From Russia With Love

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Includes: GASL, GAZ, GAZC, GZPFY, OGZPY
by: Kevin Wilson

Summary

Russia's Gazprom is feeling some pressure from the imminent addition of U.S. LNG exports to an oversupplied global LNG market.

Russia could undertake an LNG price war for similar reasons to the OPEC price war, i.e., to preserve market share from competition by high cost producers.

There would be much direct and collateral damage from such a price war, including impacts on shale gas E & P companies, and service, shipping, and engineering firms.

Beneficiaries might include U.S. private equity firms, manufacturers and chemical companies.

A recent article in the Financial Times by Jack Farchy pointed out that LNG competition from America may be causing some problems for Russia's Gazprom. Prices for natural gas are already low enough, according to Farchy, that Gazprom could readily fight back by starting a gas price war similar to the one going on between OPEC and the North American shale oil producers. Asian LNG cargoes sold for an average of $20/MMBTU in early 2014, but have recently sold for only $4.95/MMBTU in Japan, according to Platts. In fact, Japan is now selling unwanted LNG volumes on the open market, something they haven't done before. Clearly there has been a tremendous increase in global LNG production associated with these price declines, and it would appear that more is to come. LNG production volumes are expected to rise from 250 MMT/A in 2015, to about 330 MMT/A by 2018. The Russian gas industry already sees this as a potential threat, and they might be willing to do something about it, either in the short run or in the long run.

This would have big implications for the health of the nascent LNG industry in the U.S., but also for North American natural gas producers, who are predominately shale players. Ironically, the first U.S. outbound LNG shipment will leave the Sabine Pass facility in Louisiana next month. Of course, this plant has long-term contracts to support it, so it will probably not be affected in the short term by a Russian price war. But what would happen if natural gas could only be exported from other new construction or planned LNG liquefaction facilities at a potential loss? The first thing that comes to mind is that most planned or underway construction projects for new LNG liquefaction facilities in the U.S. might be canceled or postponed. This would have an important, negative impact on engineering firms working on such major projects, like JEC, CBI, PWR, or KBR. Another impact might involve financial damage being done to the rest of the LNG industry outside the U.S., as ripple effects could potentially spill over into the Australian and African LNG markets. And certainly the LNG tanker fleet, which is already struggling with overcapacity, might face even more day rate declines. These might at some point have a negative impact on companies like GLOG, GLNG, or TGP.

Projections Used to Justify LNG Projects:

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It is also possible that North American shale gas producers would have some issues, because storage volumes might be expected to increase over time, and gas prices to decrease even further from their already abysmal lows around $2.00/MMBTU. Those gas producers who've survived in recent years on ever-increasing efficiency would eventually be forced by higher storage levels to cut back on their operations, due to increasingly negative cash flows over time. If Russia wanted to make this happen, and worse yet, make it last a while, they appear to have the spare capacity to do it. Right now Gazprom has about 3.531 TCF/A of spare capacity, equivalent to about 3% of global output. Although there have been some production problems at their huge Sakhalin 2 project, these are likely temporary and won't really effect long term spare capacity.

Rig counts for shale gas plays have already fallen even more than oil rig counts have, since 2009. This decline began before the oil rig count decline, mainly due to the steady oversupply from the shale fields in the last few years. Some producers have long-term contracts which help to provide a buffer against spot price declines. Such contracts do not tend to happen very often for crude oil production, although hedging works in somewhat the same way to offset spot price declines for a period of time. Anyway, if LNG export volumes don't increase as expected because of a potential price war, then the oil & gas service companies in the eastern U.S. shale gas plays might be further harmed, impacting the earnings of companies like BHI, SLB, and HAL. Drillers would also obviously feel some pain. The Marcellus, Utica, Haynesville, Barnett, and Fayetteville shale plays could all see potential long term declines in operations from already low levels. This would even at some point affect the tax revenues in shale gas states like Louisiana, New York, Pennsylvania, Ohio, Texas, and West Virginia.

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For those willing to play the long game, acquisitions of existing production, mineral rights, and leases, all for a potential song, might be possible in a couple more years. Private equity shops like BX or KKR might be expected to boldly go in and make long term plays by buying assets on the cheap. Surely some of the really big players will also benefit from this scenario, if it occurs, at the expense of the smaller, less well-funded players. There might even be ripple effects into the banking sector, as banks (e.g. CFR) that supported shale players with revolving credit lines take a hit for possible non-performing loans in the shale gas plays. As usual, and as I've mentioned elsewhere, the normal cycle of creative destruction caused by energy cycles would hit the natural gas industry even harder than it already has.

Finally, another group that might stand to benefit from this potential gas war would be U.S. manufacturers, whose cost of production will potential fall even more than it already has. This gas price war could only be good for otherwise challenged profit margins in the manufacturing sector, which is suffering from the high dollar right now. It might make sense, if the natural gas price war takes off, to go long some manufacturing companies likely to benefit from it, or to simply go long an ETF like XLI.

There might also be some knock-on effects in the chemicals industry, since the feedstock for some important manufactured chemicals is natural gas. Beneficiaries in the chemical industry might include DOW, EMN, or WLKP.

Disclosure: I am/we are long EMN, WLKP, BX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks or other securities mentioned or recommended.

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