SumZero/Interactive Brokers Award Winner [email protected]Goin’ Golar: A Thematic Analysis of LNG, Geopolitical Economics, and The Future of Energy Introduction In order to understand where we’re going, we need to look at where we’ve been. The liquefied natural gas business is not too unlike that of the crude oil business – both were shaped by greed, competition, and most notably, war. Over the last week, I have spoken with academics, policy makers, and oilmen - all of which in differing parts of the world - despite their differing views of the future, no one disagreed with the fact that world will soon witness a revolution; over the next four years, we will see the largest increase ever in LNG export capacity. The Revolution What if I told you that I could balance the federal budget, end the trade deficit, bring manufacturing jobs back to the states, satisfy environmentalist, and make a 30 percent annualized return during the process? No, I’m not running for president – I’m talking about natural gas. Despite Wall Street’s addiction to instant gratification – rewarding those companies whom sacrifice long-term survival to meet imaginary guesstimates – (some) energy companies think like countries, in decades and centuries, not milliseconds and quarters. The companies will soon experience an industrial cleansing – the countries, an unconventional war on energy; to the victor comes the spoils. This paper will navigate through Golar’s business model, take a top-down view on the LNG sector, and most importantly, explain why this company is poised to benefit from the inevitable revolution. A few quick facts about Golar LNG (“GLNG”): § Through his holding company World Shipholding in 2000, Fredriksen took-over the company Osprey and transferred their LNG business to Golar LNG – Golar was subsequently listed on the Oslo stock exchange in 2001 and the NASDAQ in 2002 under the ticker symbol GLNG. § Golar LNG owns 19M shares of Golar LNG Partners – a Master Limited Partnership – along with a 2 percent interest in the General Partnership as well as 100% of GMLP’s Incentive Distribution Rights (“IDR”). § Golar LNG operates in three core areas: LNG Transportation (“LNG”), Floating Storage & Regasification Units (“FSRU”), and Floating Liquefaction (“FLNG”) Downloaded from www.hvst.com by IP address 192.168.224.11 on 04/14/2022
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Goin’ Golar: A Thematic Analysis of LNG, Geopolitical ...
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Inorder tounderstandwherewe’regoing,weneed to lookatwherewe’vebeen.The liquefiednaturalgasbusinessisnottoounlikethatofthecrudeoilbusiness–bothwereshapedbygreed,competition, andmost notably, war. Over the last week, I have spoken with academics, policymakers,andoilmen-allofwhichindifferingpartsoftheworld-despitetheirdifferingviewsofthefuture,noonedisagreedwiththefactthatworldwillsoonwitnessarevolution;overthenextfouryears,wewillseethelargestincreaseeverinLNGexportcapacity.
TheRevolution
What if I told you that I could balance the federal budget, end the trade deficit, bringmanufacturingjobsbacktothestates,satisfyenvironmentalist,andmakea30percentannualizedreturn during the process? No, I’m not running for president – I’m talking about natural gas.Despite Wall Street’s addiction to instant gratification – rewarding those companies whomsacrificelong-termsurvivaltomeetimaginaryguesstimates–(some)energycompaniesthinklikecountries,indecadesandcenturies,notmillisecondsandquarters.
The companieswill soon experience an industrial cleansing – the countries, an unconventionalwaronenergy; tothevictorcomesthespoils.ThispaperwillnavigatethroughGolar’sbusinessmodel,takeatop-downviewontheLNGsector,andmostimportantly,explainwhythiscompanyispoisedtobenefitfromtheinevitablerevolution.
This paper will navigate through several core factors that we believe will lead to 100 percentreturn over the next 12 to 18months. For themost part, the equity is highly correlated withnaturalgas futures– inaddition, twoof thethreebusinessescanbevaluedaccordinglywithoutmuchspeculation.Thecatalystontheotherhand, ishighlyspeculative–however, thisbusinesshas,andalwayswillbe,speculative.
§ FloatingLiquefactionNaturalGas (“FLNG”)vesselspresenta revolutionaryopportunity inthe energy sector. These water-based vessels bring both environmental and economicadvantages that can be used to extract gas from energy rich areas that were previouslyoverlookedduetopoliticalandfinancialreasons(e.g.,WestAfrica).
§ LowPremium:Perour calculations, theNAV for theLNGandFSRUbusinesses is$2.42B~$24.47pershare(thisgivesapremiumof~$13 for the futureFLNGbusiness).Between thefuturecash flows, thedropdownto theMLP,and the futuredistributionsvia theMLP,eachFLNGprojectcouldcontributeupto$25pershare.
§ Asymmetric Risk: If we use conservative probability estimates on the future projects anddiscountbackthedividends,theequitywouldyield$32~13%downsiderisk.
§ Infrastructure: several infrastructure projects will come to market within our investmenttimeframe,whichwillincreasethedemandforshippingvessels,andthus,addtop-linegrowthoftheremainingbusinesses.
Between 2014 and 2030, the US Energy Information Administration (“EIA”) hasprojected that global energy consumption will increase by 44 percent. By 2035,promoted by demand in the growing Asian market, natural gas will move intosecondplaceintheglobalenergymix,behindoilandsupersedingcoal.i
Lackoftransmissionnetworksandthefactthatfouroutofeveryfiveinfrastructuremegaprojects fail in theirobjectivesdue to longdevelopment times,highcostandsubstantial budget overruns, floating liquefied natural gas units are increasinglybecomeseenasthesolutiontothefutureofnaturalgassupply.
