and going back to drilling oil and gas wells won’t play well with the population. Not to mention the upfront capital for rigs and equipment plus time for permitting and hiring.

LNG is the best option.

With LNG, countries can now rent an FSRU, a floating LNG regasification ship and skip the upfront capital and time to build an on-land regasification terminal.

Excelerate Energy, a leader in the FSRU space said they have been getting lots of calls from interested European partners ever since the Ukraine invasion began. This confirms our view that LNG is Europe’s first supply option to replace Russian gas.

How an FSRU Works

Not to mention gas emissions from power generation are less than half of coal and 25% less than burning oil. LNG fits the European ESG narrative while being the quickest and least capital-intensive way to replace Russian gas.

With Europe’s help, the LNG market will grow even faster than current estimates over time.

How to Make Money?

I think the two best way to invest in the LNG theme is through

  1. Vertically integrated LNG Shippers
  2. Low-cost suppliers of gas for an LNG facility

LNG Shippers

Our preferred way to invest through theme #1 is with a company like Royal Dutch Shell (Ticker: Shel). One of every five LNG shipments in the world today is with a Shell-owned vessel.

More importantly, Shell produces its own gas and owns a trading company. Making money in the shipping game is hard and without the ability to exploit local pricing differences and supply ships with your own gas, Shell could struggle to make money even if demand for LNG shipping explodes.

Flexibility Sourcing and Sales of LNG (More Color Shades the Better)

Shell has an insider’s view into the LNG market and is a strong, diversified way to take advantage of undersupplied LNG markets and high LNG prices.

Shell’s Global LNG Footprint

Low-Cost Gas Suppliers

Owning the gas producer who can supply an LNG terminal cheaper than everyone else means they can undercut everyone else’s prices and win the sale every time.

US LNG is the cheapest LNG in the world. Even if globally, supply exceeds demand, US LNG will continue to grow exports and take market share while global LNG prices remain higher than those in the US.

We believe strongly that the US gas producers will be the largest beneficiaries of LNG growth. More LNG exports = more gas demand = higher gas prices.

Our three criteria when picking gas names are:

  1. Low cost of gas supply
  2. Access to pipelines going to the Gulf Coast where LNG is exported from.
  3. Has debt, but not so much that one bad year could kill the company

Using these three rules, our preferred gas names are Range Resources (RRC), EQT Corp (EQT), Southwestern Energy (SWN), Silverbow Resources (SBOW) and Comstock Resources (CRK). They check all the boxes.

You may be wondering why we didn’t recommend any companies liquifying the gas into LNG?

There are three reasons.

  1. Most LNG providers contract out 90% or more of their capacity for 10+ years, giving them little room to increase prices unless they build new capacity. Gas producers make more money immediately if gas prices go up.
  2. It takes a long time, 4 years, to build an LNG facility. A gas well takes 2-3 months to drill and complete. LNG companies need way more money than a gas producer to grow. We want cashflow now.
  3. Valuation: Cheniere, the largest LNG exporter in the US is 2x-3x more expensive than gas producers due to the lower risk cashflows. Given our expectation of higher gas prices, we want high, not low-risk cashflows!

Phew That Was A Lot to Take In!

I may have dumped a lot on your plate, but at least you now can say you know more about LNG than 95% of the population. And considering we think gas is potentially the biggest energy trade of this decade, I think it will end up being worth the read.

The best way to make sure you don’t miss a time-sensitive episode of the oil drum report is to sign up for my substack HERE

And a last request from me. If you know anyone who should be reading this primer feel free to share this post. The only thing I like more than making money is helping others do it too. Please make my dreams come true!

About Author

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.