Despitebeingheavilydebatedoverthepastmillennia–sizedoesnotmatter–it’sthemotionoftheocean;thismotionhasaconsiderableamountofinfluencewhendealingwithaboatholding175Olympic-sizepoolsworthofmethane.Unlikethefirstcoupleofprojects(i.e.,Shell’s$13BPreludethat will travel to Western Australia for a 25-year contractii), the majority of FLNG’s will beconceivedtomonetizesmallmarginalgasfieldsandwill,therefore,havetobeofsizeandcosttocomplementtheeconomicprofileofboththecompanyandthefield.
Top3reasonswhythisisimportant:
1. FLNGvessels are theoptimal choice inextractingnatural gas in aneconomic fashionwheredemand ishighest:SoutheastAsia.SmallerversionsofFLNGprojectswillhave theability todevelop smaller marginal gas fields in this region (e.g., Malaysia) and market the energyregionally.
2. FLNG will be able to relocate and be a prime solution for those gas fields that lackinfrastructureaswellasforareasthatarenotwellpreparedsuchasPapuaNewGuinea–anareathatGolarwilldevelopwithOphirEnergy.iii
3. FLNGprojectswillbelocatedamongthecoastlineoftheworld’sfastestgrowingpopulations–this ismonumentalshift inbothenergyanddemographics;naturalgas in turnreflects thesepopulationsinasense:longhistory,exponentialgrowthinrecentdecades,andakeypartofourworld’sfuture.
NaturalGasThesisAsecularbearmarkethascurtailedgrowthinthesupplyofnaturalgasanddemandhasincreasedduetoelectricitygenerationandindustrialdemand.Asabyproductofoildrilling,thesupplyofnatural gas will fall further as many oil companies discontinue operations when oil priceseventually push high-cost producers out of the market. Unlike oil, natural gas prices will risethroughoutthedecade–changingtheentirelandscapeoftheworldenergymarket.
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Withgreatcomplexityoftencomesgreatopportunity– if thisclaimis true,Golarshouldbeonehelluvaanopportunity.Mynaturalpredilectiontoshort-sellinghasmadethisthesisaninterestingcase–Ihavespentcountlesshoursfindingthesourceofthesetransactionsasthecorporateshellgameamongstpartnershipstypicallyraisemorequestionsthancapital.Myconclusion–althoughnaturallybiased–wasasurprise:theshellgameisonenotofdeceit,butofsurvival.Duringtheseuncertain times, opportunities are abundant – value however, is few and far between – Golar,withoutquestion,isoneofthegreatestvalueopportunitiesinthemarkettoday.
A Master Limited Partnership is a common legal structure found in the energysectorthatconsistofa limitedpartnersandageneralpartnership;MLPspaytheirinvestors throughquarterly requireddividends; typically, thehigher thequarterlydistribution paid to limited partners, the higher themanagement fee paid to thegeneralpartner.
A GP in anMLP beginswith a small stake in the partnership (~2%) but is givenincentive distributions (“IDRs”) from net income after the quarterly distribution(NOTE:Sincethesedistributionsarenormallypaidintheformofincreasedequityclaims,theGPmayattainanincreasedshareoftheMLPownership.)
GLNGownsapproximately19,000,000shares(~29.8%)ofGMLP,twopercentoftheGP,andalloftheincentivedistributionrights–theserightsentitlethecompanyto25%ofGMLP’sdistributions- will go to 50% after the drawdown of the FRSU Tundra (The Tundra is currently underconstruction and will be delivered in December 2015 – dropdown should be Q4 of 2016).Typically,thecompanytransactswithGMLPasfollows:
Before navigating through the financials, it is important to familiarize yourselfwith the vesselswithin thepartnership.As for theMLP, thedarkblue indicatesa long-termcontract; theblue isindicative of extension options; robin’s eggs blue indicates spot contract. Going forward, asweanalyze thesevesselsandtheirpotentialcash flow,eachship isassociatedwithan independentcredit facility – all with differing contract structures, debt organization, andmost importantly,futurecashflows.
Ship Built Charterer 2015 2016 2017 2018 2019 2020 2021 2022 Golar MLP Methane Prin. 2003 BG Group
Golarhasoneoftheyoungestfleetsinthemarket–thisqualitycontributestotheeconomicsasnewershipstypicallyhavelowerfuelexpenses.Forthefirstpartofouranalysis,wewillplaceavaluationon the existingbusiness– aplatformwewill use to analyze thedownside riskof thetradeaswellastheasymmetricopportunitythatwebelievehaspresenteditselfinGolarLNG.
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The valuation of this company less the FLNG opportunity can be readily quantified as sell-sideanalyst readily cover this industry and the majority of business is completed via long-termcontracts. Although we could go through the complicated structures and forecast potentialspreadsandspotprices,weareneithercommoditytradersnorshippingexecutives;therefore,ourassumptionsarebasedonthosewhoare.
TheTri-FuelDieselCarrier(“TFDE”)valuationwasbasedonindustrycompsanddatacompiledbythe sell-side, we see little fluctuations as these prices are well known and can be quantifiedwithoutmucharithmeticasvesselsupplyandcapacityprojectsarewellknown.
Golar LNG Valuation: LNG + FRSU + GMLP
Vessels Value Total TFDE (2013/2014) 10x $200M $2,000M LNG (Arctic) 1x $115 $115M FSRU (Tundra & Newbuild) 2x $270M $540M Less: Rate Guarantee $50M Fleet Value ~$2,605
Shares GMLP Price
Shares 18.9Mx $20.36 $384.80 Cash Flow Multiple
GP/IDR $17.70 20x $354 GMLP Value $698.5M
Cash $375 Loan GMLP ($120M Paid) $100
Remaining CAPEX: Newbuild ($257) FLNG Payment (Hili & Gimi) $470 Total Debt ($1,666) NAV $2,325.00
The consensus valuation for this business amongst analyst comes in around ~$27.5 per share($25-$30),wefeelthatitisonthelower-endofthatspectrum.Currently,thedividendyieldstands~5 percent~$0.45 per sharewith a $37 average share price. Despitemy distaste of stress-testscenarios, it appears that the dividend should theoretically stay intact under a multitude ofdisastrouscircumstances(didnottestasinkingship).Giventhemoataroundthisbusinessalongwith themost respectedmanagement team in the industry, thedividend is safe.Downside riskcomesinat~25%withabackdropofasteady5%yield.
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ThetotalcostoftheHiliconversionisexpectedtobearound$1.2B~$475/ton($846MinCAPEX+$304 CAPEX on Jetty and contingencies). As with similar LNG projects, free cash flow can bederived from modeling the tolling fee with liquefaction metrics; tolling fees are flexible andcorrelates with Brent Crude prices – ranging from a floor of $60/bbl to a ceiling of $102/bbl(we’regoingtogoaheadandassumethelatterwillnotbetakingplace).
Each shipwillmost likely be financed by the following: drawdown of 70% from credit facility($800M)andissueequityfortheremaining30%($370M);interestcostwillbe$44.3Mperyear,andwe’llassumeafeeof$25M.Usingthesemetrics,whichwewillillustratelater,willequatetoaround$122Minleveredcashflowforthefirstoperatingyear(FCFyield~33%).
Asmentionedearlier,itisanticipatedthatthegasreserveswillbeproducedatarateof1.2milliontonnesofLNGperannum(“mtpa”).Forsimplification– if that’sevena thingat thispoint– thetolling contract usesMMBtu (“trillion btu”); to convert trillion btu tomtpa,wemultiple 1.2 by50.2,givingus60.24trillionbtuperyear.Lastly,wemultiplyourexpected$3.30tollingrateby60.24M,givingus$198.8Minrevenues.vi
TheEquatorialGuineaprojectisfivetimeslargerthantheoneinCameroon–2500Billioncubicfeet vs. 500Billion cubic feet, respectively.With such a larger field, the company anticipates toproduce2.2mtpaperyear.Ata$3.30tollingfee,thisprojectwouldbringin~$365Minrevenues–or about$280 in levered free cash flow (this assumes$40MOPEX/Maintenanceand$44M ininterestwithsimilardebtcost).
WestAfrica-Gimi
InMarch2015thecompanyannouncedtheirintentiontoenterintonegotiationswithKeppelfortheconversionoftheirthirdFLNGvessel–theyshouldannounceapartnerwithinthenextseveralweeks/months. According to management, despite in discussions with Russia’s Rosneft andCanada,theupcomingprojectwillmostlikelynotbeintheirtimetableandwillmostlikelybeinWestAfrica;however,itisunlikelythatitwillbeintheCameroon/Guineaarea.ThisFLNGprojectisonscheduletobedeliveredin2018.
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According Wells Fargo Analyst, Michael Webber – “Depending on the specifications and riskinvolved, we could see a similar tolling level to Golar LNG’s other projects of $4.00/MMBtu –althoughitremainstobeseen–withthosetollsequatingtoanunleveragedinternalrateofreturnof 15-20%”. For this specific project, the LNG capacity is expected to be 4.7mtpa – this is thereasonforthetwoseparate,four-trainprojects.
Rosneft holds a tremendous amount of reserves –most ofwhich is in Russia; namely, Russia’sNorthPacificRegion,thiscouldbedevelopedasa ‘FarEasterLNG’projectwith~5mtpa(thisishighlyspeculative,bothworthnoting).Inadditiontothesereserves,RosneftalsoownssignificantresourcesinVenezuela–includingvolumesfromflaring.AccordingtoanErikStavseth,ananalystatArcticSecurities, “The fact thatpartof the fieldsare flaringgas todayunderpinsGolarLNG’sstrategytohelpdevelop‘zerovalue’gas”.
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Althoughyearsdowntheline,Canada’sLNGindustrycould–andmostlikelywillbe–oneofthemajorplayersintheunconventionalenergyrevolution.Golarrecognizesthis–thecompanyisindiscussionswithCedarLNG–anexportdevelopmentcompanyownedbyCanada’sHaislaNation.The Haisla people have occupied the Haisla territory, located on four million acres of BritishColumbia’swestcoast,forover9,000years–soyeah,they’rereadytomonetizeit.
In September, the Haisla-owned company applied for an export license to the National EnergyBoard for threeproposed liquefactionprojects– themarketing focuswillbeonAsia,obviously.This istheperfectopportunityforGolarfromamultitudeofperspectives–thiscouldalsobeinthesamevicinityofafutureRosneftdevelopmentinoffshoreRussia.
Theexportlicenseapplicationeachrelatetoaproposalforvolumesofupto2.9mtpa,witha15%annual tolerance, over a period of 25 years. The point of export would be at the outlet of theloading arm of the liquefaction terminals, which would be located in the Northern DouglasChannel,nearKitimat.Themetricsaresimilar topastdeals,analysthaveattachedabouta40%probabilitythatthisprojectwillcometofruition–whichisprettydamngood.
Left: Currently, there are a totalof 26 applications for an exportlicense. Despite the relativelylarger number, the resourcepotentialinthisareaisequallyasmassive. Cedar’s threeapplications amount to a totalexport capacity of 2Bcf/d. Weexpect a decision on theseprojects in early 2016 – theycouldpossiblycomeonlineattheendofthedecade2020/2021.
Right: As illustrated by the graphic totheright,themarketingforthisgaswillfocusonSoutheastAsia. Youknow thepossibilities here – we’ll save you themind numbing financials. The point isthat confidence and inquiry is buildingin this technology – and mostimportantly, this company isbecomingless correlated with the price of LNG.Welikethat,especiallyasthearbitragebetweenmarkets tightenanddomesticpricesriseoverthenextdecade.
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Pertheillustrationbelow,approximatelyonequarterofcompany’sequityisownedbytwolargeinstitutions:CapitalGroupandFMR.Furthermore,asdiscussedpreviously,thecompanyholdsasignificant position in the partnership,which is followed by a short list of institutionalmoney;namely,GoldmanandOppenheimer.Despiteourtrustinmanagement/BOD,webelievethattherearetwosignificantcharacteristicsthatshouldbetakenawayfromtheshareholderillustration:1)both companies are owned by large institutions; and 2) with a 13 percent yield from thepartnership,we should be able to protect our downside risk aswell as be paid towait for thefuturecatalystwithinourtimeframe.
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42%
GolarLNG
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TorOlav
SteinbergAsset
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KayneAnderson
Oppenheimer
Salient
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Heuber
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GolarLNGLtd.(Nasdaq:GLNG)
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Ourvaluationtechnique isasmethodicalas it isspeculative;ourmostvulnerableassumption isthe belief that current projects will continue on schedule – a broad assumption. For eachprospectiveproject,wewilldiscountthefuturecashflowsasprojectedbyourownassumptionsand then combine these metrics with the partnership – we will use past transactions as abarometertogaugebothmultiplesanddistributions.
OurfirstmodelforecastthefuturecashflowsfromHili–theprojectsareforwhat iscontractedonly,wearenotspeculatingonthepotentialrevenuesfromadjacentfieldsortheutilizationoftheremaining two trains. The 8-year contract is worth about $7 per share, andwill eventually bedropped down to GMLP at 7.5x EBITDA~ $1.2B. This amount is equal to the present value offuturecashflowsovera25-yearlifespan–lessthepresentvalueoftheconstructioncostspreadoverthethreeyearsofconstruction($1.2B).
Although the sum is $686.3M for the three-year contract, remember that Keppel owns a 10percentstakeinthevessel–thus,thediscountedcashflowswouldactuallycomeoutto$617.67.Inthetablebelow,youwillhowwecalculatedthesefigures:
Hili Project 2018 2019 2020 2021 2022 2023 2024 2025
In thenext table,wewill use a similarmodel to value theGimiProject. UnlikeHili, thisprojectcomesundera20-yearcontract.Iwasunabletocalculateareasonablescrapvalueforthisspecificvessel,sotakethatforwhatyouwill.Asinthepreviousproject,weusedataxrateof4%alongwithadiscountrateof10.95%.Ofcourse,asinbothmodels,theinvestments(drydock)feesareupdebate–welookedatcomparableprojectsandaskedseveralanalysts,it’sareasonableamountthatshouldnotveryimmensely.
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Less the debt and add the cash, the value of the equity comes out to around $65 per share ~doublethecurrentshareprice.Ofcourse,thefuturecashflowsfromtheLNGcarriersarehighlyspeculative,webelieve that spotpricesarebottomingoutandshouldnotgobelow thealreadydepressedrates–despitethis,wedonotagreewiththeconsensusthataveragespotrateswillbe$70K-$80Koverthelifeofthevessel.
As for theFSRUvessels, thecash flowsaremorequantifiable–mostof thesevesselsareunderlong-termcontractswithintegratedoilandgascompanies.Furthermore,thisprojectiondoesnotincludeanyspeculationonfutureFLNGprojects;namely,theconversionofGandria–aprojectwethinkwillbeannouncedwithintheyearandgointoproductionin2018.
With these assumptions andmetrics in place,we agreewith analyst estimates that each FLNGvessel could add approximately $25 per share to GLNG: $17 from distribution rights afterdropdown,$5viapremiumfromGMLPsell,and$1-$3inMLPshareappreciation.
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TheDistributionAsdiscussedearlier,thedropdownofafuturevesselwillbenear-termcatalystfortheequity,asthe increased dividends will double the marginal percentage distribution from 25% to 50%.Additionally,thedropdownmethodhaspreviouslyattractedscrutinyasthemajorityshareholderscould play a shell game to manipulate the accounting; and thus, increase the distributionartificially.Ageneralcontentiontowardsthisargumentwas,“Ifthisisfraudulent,thenalllimitedpartnershipsarefraudulent.”Thisisanexampleofafallaciouslogicandincompetence.The reason why this is not fraudulent is because GLNG relinquished legal control of thepartnershiptoboardofGMLP;andno, it’snot thesamepeople.This isgreatdeal,withanevengreaterfuture.
Golar LNG Partners (GMLP): Distribution Targets - Marginal Distributions to GLNG
Marginal Percentage Interest in Distributions
Distribution Target Unit holders General Partner IDR Holders Minimum Target $0.3850 98% 2% 0%
TheDropdownDespitesoundinglikeDwayne“TheRock”Johnson’snexttheatricalbombshell–thedropdownislessadventurousandslightlymorecomplicated.Thedropdown–or,ThePeoplesElbow,tocarrythe analogy further – is based several broad, yet extremely conservative, assumptions andmodeledsimilarlytoindustry-wideanalyst.Anoteworthyquantitativefactorisourmodelisthefinancialsarebasedonanoil-saturatedenvironment;no,we’renotallocatingashipwreck,we’resayingassumingthattheBrentCrudemarketwillstayinwithinthispricingrangethroughouttheendofthedecade.Whichletsfaceit,thisisextremelyspeculative–conservative,bustspeculativenonetheless.Anecdotally,justashortfourteen-monthsago,analystwerecallingfor$200oil–now,ayearlater,the same analyst are calling for 1/10th of that – like I said, speculative.viii The chart belowillustratesWTIPrices aswell as the standarddeviation (Yes, I know– the contract isbasedonBrent,wehaveaforecastonWTIaswellasthecrackspread).
TheCarrierBusiness:Panamax’sParadoxOn April 24, 2006, Then-Panamanian President Martin Torrijos proposed the Panama CanalExpansion project (AKA Third Set of Locks Project) – he would later say this project wouldtransformPanamaintoaFirstWorldcountry,turnsout,hewasprobablyright.Thisprojectwillallowmuchlargervesselstoflowthroughthecanal;thissizeisrefereedtothePanamax.So, what in the hell does this have to do Golar? Everything. Let’s think about the logic here,SoutheastAsia/Japanhasfouroptions:Qatar,Australia,Canada,andtheUnitedStates.Priortothecanalexpansion, a round-tripvoyage fromSabinePass,Louisiana (ChenierEnergy) toFukuoka,Japancostsabout$11.4M(~63.6Days)togothroughtheAtlanticandtransitaroundAfrica.Post-Expansion,thatsametripwillcost$8M(~43.4Days)–a30%pricereduction.Logically, this should reduce revenues for the shippers, right?Not exactly, the $11.4M tripwasneveranoption– if thiswasthecase,Asiawould look forcheaperalternatives(theotherthreelocations) and Sabine Pass would market gas to Europe – which would obviously mean lessrevenuefortheshippers.However,sinceHenryHubpricesaresocheap,AsiawouldopenuptradewiththeGulfCoast–thus,theshipperswillmakemore,astheiralternativewouldbeshippinggasfromAustralia/Qatar/CanadatoAsia.Trustme–it’slegit.Let’scheckoutthechartbelow–thisillustrationrepresentstheglobalmarketforLNG.Asyoucansee, spreads are ludicrous; in 2011, LNG in Asiawas 8x higher than that at HenryHub. In thefuture, as gas trades between countries easier – the spreads will compress; the market willbecomemoreefficient,andGolarwillbeextremelyprofitable.
“There are twopoints to bemadenow. First, the scale of AmericanLNG exportswill be naturallylimitedbythecompetitionfromotherexistingsuppliersaroundtheworld,aswellasbynewsuppliescomingrecentlargegasdiscoveriesoffshoreofEastAfricaandIsrael.Second,isalargercontext.TheU.S. is successfullypushing Japan to reduce itsoil imports from Iran,oneof the largest traditionalsuppliers.Atthesametime,Japan..isbuyingexpensiveLNGfrombothspotmarketsandtraditionalsupplier in theMiddleEast andAsia to replacenuclear power for generating electricity.How canAmerica,havingaskedJapantoreduceIranianoil imports, turnaroundandprohibit theexportofsurplusnaturalgastothiskeyally?”ix–DanielYergin
AlookthroughthespecsofGolar’sexisting11LNGcarriersshowsthatwhilenoneofthemcouldfit through the canal today, all of themmeet the new Panamax standard. The Panama projectsuppose to be completed by January 2016 – the same time that the Sabine Pass liquefactionprojectwillbecomeon-line.
As capacity comes on-line, spot rates should emerge fromdecade-low spot rates and return toprofitability.Additionally,theimprovedpricingenvironmentwillbeasurprisetomanyandwillthus create an opportunity for thosewho can navigate through Panama’s Paradox. In the nextchart,wewilltakeadeeperlookintothesupply&demandmetricoftheLNGcarriermarket;withthisdata,wefullyexpectspot-ratesthroughoutinvestmenthorizon–anadditionalcatalystandsafetynettoouroverallthesis.
Accordingtothecurrentorderbook,61vesselsweredeliveredbetween2014-15and–naturally–supplyovertookdemandandutilizationfell.Asthechartillustrates,LNGfleetsareexpectedtorebalancethrough2016andtightenin2017asnewexportsupplycomesonline.Spotpricesandutilization rates are both around the thirty-three area ($33K/Day ~ 33% utilization), thecombination of increased capacity and vessel deficit should double the current rates to morefavorabletermsinthe6-18months.
The downward momentum seen in the future surplus curve is due primarily to the futurecapacity; namely, from Eastern Australia and the Gulf of Mexico. In fact, by 2017, Australia ispoisedtoovertakeQatar–theworld’slargestLNGproducer–atmorethan10billioncubicfeetcapacity.However,thisengineeringmarvelhasnotcomewithoutitstroubles–costoverrunsanddelayscontinuetoprolongtheconstructionphase.Thisinherenthurdleisubiquitousthroughoutthe industry – most industrialists are pessimistic about the majority of projects; however, themisfortuneofothersoftenbecomesthetreasureofothers.NorthAmericaisnottoounlikeAustralia– inregardstoLNGprojectsanyways.In2015,SabinePasswillfinallymakeitsdebutandhasbeenapprovedbytheDepartmentofEnergyforFTAandNon-FTAExportation(FreeTradeAgreement“FTA”)x.In2017,CameronLNGandCovePointwillfollow; both are in 20-year agreements with Japan. As Australia runs intomore problems andNorthAmericacomeson-line,shippingcompanieswillbenefitmaterially.Onthenextpage,we’lltakealookatthecurrentgeo-politicallandscapeaswedissecttheworldintocountrieswithFTA(green), thosewithproposedbilateral/multilateralagreements (orange),and thosewithoutanytypeoffutureagreement(grey).
being at the right place at the right time (it’s like getting a girl friend inhigh school, it’s allabouttimingthebreak-ups–orinthiscase,positioningthevessels).
§ Purchase of Natural Gas: the advent of US LNG exports paved the way for the use of USdomesticgaspricesasanalternativetotheJapaneseCrudeCocktail(“JCC”)–ablendofvariouscrudesimportedtoJapan.CheniereEnergysignedaHenryHubplus-dealonwhichpricingwas1.15xHH+anegotiatedconstant.
o The 0.15x premium to HH reflects the fuel spent for cooling the produced LNG,whiletheconstantisCheniere’spaymentfortheliquefactionwork.
§ Liquefaction Cost: this cost is also known as the tolling fee, which we estimate to be$3.5/mmBTU,plusthefuelcost(thisincludescapex,opex,andstoragecost).Industryinsidershavesaidliquefactionisanaturalcandidateforcostcutting.Duetothecurrentoilenvironment,Engineering Procurement & Construction (“EPC”) contractors will be hurt as they lackalternativeprojects;therefore,projectsshouldabletonegotiatemorefavorablecontractsandthusreducecapex–capitalcostisobviouslythelargestexpense.
§ FuelCost:thegascostisactuallyavitalcomponenttotheliquefactionprocess.Analystsbelievethat one potential way to cut this cost is from agreeing on a lower price for fuel gas thanexportedgas.FromwhatIhaveseen,theruleofthumbtocalculategascostistotake10%ofthegasvolumesliquefiedtoproduceLNG.Therefore,ifwehave$4/mmBTU,thegascostwouldbe$0.40/mmBTU.
§ TransportationCost: there is limitedpotential for cutting transportation cost.DNBMarketsestimates transportation cost from theGulf ofMexico toAsia (Korea) to be $2/mmBTU, thisassume the use of a modern Tri-Fuel Diesel-Electric (TFDE) vessel and transit through thePanamaCanal($1M).
§ Regasification Cost: as illustrated in the chart, the regasification process is a non-materialcomponent of the value chain. The typical regasification cost for LNG is $0.30-0.40/mmBTU,which includes storageofLNGat the receiving facility.About95%ofall regasifiedvolume iscurrentprocessedon-shore;theremaining5%isregasifiedatanFSRU.
Production Gas Liquefaction(andstorage) LNG Shipping
LNG
(storageand)RegasificationGasGasMarkets
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Ifyouarestillreadingthisresearchpaper,youaremostlikelywellawareofPine’sstrategy:top-downmacro,event-driven,andupuntilthisinvestment,voraciousshort-seller.ThisproclivityforpessimismleadsmetoasksimilarquestionswhenitcomestoGolar–biasisavirus,let’sleavethetongue twistersand takea lookat thebook.For this analysis, I asked severalprominent short-sellers(naturally,theychosetoremainanonymous)fortheiropinion–IneverdisclosedthefactthatIwaslookingatalongposition–youknow,torefrainfromthebias.Question: The distributions of Golar LNG Partners (GMLP) look a little Ponzi-ish, aren’t thedividendsarepaymentofcapitalinvestedratherthanareturnoninvestment?Answer:Thisisagreatquestion,andonethatIstruggledwithinitially.However,tostart,Ithinkmostpeoplethatlookatthiscompanystartwithafalsepremise:GMLPisnotaMLP–Iknow,itsoundssketchyright?Here’sthedifference,GMLPisincorporatedintheMarshallIslands–likeallof the subsidiaries (vessels) and shipping income is generally untaxed by local jurisdictions;therefore,theyarenotrequiredtopayout>90%ofincometounitholderstoqualifyfortax-freestatus.Weagree–thetickershouldprobablybechanged.Here’sthepointthough:thecompanyoperateslikeanMLP,butwithholdsasufficientamountofcashflowtosustainoperations–somethingthatseveralMLP-likecompaniesshould takenoticeof (Iwouldname-dropacompany,but I’m fromTexas–oddsareIknowatleastonepersonthatworksthere,notveryTexan-like).Question:Howdo theygetawaywith sellingvessels toGMLPat inflatedprices? It looksas if themajorshareholderisplayingashellgame–Imean,theminorityholdersaregettingscrewed.Isn’titodd that the ‘independent valuation’ used to sell the vessels are provided by the same firm thatunderwrotetheGMLPIPO?Answer:Let’sbehonest–sellingvesselsat>8xEBITDAisexpensive,andmostimportantly,ahellofa lotmorethanwhatGLNGpaidfortheconstruction.Here’sthethingthough,thereisahugelucrativecontractattachedtothesevessels–weshouldn’tvaluetheseassetsbytheirconstructioncost.Themajorityofthesevesselswillstillhavehalfoftheiruseful lifepost-contract, ifwetaketheNPVatareasonablediscountrateandaddthevalueofthevesselpost-contract,thevaluationisn’tcrazyatall.Question:Thequalityofearningsisterrible–plus,Golardoesn’texactlyhaveaperfecttrackrecordfornewprojects.Whywouldyouthinkthefuturewouldbeanydifferent?Answer:Thequalityofearningsisterrible–that’sreadilyapparent;paradoxically,thisprovesourpointinourbeliefinmanagement.DespiteashittyLNGshippingmarket–we’readultshere,let’scallitwhatitis–thecompanyhassteadilypaidgreatdividendsandhasdoneanincrediblejobofadaptingtotheenvironmentbyturningtrashintotreasure(e.g.,Hiliconversion).Ofcourse,theirrecorddoeshaveblemishes,buttheseweresmallasymmetricgambles–somedidn’tpayoff,butthese are severalmillion dollar bets – I hope they keep taking them. Furthermore, they’ve hadsomeincrediblesuccesstoo–one’sthattransformtheindustry(e.g.,FSRU).
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3. Golar’scounterpartiesarenot integratedoilcompanies–but in fact,smallerE&Pfirms(e.g.,OphirEnergy);duetoamultitudeoffactors,thecontractscouldnotbefinalized(i.e.,FID)
4. If one of these catalyst are true, GLNG has massive contracts with the shipbuilders – thecompanywouldbeout theirmassive investmentas thecontracthasplacedGolar’snuts inavice.
Fredriksen’sFarewell–WTF?
Argument: The founder of the company, John Fredriksen – one of the richest persons on theplanet–hassoldoffamajorportionofhisholdingsinGolarLNG;thissell-offbeganinthemiddleoflastyearastheoncedubbed“DynamicDuo”FridriskenandTorTroim,decidedtodivorcetheirbusinessrelationship.Albeitirrelevant,it’sworthnotingthatTroim’sdeparturefromSeatankersGroup – Fredriksen’s holding company, and more importantly, the nucleolus to this nebulousdivorce– landedhimaseverancethe included3MsharesofGLNGand2MsharesofSeadrill,orabout$267M.
So, as I am sure you’re wondering – why would the largest shareholder, and founder for thatmatter, liquidate his holdings just as his company is on the precipice of making a shit-ton ofmoney? Zero clue, what makes this odd is that Fredriksen is known for his iron-stomach andtakingspeculativerisk–thereisobviouslyinformationtherewesimplydonotknow.FromwhatIhaveread,thisdivorcebeganwithGolar–FredriksendisagreeswiththeFLNGmarket.
Ofcourse,wecannotspeculateonthemood-swingsofaNorwegianShippingMagnate–however,we canassume thatFredriksenwouldnot liquidatehisposition if hewas fully confident in thefutureofGolar;thisobviouslyleavesuswithmorequestionsthananswers.
Rebuttal: Let’s not get it twisted;we’re talking about a guy – JohnFredriksen –whomadehisfortunebytransportingoil in/outofbattle-strickenareasduringtheGulfWar(i.e., theIran-IraqWar), Ihardlybelievethathisdivestment isduetoriskynatureinFLNG.If thereisanyonethatshouldbeworriedaboutprojectdevelopment, itshouldbetheonshorefacilities–nottheFLNGvessels.Theventureobviouslyhasitsrisk,butthat’sinherentinanyopportunity,wehaveyettofindanyevidencethatthisisanythingmorethantwobusinessmenpartingways.
LNGOvercapacity
Argument: there’s no argument here – when these operations come on-line, there will be asupply-gut,notquestionabout it. In theUSalone,60MtonsperyearofLNGcapacity isalreadyunder construction; internationally, there is about 140M tons per year in the works (currentmarket is forabout250Mtonsperyear).However,despite themathematical axiom, companiesarestillmovingforwardwithplanstoputanother100Mtonsperintoconstructionthru2017–whatinthehellaretheythinking?PerWoodMackenzie,iftheseprojectsarerealized,thesupplygutcouldlastthrough2025.
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Theproblemisthattheproposedprojectsdidnotcomeeasily–mosthavebeenintheworksforyears,workingwithlocalcommunities,environmentalregulators,andthefederalgovernment,thecompanies will shelve these projects until they lack any other alternative. Furthermore, thissupply gut is forecasted without a slowdown in China – obviously, that scenario is definitelypossible.
Rebuttal: in a perfectworld, the above contention appears logical; however,we don’t live in aperfect world, and people – most of the time anyways – do not throw goodmoney after bad.DespitethebullishexpectationsonLNGcapacity,amultitudeoffactors(e.g.,HUGEcostoverruns,poorplanning,andskinnymargins)willmostlikelyshelvecountlessprojectsacrosstheworld.AsUS LNG exportation, the shale playerswill most likely be able to continue to supply relativelycheap gas to the rest of the world for the foreseeable future – most analyst undermine thispossibility because they fail to consider the rapid evolution of technology. If necessity is themotherofinvention,expectshaleplayerstofindwaystobecomemoreeconomical.
Moreover,theovercapacitywillleadtocost-cuttinginitiatives;namely,intheliquefactionprocess–aprocesswhereGoFLNGisamongthelowestcostproviders.Furthermore,fallingLNGpricesinAsiawill actually stimulatedemand– it’s just likeoil: thebest cure for lowoilprices is lowoilprices.ThelargestconsumersofLNGareamongthemostprice-sensitive;inparticular,ChinaandIndia–implyingthattheLNGmarketcouldactuallyexpandmorerapidlythanpreviouslythought.
Argument:OphirEnergy’sstockpriceisdown~65%overthelasttwelvemonths;theirmarket-cap is justover$600M– theFortunaFLNGprojectalone isestimatedat+$800M, there ismoreriskherethanpeoplethink.Thecompany’scapitalstructuremustbeextremelyflexible,beingabletoscalebackcapex immediately if thingsworsen– if theFIDdoesn’tcomethrough,Golarcouldfindthemselvescompletelyscrewed.
Rebuttal:Relative toExxon,yeah–OphirEnergy is a smallE&PPlayer;buthell, relativeSaudiAramco–ExxonMobileisasmallenergyplayer.Inthiscase,it’snotaboutthesize,it’sabouttheliquidity, it’s about the numbers – nothing more, nothing less. Although we’ll get back to thecapitalrequirements–thisisOphir’sCOO,BillHiggs,onGolar:
“…we’vemaderealprogressinde-riskingtheproject[EquatorialGuinea]throughthefirsthalfoftheyear.EGisessentiallya$60MoptiontoFIDtorealizeamultipleofthe$600Minvestedintheprojectto date.We continue in very live discussionswith numerous gas buyers that are attracted to theproject.AndIjustremindedeveryonethatourgoal,withthe2.2milliontonsperannumoff-take,isthat we’re trying to sell <1% of the global LNG demand. And we see the project has very, verycompetitivecoststack,whichmakesitcompetitivewithprettymuchanyprojectouttherethat’sinthemarkettoday.”xii
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Projecting Ophir’s success is beyond the scope of this thesis – however, the economics of thisproject will attract JV and Upstream partners. They will most likely have to sell down equityand/ordebt but the cost structure really is unlike anyproject on theplanet – the likelihoodofreceiving a FID in mid-2016 is ~90%. Even with the modifications needed for this project,liquefactionshouldbelike≤$3.75/mmBtu.
Rebuttal:asIanClarkepointedoutinhisKeppelresearchthesis,thecontractisactuallyinGolar’sfavor–nottheshipbuilder.Ifaneventwastooccur(e.g.,Keppelcannotcompletethedesign–theengineeringiskindofafeatinitsown),Golarcancancelandwillberefundedtheirdownpaymentandmilestonepayments,lessasetcancellationfeeofcourse.Furthermore,Keppelholdsanequityinterest in these projects – I would contend that it’s on top of the priority list; per the recentpresentation,theprojectisunderbudgetandaheadofschedule.
Despite being coined a revolution – this technological renaissance is actually an evolution, anaturalprogressiontogreaterefficiencies,forbotheconomicaswellasenvironmentalreasons.Ifhistoryisindicativeofourfuture,it’slikelythatthenaturalgaserawillevolvemuchlikethefossilfuel before it – oil was a byproduct of Kerosene, in the early days, drillers would drain oil innearbyriverastheydidnothaveauseoraninfrastructuretosellit.NaturalGasbeganmuchthesameway–infact,inlastyearalone,over$1BworthofnaturalgaswaswastedinNorthDakotaalone.Thepicturebelowillustratesjusthowmuchnaturalgasisbeingflared.
Aswithany investment, this trade isnotriskless– that’sapparent.ThetechnologythatGolar isbettingonisunlikeanythingseenbefore;bothanalystandengineershavecalledthemcrazyforconsidering this investment. However, to put things in perspective, investors thought GeorgeMitchellwasinsaneaswell–hewouldlatergoontopioneeranewwaytoeconomicallyextractshalegas,anindustrynowknownashydraulicfracturing.
It’s easy to call this analogy an over-generalization, but it’s truly not – the majority of peoplecannotconceivetheevolutionof technology.Peran industry insider,andagreat friendofmine,“We’reabout toexperience thenextgreat shift in technology– theenergysector isabout togofromthetransistortotheintegratedcircuit,thenextSiliconValleycouldverywellbetheBrazosValley– turningthe industryon it’shead, findingwaysnot todrillmoreholes,but to findwaysdrill less.” (Note:BrazosValley is inCentralTexas–hometoTexasA&MUniversity,andwithinshortdrivingdistanceoftheUniversityofTexasandRiceUniversity)